What are we thinking?
What is our investment process?
At JCIC we combine a top down view of the economy and the macro environment with bottom-up stock selection.
Our top-down view includes an assessment of global economies, relative attractiveness of different asset classes (cash, fixed income, equities) and geographies (Canada, US, International). Return objectives and risk tolerance are also key.
Our bottom-up stock selection is primarily driven by fundamental analysis. Stocks will primarily be mid to large capitalization dividend-paying companies. Portfolio construction will focus on risk adjusted returns and consider the balance between defensives, cyclical, growth, and interest rate sensitive securities. Emphasis is on protecting client's wealth.
What are we looking for in a company?
Our fundamental analysis of a company includes making an assessment on the company's business visibility, free cash flow generation, growth, management team track record, competitive positioning, industry fundamentals, return on equity, balance sheet strength, shareholder remuneration and ESG/SDG. We also overlay valuation, potential risk/reward and estimates of revenue and earnings expectations and revisions.
What is our outlook on the economy?
Growth in the first half of 2020 has seen a significant negative impact as COVID-19 spread globally with government mandated lock downs and social distancing affecting consumer behavior, travel, manufacturing, and the global supply chain. The impact depth has been substantial with the shape of the recovery hard to predict, but central banks have taken decisive action to support the economy and provide liquidity in the financial system.
Prior to the COVID-19 spread, the US economy was improving with strong wages, low unemployment, and a healthy consumer. However, U.S. economic momentum has weakened dramatically to slow the spread of COVID-19. The U.S. government has aggressively lowered interest rates, relaunched quantitative easing and has provided a significant stimulus package to consumers and businesses. While the negative impact to the economy is significant with an evolving path of recovery, supporting factors include a healthy financial system and significant government stimulus.
Canadian economic growth has been hurt from attempting to slow the virus spread as well. Canada will be hurt by the additional shock of weak oil prices, which cannot be offset by co-ordinated production cuts, as the global demand destruction outweighs any such cuts. We expect economic improvement in the second half of the year after significant weakness in the first half of the year.
European growth in the first half of the year has been quite negative with the lock down of numerous countries. Europe is also more exposed to the export market where demand has been weak. As the virus infections peak, we expect an economic rebound supported by domestic demand, fiscal policy expansion, lower rates, and quantitative easing.
Chinese GDP growth has seen a very significant negative impact from COVID-19 in Q1/2020 with a bottoming process in Q2/2020. Infections appear to be under control, but sporadic breakouts linger. Over 90% of manufacturing plants have resumed operations while lockdown measures have been gradually lifted. However, a cautious consumer and a weak global economy is a headwind to China’s growth in H2/2020.
The Bank of Japan continues to maintain loose monetary policy and has launched a large stimulus package, but GDP will be negative for the year.
In response to weaker global growth, central banks have lowered interest rates, while governments are launching major fiscal policy expansion to help support global growth.
JCIC Portfolio Model Asset Allocation Benchmarks
JCIC client portfolios are managed within four models and on two platforms with the asset allocations/benchmarks as follows:
Equity Model - 5% Cash/T-bills, 0%Fixed Income/FTSE Bond Universe, 40% Canadian Equities/TSX, 40% U.S. Equities/S&P 500, 15% International Equities/EAFE Index
Growth Model - 5% Cash/T-bills, 25% Fixed Income/FTSE Bond Universe, 30% Canadian Equities/TSX, 30% U.S. Equities/S&P 500, 10% International Equities/EAFE Index
Balanced Model - 5% Cash/T-bills, 35% Fixed Income/FTSE Bond Universe, 25% Canadian Equities, 25% U.S. Equities/S&P 500, 10% International Equities/EAFE
Income Model - 10% Cash/T-bills, 45% Fixed Income/FTSE, 30% Canadian Equities, 10% U.S. Equities/S&P 500/S&P 500, 5% International Equities/EAFE.
All models are available in a separately managed segregated portfolio platform while the Equity and Balanced Models are also available in pooled fund format for smaller accounts.
