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Financial Update | April 2021

Listen to the brief audio version or read the full overview below.

A Volatile But Positive Quarter for Equity Markets

March turned out to be another volatile month for equity markets. The continued rise in U.S. bond yields continued to put pressure on equity markets, especially on higher valued growth stocks.

The sharp sell-off in U.S. Treasuries since the start of the year raised hopes that the Federal Reserve (Fed) would take a more active role in calming markets. They did not do that, disappointing financial markets. Instead, Jay Powell (Chairman of the Board of the Federal Reserve Bank) stressed that the Fed takes a broad view of financial conditions and that they remain highly accommodative, justifying the Fed’s current stance.

Moreover, he stressed that the economy is still far from meeting conditions that would warrant tighter monetary policy. He highlighted the fact that the unemployment rate is still high and that it will take time for the U.S. economy to recover properly.

The good news is that the economy is recovering as evidenced by economic data. Helped by the economic stimulus combined with the vaccination drive, the global economy should continue rebound over the course of the year, with momentum rotating from the US to the rest of the world.

The approval of the American Rescue Plan by congress also stoked fears that the additional $1.9 trillion of stimulus will lead to much higher inflation. U.S. households were sitting on around $1.7 trillion in excess savings as of the end of January. Households generated about two-thirds of those excess savings by cutting back on spending during the pandemic, with the remaining one-third stemming from stimulus payments.

It is estimated that the latest stimulus bill will boost household savings by an additional $300 billion, bringing the stock of excess savings to $2 trillion by April. As the lockdown measures ease, it is reasonable to assume that households will spend a portion of this cash cushion.

Unlike President Trump’s Tax Cuts and Jobs Act, Biden’s American Rescue Plan Act will raise the incomes of the poor much more than the rich. Since the poor tend to spend a greater share of each dollar of disposable income than the rich, aggregate demand could rise meaningfully.

Well, who’s afraid of a little inflation? Certainly not the Fed.

Consumer prices will rise “well in excess” of 2.5% before settling back, Robert Kaplan (President of Dallas branch of Federal Reserve Bank) said, adding that the Dallas branch forecasts GDP growth of around 6.5% this year. Charles Evans (President of Chicago branch of Federal Reserve Bank) also downplayed inflation of 2.5%, saying even 3% “would be welcome, actually” for some period. He reiterated that rising bond yields is a sign of economic optimism.

Chairman Powell also reiterated that the Fed views the upcoming inflationary spike as transitory and will not justify a change in Fed policy. Powell’s recent speeches highlighted that while Fed policy will remain accommodative for an extended period, the central bank will not attempt to micromanage fluctuations in long-dated bond yields.

Is the Federal Reserve’s Relaxed View Towards Inflation Risk
Justified?

The Fed knows full well that headline inflation could temporarily reach 4% over the next two months due to base effects from last year’s economic shock, supply chain disruptions, the rebound in oil prices, and the lagged effect from dollar weakness. However, as it did in late 2011, when headline inflation nearly hit 4% and producer price inflation briefly topped 10%, the Fed is inclined to regard these price shocks as transitory. The Fed believes that headline inflation will tick up to 2.4% this year but then settle back down to 2% by the end of next year as most fiscal stimulus measures end.

Our view is that the Fed will be right about inflation in the near term, but that it could be wrong in the long term. That is to say, we think that core inflation will probably remain subdued for the next two years, as the Fed expects. However, inflation could rise significantly towards the middle of the decade, an outcome that is likely to surprise both the Fed and financial markets.

Stocks usually outperform bonds when economic growth is strong, and money is cheap. The end of the pandemic and ongoing fiscal stimulus should support growth this and next year, allowing the bull market to continue. With inflation slow to rise, monetary policy will remain accommodative over this period.

The recent back-up in long-term bond yields could destabilize stocks for a month or two. However, as long as yields do not rise enough to trigger a recession, stocks will shrug off their effect. Over the coming 6 to 12 months, a comparatively sanguine perspective on inflation supports a bullish view on stock markets.

End of the Pandemic

Over the past 6 weeks, the U.S. has continued to make incredible progress in vaccinating its population against COVID-19.

The pace of vaccination is now well within the range required for herd immunity to be in place by the end of the third quarter. If this pace continues at an average of 2.5 million doses per day, the U.S. will have vaccinated 90% of its population by the end of September. And these calculations assume the continuation of a two-dose regime, meaning that the rollout of Johnson & Johnson’s Janssen vaccine – which requires only one dose and has shown to be extremely effective at preventing severe illness and death – could shorten the time to herd immunity rates of vaccination among adults even further.

The situation is clearly different in Europe. The vaccination progress in several European countries is well behind that of the U.S. and the UK, and per capita new cases in the euro area have again risen significantly above that of the U.S.

Clean Energy, Infrastructure and Commodities

Last week’s unveiling of President Biden’s $2.4 trillion “American Jobs Plan” to modernize U.S. infrastructure is the biggest construction and highway upgrade since the 1950s. Spending will take place over 8 years, financed in part by an increase in corporate taxes. This will provide a short-term boost to growth and is positive for equity markets as investors expected the tax component and the spending is front-loaded while the tax increases are spread out over 15 years.

The proposal is not pure old economy – it includes $650B for green infrastructure, clean water and high-speed broadband, along with $180B for the biggest non-defense Research and Development program on record. The proposal has a high likelihood of passage before the end of the year given that infrastructure is popular and Democrats can pass the bill via reconciliation with zero Republican votes.

The plan will create jobs but will likely also need a lot of base commodities from iron ore for railroads to copper and lithium for upgrading the broadband grid.

The past 10 years have been rough for commodity investors. After a decade-long bull market in the early 2000s, major commodity indices have continuously underperformed equities. The question now is what to expect going forward?

The conditions that propelled natural resource prices in the early half of the 2000s are very different from today. Back then, China’s economic expansion was a major tailwind. Fast forward to today, China is prioritizing stability over growth.

However, another tailwind for commodities is emerging. Alongside preventing financial risks, Chinese policymakers are also prioritized the environment. This is consistent with global efforts to adopt greener technologies. Somewhat ironically, it implies greater demand for commodities – industrial metals in particular – to buildout power grids.

The global movement toward a low-carbon renewable-energy future is a key factor underpinning metals demand over the next decade. The U.S., E.U. and China have committed to net-zero carbon targets by 2050 / 2060. This will unleash immense investment into and restructuring of everything from energy grids to city design to even bitcoin mining. Advances in renewable costs likely mean oil and coal are on their way out.

