A message to valued clients and readers, on behalf of
President and CEO, Bob Sewell, and the rest of the Bellwether Investment Management team.
This publication is intended to provide you with an update on recent economic and market events. It will also provide a more detailed summary of the actions that Bellwether has undertaken in an effort to protect our clients' wealth and position for eventual recovery, as we navigate these uncharted waters.
While the COVID-19 virus has been in the press since early this year, its rapid spread over the past month to all corners of the globe has caught governments, medical experts and financial markets largely by surprise. What began as a virus isolated to a previously little-known region of China has reached our doorstep and now presents a real and credible danger to older people and those who are immuno-compromised. As a result, governments and medical experts are now trying to catch-up and understand how to control the virus’ spread, its detection and ultimately prevention/cure.
For most of us, hearing the words "global pandemic", serves to trigger fears for our own health and that of our loved ones. The reality is that we deal with pandemics annually in the form of the influenza virus, and while COVID-19 has a far higher fatality rate than the flu, we have, as a society, adapted to cope with this annual outbreak. Ultimately, that is what will happen with COVID-19, with the creation of a vaccine for prevention, testing for rapid detection and hopefully, an anti-viral for a cure. In the meantime, we need to follow established protocols (hand washing and social distancing) to slow its spread and lessen the chances that our medical system becomes overwhelmed with sick patients. We have consulted with medical experts, including those in the field of pandemic disease, in order to stay abreast of their best estimates of the virus’ progression and potential impact on society, so that we can consider the implications to our investment strategy.
Unfortunately, it seems that sensationalizing the daily news flow can take precedence over informing the public of salient facts. This has contributed to the stories of hysteria that we have all heard or witnessed, such as toilet paper hoarding. It has also contributed to the alternating days of panic and exuberance that we have seen in the stock market.
In the 30 years that we have worked in this industry, we have never seen daily market gyrations of 10% or more. One should pause and ask: did the fundamentals of the companies in the TSX or S&P500 change by 10% over night? The answer is obviously no, albeit we do know that the closing of businesses, supply chain disruption and social distancing will most surely eliminate global economic growth for a period.
While we were positive on the global economy and financial markets entering 2020, the COVID-19 virus outbreak has altered our expectations for the current year. We view it as more of a delay than an end to the current business cycle. It is entirely possible that we will experience a “technical” recession (meaning two quarters of negative GDP growth) but we believe that we will experience a strong bounce back in the economy thereafter. This belief is based on four facts:
1. The US economy was operating at near peak levels prior to the outbreak. Employment is at historically high levels, resulting in strong consumer confidence. The US consumer drives roughly 70% of their economy. In Canada, even with far greater economic headwinds, employment has been surprisingly strong.
2. The global central bank easing that we saw in 2019 has increased considerably in recent weeks with rates now at or near zero in most developed countries, and quantitative easing is back in force with the recent action by the US FED. Most recently, the FED announced $500 billion of quantitative easing and cut the FED Funds rate to zero. The Bank of Canada and Bank of England also made significant cuts now approaching zero rates. All of this means that the economy is awash in cheap money intended to stimulate borrowing and spending.
3. Spending by governments, called fiscal stimulus is also increasing materially with announcements from both the US and Canada in recent days. Canada just announced 80 billion in spending and tax deferral. We believe there will need to be more coordinated fiscal stimulus before this situation is fully resolved and likely there will need to be comments suggesting, “we will do whatever it takes” from world leaders to turn the current sentiment positive.
4. The current turf battle between the Saudis and Russia has depressed oil prices and pushed Canadian oil and gas producers closer to the brink, but it does have a positive effect on consumers. The money consumers are saving at the gas pump will ultimately be spent elsewhere.
WHAT WE HAVE BEEN DOING AHEAD OF THE RECENT SELL-OFF
We have been reducing portfolio risk throughout late 2019 and early 2020. This is one of the benefits of working with a discretionary portfolio manager, we can make these changes on your behalf. We reduced risk by doing the following:
1. We trimmed equity holdings reducing our overall exposure to what we define as a “neutral” allocation within our investment policies (i.e. the defined asset mix ranges that we have discretion to move within).
2. In the PIMCO Monthly Income fund, the PIMCO team reduced credit risk which has been very beneficial as credit spreads have increased dramatically which would have significantly reduced the price of corporate bond investments, if retained.
3. After a very strong year of performance from our Alternative Income fund that generated close to a 10% return, we began reducing our allocation to preferred shares in January as prices had more fully recovered after the price weakness of the last few years.
4. We also added a new manager, Maritime Partners to the Alternative Income fund. This manager has a highly specialized niche strategy of financing tugboats and barges on the Mississippi river which has historically been largely recession proof. This brings our total managers in the fund to 13 executing 14 distinct strategies.
