A Mid-Summer’s Commentary
It has been a while since we’ve offered a comprehensive commentary. It’s not that nothing is happening, it has been more that little is changing, but that may change…
This past has been a week of investment updates with lots of new information about our current state as well as what the next year or so may hold. Regrettably, even though we are a Canadian investment firm, much of the investment research we receive is primarily U. S. centric. While the Canadian experience may not be exactly the same, we can, in many ways, extrapolate for Canada from what is transpiring south of our border. Here are some highlights: (Btw, if you are not all that into investment highlights … we understand … but, you may find the COVID vaccine facts and figures below of interest.)
It’s the Economy … Silly
Speeding More Slowly
Whereas, economic growth, as a natural part of a rebound / recovery, is currently above the expected long-term rate, the rate of growth will likely moderate in the near term, yet it is still expected to be at an above average rate of growth for some time to come.
Interest Rates Are so Low They are Negative!
Ultra-low interest rates, as indicated by government bond yields, and higher than normal inflation, has translated into real negative yields on “risk-free” securities.
Whereas inflation in Canada is currently running slightly above 3%.
The real (after-inflation) yields of U.S. government treasury bonds (%):
A loss of purchasing power for holders of said securities does cause investors to look elsewhere with their money; equities and real estate have been beneficiaries of this.
Bifurcated Market – What?
What does this mean? If you can remember back to the turn of the last century, we experienced a bifurcated market that was made up of technology and internet stocks and then everything else. When the tech bubble burst, much of the money that flowed out of tech found a home in banks, lifecos, utilities and more. ( The economic recession and market slump that followed 9 / 11 exacerbated the tech wreck of 2000 / 2001.) We appear to be facing something similar in that the forward P/E ratios of the top 10 companies in the S&P 500 are around 30x, whereas the combined forward PE of the remaining companies is a much more modest 18x, and leads us to believe there are still attractive investments available that don’t carry a high degree of valuation risk.
Will 2022 be the Year Things Change
At some point the trajectory for the economy will moderate, interest rates will likely begin to normalize, profit growth will do much the same, and countries will continue along their own paths to reopening, and perhaps achieve some lasting degree of normalcy.
Even When Things Are Good, We Can Still Get a Spoiler
Energy: Why is Gas so Expensive All of a Sudden?
Boy, in a matter of months we’ve witnessed the price of gasoline jump from well below $1 / litre to approaching $1.50 / litre in some places. What’s this all about?
A number of things have occurred in this domain since the pandemic set in. One is the increase in Canada of the carbon tax on April 1, 2021 which is levied on each litre of gasoline (from $0.066 to $0.088 /litre in Ontario –source: Canadian Taxpayers Federations, www.taxpayer.com )
However, the most significant reason is the price of a barrel of oil is now higher than it was pre-pandemic due to widespread production cuts and a sudden surge in demand as economies reopen.
COVID Update
Finally, we remain in the embrace of a global pandemic, but even that is changing with the broad distribution and administration of vaccines. Below is an interesting analysis by a colleague, with permission, who has a talent for number crunching and sourcing data:
“Obviously, we have seen a fair bit of delta talk over the past few weeks and I would in no way wish to downplay the concerns that the delta variant raises. That said- I do think it is important to dig into the numbers to get a better sense of what is really happening. For that, we are going to turn to the United Kingdom. Why the U.K.? The data from the U.K. is probably the best we have right now as it relates to COVID because 1) the population is highly vaccinated – so we get to see whether or not the vaccines are making a difference (in the U.K. it is primarily the AZN vaccine); 2) it a large sample set – unlike Israel, which is also highly vaccinated, the U.K. has a much larger population and thus it is a more robust data set to use; 3) it has been hit hard with delta and relatively earlier than other locales, so we can better draw some conclusions. With that in mind, let’s start with a chart and then comment:
Okay, right out of the gate, we can see that the second wave (the alpha variant also known as the U.K. strain), which occurred last summer, looks very similar to the third wave, which is occurring right now. Cases per 100k match pretty well; although, us until Day 50, the second wave was worse than the third wave. So, what can we conclude from this? We might conclude that either the vaccines are not helping all that much to prevent transmission of the virus or we might conclude that delta is simply much more transmissible than was alpha and even though it has a tougher road to spread because so many are now vaccinated (none were vaccinated during the alpha strain), it is still able to roughly match alpha as it is infecting a smaller pool, but at a much higher rate than was alpha. Okay, let’s now specifically focus on the second wave and add fatalities to the chart:
Okay, now we have added deaths per 10 million of population. As you can see, during the second wave, fatalities tracked cases at roughly a rate of 1%. That is, for every 100 cases of COVID, 1 person passed away during the second wave. Okay, now let’s do the same thing, but focus on the third wave:
Here’s where it gets really interesting. While, as we mentioned, the case counts from wave 2 to wave 3 look similar, the fatality rate looks dramatically different. Whereas the second wave saw the fatality rate stay at around 1%, the third wave has seen it hover around 0.1%. Put another way, for every 1,000 people that got COVID in the second wave, approximately 10 of them passed away, while during the third wave, only 1 of them has passed away. While the causality is not 100%, it is pretty clear that this dramatic drop in fatalities is largely a result of the vaccine’s effectiveness and the high rate of vaccination of the most vulnerable groups (the U.K. is at about 95% of seniors fully vaccinated). Let’s finish this thread with the obvious last chart:
At 50-days, deaths per 10mn are now down to below 6% of deaths per 10 million in the second wave. This should give us some comfort that while we may not move past COVID any time soon, we are at a point in which it is starting to resemble the seasonal flu at least in terms of the risks of causing death. It also should inform anyone who has not gotten vaccinated to go get ‘er done.
On the last point and before we move on, we recently ran across an article done by some mathematicians, which looked at the likelihood of herd immunity. An approximate formula for the level you would need to reach herd immunity is: (1-1/R-naught of the virus)/(the efficacy of the vaccine). Put into English, if we subtract the virility of the virus from 1 and divide by how well the vaccine works in preventing the virus, we get the % of the population we have to vaccinate to reach herd immunity.
For the original COVID strain, which was believed to have an R-naught of around 2.5, a vaccine that was 95% effective (roughly where the mRNA vaxes are) would have required a vaccination rate of ~63% to reach herd immunity. For the delta strain, which is believed to have an R-naught of around 6.5, the vaccines, which we now know are 95% effective, require a vaccination rate of ~89% to reach herd immunity. The former is achievable, the latter is likely not. Thus, the effectiveness of the vaccines in preventing severe cases becomes much more important their ability to prevent transmission.”
Until next time, please reach out via phone or email if you have any questions arising from the information above or regarding your own personal finances. Have a wonderful Summer!
All the best,
The Davidson Professional Wealth Management Team
RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. RBC Dominion Securities Inc. is a member company of RBC Wealth Management, a business segment of Royal Bank of Canada. ®Registered trademarks of Royal Bank of Canada. Used under licence. © RBC Dominion Securities Inc. 2016. All rights reserved.