This comes after years of low capital investment in metals and mining. The confluence of supply constraints and rising demand will ultimately drive-up commodity prices.

Bond Portfolios are Suffering

Global bond markets are experiencing one of their worst starts of the year and are down circa 4%. Given the low interest rates, it is hard to see how global fixed income can generate a positive return this year.

Interest rates continue to tick higher on the back of solid economic data. There is a self-limiting aspect though to how high bond yields can rise when inflation is subdued. Higher bond yields lead to tighter financial conditions. Tighter financial conditions, in turn, lead to weaker growth, which justifies an even longer period of low rates. It is only when inflation rises to a level that central banks find uncomfortable that tighter financial conditions become desirable. We are far from that level today.

However, sharply falling bond yields are also not in the cards, so being short duration and owning corporate bonds and emerging market debt in our fixed income portfolios is helping us to create outperformance.

Investment Implications

Equities might face some more near-term volatility stemming from the recent rise in bond yields. But our core view is that the “Goldilocks” environment for risk assets, where growth is strong, inflation is contained, and monetary policy is accommodative, should last another two years. We expect corporate earnings to grow healthily this year and next, and strong earnings will continue to underpin the global equity markets.

Value stocks could lead the equity market higher over the next 12 months. The pandemic benefited growth names, especially in the tech space. The end of lockdown measures will favor value names. Not only is value still cheap in comparison to growth, but traditional value sectors such as banks and energy companies have seen stronger upward earnings revisions than tech stocks since the start of the year.

Looking further ahead, the cyclical bull market in stocks could end when inflation rises so high that central banks are forced to tighten monetary policy. While this is not a near-term risk, it is a major risk for the middle of the decade and beyond. Inflation is often slow to rise in response to an overheated economy, but when it does rise, it can rise fast.

Investors looking to hedge long-term inflation risk should favor inflation-protected securities over nominal bonds, precious metals and commodities, and they should.

PLEASE READ THIS WARNING: This newsletter contains general information that may not be suitable for everyone.
The information contained herein should not be construed as personalized investment advice. Past performance is no
guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come
to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information
presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.

Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and
expenses carefully before investing. The prospectus, which contains this and other information about the investment
company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

*Investments in commodities may have greater volatility than investments in traditional securities, particularly if the
instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in
overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular
industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international
economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an
opportunity for increased return but, at the same time, creates the possibility for greater loss.

Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as
well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the
stock market in general.  It is a market value weighted index with each stock’s weight in the index proportionate to its market value.

A REIT is a security that sells like a stock on the major exchanges and invests in real estate directly, either through
properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a
highly liquid method of investing in real estate.  There are risks associated with these types of investments and
include but are not limited to the following:  Typically no secondary market exists for the security listed above. 
Potential difficulty discerning between routine interest payments and principal repayment.  Redemption price of a REIT
may be worth more or less than the original price paid.  Value of the shares in the trust will fluctuate with the portfolio
of underlying real estate.  Involves risks such as refinancing in the real estate industry, interest rates, availability of
mortgage funds, operating expenses, cost of insurance, lease terminations, potential economic and regulatory
changes.  This is neither an offer to sell nor a solicitation or an offer to buy the securities described herein.  The offering is made only by the Prospectus.

By

March 2021 Financial Update

When Good News Becomes Bad News

Just like in January, global markets gave up most of their gains in the last few days of February this time because of rising bond yields, which made the market nervous.

What is important to note that it was not only U.S. Treasury yields that rose but also the European and Chinese bond yields, so it was a global sell off in government bonds.

Why Did the Equity Market Get Rattled by Rising Bond Yields?

Normally rising bond yields are an indication of strong economic growth, which should be positive for equity markets. However, historically, rising yields have been negative for stock valuations when yields increased in response to hawkish central bank rhetoric. This is clearly not the case today. The Fed’s accommodative stance should limit any near-term upward pressure on U.S. bond yields. Therefore, we continue to favor equities over a 12-month horizon.

This equity and bond market sell off was triggered by fears that all the fiscal and monetary stimulus will lead to much higher inflation, which would force the Fed to raise interest rates and tighten monetary policy, which in turn would put pressure on stock market valuations, especially on stocks with high valuation multiples. That is the reason why for example the NASDAQ dropped more than the Dow Jones Index.

Rising Yields and Inflation

We expect U.S. inflation to move higher over the coming months. Oil prices have risen 70% since the end of October and rising energy prices will likely push up headline inflation. In addition, the effect from a weaker dollar should translate into higher goods prices in the U.S.

A stronger labor market and a slower pace of rent forgiveness should also boost housing inflation. If we add everything together, we think there is a risk that headline inflation in the US could temporarily rise to 3 to 4% in the coming months, which would increase the long-term inflation expectations and could again lead to a short-term increase in bond yields, which could cause another scare in the equity market.

Fiscal stimulus could further supercharge demand, adding to inflationary pressures. The impending passage of the $1.9 trillion American Rescue Act, combined with the economic stimulus packages from 2020 brings the total fiscal support to almost 25% of U.S. Gross Domestic Product (GDP), which is arguably larger than the economic damage caused by the pandemic.

However, we think this increase in inflation numbers will be temporary as the economy is still in recovery mode. So, we do believe Fed chairman Powell when he says the Fed is planning not to take any action for the next two years. If the Fed sticks to that plan, then the economic stimulus will support corporate earnings.

We have to remember that inflation is not necessarily bad for equity markets. Deflation is bad for stocks, just as is high inflation. Somewhere between deflation and inflation, however, lies reflation. Reflation is good for stocks. We are currently in a reflationary zone, where inflation expectations have risen but not by enough to force the Fed to tighten monetary policy.

A period of ultra-easy monetary policy can sow the seeds for economic overheating, rising inflation, and ultimately, much higher interest rates. Since this is precisely what happened in the 1970s, it is prudent to ask whether something like that could happen again. Investors today certainly do not believe a replay of the 1970s is in the cards. Yet, we would argue that a 1970s-style inflationary episode is at least a risk we need to keep in mind.

While no two periods are exactly the same, there are a number of striking similarities between the late 1960s and today. As is the case today, fiscal policy was highly expansionary back then. The same goes for monetary policy: just like today, the Fed kept interest rates well below the growth rate of the economy. In the 1960s, the Federal Reserve was still focused on avoiding a repeat of the Great Depression and the deflationary wave that accompanied it. Today, the Fed is equally focused on reflating the economy.

