Market Update - July 2020

While I hope your portfolio is not a major focus during these perfect mid-summer days, rest assured that your investments are doing just fine!

For the month of July the TSX index in Canada finished up +4.5%, while in the US, the S&P 500 Index was up +5.6%. The S&P 500 is now just -1.4% below the February peak, astounding really, when you consider where we were just 4 months ago…

The stock market continues to be supported by a rebound in economic activity and positive advances in medical research against Covid-19. But the most important factor in the recovery has been the extremely supportive monetary environment (low interest rates and plenty of government money being handed out)! Real interest rates (the rate of interest you receive, less inflation) are at their lowest levels in over 7 decades. Central banks seem to be favouring negative real interest rates, much like they did after the previous two world wars. This is tough on savers, who must choose between staying the course (but falling behind inflation) or investing in more risky areas such as stocks, real estate or even gold.

Is it careless then to jump into a market that is being driven up by monetary conditions, rather than by real economic growth? That depends on how long this recession lasts.

Retail sales numbers seem to suggest that the current economic downturn will be short lived (chart below), with sales now just -3.4% below their pre-Covid peak. This is a stark contrast to the 2008/2009 recession, where the recovery took three and a half years!

An upturn in economic activity is also happening globally (chart below), as manufacturing production indices in China, the Eurozone and the United States all returned to expansion territory (>50)

Nevertheless, this doesn’t mean we are out of the woods yet. Case in point: U.S. initial jobless claims remain higher than the peaks of the last 7 recessions and have plateaued in recent weeks (chart below).

Overall, we expect that a moderate (and bumpy) recovery in economic growth will continue over the coming months. Covid-19 outbreaks are likely to continue to emerge in different regions and at different times (as we witnessed in Florida in July, below), creating more uncertainty. Yet, we think that this is more likely to slow down the recovery, rather than impede its sustainability.

A re-run of the March chaos would be highly surprising, notably due to better management of the virus (more test, more protection of the population at risk, progress in medical research). And while the soaring case numbers may dominate the headlines, the mortality risk in the US does continue to decline (chart below).

If the worst of Covid-19 is behind us (and let’s all hope that it is!), our attention shifts to the next major global event – the US election in November. Could a change in the White House (or the status quo) throw equity markets off course? While, on average, the U.S. stock market has historically stalled in the 3 months leading up to an election (+0.5%), gains are generally observed over the following 12 months (+14.1% on average, chart below) after.

The above chart doesn’t differentiate between Republican or Democrat – and a closer look at history suggests that it is not the political affiliation of the new President, Senate, or House of Representatives that determines the market direction – it’s the economy!

Knowing that the Democrats plan to raise the corporate tax rate from 21% to 28% (it was 35% before the 2017 Trump tax reform), should we be concerned that current polling suggests a landslide victory for the Dems?

While company earnings will most certainly be negatively effected by a higher tax rate, the market hates uncertainty above all. A Biden administration would definitely be more stringent on business and the wealthy, but it would also be more predictable. In addition, the Democrats’ agenda also entails a sharp increase in spending – suggesting that fiscal stimulus may be even great than under the current administration.

Rest assured we will be paying very close attention to this and other global economic events in the coming months, as we continue to navigate through this very strange year.

As always, please feel free to reach out to any of our team members if you have specific questions about your portfolio.

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