To my clients:
It was an up week for North American stock markets with the Canadian TSX finishing up 2.4%; the U.S. Dow Jones Index finishing up 2.6%; and the U.S. S&P 500 finishing up 3.5%.
20.5 million U.S. jobs lost in April. A U.S. unemployment rate at 14.7%. 2.0 million Canadian jobs lost in April. An unemployment rate of 13.0%. A U.S. ISM Services Index reading of 41.8 – well into contractionary territory and the worst reading since the Great Financial Crisis. A U.S. manufacturing Index reading of 41.5 – also the worst reading since the Great Financial Crisis. I could go on, but let’s just acknowledge that economic data is horrendous…
... and it’s likely to get worse. The jobs data is generally compiled during the second week of the month. For April this was sometime around April 12th. There were likely very substantial job losses subsequent to April 12th that will be captured and reported in next month’s data.
But the stock market continues to recover strongly from the lows set on March 23rd. What’s going on here?
Well, as I wrote in a previous update, the stock market is a forward looking mechanism. Generally speaking it tries to anticipate what will happen 6 to 12 months in the future. The stock market is obviously projecting the “green shoots” of flattened COVID19 infection curves into a meaningful economic recovery.
But the stock market is not precise nor is it efficient. The market was still heading up into late February after community spread and asymptomatic transmission of COVID19 became apparent. I wrote about both of these developments in my weekly updates – including a “special” update - at the time. I reduced client equity (stock) weightings to underweight as a result of these two developments. But to reiterate, the stock market was in the final stages of continuing to trend up and was largely turning a blind eye to these developments. I think, similar to the blind eye the market was turning in late February, the market is likewise turning a blind eye to the very real challenges that will emerge over the coming weeks and months. I’d ask, what if:
- after a two to three week lag, we start to see infection rates rise as social distancing measures in the here and now are being are relaxed?
- in order to maintain a U.S. daily new infection rate of 25,000 – 30,000 (the persistent rate of the past month – one which has not materially declined on a national level), the economy cannot “re-open” more than 30 to 50% (in other words, social distancing requirements limit restaurant capacity, mall traffic, factory floor staffing etc.)?
- in spite of economic reopening, consumers limit their participation owing to concerns for their safety?
- a vaccine is not developed within the next 12 months (as many seem to hope but which would be far faster than has ever been done before)?
- similar to the flu, COVID19 mutates on an annual basis thereby reducing the effectiveness or utility of any vaccine developed?
- like AIDS or the common cold, a vaccine is never developed?
There are many other concerns, but to my way of thinking, the above are the more notable. Individually, any one of these could prove a material setback to economic and market expectations. Yet each has at least a credible chance of occurring.
But the market appears to be pricing in the likelihood of a relatively smooth return to normalcy. I’m sorry, try as I might to challenge my thinking, I just can’t assign a realistic probability of this occurring. As such, portfolios will remain underweight equities until such time as a more "rational" entry point is presented, OR, I can credibly "rationalize" the expected return to economic normalcy.
That’s it for this week. All the best and stay safe,
Nick Scholte, CIM, FCSI
Vice-President & Portfolio Manager
Scholte Wealth Management
RBC Dominion Securities Inc. │ Tel: 604.257.7569 │ Fax: 604.235.9950
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