As long as the economy is growing solidly and the Fed remains on the sidelines, it is too early for investors to sell out of equities. Instead, equity investors should favor sectors that could benefit from higher inflation. Looking further out, the secular bull market in stocks will end when inflation rises to a level that the Fed cannot ignore. That day will arrive, but probably not for another two years.

Pandemic Subsiding

We cannot yet declare victory over COVID-19 but it is clearly going in the right direction as new case counts have plummeted from their January peak. Restrictions helped turn the tide in Europe, albeit at the cost of cutting off oxygen to the economy, but even in Sweden and the U.S., which avoided EU-style restrictions, the virus has lost momentum. The roll-out of the vaccines will help to suppress another flare up of the virus and supports our view that economies will be able to open up sustainably within the next three months. The potential for vaccine-resistant variants is a concern, but the pandemic news is clearly trending in the right direction.

Why This Time It is Different

The global economy has seen two significant crises in the space of a dozen years. The monetary policy response to both events has been substantially identical; the Fed swiftly cut the fed funds rate back to zero and started buying large amounts of Treasury and agency securities to support market liquidity.

The fiscal response has been dramatically different, however, with governments this time seemingly not concerned at all by borrowing large amounts of money to finance the economic stimulus plans.

Therefore, the outlook is quite different today compared to 2010 as central banks have gained a powerful and willing partner in their efforts to combat the damage wrought by a sudden shock. Pandemic fiscal stimulus initiatives have dwarfed the fiscal efforts after the Global Financial Crisis across the major economies. Once Congress passes the $1.9 trillion American Rescue Act, the U.S. will have doubled down on its 2020 initiatives, committing to aid equivalent to an extraordinary 25% of its annual output. The ultimate effect on inflation, interest rates and exchange rates remain to be seen, but it is clear that the post-pandemic economic recovery will not unfold in the same way as in the past decade.

The Difference

From 1966 until 1997, U.S. equity prices were negatively correlated with U.S. Treasury yields. Since 1997, U.S. share prices have been positively correlated with US government bond yields. We believe we are now in the process of a major paradigm shift in the stock-bond correlation, reverting to the pre-1997 relationship.

The positive correlation between share prices and US bond yields – that has been in place since 1997 – is likely to turn negative, which effectively means that stock prices will fall when U.S. bond yields rise and will rally when Treasury yields drop. The reason is that the market will shift its focus from seeing deflation as the major risk to seeing higher inflation as the main macro risk. Investment strategies and frameworks that have worked over the past 24 years might require modifications as balanced portfolios that only hold equities and fixed income might not provide sufficient diversification in this macro climate.

What Happened in 1997?

In case you are wondering what happened in 1997: The basis for the 1997 reversal in the stock-bond correlation was a regime shift in the global macro backdrop. Before 1997, the main risk to business cycles and share prices was inflation. From 1997 until very recently, the main risk to equity markets was deflation or very low inflation. The watershed event that triggered this global macro shift from inflation to deflation was the Asian Crisis in 1997. The Asian currency devaluations allowed local producers – operating in these large manufacturing hubs – to cut their export prices in US dollar terms. The price reductions unleashed deflationary forces that spread all over the world.

The Impact on the USD

The Fed’s accommodative stance should limit any near-term upward pressure on the U.S. dollar. Whereas stocks are most sensitive to absolute changes in long-term real bond yields, the dollar is more sensitive to changes in short-term real rate differentials with U.S. trading partners. Since the Fed is unlikely to tighten monetary policy anytime soon, U.S. short-term real rates could fall further as inflation rises.

The Fed falling behind the inflation curve is fundamentally bearish for the U.S. dollar. That is why the primary trend for the dollar remains down. However, the dollar is oversold, and a short-term rebound is possible, especially if U.S. bond yields continue to rise, triggering a period of risk-off in global financial markets.

Investment Strategy

Given these conclusions, we recommend the following investment stance over the next 12 months: Stay positive on equities, which will generate excess returns over government bonds and cash in the absence of a negative COVID surprise.

Despite the high valuations of growth stocks, we favor a balanced approach as we expect corporate earnings to remain strong this year, also for growth stocks. We could see periods of rising bond yields which will create short-term fears and corrections in the markets. But we think bond yields will not rise sustainably this year and the monetary backdrop will remain supportive for equity valuations.

Longer-Term Investment Strategy

Relatively higher equity valuations means that a lot of good news is already discounted in prices and that means the equity rally is entering a riskier period where short-term corrections become more likely. Share prices will advance when U.S. bond yields drop, and they will dip when Treasury yields rise. As and when share prices drop due to concerns about higher inflation, the Fed will attempt to calm investors arguing that inflation is transitory, and it knows how to deal with it. Stocks and bonds will likely rally on reassurances of this kind.

Commodities

We are following commodities and may favor holding a position in precious metals and base commodities as a long-term diversification in a multi-asset portfolio.

Base metals prices have rallied by over 50% in dollar terms since last year’s COVID-induced meltdown. Nevertheless, we see further upside in metals prices, with the potential to develop into a multi-year structural bull market. The key driver is the world’s decisive push to a greener future, which in turn will significantly boost demand for several key base metals used in new energy infrastructure.

Although the world’s awareness of climate change has been increasing over the past several decades, 2020 became a pivotal year as major countries affirmed their commitment with concrete and measurable targets. The EU and Japan announced last year that they are striving for net zero greenhouse gas emission by 2050, while China is aiming for the decade after.

In the U.S., President Joe Biden also intends to set the U.S. on a path to net zero emissions by 2050 and has issued an executive order to rejoin the Paris Climate Accord, alongside other actions in favor of environmental policies. To meet the ambitious goals outlined in the Paris Agreement, governments need to implement aggressive efforts focused on improving energy efficiency, decarbonizing the power sector, switching to low or zero-carbon fuels, and utilizing carbon-capture technologies. These efforts could profoundly change energy infrastructure and consumption patterns in the coming decades.

In short, the combination of regulatory, financial, and social incentives points to an acceleration in the development of green infrastructure, including the construction of solar and wind energy power plants and electrification of vehicles, many of which are heavy consumers of copper and some other base metals. This holds the promise of significantly boosting demand for these resources.

