Canso Investment Counsel - Fixed Income

Contributed by Canso Investment Counsel Ltd.

Markets came roaring back in spectacular fashion from their pandemic-induced first quarter selloff. This was helped in no small part by massive Government assistance and central bank actions. The US Federal Reserve has implemented a number of, what they describe as, “funding, credit, liquidity, and loan facilities”. These include the direct purchase of corporate bonds and related ETFs in both the primary and secondary markets. The Bank of Canada has also implemented similar programs, on a smaller scale. Overall, credit spreads significantly narrowed, especially in sectors largely unaffected by the pandemic, so that corporate bonds outperformed Canada bonds by a wide margin with a return of 8.1% versus 2.3%. This spread tightening had the greatest price impact on long term bonds, so that longer duration Provincials were also strong performers.

The AA and higher corporate sector is dominated by shorter term financials so its 4.1% return underperformed the broader corporate market. Spreads narrowed significantly on A rated bonds and even more on BBB bonds so that they returned 8.4% and 9.7% respectively.

Cidel Asset Management Inc.

Contributed by Cidel Asset Management Inc.

The second quarter of 2020 turned out to be nearly a mirror image of the first quarter. Previously uncontemplated quantitative easing by various central banks stabilised the credit markets (U.S. BBB rated credit spreads, which started the year at 110 basis points, ballooned to 409 basis points in late March, but had settled back down to 172 basis points by the end of the quarter), which helped to put a floor under equities. Early signs of economic resilience began to manifest from May onwards, which further supported the equity market rally that began on March 23rd. Finally, positive updates on trials of potential COVID-19 vaccines and treatments helped to buoy investor confidence. However, spiking new cases globally, particularly in the U.S., capped the rally toward the end of the quarter. Canadian equity markets, as measured by the S&P/TSX Composite Index, ultimately gained 17.0% during the quarter, bringing the year-to-date loss for the Index to -7.6%; a remarkably benign number given the volatility and uncertainty in the global economy. Driving the Index higher were the Information Technology and Materials sectors, gaining 68% and 42%, respectively.

The speed and ferocity of March’s equity market declines was extraordinary; however, only three months later, much of that decline has been recovered. This serves as a prime example of the benefits of sticking with a long-term investment philosophy, process and playbook and taking advantage of opportunities as they arise. However, when we look toward the near-term outlook for equities, we believe that it can charitably be described as “opaque”. Given the sharp rise in equities in the second quarter, depending on the shape of the recovery in earnings, valuations can conservatively be described as “elevated”. Other challenges that the equity markets will have to overcome are the coming tide of small business failures and bad loans in the banking system, sharply lower margins in many industries, the sharply rising new cases of COVID-19 in many U.S. states and a host of emerging markets, and significantly higher levels of unemployment which will undoubtedly suppress consumer demand in the coming quarters.

Capping off the challenges faced by the markets will be uncertainty around the outcome of the U.S. Federal election in November – the chief concern being that a Democrat-controlled White House and Senate could seek to reverse, or let expire, many of the corporate tax cuts enacted under the current administration. That being said, we have to be cognizant of the sheer vastness of liquidity that central banks have pumped into the markets. This has clearly calmed the credit markets, which in turn has reduced the volatility that we witnessed in the equity markets in the first quarter. Also, job losses globally, while staggering in number, have been less than originally feared and have recovered faster than expected. Emergency fiscal measures enacted by many central governments have also served to dampen the impact on those individuals and businesses directly impacted by public health restrictions. Finally, public health officials and citizens in Canada, Europe and Asia have made solid progress in reducing the rate of new infections of COVID-19, and there are several promising vaccine candidates rapidly progressing through clinical trials.

Over the longer term, a big debate is emerging over the prospects for higher inflation. Over the short term, the reduced capacity utilisation, weak demand and depressed input costs will encourage disinflation and perhaps even outright deflation. But there is a school of thought that over time, a greatly expanded money supply will ultimately increase the velocity of money, and that, when combined with lower labour force participation, greater tariff barriers and rising demand will eventually lead to accelerating inflation. That, in turn, could have an impact on so-called “risk free” interest rates. While better growth and higher inflation would be a boon to many of the stocks that fall under the banner of “Value” investing – financials, energy, materials – it would likely serve as a headwind to long duration, “Growth” equities such as non-dividend paying, high multiple tech  stocks. Not wanting to minimise the very real human toll (physical, emotional and financial) extracted by the COVID-19 pandemic, we would encourage our investors and partners to look past the nearterm uncertainty, stick to their playbook. We believe that our philosophy of investing in highly cash-generative, financially strong companies that pay a growing dividend has served our investors well for many years, and will continue to pay dividends (excuse the pun) well into the future.

Cardinal Capital Management Ltd.

Contributed by Cardinal Capital Management Ltd.

Markets have continued to recover in the second quarter with the S&P 500 flirting with breakeven levels year to date while the TSX is in mild correction territory, down around 7.5%. So why have markets rebounded so strongly? The biggest factor has been government stimulus efforts, which are now approaching $10 trillion globally. The U.S. and Canada hit unemployment peaks of 14.1% and 13.7% in May but recovered quickly to 11.1% and 12.3% as of June. We expect continued employment gains over the next few months, which should set the stage for GDP to begin recovering in the third quarter. The challenge for the global economy is that while the economy has reopened, daily new Covid cases have nearly doubled relative to April and May levels. The economy will probably not achieve a full recovery until there is a vaccine or effective treatment for the virus.

Oil has rebounded sharply from the incredible subzero prices that were reached on April 20th and is now trading in the $40 range. Although demand has rebounded, it remains 8 million barrels per day lower than last year; the largest demand decline in history. This decline has been offset by OPEC cuts and a sharp drop in global production from major companies. The Canadian dollar, as well as most other currencies, has rallied against the U.S. dollar since last quarter. The Loonie reached it’s low of $0.69 on March 23 at the market bottom, which is typical as investors dump risky assets for the liquidity of the greenback. We think the Canadian dollar should continue to rally to the high $0.70’s as markets recover.

Mawer Investment Management Ltd.

Contributed by Mawer Investment Management Ltd.

Following the market’s plunge into bear territory and ultimate low on March 23, the second quarter of 2020 saw an exuberant rebound. Many governments began to reduce COVID-19 restrictions and investors appear to be betting heavily that economies will recover quickly from the coronavirus crisis, fuelled by zero interest rates and abundant monetary and fiscal stimulus.

The economic backdrop remains admittedly murky, and the path toward a full re-opening of the economy is still unclear. But ultimately, in the tug-of-war between the virus, stimulus, and economic fundamentals, optimism ultimately prevailed in Q2.