Global Review (Q3 2020)
The COVID-19 whipsaw strikes again
The third quarter of 2020 sent global markets on yet another rollercoaster ride courtesy of the global pandemic. Initial optimism grew with the cautious reopening of businesses around the world, only to stall later in the quarter amid a resurgence in COVID-19.
While still extremely high, the U.S. unemployment rate dropped, as the American economy continued to improve despite rampant COVID-19 case growth. Meanwhile, European economic data worsened in Q3 as concerns increased over sharp infection rate acceleration in several countries, particularly France and Spain.
Emerging markets outperformed developed markets in the quarter, led by strong gains in countries which have largely curtailed COVID-19 infection rates and whose economies benefit from the strength in information technology demand: Taiwan, China, and South Korea.
COVID-19 continues to drive volatility, dragging on returns
The significant volatility and unpredictability of COVID-19, combined with an uneven path to a global pandemic recovery, have continued to weigh on risk-asset returns.
Year to date, as of Sept. 30, developed market equities were up 1.7% (in local returns), and Canadian equities declined 3.1%. Canadian benchmark 10-year government bond yields fell 1.14% to 0.56%. CDX high yield and investment grade credit spreads rose by 130bps and 14bps, respectively. The CBOE Volatility Index (VIX), which is used as a measure of the level of fear and expected volatility in the market, stood at 26 points. While this was still an elevated level compared to late 2019, it was a significant improvement from mid-March 2020, when the pandemic hit and VIX crossed the 80-point mark. The Canadian dollar fell 2.5% versus the U.S. dollar, to $0.751 from $0.770. Crude oil (WTI, near contract) slid to US$40.22 from US$61.06 on Dec. 31.
Pandemic sets the risk agenda
Virtually all of the risks facing investors for the balance of the year are linked to COVID-19.
First, as schools and businesses have reopened and the flu season arrives, the risk of a global second wave of infections remains high and is already coming to pass in parts of the world, leading to renewed lockdowns and restrictions. Virus prevention measures, advances in treatments and a proven, deliverable vaccine will be key to managing the economic impact of a winter infection wave.
Second, central banks and fiscal authorities around the world have gone to unprecedented lengths to mitigate solvency and liquidity risks in their respective markets. However, neither money nor policy firepower are in infinite supply. As a result, it’s possible that a premature withdrawal of monetary policy support or a political impasse over future fiscal stimulus could further depress economic activity along with deepening financial risks across many sectors of the economy.
Finally, political uncertainty ran high in the third quarter and continues to persist even now, with the U.S. presidential election concluded. The Democratic victory could lead to renewed fighting about the nature and size of the country’s COVID-19 response, usher a reversal of parts or all of the Trump administration’s tax cuts and lead to corporate regulatory reform. On a related note, the December deadline to negotiate the details of the UK Brexit withdrawal from the European Union is also fast approaching, which could stoke further uncertainty.
Low visibility calls for high caution
Our view that returns in major asset classes will likely be lower in the future has not changed. In fact, it’s clear the pandemic is compounding a number of long-term risks, from structural economic headwinds and monetary and fiscal policy exhaustion, to a compression of the illiquidity premium in private markets. The result is a low-visibility environment in which investors should focus on diversification and look to active management strategies to create value, while always remaining mindful of cost.
Regardless of whether COVID-19 vaccines are deployed tomorrow or six months from now, the pandemic has already created a long tail of severe impacts that could linger for years to come, even with the assumption of a strong economic recovery. As a result, we continue to urge investors to proceed cautiously and focus on the fundamentals.