5. We increased your investments in US dollars which has generated a positive return year to date of 6.4% relative to the loonie.
Collectively, all the steps taken above have served to considerably reduce the exposure to the equity market and reduced the overall volatility of the equity holdings that remain. As an example, our Balanced Investment Policy currently has approximately 22-25% of its investments in alternative strategies and 50%+ of its total holdings outside of the stock market.
WHAT WE THINK NOW AND WHAT WE ARE DOING
Since this pandemic is quickly evolving and there have been few events to compare to, it remains difficult to fully anticipate how the global economy and markets will play out over the coming weeks. Global GDP impact will largely depend on the length of the outbreak and number of people infected as well as the death rate of those infected. We continue to believe that this current sentiment driven sell-off is relatively short term.
If we consider the points outlined in our economic outlook presented earlier and the experience of the Chinese stock market during the height of its COVID-19 outbreak, it is our expectation that we will experience a V-shaped recovery when investor sentiment turns more positive. In addition, the depth of this sell-off has created some tremendous value opportunities in the market which will quickly get realized. This is in part why we believe that it is extremely difficult to “time the market” and get out and back in at the right time. The following points highlight what we are doing currently and plan to do as we reach an inflection point:
1. Recently, we have reviewed all investments in our funds and strategies to evaluate what companies are likely to be least effected by the outbreak and those that are likely to recover the fastest.
2. We are continuing to maintain a high allocation to US dollars across our portfolios as we believe the US dollar will remain strong. Our US dollar exposure has remained unhedged and this will continue to be a positive contributor to relative performance.
3. As the Canadian dollar continues to weaken, we are making plans to hedge at least part of our US dollar exposure in our funds back to the Canadian dollar. This will serve to protect currency gains. We will only consider this hedge when we reach what we feel is an extreme low in the loonie.
4. With credit spreads now at extremes, it is our expectation that PIMCO will add to their corporate debt exposure as markets start to revert to the norm.
5. More recently with the weakness in preferred share prices, we began adding to our holdings as yields approached 9 and 10%! For example, the TD Bank Series K preferred currently has a 9.5% yield which is also tax efficient versus interest income. With 10-year US and Canadian government bonds yielding approximately 1%, we believe that the price volatility of preferred shares is a reasonable trade off versus return when compared to government bonds.
6. We have been in contact with all third-party managers that are managing funds for our clients. We are monitoring their strategy’s performance in the current environment and to date, we have seen nothing of concern regarding the functioning of their individual investment strategies.
7. For clients requiring funds in the near term, we have been selling fixed income investments whenever possible to avoid selling equities at these depressed prices. We will continue to do this while remaining within the limits of our investment policies and rebalance portfolios once we see equities start to rebound.
8. We have accumulated cash in our funds and strategies, what is often referred to as “dry powder”. At the time of writing, we aren’t ready to reinvest that cash, but we are watching closely for opportunities to put the cash back to work in anticipation of the market recovery that will come. We see plenty of great value opportunities in the market today, but we will be prudent in our deployment.
9. Finally, once all dry powder has been reinvested, we will rebalance all portfolios back to their target equity allocation based on the investment policy statement of each client.
Recently, we invoked our Business Continuity Plan that is part of our corporate policies. This plan is designed to be invoked whenever there is an emergency affecting our workplace. We have structured our business such that our team can work effectively from remote, safe locations. Our team is now operating under this plan to ensure their safety and that of their families. Let me assure you that we are still hard at work ensuring that your portfolio is being managed effectively and that we are well positioned to react to the ever-changing global landscape.
To that end, we are continuing to actively monitor the situation and are following the advice of Public Health, Health Canada and other medical experts that we have access to. We will keep you updated as the situation evolves and are committed to working with you to meet your needs.
Most importantly, we encourage our readers to be hyper-vigilant during this time of uncertainty and we wish a speedy recovery to all those that contract the virus.
We thank you for your continued trust in our services. We would encourage you to reach out to your advisor or portfolio manager, if you have any questions regarding the content of this publication or any other questions you may have. The Bellwether-Adaptive ETF team is committed to doing everything we can to support our clients, team members and communities.
Unfortunately, we cannot dictate market volatility, but we can manage through it and hopefully this commentary has demonstrated our commitment to that end. We do anticipate that markets will remain volatile in the near term as we expect the number of COVID-19 cases will rise dramatically in Canada and the US. Portfolio diversification is the best form of defense and hopefully we have illustrated just how diversified our portfolios are and how actively we are managing the current situation. Our team has managed through many recessions and market shocks and we are confident that we will weather this storm too.
Finally, at times like these, it's important to emphasize investment discipline and sticking to your investment plan is crucial. This too shall pass, and we will return to normal life, albeit perhaps a new normal that is better prepared for the next wave of this virus or some other in the future.
Bob Sewell, CFA, CPA, CFP
President and CEO