The bellwether S&P 500 ended August up 7%, its strongest August performance since 1986. In the same month, the Nasdaq Composite Index, holding a number of surging tech stocks, climbed 9.5%. It was its best summer showing since the tech bubble of 2000, which collapsed in the “tech wreck” sell-off. Will the market retrench again? Only time will tell. But given the market’s five-month-long rally off its March bottom, we are holding to our overall neutral equity weighting.
Within our asset mix, in August we continued to overweight U.S., emerging market and European equities. However, while remaining underweight, we added to our Canadian exposure.
As we enter the final months of the year, risks appear to be growing. Markets have risen to record highs on the back of massive stimulus spending and rock-bottom interest rates. Even if inflation runs hotter than expected, the U.S. Federal Reserve has also indicated its intention to keep rates low for many months (if not years) to come. But the second $1 trillion stimulus package has yet to exit Congress. Nor has the U.S. been able to bring COVID-19 under control to the same extent that Europe and Canada have.
In addition, the highly polarized U.S. election campaign could trigger market turbulence as the November vote approaches. We are closely watching the market’s response to the campaign, and held about a 3% overweight position in U.S. equities in August.
Retail investors buying the shares of large tech companies, drove the run-up in U.S. equities. Their use of derivative trades reached levels never before seen in the market. With it reaching new highs, we continued to prefer growth (though taking some profits) and active investment styles in August. However, our bias may tilt toward value if a vaccine is released, the economy normalizes and the market rebound broadens.
To generate income, we tactically used short calls and short put positions over the last two months on gold and technology stocks. Both equity categories performed strongly in the market’s surge. The short put strategy worked particularly well in August when the Nasdaq kept moving up as we collected the premium.
We also continued to overweight emerging markets. By some estimates, China’s manufacturing activity expanded in August at its fastest pace in nearly a decade. The increase was driven by increased export demand as major economies slowly opened up. Emerging markets also continued to benefit from a cheaper U.S. dollar, which lowers the price of many raw material inputs.
However, we expect the recovery in emerging markets to be uneven. Indeed, while China improves, regions and countries such as Latin America, India, and Indonesia, are still struggling to control the virus. As the U.S. election gets closer, China could also increasingly be the focus of U.S. President Donald Trump’s attacks. This may trigger increased market volatility.
Given a potential rotation into value, we reduced our underweight exposure to Canadian equities in August. But it is still our largest underweight.
There were some positive signs in the domestic economy. Consumers, supported with cash from the Canada Emergency Response Benefit and Canada Emergency Wage Subsidy, continued spending. As well, house prices reached record levels in some larger markets, with supply/demand potentially supported by mortgage deferrals.
But there were signs in August that those initial government subsidies have been exhausted with spending starting to slow. In terms of house prices, we believe that despite low interest rates, prices could soften in a protracted low-growth environment. The economy has also been hurt by low oil prices, which continue to trade in the US$40 a barrel range.
In terms of Europe, we remained slightly overweight in August. COVID-19 is more contained in the European Union (EU) than many other parts of the world. To help the hardest hit countries, the EU has also launched a US$888-billion recovery fund. With the increased stimulus spending, and the economy continuing to reopen, European equities posted their strongest August since 2009.
Even with that show of strength, when compared to the S&P 500, European equity valuations are still more attractive. At the end of August, the S&P 500 had a P/E ratio of almost 30. By comparison, the Euro Stoxx 50 Index, which holds the 50 largest European companies by sector, had a P/E of about 20. This suggests if the economy continues to recover, European equities (which have more of a value tilt) may have greater upside.