China’s demand for copper has been strong in the past several decades, and still holds the key in the near future. While the country’s transportation infrastructure has vastly improved, its campaign to build “new infrastructure” on the digitalization of its economy has just begun. The country has laid out ambitious plans to expand its 5G network and data centers, all of which are heavy consumers of copper.

Portfolios

Global Equity markets performed strongly up till the last week of February when the rising bond yields created a sell-off which wiped out most of last month’s gains. Our balanced approach in portfolios of combining value with momentum worked well.

As bond yields have been rising globally, bonds didn’t have a great start of the year. Global fixed income markets are down 2.5% since the start of the year while equity markets are up 1.5%. Which means that fixed income heavy portfolios are lagging. Non-qualified models have benefitted from municipal bond holdings as they have fared better than their treasury counterparts. Qualified models will see the return of senior floating rate bank notes to the lineup after a short absence. The potential for rising rates and the low duration associated with senior notes make them a favorable addition.

By

BFT Financial Market Update: Q4 2020

Listen to the brief audio version or read the full overview below.

Twelve months after the first reports of a new virus started to show up and ten months after the start of a global pandemic, there is a light at the end of the tunnel. Vaccines developed by Pfizer-BioNTech and Moderna seem to have efficacy rates of around 95%. AstraZeneca’s vaccine, developed together with Oxford University, has shown an efficacy rate of 90%. Russia and China have also launched vaccines. The Russian vaccine, Gamaleya, displayed an efficacy rate of 91% based on 22,000 test participants. Such high efficacy rates are on par with the measles and smallpox vaccines, and well above the typical 30%-to-50% success rate for the seasonal flu vaccine.

If we combine the global roll-out of the vaccines with the typical cycle of previous viral pandemics, we could very well see a sharp drop in new Covid cases in the coming months. When effective vaccines allow everyone to live a normal life again, there will be a burst of economic activity of every kind. When this happens, it will unlock tremendous pent-up demand around the world. There will be party booms, travel booms, shopping malls will be filled with people and airports will be busy again.

The Covid-19 crisis is a natural disaster and historically, the impact of this kind of crisis on the economy and society is always “temporary”. This time is no different. The speed of the economic rebound since April has been fast and surprised many investors. Retail sales in the U.S. and Europe have not only clawed back all their lost ground but have made new highs.

Another reason for a recovery boom is that, although the Covid-19 crisis is a
temporary shock, it has caused structural shifts in policy. This will make the
recovery story very different from the post-2009 recovery. Back then, the world economy was plagued by a badly damaged banking system in the West, prolonged deleveraging, and a crash in Chinese investment spending. This led to a long period of low growth, sustained deflationary threat and a secular bear market in commodities.

A Roaring 2020s?

The 1918 Spanish Flu pandemic gave way to the roaring 1920s, business boomed, stocks roared ahead, and the world economy experienced unprecedented prosperity. Is there a chance that we will see a repeat with a roaring 2020s?

This is certainly possible as all the economic and monetary stimulus most likely has extended the economic cycle and the secular bull market by another few years.

The path is already well greased with liquidity, and the current economic backdrop bears some similarities to the 1920s. Back then, there were many game-changing new technologies and innovations such as electricity, the automobile, the telephone, radio, consumer appliances, assembly-line production and so on. These new developments played major roles in driving down inflation and stimulating growth, which led to rising profits and stock prices until it abruptly ended in 1929.

Today, corporate profits are recovering strongly from the recession last year and stocks are trading at a forward Price/Earnings Ratio (P/E) of 22, which is not low but also not overly expensive by historical standards, especially taking into account the much lower interest rates. This is not to mention the many important technological advances in recent decades.

Obviously, there are key differences between the 1920s and now. More than a century ago, Americans were younger, and the economy was more vibrant and growing faster. Today, the population is getting older, the economy invests a lot less and growth is much slower. However, these differences are not the reasons preventing a financial mania. There are already areas of speculation, but we must differentiate between pockets of speculation like stocks of electric car makers or bitcoin, and the general market. We are nowhere near a general financial mania yet.

If we get a roaring 2020s, when and how could it end?

We could see an extended bull market in risk assets until we see the next financial recession, which could be triggered by monetary tightening. Almost all previous asset bubbles were pricked by monetary tightening. If the Fed is serious about its forward guidance, rates are likely to stay low for a few years, which is the key reason why the market could run up a lot further and could lead to asset bubbles and financial manias this decade.

But be careful: policymakers can change their minds quickly and the risk to equity prices will escalate when the Fed is preparing to “normalize” policy again. However, this likely still several years down the road.

The world economy is recovering fast but governments and central banks are still worried about a “double dip” for the economy given the continued lockdowns and they will continue approving large economic stimulus packages. The U.S. has just agreed another fiscal package of around $900 billion, while the EU will push through its own €750 billion recovery fund.

Politically, the right thing to do is to give more money to the most affected people, but for the U.S. economy as whole, additional income subsidy might not be necessary to sustain the recovery. A large part of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) expired at the end of July but the unemployment rate has continued to fall and the economy has continued to improve. Additional fiscal support in the U.S. or Europe will simply add more fuel to the potential spending recovery.

The Democratic wins in the Georgia senate races will also give the Biden-Harris administration more leeway to get larger economic stimulus packages through congress and investors do not need to fear a premature tightening of fiscal policy in the U.S.

Several European countries will hold elections this year or early 2022, which means politicians have very little incentive to stop the economic stimulus any time soon.

Fiscal policy around the world has been so far focused on giving out income support for people, but the emphasis could shift to rebuilding the economy. As such, infrastructure spending could be increased significantly from the U.S. to Europe to Asia, fueling a surge in construction activity. This could be good news for commodity prices. And indirectly emerging markets.

Our overall view is therefore that the global economy will strengthen in 2021 as the pandemic winds down. Inflation will remain low for the next 2-to-3 years before possibly moving higher by the middle of the decade.

Interest rates should stay low as long as there is no real inflation threat, and this is positive for equity markets. Right now, stocks are technically overbought and vulnerable to a short-term correction. Nevertheless, investors should continue to favour equities over bonds in 2021 given the likelihood that earnings will accelerate while monetary policy stays accommodative. If social instability in the U.S. would affect the markets in the short-term, we would be more inclined to buy the dip rather than sell.

Given the strong divergence in markets last year with large cap tech stocks accounting for most of the gains, it is not unlikely that we will see some mean-reversion this year and last year’s losers could be this year’s winners.