We vary the actual portfolio asset weightings depending on which asset classes look to provide better value over the course of the following 12 months.
With the current backdrop, we have a defensive position within asset allocation and are market weight equities, underweight fixed income, and overweight cash. Within equities, we are skewed to defensive companies, but have taken opportunities in underperforming stocks which have improving incremental trends. Within fixed income our duration is slightly lower than our benchmark and we are overweight corporate bond exposure, where see we better potential upside than government bonds. During the market correction, we took the opportunity to buy higher quality companies, as the market sell down was very broad based. Equity markets have recovered a significant portion of the weakness seen in February and March and the market seems to be discounting a stronger recovery in earnings. We have taken some opportunities to reduce cash and increase equities where we see earnings expectations bottoming, as the economy recovers.
What is our fixed income view?
Within the fixed income segment, we are 10% cash and 28% fixed income. The fixed income market performed better in 2019 and YTD2020 than we expected as bond yields declined to very low levels due to slowing growth concerns. However, from a long-term perspective the outlook for strong fixed income returns is unlikely. We remain overweight cash and underweight bonds and have a duration modestly shorter than benchmark. Our corporate bond exposure is about 53% of fixed income which is above benchmark weight of 28%. We believe corporate bonds are a better opportunity than government bonds given current level of credit spreads.
What is our view on equities?
We are market weight equities as compared to our benchmark weights but with a defensive positioning. The outlook for equities will be driven by progress on controlling the spread of COVID-19, the launch of a COVID-19 vaccine and treatment, the US presidential election outcome, visibility on earnings growth going forward and the economic recovery. Defensive equities have performed better than businesses most affected by COVID-19, but we have seen some rotation into the most negatively impacted COVID-19 stocks as a bottoming of expectations have become more visible. We are maintaining are more defensive posture but have taken the recent market correction as an opportunity to improve the quality of companies with equities. While the equity market has recovered a significant portion of its decline seen in February and March, we are of the view that current valuation reflects a stronger earnings recovery than we anticipate at this time but have been shifting the portfolio to be more balanced from our highly defensive positioning.
What is our view on the trade war?
One of the long-term concerns in the market is a global trade war. The US first started with import duties on steel and aluminum from all foreign countries. The US has threatened tariffs on imported goods from Europe, Japan, China, Canada, and Mexico. Currently the US has reached a deal with Mexico, Canada, South Korea, a mini deal with Japan and has agreed to continued talks with the EU. The US has implemented tariffs on most Chinese goods. However, noise and threats over trade talks still flair up between the US and Europe, Japan, and Mexico at times.
With China and the US, the Phase One trade deal had been signed in January which included some tariff reductions on some goods and significant Chinese purchases of US goods. That said, most tariffs put on Chinese goods remain in place. Success of the Phase One trade deal is not clear due to COVID-19 impacts and increased tensions between the two countries. This makes a Phase two deal highly uncertain. Significant hurdles would remain in a phase two deal involving IP protection, enforcement, regulation, and the cutting of the trade deficit. A global trade war will not be good for any economy and is not good for equity markets. We believe US-China relations will remain strained for the foreseeable future as China's economic trajectory moves towards matching the US by GDP size by 2030.
What do we expect of the equity markets going forward?
