The Calm Before the Storm?

Is the Storm upon us? In mid March we sent out a market commentary with our analysis of the market situation at the time, and our outlook going forward. The biggest story at the time was obviously the Covid-19 situation, but there were a couple of other factors at play, such as profit taking and the ‘oil war’. We had anticipated that there would be some continued downward pressure in the 2nd quarter, which there has been, and anticipated that things would start to look more positive in the 3rd and 4th quarter.

Since our last commentary, we’ve seen an overall bounce-back from mid-March, which saw markets plummet as much as 40% or so. Several markets around the world have recouped much of their losses, with the U.S. leading the way – many still have quite a way to go, however. It seems that a big chunk of the gains since our lows in March in the U.S. have been from the tech side of things, but there hasn’t been as much momentum in other sectors. This has been more of a ‘tech rally’, as opposed to an overall ‘market rally’. It seems like that downward pressure has continued in most global economies as the world still works to combat the virus. Much of what we had anticipated had come to fruition, with things like stimulus packages being announced, forms of quantitative easing, rate cuts, etc…, all helping to move the markets up.

That being said, in the last 4 months there have been multiple events that have caused us to update our outlook and our recommendations going forward.

2nd Wave & Lockdowns

In March, there was virtually no talk or indication about a ‘2nd wave’ of the virus coming. That is understandable, as the ‘1st wave’ had just started and the world was still learning about the virus and how to deal with it. Over the last couple of months, we’ve heard increased talks about the ‘2nd wave’ that is said to be coming some time in the fall. If this does happen, it would likely cause a ‘2nd wave’ of lockdowns to be implemented. Over the last couple of months, we’ve seen cities/provinces/states/countries gradually re-opening their economies and people trying to get back to somewhat of a ‘normal’ life. Going back into lockdowns, which we see as probable if a 2nd wave does hit, would be devastating for already fragile economies, and by extension, the markets. Recessionary fears, which we’ve already heard talk about, would likely become a reality.

There are certain jurisdictions who still have substantial limitations on how and when they can ‘open their economies’, and a 2nd wave would essentially extend those existing lockdowns, or cause even more restrictions. Unemployment would likely go through the roof (again) and a good chunk of the population would be under a tremendous amount of pressure, financially (and psychologically).

Social Unrest

Unless you’ve completely unplugged from all media/society, we’ve all heard about and seen the protests and riots – mostly in the U.S., but also in Canada to some extent. The killing of George Floyd caused major backlash against police and by extension, the government, and we’ve seen essentially 2 months straight massive social unrest in multiple cities, specifically in the U.S. Although there have been peaceful protests, that has largely been overshadowed by the violent riots that have, and continue to take place in multiple cities around the country. Calls for defunding and abolishing police departments altogether have caused police in some jurisdictions to be target of scrutiny, harassment and violence. Many officers have even walked off the job citing little or no support from their municipalities – conversely, crime such as violence/murder/theft in those cities has skyrocketed and it doesn’t look like it’s getting any better at the moment. Rioters have also essentially shut down entire sections of cities and have caused massive amounts of damage, violence and looting. Businesses are suffering and those local economies are feeling the hurt.

We anticipate many of the social unrest to continue, and potentially even intensify, leading up to the elections. Not only does this directly impact local businesses/economies, it also creates a huge amount of risk when it comes to the spread of Covid-19. The resulting violence and destruction also causes law enforcement and health care to be drastically overwhelmed, which can exponentially increase all problems mentioned above. Not only will there be a hefty bill for cities/municipalities in regards to cleaning up the mess and repairing damages caused by the protests/riots, but there will likely be legal action taken against local and state officials by local residents and businesses for lack of response, and in come cases, encouraging/condoning the mayhem. These things would have further downward pressure on local economies, and by extension, the markets.