In 2021, international stocks could outperform US stocks, small caps can outperform large caps and banks and industrial companies can catch up to large cap tech. A weaker dollar will also help to make international markets more attractive.

Bond yields could rise modestly this year on the back of an improving economy, but the move is unlikely to be very large as central banks will want to avoid the situation that fast rising bond yields would hurt the recovering economy.

Investment grade bonds remain preferential to treasuries as we continue to view credit risk as a better alternative to rate risk. Given the rise in inflation expectations (which is not the same as inflation), inflation-protected securities may be attractive as well.

The US dollar will likely continue to weaken in 2021. The collapse in US interest rate differentials versus its trading partners, stronger global growth, and a widening US trade deficit are all bearish for the dollar.

Positive Risk In 2021

There is a ‘risk’ that stocks rise much more than investor can imagine and mega-cap growth stocks continue to lead the way. A liquidity tsunami is still in the making and major central banks except China are working in overdrive to print money and monetize debt. Next year, Quantitative Easing (Q.E.) will likely be significantly enlarged.

The U.S. Treasury will likely issue $2.4 trillion in new debt, and a large part of the new issuance will be absorbed by the Federal Reserve. This means that the Fed’s balance sheet will continue to grow, particularly if they try to keep bond yields down.

All this newly created money will not create inflation in the short-term, but it will flow into stocks, real estate and anything that has some yield, or into momentum plays like bitcoin.

In the meantime, there are captivating growth stories in the technology, biotech and clean energy space, which could easily capture investors’ imagination and generate more inflows into these sectors.

The price pattern of Facebook, Apple, Amazon, Netflix and Google (FAANGs) is very similar to the financial mania in technology, media and telecom in the 1990s. These mega-cap names are natural hot spots for investors to deploy large amounts of liquid capital. At the height of the last technology bubble, the average annual return for the S&P500 was 30% from 1996 to 1999.

Geopolitical Risks

Beijing has been the key source of negative shocks to risk assets in recent years. Policymakers in China are fixated on their Debt-Gross Domestic Product (GDP) ratio and have taken every opportunity of the economic recovery to hammer. Next to that China has taken a firmer stand regarding Taiwan and the South China sea and this has the potential to lead to conflicts.

The announcement from Iran that they will start to enrich more uranium will increase tension not only with the U.S. but also Europe.  The recent seizure of a South Korean tanker could be the start of more tensions in the Middle East.

Geopolitical risks could lead to sharp corrections in equity markets but are unlikely to unsettle the underlying economic trends.

Emerging Markets Transition to a Structural Bull Market

The current macro environment surrounding emerging market assets shares some similarities to what happened after the U.S. tech bubble bust two decades ago. Emerging market assets were battered by multiple crises in the 1990s and became deeply undervalued and under-owned. The Fed eased aggressively to fight the deflationary shock, which pushed down the dollar and released massive liquidity into the global financial system. This, together with strong Chinese growth, created a spectacular bull market in emerging market that lasted until after the Global Financial Crisis in 2008.

While history never repeats itself and it is overly simplistic to draw historical parallels, financial markets are subject to long-term mean reversion. The fact that emerging market equities have underperformed developed markets by so much in the past decade and are trading at much more lower multiples holds the promise of higher returns over the long run.

In addition, a few important factors suggest that the cyclical emerging market bull market has the potential to develop into a multi-year structural one.

First, the ongoing rally in commodity prices likely reflects more than just the Fed easing and a weaker dollar. Rather, it could be a sign of a demand-supply mismatch. On the demand side, China is full-throttle supporting the development of the country’s booming new energy vehicles (NEVs) industry, aiming to double its market share in auto sales in five years, which requires aggressive investment in related infrastructure. The country is also pushing development of “new infrastructure” such as 5G stations, high-voltage power grids, intra-city rail transitand data centers, all of which are commodity intensive undertakings.

In addition, China’s “belt and road initiative” has suffered a setback due to U.S.- China tensions and the pandemic but will inevitably continue to gain momentum in the coming years. The belt and road initiative is essentially a series of basic transportation infrastructure projects in developing countries financed by Chinese institutions.

Meanwhile, the U.S. under a Biden presidency will also likely push on infrastructure development, setting the stage for stronger demand for commodities.

On the supply side, a decade-long bear market in commodity prices has significantly reduced capital spending in mining.

Investment in infrastructure and clean energy technology is a trend that will continue in the coming years.

Portfolios

In previous years, we’ve been more inclined to tactically reallocate portfolios to meet changes in the economic cycle and market attitude. This year was a return to traditional rebalancing of portfolios and a harvesting of profits and purchase of lesser performing assets. The result, our portfolios have remained globally diversified and maintained have their weightings. As such, we have participated in the “stay at home” tech momentum and have benefitted from strengthening foreign companies as well. While value hasn’t kept pace with growth for some number of quarters it has been profitable and the past few trading sessions it has been the benefactor of a slight sell off in growth and big tech stocks. Should that continue we are positioned to benefit as well. Our attitude on bonds is reflected in our positioning; we are satisfied to collect the yield, albeit lowered, and not stretch for more than is realistic. Our risk exposure is derived from our equity positioning and shouldn’t be enhanced with a reach for yield.

Disclaimers: This newsletter contains general information that may not be suitable for everyone. The information contained herein should not be construed as personalized investment advice. Past performance is no
guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.

Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

*Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred.  Returns do not include reinvested dividends.

By

Financial Updates | July 2020

As things stand today, there are many encouraging signs of a rapid economic rebound around the world, but uncertainties also abound. Federal Reserve Chairman Jerome Powell describes the prospect of U.S. economic recovery as “extraordinarily uncertain.”

This probably best characterizes the broad economic environment facing most investors. To be clear, we are still bullish on risk assets, but also think that a short-term set back in markets is very well possible.

Will The Bulls Continue?

Although the U.S. stock market has so far shrugged off the renewed viral spikes in Florida, Arizona and Texas, the increasing number of COVID-19 infections will remain a key risk to equities. At present, the market seems to be assuming that the viral spikes will likely be contained within these states, while the broad economic reopening in the U.S. will stay on track.

Over the past quarter we saw a combination of large-scale monetary and fiscal easing stabilize financial markets. The optimism of relaxing lockdown measures continued to spur the stock market recovery through April, May and June. The question on most investors’ minds is whether this new bull market will continue.

The next few months could be a precarious time as we see renewed virus outbreaks. Depending on how governments choose to steer through the next wave there is a high chance that stock markets will be volatile over summer and we may see again a short-term correction. However, we remain positive on equities versus bonds on a 12-month period.

