In the third quarter, economic activity bounced back forcefully from the record-breaking economic contractions the quarter earlier. Equity markets rallied alongside the improved economic data before correcting in September, as it became evident that governments globally were once again considering shutting down economies to combat the spread of COVID-19. Economic output remains far below that of the pre-pandemic period and near-term growth (if any) is only expected to be incremental and at very modest levels.
An interesting and important dynamic developed during the quarter; the U.S. central bank guided markets on a more aggressive inflation-targeting regime, and then promptly passed the buck to the fiscal authorities to achieve it. Temporarily, the message has been ignored, as partisan politics prior to the U.S. election has derailed further fiscal stimulus. This topic, which at some level is occurring around the globe, has a strong and widespread impact on markets. Countries are taking turns at further debasing their currencies, and the relative strength of the U.S. dollar typically has an important impact on assets priced in U.S. dollars, such as gold, oil, and other commodities.
The MSCI All Country World Index (ACWI) gained 7.1% in local currency terms ( up6.2% in Canadian dollar terms). Emerging markets, which are included in the ACWI, outperformed developed markets, posting an 8.8% increased return in local currency terms.
Canadian equities also extended their gains before declining just over 2% in September; the S&P/TSX Composite Index advanced 4.7% over the three-month period. Small capitalization companies significantly outperformed their larger-cap peers over the quarter. Under the hood, the heavily weighted energy sector continued to dog overall Canadian equity market results. Oil prices retreated in September as OPEC lowered its global demand forecasts and the prospects of a return to pre-pandemic levels of demand for fossil fuels dimmed.
The same type of intra-quarter dynamic played out globally as it did in Canada. The U.S. S&P500 Composite, after soaring in July and August, fell nearly 4% in September. Like Canada, European summertime gains had been more muted, and in turn, so were September losses. European equities lagged the U.S. markets on weak economic data, speculation of stricter lockdowns in metropolitan areas, and the looming deadline for determining the terms of Britain’s departure from the E.U.
Volatility in the bond markets compressed materially after a sharp rise in the spring of 2020. There were only modest yield changes in the Canadian and U,S, bond markets during the quarter. Corporate and provincial credit spreads tightened as a result of strong inflows, a search for yield, and ongoing central bank support. The FTSE Canada Universe Bond Index returned 0.44% over the quarter.
Finally, as we approach the U.S. election on November 3rd, one only need look back four years to recall the tremendous short-term swings in the markets stemming from such an unexpected result. Indeed, measures of expected volatility are signaling more of the same, and this sense of dread is not just our imagination. As Christopher Cole, founder of Artemis Capital, notes: “The 2020 Election is the most expensively priced ‘known-unknown’ in the history of the VIX complex (forward volatility)”. Historically, markets move past dramatic events with the fullness of time, but perhaps with different pockets of strength. For many, broad diversification and a steady hand continue to be the best strategy.