Updated Portfolio Strategy

The first wave of the downturn in early March, was a massive liquidation of securities as investors were completely unsure about how bad the Covid19 virus would get and how deep the economic downturn would be.   Stocks, credit, commodities and even safe-havens like gold were caught up in that initial 30%+ panic sell.   In mid-March we put some of the cash available in client accounts to work, increasing equity weight from about 30-35% to 50-55% by buying into high quality, higher yield stocks.  We also reduced the bond portfolio from 45% to 35%, as we saw little upside, given how low yields already were and our view that they would stay positive.  We have now seen a huge technical rebound driven by short-covering, some re-balancing into stocks from major pension funds and an easing of the initial liquidity fears.  The latter was driven by the ‘five star’ responses of central banks, particularly the U.S. Fed, which provided unheard of liquidity into the market and stopped this from becoming a ‘solvency crisis’.   However, we see the recent recovery as a ‘bear market rally and took our stock weights back down to 40-45%.  While predicting with certainty that the stock market has already bottomed out is likely overconfident, it’s a fair bet that many individual stocks have already achieved their lows. During the financial-crisis bear market, the S&P500 didn’t hit its 666-point trough until March 2009. But many individual stocks didn’t go below their November 2008 lows after the most indiscriminate phase of the selloff eased. The same pattern occurred after the dot-com bubble burst.  We think it is likely that the March sell-off followed that pattern as well, which suggests that stock indices will still see some downside over the next few months but that we probably won’t break below those March lows.

The mid-month rally in energy stocks on hopes of a massive production cutback by all global producers gave us the chance to exit the small remaining holding in producers, with some of those stocks at levels 40% or more above those at the end of March.  We don’t see the OPEC+ agreement coming anywhere close to offsetting the massive decline in energy demand globally.  Basically no Canadian producers are making money at current prices and we see more production shut-ins, losses and defaults before this sector truly bottoms out.

Financial stocks, particularly in the U.S., have had some of the worst sectoral performance this year as they are impacted by rising loan losses such as those seen in the earnings releases from JP Morgan, Citi, Bank of America, Wells Fargo and AMEX.  They also have to deal with decreased corporate activity and a difficult interest rate environment.  Capital markets trading gains have offset some of the damage in the short-term, but it will be harder to generate similar fixed-income trading gains going forward.  The Canadian banks are a somewhat different story in our view.  While the sector headwinds are much the same here, particularly given the high level of consumer debt in Canada, but the valuations are attractive and the dividend yields are at levels not seen since the Financial Crisis.  Some analysts have stress-tested those earnings and find that they could absorb as much as a 70-80% decline in core earnings and retain the ability to pay the current dividend without impacting capital ratios.

We also continue to have a strong position in gold stocks.  Although they got caught up in the initial liquidity driven downturn as investors sold whatever they could, the massive monetary stimulus and build-up of debt should prove to be a tailwind for gold prices.  The debt being built up to survive this crisis will have to be dealt with at some future date and we see that the devaluation of paper currencies of the most indebted countries (which now includes the U.S) as the most likely scenario   This would all be positive for gold and we stick to our earlier projection that gold prices will crack through US$2000 in this cycle, more quickly if we start to see some crack in the US dollar as a safe-haven.  Bank of America Corp. raised its 18-month gold-price target to US$3,000 an ounce — more than 50% above the existing price record — in a report titled “The Fed can’t print gold.”  The bank increased its target from US$2,000 previously, as policy makers across the globe unleash vast amounts of fiscal and monetary stimulus.

We also continue to like the telecom companies (Bell, Telus, Rogers, Shaw) as well as the pipeline companies (TC Energy, Enbridge and Keyera) for their safer earnings profiles, lack of economic cyclicality and exceptional dividend yields.  Given the sharp recovery in U.S. stocks and the reduced upside in the short term, we have reduced core overweight positions in the technology group.  This included Apple, Microsoft, Disney and the US semi-conductor ETF.  In our Hedge Fund, we took the equity position back down to about 40% from over 70% three weeks ago and added back some short positions in U.S. indices for the first time in over a month to hedge out the long positions in gold, pipelines, telecom and technology.   The net equity position in our Hedge Fund is now close to zero (i.e. net neutral) as we look for better entry points on some of our core industrial, technology and cyclical names.

Central bank actions have clearly put a much-needed floor under financial markets, but the job of just stabilizing the global economy will be another hard-fought battle.   Stock markets seem to see this as mostly ‘fait accompli’ and we think that might be a bit pre-mature!  While anyone predicting with certainty that the market has already bottomed out is a longshot at best’, it’s a fair bet to say that many individual stocks have probably already achieved their lows. During the financial-crisis bear market, the S&P 500 didn’t hit its 666-point trough until March 2009. But many individual stocks didn’t go below their November 2008 lows after the most indiscriminate phase of the selloff eased. The same pattern occurred after the dot-com bubble burst.  Bottom line is that while we are now less bearish than we were, we are far from bullish, especially given how hard stocks have rallied in the past month.

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