Global equities have rallied strongly from their March 23rd lows. However, the fixed income environment in the past quarter paints a different picture. Bond yields have barely recovered from March. The US 10-year Treasury note is currently yielding 0.58%, down from 1.92% at the beginning of January and the 30-year bond yield offers only 1.24%. On the commodity side, we have seen oil and industrial metal prices mirror the bond yield picture whereas gold rallied with equities. The divergence in the markets have left investors perplexed.

Despite the second quarter rally, the world equity market is still down since the start of the year. More importantly is to realize that the market rebound has been driven mostly by large technology stocks. A number of large banks, industrial and energy stocks are still down 35% or more from their February levels.

We navigate the choppy waters by considering the main trends at play. In general, bond and industrial commodity markets tend to reflect the outlook of the real economy whereas stocks reflect the outlook for corporate earnings.

A Second Wave is Gaining Momentum

Countries all around the globe are on the path of relaxing lockdown measures. Governments are gradually permitting larger group gatherings and the opening of restaurants, bars and non-essential shops. This opening of the economy takes place against the backdrop of limited success in virus containment.

Although some countries have accomplished lower case and death rates, others still face increasing infection rates. These countries, however, continue down the path of relaxing measures, fearing the prospect of being left behind in the economic recovery.

Predicting the effect of a second wave on markets is difficult plagued by unknown factors. The public appetite for lockdown measures is clearly fading with a growing number of people choosing to flout or protest remaining lockdown measures in place. It is also unlikely that governments will impose the same lockdown measures as seen in the first wave, choosing instead to prioritize the economy by following the “Swedish model” which markets will favor.

Also, developments in technology have given governments the ability to create tracing systems which are better equipped to contain small breakout clusters. Furthermore, treatment options have improved since the onset of the first wave with medical professionals learning more about the virus.
Concerning equity markets, if a more deadly second wave occurs, we would expect to see some severe short-term weakness in the equity market as many sectors would reel from a second punch.

Geopolitical Risk

Another risk factor is the increasing animosity between China and the rest of the world. The implementation of a new National Security Law in Hong Kong triggered a reaction from countries like the U.S. and the U.K., while clashes at the China-India border created tensions with India, which prompted India to basically block many popular Chinese Apps.

Hong Kong is at risk of losing several legal and trade agreements with western countries. However, we feel Hong Kong as a financial center is not at risk in the short-term, as its capital market is too important to both China and the western world. Hong Kong also has more than enough monetary reserves to maintain the HKD-peg to the US dollar.

The positive news is that the increased tensions have spurred China to provide large economic stimulus packages to its domestic economy and start new infrastructure spending programs. This will be positive for Asian economies and indirectly for the world.

Equity Markets

Although equity markets will face an uncertain period, there are plenty of positive drivers which will likely keep the bull market pushing on higher. As economic data continues to improve equity markets should pull higher.
Although we may see a slowdown in growth during the second peak it is likely governments will not halt economic activity altogether in the same way. Typically recoveries from external market shocks tend to be more rapid than those created by internal problems. The pandemic would qualify as an exogenous (external) shock and, therefore, equity markets should see a more rapid recovery than for example after the 2008 global financial crisis.

The amount of government spending to protect people’s incomes is extraordinary. Although the CARES Act will expire by the end of July, and the 18 million Americans who are unemployed could lose the $600USD/week in extra unemployment benefits.

Both Congress and the White House agree that more fiscal support is needed, but they differ on how the next package will be structured. The Trump administration, worried about unemployment benefits being too generous, favors a “back to work” bonus. The House democrats want to simply extend the extra $600USD/week to January 2021, send another round of $1,200 cheques to each family and increase infrastructure spending.

Will ideological differences between the Republicans and Democrats lead to a blockage of the second stimulus bill? Not likely, as both parties understand that the stakes are too high. Especially now with the flare up of the virus in the southern states. Therefore, we can expect to see additional economic stimulus on top of the huge amount of fiscal spending we have already seen. This explains why the economy remains in reasonable shape despite the pandemic.

The same is happening in Europe, where it is likely that Angela Merkel will manage to get a new EU backed economic stimulus fund of 750 billion Euro approved in the short-term. Which comes on top of an earlier package of 540 billion Euro plus all the individual government spending programs.
The upcoming US elections have the potential to cause a stir in markets. If Biden ousts Trump and the democrats take control of the Senate, corporations will shudder at the prospect of Trump’s corporate tax cuts being rolled back. However, given that the current forecast is now expecting a democratic win, this risk is likely already priced into the market.

Furthermore, a Biden win would likely lead to improved relations with China which would be welcomed by global markets. Anyway, four months is still a long time in Presidential politics, and anything can still happen.

Source: Predictit via BCA Research

Source: Predictit via BCA Research

Bond Markets

Bond yields will remain depressed until inflation picks up, which we do not expect to happen any time soon. The unemployment rates have jumped so rapidly it will take likely 1-2 years to return to the levels before the pandemic and even then, it will still be another year or more before a tight labour market would lead to higher inflation.

Central banks would likely let inflation levels run up before stepping in to increase rates. Furthermore, highly indebted governments will prefer a higher inflation environment so that the real value of debt is eroded.
Bond yields could see some recovery alongside global economic growth. We will likely begin to see long term yields rising more than short-term rates. However, yields will remain low in absolute terms.

The Fed has been actively buying fixed income Exchange Traded Funds (ETFs) in the past two months to provide liquidity to the (high yield) credit market. This means the credit market does not offer particularly attractive opportunities at the moment. Given our outlook for the world we would prefer to add credit risk in emerging market debt or, for clients who can accept low liquidity, opportunities in private credit.

Investment Strategy

During the past quarter we made slight changes to our investment allocations. After the initial rebound we de-risked the portfolio slightly which we intend to hold until we see opportunities in the market which would warrant an increased appetite for risk. Specifically, we are looking forward to the presidential election in November.

There are several themes we are incorporating into our models. First, we feel that higher quality companies with stronger balance sheets and sound financial statements are better suited for a prolonged slow down should that prove to be the case. Second, we view health care innovation and biotechnology as a potential expanding segment as the pandemic crisis should lead to even more investment in healthcare and especially in health technology. And third, we believe big tech, which provided a significant boost to the market rebound, can continue to lead as the reliance on technology becomes evermore critical for business operations in a shutdown COVID environment.

