The fourth quarter of 2020 marked the reemergence of the equity bulls, as stock markets around the world accelerated to the upside starting in November. The timing was coincident with the announcement and expected rollout of several highly effective vaccine treatments for COVID-19, as well as renewed lockdowns and restrictions across many regions. Significant macroeconomic developments also received credit for the rally – the passage of another fiscal stimulus program in the U.S. and a last-minute resolution of Brexit trade negotiations between the UK and the European Union both made for convincing talking points among market participants.
More subtly, the equity markets also like a positive rate of change in the economic growth rate, and to be sure, coming off record lows in the first half the year is leading to such an environment. Helped along by accommodative fiscal and monetary policy, inflation expectations are also creeping higher. Markets have noted the Biden administration’s appointment of labor economist and former central bank chief Janet Yellen to lead the U.S. Treasury. Bond markets appear increasingly nervous, as longer-term yields have been marching higher.
In numerical terms, the MSCI All Country World Index gained 12.9% (9.5% in Canadian dollar terms) in the fourth quarter. Emerging markets outperformed developed markets by posting a 16.1% return in local currency terms. Developing countries, many of which have borrowed heavily in U.S. dollars, benefit from a combination of increased global demand and a depreciating greenback.
Similar to the themes observed globally, Canadian equities finished the quarter in positive territory, with the S&P/TSX Composite Index advancing 9.0%. The Canadian market was driven by gains in the equities of small and medium sized companies, particularly in procyclical sectors such as energy, consumer discretionary, and financials. On the flip side, and to the relief of many value-oriented investment managers, gold miners took a break from their torrid run. Gold doesn’t like the competition for individuals’ savings that comes from rising real interest rates.
The bond market often gives investors some clues for deciphering the state of future economic and market activity. Although the broad Canadian bond market returned 0.63% during the quarter – the corporate and provincial securities were significant contributors – the movement of the yield curve has been decidedly less optimistic for savers and those on fixed incomes. With short term rates anchored at very low rates, rising longer-term yields have created what is called a “bear steepener”. Conventional wisdom suggests this is a sign of rising inflationary pressures, which is exactly what central bankers have been trying to achieve for years.
On the monetary policy front, and in direct contrast to the typical policy response to rising inflation, the Bank of Canada has committed to keeping its policy rate at current levels (or, presumably, lower) until 2023. The Bank also expanded its corporate bond purchase program and tweaked its quantitative easing program, directing asset purchases to that part of the yield curve (longer dated bonds) where markets are pushing rates higher.
With all of the above as a backdrop, news from the periphery of the institutional investing world is perhaps the most interesting and also a harbinger of things to come. PayPal launched a new service enabling users to transact in cryptocurrencies; pro-Bitcoin Senator Cynthia Lummis joined the U.S. Senate Banking Committee, and corporate entities are starting to hold cryptocurrencies on their balance sheets (in early February, it was revealed that Tesla bought $1.5 billion USD worth of Bitcoin). Central Banks globally are also talking about introducing centralized and regulated CBDCs (Central Bank Digital Currencies). Throughout history, global monetary regimes have changed, whether organically or through coordinated planning. With nations drowning in debt and no longer able to spur growth through traditional policy, this “periphery” investment topic may well become more front and center in the months and years to come.