Government Debt

This should come as no surprise to anybody. Governments have been piling up massive amounts of debt due to stimulus packages and other benefits provided to both its citizens as well as businesses. Spending even before Covid-19 was worrisome, but the exponential increase in new spending added has gone out of control. Canada’s debt rating recently was downgraded by one of the major rating agencies and that may not be the end of it. At some point, the bill has to be paid, and no doubt it will be a situation of ‘The Tax Man Cometh’. The inevitable outcome is that taxes will rise for all – the federal government is already looking at certain mechanisms to generate additional revenue, such as implementing a capital gains tax on primary residence, increasing the capital gains inclusion rate on investments (from 50% to 75% or more) and adding an inheritance tax. All these mechanisms will have adverse effects on Canadians and their ability to save and spend, causing further downward pressure on the economy.

Unless governments get their spending under control, which seems unlikely at this point, we are in for a whole bunch of hurt. It would likely take years to actually get into some sort of surplus (which mostly would have to come from spending cuts) and decades to get the debt under control. At this point, having Cash is definitely King.

Foreign Affairs

There are multiple foreign issues currently at play here, a couple of which have been carrying over for the last few of years. Among the most dominant issues currently from a global perspective is the ongoing dispute between the U.S. and China. The trade dispute has been going on for a while, but it seems to have progressed into espionage/security issues and even the blame game on the Covid-19 virus. Tensions have been increasing with each country demanding the other to close one of their consulates – the U.S. ordering China to close its consulate in Houston, and China ordering the U.S. to close its consulate in Chengdu, China. This past weekend President Trump had also issued an order to TikTok (the social media platform that allows for the creation and sharing of videos/content) to sell its U.S. operations, again citing ‘security’ concerns of the app feeding information back to the Chinese government – other softwares such as Zoom have also been under scrutiny for similar issues. The power struggle between the 2 countries doesn’t seem like it’s going away any time soon, and it will likely put some more pressure on the stock market, as things continue to intensify.

At the risk of getting too political, there are other major issues happening within the U.S. itself – some more at the forefront than others. The obvious one is the ongoing issue with Jeffrey Epstein (who had a very mysterious death last year) and Ghislaine Maxwell – who had recently been taken into custody by the FBI. Although the plot somewhat seems like a Hollywood movie, the outcome of this can have drastic consequences for the entire U.S. political system, as there is suspicion that multiple top level U.S. politicians, both current and previous, may have been involved in some very dirty business. Time will tell, but many fear the testimony of, and information provided by, Ghislaine Maxwell may expose many top level officials and open a can of worms into the dealings of some of these individuals.

Another issue that is somewhat lurking in the background is the Hillary Clinton e-mail scandal. Although many thought this was over and done with, it has continued to move forward, with Clinton being ordered by a judge to appear in court and testify at a deposition in relation to her use of a private email server, while she was working as the Secretary of State from 2009 to 2013. The timing of this testimony is vital, as it is in September, just 2 months before the election. Depending on what is said in the testimony, it may implicate former and current top level politicians, which will throw a wrench into the entire election landscape. Markets would likely react negatively, as generally they don’t like uncertainty and mayhem, especially right before an election.

Our Outlook & Recommendations

As you may have guessed, we are being very cautious, at least for the short term, as there seems to be too much risk on the horizon. Although there will always be uncertainty in the markets, it seems in our current environment there are too many things going on at the same time which have caused risk to skyrocket.

We know it is almost impossible to time the markets accurately (when to get in and when to get out), but this may be a time to sit on the sidelines and just let things play out. We are recommending to most of our clients to take a defensive position – this would mean either moving into a very conservative portfolio or just straight into cash. Being in a low risk conservative portfolio would still mean exposure to the market – this would allow you to participate somewhat in market gains, if there are any, but would also expose you to losses if the market went down. Going into cash would mean that your principal is maintained and there is no upside or downside capture of the markets. At this point, cash would be the most secure.

We generally are not fans of trying to time the market, but if looking at the ‘cost-benefit analysis’, we feel, at this point, the ‘cost’ (risk) is too great for the potential ‘benefit’ (returns) that would be had by staying in the markets. We feel that being defensive until at least the elections are over – more likely into the new year – is the reasonable action to take right now.

In order to make the changes, please reach out and you will be guided on what to do next.

As the situation progresses and evolves, if there are other factors that come into play that cause us to shift our outlook, you will be kept informed.

For any other questions or concerns, please do not hesitate to reach out.