With those ideas in mind, our model allocations were adjusted to reduce or eliminate small cap equity exposure, introduce large cap healthcare and technology positions and slightly underweight developed foreign large value equity. Our fixed income weightings remain unchanged overall for all allocation models and our sentiment for quality mirrors that of equities.

DISCLAIMER: The views expressed in this economic update are those of the author and do not necessarily reflect those of BFT. This update contains “forward-looking statements” that relate to future events, including future economic performance and plans. These forward-looking statements can be identified by the use of such words as “believe,” “think,” “intend,” “may,” “will,” “should,” ”expect,” ”anticipate,” “estimate,” or “could,” or variations of these terms or the use of other comparable terms. There are certain risks and uncertainties that could cause actual results to differ from those predicted in the forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this update.

Mutual Funds and Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices do not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.

Emerging Markets Disclosure: Investments in emerging markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.

By

Quarterly Review Q1 2020

In the first quarter of 2020 the Dow Jones Industrial Index2 declined 23%, which makes it the worst quarter in its 135-year history1. However, the Dow declined 38.4% from February 19th till March 23rd before a rebound in the last week of March. Markets have never dropped this far this fast before.

A month ago, there was still hope that the Coronavirus outbreak could be brought under control before it would paralyze the global economy. Since then, the number of new, recorded COVID-19 cases has mounted every day and outright fear prevails.

At the moment, a painful global recession is underway. Consumers are not spending; firms are facing a cash crunch and potential bankruptcy. And globally employment will be slashed. The next few quarters could result in some of the worst Gross Domestic Product (GDP) growth numbers since the Great Depression.

Risk assets have very quickly discounted this dire scenario. The global stock-to-bond ratio has collapsed by 47% since its peak in January. 10-year US bond yields temporarily fell below 0.4%¹.

The dollar has rallied against every currency and even gold traded below $1500 an ounce. Brent crude trades below $30/bbl¹.

In this context, investors must assess if risk asset prices have declined enough to compensate for the economic hazards created by the COVID-19 pandemic. If the massive amount of monetary and fiscal stimulus announced can turn around the economy in the second half of the year, then stocks and risk assets are attractive. Otherwise, they are still not cheap enough.

It is important to remember, this is a medical crisis and the situation is not comparable to the Global Financial Crisis (GFC) of 2008 or even the 1930s depression. While the shock is of unknown depth and duration, what we do know is that the containment measures and social distancing almost automatically bring economic activity to a halt. The impact on economic activity will likely be sharp and deep. We see the shock as akin to a large-scale natural disaster that severely disrupts activity for one or two quarters, but eventually results in a sharp economic recovery.

The OECD released its estimate of the economic impact of COVID-19 lockdown policies around the world. The sobering conclusion of the OECD’s work is that the initial direct impact of the shutdowns could be a decline in the level of output between one-fifth to one-quarter in many economies. Put differently, the OECD’s estimates imply a decline in annual GDP growth of up to 2 percentage points for each month that strict containment measures continue. If the shutdown continued for three months, with no offsetting factors, the OECD’s research suggests that annual GDP growth in OECD economies could be between 4-6 percentage points lower than it otherwise might have been.

Fortunately, monetary and fiscal authorities are responding forcefully to the crisis, but the length of the lockdowns remains a major source of downside risk to the economy. We see encouraging signs from major central banks and governments that monetary and fiscal response is starting to take shape. The pledged policy response has been swift, and we expect total fiscal stimulus to be similar in size to that of the global financial crisis but compressed into a shorter timeframe. At this moment, global governments have pledged an amount of economic stimulus equal to 5% of global GDP. In the US, the Coronavirus Aid, Relief, and Economic Security (CARES) Act provides for fiscal spending on the order of 10% of GDP, the majority of which is likely to be spent this year.

Macroeconomic Outlook

The global economy is now in recession and this has occurred because policymakers saw it as the lesser of two evils. They judged, with good reason, that a temporary shutdown of most non-essential economic activities was a price worth paying to contain the virus.

Outside of China, the level of real GDP is likely to be down 1%-to-3% in Q1 of 2020 relative to Q4 of 2019, and down another 5%-to-10% in Q2 relative to Q1. On an annualized basis, this implies that GDP growth could register a negative print of 40% in some countries in the second quarter, a stunning number that has few parallels in history. Growth in China should stage a modest rebound in the second quarter, reflecting the success the country has had in containing the virus.

Nevertheless, the level of Chinese economic activity will remain well below its pre-crisis trend, with exports increasingly weighed down by the collapse in overseas spending.

A One-Two Punch

The “sudden stop” nature of the downturn stems from the fact that the global economy was simultaneously hit by both a massive demand and supply shock. When households are confined to their homes, they cannot spend as much as they normally would. This is particularly the case in an environment of heightened risk aversion, which usually leads to increased precautionary savings. At times like these, businesses also slash spending in a desperate effort to preserve cash.

All this reduces aggregate demand.

On the supply side, production has been impaired because of workers’ inability to get to their jobs. According to the Bureau of Labor Statistics, less than 30% of US employees can work from home. Since modern economies rely on an intricate division of labor, disturbances in one part of the economy quickly ripple through to other parts. The global supply chain ceases to function normally.

The fact that both shocks have been concentrated in the service sector, which represents at least two-thirds of GDP in most economies, has made the situation even worse. During most recessions, the service sector is the ballast that helps stabilize the economy in the face of sharp declines in the more cyclical sectors such as manufacturing and housing. This time is different.

The Night Is Always Darkest Just Before Dawn

“The night is darkest just before dawn. But keep your eyes open; if you avert your eyes from the dark,  you’ll be blind to the rays of a new day…So keep your eyes open, no matter how dark the night ahead may be.” –  Hideaki Sorachi

Right now, we are fighting an invisible enemy that is ravaging the world. However, victory might be in sight. The number of new infections has peaked in China and South Korea. We should watch Italy closely. If the number of new infections peaks there, that would send an encouraging signal to financial markets that other western democracies will be able to get the virus under control. While it is too early to be certain, this may be happening: Both the number of new cases and deaths in Italy have stabilized over the past week. Of course, there is still the risk that the number of new infections will rise again if containment measures are relaxed prematurely. Nevertheless, it is likely that global growth will begin to rebound in the third quarter of this year.

President Trump signed into law the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The bill provides fiscal stimulus of $2.2 trillion (or 10% of GDP), with at least 46% of the spending taking the form of direct funds for households and small businesses including $290 billion in direct cash handouts to middle-class households.

