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COVID-19: What it means this week

 

On a day when equity markets saw their largest drop since the 2008 financial crisis, Michael Gregory, Deputy Chief Economist, Ian Lyngen, Head of U.S. Rates Strategy, and Brian Belski, Chief Investment Strategist, all at BMO Capital Markets, hosted a client conference call to examine the impact of COVID-19. Belski opened the discussion by calling for calm. “Fears and headlines clearly outweigh facts and actualities,” he said.

Quoting from Sir Winston Churchill, Belski also said investors should “see the opportunity in every difficulty” and called for perspective, poise and process, three traits that the economists, strategists and analysts at BMO must utilize in times like these.

Economic Impact

While economists knew COVID-19 would be a major headwind for the United States and Canada, Gregory noted that it was still difficult to predict the public and policy responses. The most vulnerable sectors were going to be anything tied to travel and tourism or activities in which people gather in larger numbers, with the crest of the impact likely to occur during Q2.

Both Canada and the United States had a shaky start to the first quarter, the former due to labor and rail disruptions and the latter due to the suspension of Boeing 737 Max production, all of which dampened growth. Now, in addition to these challenges, there’s the impact of COVID-19. And, if that wasn’t enough, the collapse in oil prices owing to the failure of OPEC+ to extend its production cutback, at a time when the demand for oil is already dampened owing to COVID-19, is yet another challenge for both economies.

Gregory said that first quarter growth was just below 1 percent on both sides of the border, but that both countries would move into negative numbers in the second quarter, with the United States penciled in at 2 percent annualized reduction and Canada at 3.5 percent annualized reduction. He expects a rebound in the second half of the year, sufficient to propel the average pace for all of 2020 to about half a percentage point in Canada and 1 percent in the United States. Before the virus and oil prices became concerns, both countries were projected to expand around 1.75 percent.

Central banks have already stepped in once, providing a reduction of 50 basis points, and Gregory anticipates another 100 basis points reduction by both the Federal Reserve and the Bank of Canada in the next couple of meetings. A fiscal policy response is likely to come out of Ottawa, especially as the oil patch faces strong headwinds, however a response from Washington is less clear and will likely depend on how much of a slowdown in growth there is in the second quarter.

What does this mean? Sharply lower interest rates, fiscal stimulus, the potential for hefty U.S. household refinancing that frees up cash flow, and even prospective deals in the travel and tourism sector point toward an eventual pickup in activity as the second half of the year unfolds. But there’s lots of uncertainty right now (e.g., how severe and persistent will the COVID-19 outbreaks be, and how long will Saudi Arabia and Russia wage an oil price war).

Market Uncertainty

We’re at unprecedented levels in the market in terms of key near yields and 30-year yields, according to Lyngen. “Frankly, this does reflect investment ideas of investors that simply have no idea how to trade the market at this moment,” he said, “other than a classic flight quality.”

Lyngen agreed that quantitative easing was going to become a reality sooner rather than later. He also said there’s a very good probability that the front of the yield curve dips below zero, in terms of yields, but it’s very unlikely the Federal Reserve will dip below zero. Yes, the markets indicate that the Fed needs to be more aggressive, but that doesn’t translate to negative yields becoming a reality in the United States.

“There are moments in the market in which the price action in and of itself becomes somewhat self-fulfilling,” Lyngen said. “I'll make the argument that we're pretty close to one of those right now.”

As investors get used to these lower rates, it will recast how the market is valuing risk assets and it will recast expectations going forward, he explained. His baseline take is that as conditions worsen, due to COVID-19, we’re beginning to see several sectors experience the pressure that will lead to a more durable, lower rate environment for the foreseeable future.

Perspective, Poise, Process

In terms of perspective, no one has seen a situation like this in their 30 years of work. It’s important to remember that panic isn’t an investment strategy, Belski said. There’s been a real escalation in fear, with everyone becoming an expert in COVID-19 epidemiology, but he warned that facts are still not actualities, with the situation changing by the minute.

“We really do not advise clients to be changing their investment strategies, along with the headlines,” Belski said.

In terms of process, he advises clients to stick with those high quality assets from a growth perspective and from a dividend growth perspective. It seems like investors will continue to pay for stability, so BMO strategists believe dollar-denominated assets in terms of equities, fixed income, and the dollar itself will continue to be a home for investments, long term. It’s too early to call this a recession, so clients should be in touch with their relationship managers and stick to their process.

Stocks to Watch

Canadian energy stocks are still preferred over American energy, because Canadians have “more religion” in how they’re managed. Because financial stocks have been hammered, we prefer those larger companies with multi-divisional properties, said Belski.

From a sector standpoint, we believe communications services and technology are where consumers are spending their money, so we are overweight there, he said. In addition, the consumer discretionary sector is also overweight, because of the power we’re seeing in Western consumers, and some select industrial companies.

“We believe utilities in both the United States and Canada are at the most expensive levels we've seen in terms of our valuation models that go back multiple decades,” Belski said. Because they have not seen this for a long time, Belski said they would not be rushing in and overweighting utilities in portfolios at this time.

What to Expect in the Coming Months

Gregory believes we’re still weeks, if not months, away from the crest of increasing COVID-19 incidences, at which point the markets will find some equilibrium. The key, though, is the assumption that this is a limited outbreak. The net risk is of a wider outbreak that impacts the broader labor supply response. Gregory said that he thinks it will begin to smooth out in the second half of the year, but to expect a bumpy ride before we get there.


Conference Call Replay:

Toll-free dial-in number (Canada/US): 1-800-408-3053
International dial-in numbers: https://www.confsolutions.ca/ILT?oss=4P45R8004083053
Passcode: 8900622# 


Related Content:

Macro Horizons podcast, with Ian Lyngen: Breaking Down the Breakout

BMO Economics: Recent Releases

Brian BelskiPanic Is Not a Winning Investment Strategy and Epidemic of Fear

 

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Michael Gregory, CFA Managing Director, Deputy Chief Economist and Head of U.S. Economics
Ian Lyngen, CFA Managing Director, Head of U.S. Rates Strategy
Brian Belski Chief Investment Strategist



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