The market will be volatile with both positive and negative factors to consider. Investors are weighing the risk of rising COVID-19 cases, elevated political tensions, elevated market valuation with weak earnings against rebounding economic data, neutral to defensive investor positioning, extraordinary levels of fiscal and monetary policy, low interest rates, cheap cost of capital and a bottoming of earnings expectations in some segments. Equity markets corrected in February and March but have since rebounded and year-to-date are down much less than the drop we have seen in earnings expectations. As a result, valuation has expanded. We believe this reflects global central banks injecting a significant amount of liquidity into the financial system, expansion of fiscal policy, the restarting of quantitative easing, economic data showing a bottom from extremely depressed levels and very importantly very low interest rates and cheap cost of capital. However, the leadership in the equity market recovery has been narrow rather than broad based. Mega-cap companies with strong market positioning, secular tailwinds and highly resilient earnings or even COVID-19 winners have driven performance. The median stock market performance has been weaker making the equity market index performance somewhat misleading. In addition, the US market has outperformed other global markets with its high exposure to information technology stocks (offering secular growth, COVID-19 resistant earnings and high return on equity) and other industry disruptive companies. While the equity market looks to be discounting a strong earnings recovery that we do not have good visibility of, the move is more concentrated in a smaller group of mega-caps rather than the broader market. Once the economic recovery is on firmer footing, we would expect a rotation into the most beaten up parts of the market as the earnings outlook and valuation prove more compelling. Performance going forward will be a function of the containment of the Coronavirus, the launch of a vaccine and treatment, US presidential election outcome, earnings delivery, and recovery of global growth expectations.
What sectors are we favouring or avoiding?
We have been moving more towards a balanced approach within our sector exposures. Within Canada we cut our exposure to the most cyclical areas including materials (ex-gold) and energy producers early in the year while increasing our defensive exposure including gold, pipelines, and infrastructure. Defensive sectors remain less attractive from a valuation perspective but offer higher visibility and better earnings estimate momentum. Within the US, we are positioned well with companies that are beneficiaries of long-term secular trends and who are leaders within their segment. Within our international equity exposure, we have significant defensive exposure and reduced weights to companies that will be more affected by the Coronavirus. Our mix between defensive and non-defensive sectors will depend on valuation, visibility, and the earnings outlook.
What is our view on the Coronavirus impact?
The Corona virus started to spread in early December 2019 in Wuhan, China. It became more of a global public concern in mid-January. While economic fundamentals appeared to be stabilizing, it is still a challenge to gauge the magnitude and duration the Coronavirus will have on growth. The number of cases and deaths are not consistent globally. Some countries demonstrated containment; some countries did not contain the virus well and continue to see high levels of spread while other countries which did show good containment after lock down have been seeing a second wave of infections. In China, the rate of new infections peaked in late January/early February and have been reduced to low levels. As such, over 90% of manufacturing facilities are open and restaurants and shops have been reopening. However, the Chinese consumer has been slow to recover due to job loss, fear of job loss, and behaviour consistent with the fear of the second wave of infections. This recovery has been slow but has showed steady improvement. In addition, while manufacturing facilities are open again, demand globally is weak and is depressing export orders.
As the virus seems to be controlled within China, it spread globally to the rest of Asia, Europe, the USA, and Latin America. Currently the USA, India and Brazil remain COVID-19 hot spots. Numerous countries locked down activity, restricting travel and encouraging social distancing. Asian countries such as China, Taiwan and Korea seem to have done a better job on flattening the infection curve vs. rapid growth in the US. The impact to EPS and GDP has been very negative with a bottoming seen during Q2. However the shape of the recovery (V, L, W, U, square-root, Nike Swoosh shape) remains unclear with indications showing that a sharp V-shaped recovery in the economy is happening initially but turning into a square root before a full recovery has taken place. Other countries have not shown a V-shaped recovery but are showing slow and steady progress from depressed levels.
What do we view financial markets under a Biden Presidency?
