Asset markets continued their-V-shaped bounce off the March lows, with many equity markets nearly recovering to all-time highs by the end of June. This continues to be in stark contrast to economic activity, which is still undeniably weak and recovering much more slowly in the face of on-again, off-again lockdowns and general COVID-19 fears. In the United States (U.S.), still a key driver of global economic activity, second quarter economic production plunged by a record 33%. After losing in excess of 20 million jobs, the pace of the jobs “recovery” appears to be slowing. Worse are surveys that indicate that nearly half of unemployed respondents now expect their pre-pandemic job never to return.
More broadly, the International Monetary Fund (IMF) recently downgraded its estimate for global economic growth to a negative 5% in 2020. The IMF highlights that, for the first time in history, there is an expectation that all regions are likely to contract in 2020. This was a factor in the tumble in oil prices in April, which dipped below zero (storage costs make this possible) before rallying back into the $40 range.
The MSCI All Country World Index (ACWI) of global equities rose 18.4% in local-currency terms over the quarter. Emerging markets marginally underperformed developed markets, posting a 16.8% gain in local-currency terms. The S&P 500 Composite – the most popular measure for the U.S. market – rose 20.5%, while in Canada, the S&P/TSX Composite Index climbed 17.0%, making this the fastest bear market recovery in 40 years.
Despite these impressive returns, one must look under the hood and realize that these results do not reflect broad market strength; five stocks (Facebook, Amazon, Apple, Microsoft, and Google) representing over 20% of the S&P 500 and a significant portion of the global market, posted a year-to-date return of 2% to mid-July, whereas the other 495 companies in the S&P 500 were collectively down 5%. A similar phenomenon occurred in Canada, where the marginally profitable Shopify surpassed Royal Bank as the largest company (by market value) in the country.
The FTSE Canada Universe Bond Index returned a solid 5.9% over the quarter. Globally, volatility in fixed income markets calmed, and bond yields remained in a narrow downward range. Earlier in the quarter, with target policy rates already at or near zero, central banks announced additional measures to support the markets. The U.S. Federal Reserve began purchasing recently downgraded and at-risk corporate bonds, while the Bank of Canada added provincial, corporate, and inflation-linked bonds to its asset purchase program. Bank of America projects that the central banks of the major economies will soon hold more than $28 trillion in assets, equivalent to over a quarter of the globe’s annual economic production.
As the third quarter progresses, a narrative not seen in years is starting to develop. Market participants are starting to contemplate the risk of serious U.S. dollar debasement and prolonged negative real interest rates (nominal less inflation). Volatility has picked up, and the commodity complex – especially the precious metals space – looks to have begun pricing in future economic stagflation (a prolonged period of low growth and high inflation).
A sobering thought to end this quarter’s review: it took the U.S. 210 years to run the national debt up to $2 trillion, and it took just over 2 months to add the most recent $2 trillion. Other countries, including Canada, are experiencing similar fiscal pressures, the impact of which may be felt for generations. We can only reiterate the importance of having a long-term plan, broadly diversifying one’s assets, and keeping as much financial flexibility as possible.