Despite worsening news on the pandemic front during July and some backing off of re-opening plans for many parts of the global economy, ‘big tech’ in the U.S. lead a resurgence in stocks, erasing losses on the S&P500 for the year and pushing the Nasdaq Index into record territory.   North of the border, the fuse was lit for the stock averages by the 18% monthly gain in the Gold sub-sector as low interest rates and currency weakness provided fertile ground for the precious metals complex.   Stocks, bonds and commodities are heading for their strongest simultaneous four-month rise on record, highlighting the breadth of the market recovery during the 2020 economic slowdown.  Bonds also continued to generate some gains as interest rates drifted slightly lower and central banks indicated that they “weren’t even thinking about when they would start thinking about raising interest rates!”   Adding to the ebullient atmosphere in financial markets, commodity prices tacked on a 4% gain for the month, lead by a 33% surge in silver prices and a 34% gain in lumber.  However, weaker oil and agricultural prices have put a damper on the commodity group overall in 2020 and the CRB Commodity Index remains down over 22% year-to-date despite the gains in precious metals, copper, uranium and lumber.  Bottom line though, in terms of the strength of this recovery off the March lows, this is the first time that stocks, commodities and bonds have all risen this much in a four-month period since 1976.

While most investors, ourselves included, continue to try to reconcile the strength in these financial markets with the reality that we are facing probably the worst quarter of economic performance in North America in almost 100 years!  Analysts have attributed the broad rise in financial markets primarily to faith in government and central-bank stimulus programs, as well as hopes for vaccine development and wagers that the coronavirus crisis will spell opportunity for a number of large but nimble, well-placed companies at the expense of others whose struggles are deepening. That has also shown up in the clear division between the ‘haves’ in the market (technology and ‘stay at home’ stocks) and the ‘have-nots’ (financials, real estate, travel and consumer services companies).  The broad advance is prompting many investors who had been skeptical to join the rally, giving it further fuel. Call if the FOMO syndrome (Fear of Missing Out).  Investors are effectively once again faced with the TINA, ‘there is no alternative’ market, meaning that record low interest rates make traditional, less risky, investments unattractive options since they provide no income.

Prior to the pandemic, we had been concerned about financial markets for some time, with key worries being that we were late in a ten year economic expansion, profit margins had peaked, debt was at record levels and interest rates were poised to rise.  Those conditions no longer exist to the same degree.  We’ve now had the recession, the worst since the 1930’s, but also the shortest.  While debt levels remain at record highs and are poised to rise much further, there is no fear that interest rates will rise, so that financing those debts will be manageable, for now.  Corporate profits have also collapsed but expectations were so low going forward that exceeding those expectations has not been that difficult, particularly for those companies who have thrived in this ‘locked down, work from home’ economy.  The result is we are probably now, once again, in the early stages of an economic expansion.  But this expansion is going to be hampered both by a very slow return to normal working and living conditions and the massive debts needed to keep the economy running during the downturn.  This hardly seems like the type of scenario that should see stocks, which are already at record valuation levels, running back up past their old highs.  There’s lot of momentum in the market right now due to the largesse of the monetary and fiscal policies, but we still believe that investors are being far too optimistic about the timing and strength of an economic recovery.  As those realities set in, investors might find there is a ‘lot of air’ underneath the major stock market averages!Wile E. Coyote off the cliff

Despite the pandemic risks, our strategy in our managed funds since March has been to remain fully invested in stocks but to focus on those companies and industries where we see sustainable earnings, less economic sensitivity and, most importantly, high dividend yields.  The fact that we have probably already seen the worst economic data of this cycle, central banks remain extremely supportive of financial markets and there is the possibility that a vaccine may be found are all reasons not to fight the momentum in stocks right now.  But the elevated level of expectations, the record high valuations of stocks, the price surge already seen and the inability to decrease interest rates further all suggest a degree of caution in managing these investments.  While many portfolio managers believe the gains are justifiable, we do need to be wary of the formation of another ‘asset bubble’ as recent signs of a “melt-up” are occurring in some market niches, particularly around technology, in which investors are buying assets in large part simply because they are rising. Traders are riding the momentum in everything from Tesla to the largest technology stocks (Apple, Microsoft, Google, Amazon, Shopify) to ‘stay at home’ stocks such as Peloton, Spotify, Zoom and Netflix.  While the objective of the largesse from global central banks was meant to stop the economy from falling into recession by loosening credit conditions to keep the financial system solvent and stimulate growth, risking creating some inflation in the process.  That has just not occurred as individuals and corporations have not put these increased funds into the economy but are, instead, just shifting more and more money into financial assets.  Consequently, we might not be getting inflation in the real economy, we are certainly getting lots of ‘stockflation’.

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