The US Presidential Election will be taking place on November 3rd. Currently polls are showing Biden at 49% of the vote while Trump trails at 43% but has been regaining some upside momentum. Betting odds are putting Biden at a 56% probability of winning and Trump at 44%. The election could cause some short-term market disruption as some of Biden's economic policies appear to be anti-Wall Street and a proponent of greater wealth distribution. Biden plans to roll back some of Trumps corporate tax cuts which would see a 21% tax rate increase to 28% and additional taxes for companies making over $100mln. in net income. Taxes for the wealthy individuals who earn more than $400,000 per year would see increased taxes. There is risk he will increase capital gains taxes as well. Biden is looking to increase spending on infrastructure and clean energy related investments which requires $2 trillion over four years. Biden's plan could see minimum wage rise to $15/hour by 2026 versus the current $7.25/hour rate. This is over 100% increase over 5 years which is well above inflation and would cripple some small businesses. Overall Biden's plan could see increased taxes to corporations and wealthy individuals, significant wage increases for lower end workers and massive spending on infrastructure and clean energy. What could this mean for the equity markets? The earnings impact of the corporate tax rate would hurt S&P 500 earnings by mid to high single digits. The equity market does not seem to be discounting this risk, especially as Trump's polling numbers are improving and COVID-19 figures are incrementally improving. In addition, the market may be anticipating that Biden will not be able to implement the tax increases and wage increases initially given the economy is depressed and needs stimulus rather than tightening. Infrastructure spending would also help the economy and some sub-sectors. Lastly, interest rates and bond yields are very low today which argues for higher equity market valuation with lower discount rates and little returns expected to be generated within fixed income. The US dollar has been weak which could help support US exports and US multinational companies with significant foreign revenues and profit. At first glance a Biden Presidency would be negative for equity markets. However, there are several mitigating factors that should reduce the overall impact.
What is our ESG and SDG policy?
ESG (Environmental, Social and Governance) and SDG (UN's Sustainable Development Goals) has become an increasing focus of investor agendas. While JCIC does not have devoted ESG or SDG mandates, we do incorporate ESG and SDG factors within our investment process. Among a number of investment criteria, we will assess a company's positive or negative standards within the areas of Environment (e.g. carbon emissions, energy consumption, water intensity), Social (e.g. labour conditions, gender diversity, data security), and Governance (e.g. CEO/Chairman separation, bribery, compensation metrics). Certainly, the companies we invest in can rank high and low across different areas of ESG. However, companies that rank low across all areas are likely to be excluded within our select securities list.
The UN's Sustainable Development Goals include 17 goals which are 1. no poverty; 2. zero hunger; 3. good health and well being; 4. quality education; 5. gender equality; 6. clean water and sanitation; 7. affordable and clean energy; 8. decent work and economic growth; 9. industry innovation and infrastructure; 10. reduced inequalities; 11. sustainable cities and communities; 12. responsible consumption and production; 13. climate action; 14. life below water; 15. life on land; 16. peace and justice strong institutions; and 17. partnerships for the goals. SDG has gotten much less attention than ESG, but attention has been growing rapidly within corporate strategies and sustainability goals. Along with ESG, we will assess a company's progress on SDG.
What is our FX Policy?
At this point we do not hedge our foreign exchange exposure. The greatest foreign exchange exposure is to the US dollar, but we also have exposure to international stocks from Europe and Asia. We are currently looking into adding FX hedging capability for our pooled funds.
What is our view on the Canadian Dollar?
The Canadian dollar started the year at $1.30 USD/CAD and got as weak as $1.45 in March when there was maximum pessimism on energy prices, commodity prices and the economic outlook. It quickly rebounded from those oversold levels to $1.39-1.42 range until late May.
Since late May the Canadian dollar has strengthened to $1.34 due to a few factors. First is the positive risk backdrop. There has been some bottoming of data (or better than expected) and an improved outlook on COVID-19 lock down measures being lifted (excluding parts of the US). WTI oil prices have also risen at the same time, reaching $39/bbl. recently from -$37 on April 20th. A third factor is a general weakness in the USD against all currencies due to improved risk backdrop. The challenge is that the market seems to be pricing in a recovery that is optimistic. There is risk that this rally fades unless the recovery is rapid.
Looking farther out, if the economy improves coming out of lock downs and COVID-19 easing, this should be positive for commodity prices and allow for some modest appreciation of the CAD. However, the move should be limited as interest rates should remain low and the Canadian consumer remains highly in debt.
Current FX price is $1.34. The forward curve is at $1.34 for the next two years. Then $1.35 in 2023-2024. The forward curve only reflects interest rate differentials.
Analyst forecast is $1.32 in Q4, $1.31 in Q1/21, $1.30 in Q2/21, $1.29 in 2021, $1.29 in 2022.