For investors, the passage of the law shifts the question about stimulus from “how big?” to “how effective?”. It is difficult to answer that question with high confidence because it depends in large part on the duration of the physical distancing measures in place. But at least two factors argue in favor of its effectiveness: the total size of the plan is large relative to other countries and relative to the fiscal stimulus that occurred in 2008/2009, and the plan will disproportionately benefit lower-income Americans who will likely need assistance the most. And U.S. politicians have already hinted that a second stimulus package might be a possibility if necessary.

The Fed has also dusted off the whole alphabet of programs created during the financial crisis to improve proper market functioning, and has even added a few more to the list, including a program to support investment-grade corporate bonds and another to support small businesses.

The good news is that there is no limit to how many dollars the Federal Reserve can create. The Fed has already expanded the supply of bank reserves by initiating the purchase of $500 billion in treasuries and another $200 billion in agency mortgage-backed securities (MBS) since relaunching its QE program on March 15th. Further MBS purchases will be especially useful given that mortgage rates have not come down as quickly as Treasury yields.

The Shape of The Recovery: L, U, or V?

Provided that the number of new infections around the world stabilizes during the next two months, growth should begin to recover in the third quarter.

What will the recovery look like? From the perspective of sequential quarterly growth rates, a V-shaped recovery is inevitable simply because a string of quarters of negative 20%-to-40% growth
would quickly leave the world with no GDP at all. However, thinking in terms of growth rates is not the best approach. It is better to think of the level of real GDP.

The following chart shows three scenarios:

  1. A rapid V-shaped recovery where output quickly moves back to its pre-crisis trend.
  2. A sluggish U-shaped recovery where output slowly rebounds starting in the second half of the year.
  3. An L-shaped profile for real GDP where the level of output falls and then remains permanently depressed relative to its long-term trend.

Source: BCA Research

In the end it will depend on how long it takes before the  world will be able to go back to work. But when it does, the amount of fiscal stimulus will likely help the global economy to rebound in a way that is in between a V and U shape. In other words, we are more positive on the economic rebound then the majority of the current media reports.

Government Bonds: Deflation Today, Inflation Tomorrow?

As noted at the outset of this report, the current economic downturn involves both an adverse supply and demand shock. Outside of a few categories of consumer staples and medical products, we expect demand to fall more than supply, resulting in downward pressure on prices. This deflationary shock will be enlarged by rising unemployment in the short-term.

Looking beyond the next 12-to-18 months, the outlook for inflation is less clear. On the one hand, it is possible that the psychological trauma from the pandemic will produce a permanent, or at least semi-permanent, increase in precautionary savings. If budget deficits are reined in too quickly, many countries could find themselves facing a shortage of aggregate demand. This would be
deflationary.

On the other hand, one can easily envision a scenario where monetary policy remains highly accommodative and many of the fiscal measures put in place to support households are maintained long after the virus is eradicated. In such an environment, unemployment could fall back to its lows, eventually leading to an overheated economy, which would lead to higher than expected inflation.

We think that the more inflationary scenario over the next 2-to-3 years is more likely. Interestingly, that is not the market’s opinion. For example, the 5-year US TIPS breakeven inflation rate is currently only 0.69% and the 10-year rate is 1.07%. This means that a buy-and-hold investor will make money owning TIPS versus fixed coupon Treasuries if inflation averages more than 0.69% per year for the next five years, or 1.07% per year for the next decade. That is a bet we would be willing to take.

Equity Markets

In order for equity markets to find a bottom and start a more sustainable recovery, markets need to have more visibility on the potential economic outcome. Right now, the market does not see the light at the end of the tunnel but that could change quickly if we see the growth rate of the number of new infections starts to decline, especially in the U.S.

If and when that happens investors can start to estimate the length of the showdown and equity markets will quickly start to discount any recovery.

Source: BCA Research

As mentioned before, we think the outlook is not as dire as the market now thinks. The extraordinary amount of fiscal and monetary stimulus will limit a lot of the current damage. And the market is discounting a lot of damage at this moment. We don’t know if of the market already has reached its bottom or that there will be further downside in the coming months, but we do think that
equity markets will start to offer value and are likely to be higher on a 12-month basis. Some of the sectors that had the largest selloffs like energy and financials could become outperformers in such a rebound.

Investment Strategy

The recent market volatility has been extreme, and it was made worse by the fact that liquidity in the market was severely disrupted, which led for example to a large selloff in investment grade fixed income ETFs and funds3. Only when the Fed stepped in and announced effectively unlimited liquidity operations, markets started to normalize.

As long-term investors, event driven market corrections generally do not move us to make changes in our asset allocations. Given the large movements in the stock versus bond ratio resulting from the market sell-off, a rebalancing of portfolios back to their strategic allocation will likely be appropriate once the market volatility calms down.

 

 

¹Performance data by Bloomberg.

²The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded “blue chip” stocks, primarily industrials, but includes financials and other service-oriented companies. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks.

³ Mutual Funds and Exchange Traded Funds (ETF’s) are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from the Fund Company or your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

Disclosures

Securities and investment advisory services offered through BFT Financial Group LLC, a registered investment advisor. Member FINRA, SIPC, MSRB.

This material represents an assessment of the market and economic environment at a specific point in time an is not intended to be a forecast of future events, or a guarantee of future results. Forward-looking statements are subject to certain risks and uncertainties. Actual results, performance, or achievements may differ materially from those expressed or implied. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Past performance does not guarantee future results.

This document may contain forward-looking statements based on BFT Financial Group’s expectations and projections about the methods by which it expects to invest. Those statements are sometimes indicated by words as “expects”, “believes”, “will” and similar expressions. In addition, any statements that refer to expectations, projections or characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. Such statements are not a guarantee of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict. Therefore actual returns could differ materially and adversely from those expressed or implied in any forward-looking statements as a result of various factors.

Neither Asset Allocation nor Diversification guarantee a profit or protect against a loss in a declining market. They are methods used to help manage investment risk.

Investing internationally carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic and political risk unique to the specific country. This may result in greater share price volatility. Shares, when sold, may be worth more or less than their original cost.

Investments in emerging markets may be more volatile and less liquid than investing in developed markets and may involve exposure to economic structures that are generally less diverse and mature and to political systems which have less stability than those of more developed countries.

The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.

The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets.

You cannot invest directly into an index.