Thoughts on the Market: March Edition
It’s never priced in…
Equity markets suffered one of their sharpest drawdowns in history during the month of March as the expansion of the Coronavirus through the Western Hemisphere led to extreme social distancing and a sharp decline in demand.
Current expectations are for a gradual re-opening of the economy in late May/June, although the situation presents numerous uncertainties. Key for equity markets is the containment of the virus, either through increased testing, improved treatment options or an expedient vaccine. This would allow business activity to increase and foster a rebound in employment. During this gap in demand, governments have committed an extraordinary amount of money to support businesses and out-of-work employees.
We believe the drawdown in equity markets was overdone and were frankly surprised at the reaction as many strong companies should see a swift recovery back to previous levels of profitability once the virus subsides. The outbreak in China six weeks earlier presented a roadmap for a North American outbreak. There is a good probability that the “strong” will emerge stronger as some weaker competitors fail to survive.
As shown in Figure 1 below, event-driven selloffs usually rebound quicker than cyclical or structural-driven bear markets. The technology sector continues to show relative strength, and we believe health care and retail spending will rebound quickly. Travel and tourism, on the other hand, may take additional time to recover.
Damage in the oil market presented a second challenge to equity returns as the Saudi Regime locked horns with Russia over cuts in output in what could be a protracted battle. Current prices at some trading hubs are close to US$10/bbl. As Canada and the U.S. have increased oil production over the past two decades, the impact of lower prices creates additional recessionary pressures on cities and industries exposed to oil production.
The Coronavirus is undoubtedly a shock to the economy and will create transient issues through 2020. It now rests on governments to manage the testing and containment of the virus and support affected industries. South Korea and Japan have proven this is possible. Moreover, the former head of the FDA has provided a very clear public road map.
As to our portfolios, we will stick with our discipline, which has served us well for over 40 years and will continue to invest for the long-term and focus on companies that are growing faster than the economy. We have used the recent market volatility to upgrade our portfolios as opportunities have arisen and will continue to do so. As we manage our portfolios for the long- term we look to consistently outperform over 3-5 years. We look forward to healthier times.
GLOBAL EQUITY GROWTH FUND
During the month, the MWG Global Equity Growth Fund fell -14.5% versus our benchmark return of -10.6%. Year- to- date performance stands at -21.8%.
We took advantage of the weakness in shares of Starbucks to purchase a 3% starter position. We believe Starbucks is a high-quality holding, with one of the best brands in the world as it scores highly among all demographics (including Gen-Z). The company is seeing a recovery in China as its economy re-opens and is benefitting from its numerous drive-through locations in North America. Its balance sheet is well-capitalized, with US$3B in cash, providing a comfortable cushion for 2020.
To fund the purchase, we sold our stakes in Constellation Brands and Eli Lilly. Although alcoholic beverage sales at the register could see strength, Constellation’s sales through the bar/restaurant channel could be impacted by prolonged hospitality disruptions. As well, its acquisition of a minority stake in Canopy Growth continues to confound, even more so in hindsight. Ely Lilly shares were near our target price and we saw better opportunities in names that were impacted by COVID-19.
We also increased our target weightings in Alphabet, Microsoft, Facebook, Amazon, Netflix and Intuitive Surgical while reducing our target weightings in Gilead, BMW, Alliance Data Systems, IBM, Royal Caribbean, Spin Master and Stelco.
INCOME GROWTH FUND
During the month, the MWG Income Growth Fund fell -28.2% versus a decline of 15.4% in its benchmark. Unfortunately, the Income Growth Fund was impacted on several fronts. Energy-related companies, which represented 17% of the fund at year-end 2019, were impacted by the global energy shock. Similarly, real estate and aerospace companies were negatively affected by social distancing directives. We expect that ETF selling also played a role. We are diligently assessing opportunities created by these dislocations.
Our only new purchase was an investment in Summit Industrial REIT, a previous holding, with industrial properties across Canada and a very strong management team. We believe there are many other beaten down REITs that should see valuations normalize with a recovery in business activity and are actively looking for new opportunities.
To fund the purchase, as well as some model weight increases, we sold our positions in Choice Properties, a REIT with a Loblaws-concentrated customer base, and Cardinal Energy, a Canadian oil producer.
We increased our model weighting for BP, Broadcom, AT&T, Enbridge, Bank of Nova Scotia, Medical Facilities, TD Bank, Capital Power, Chorus Aviation and Pro REIT. We also reduced our model weight in IBM, Chemtrade, High Arctic, Intertape Polymer, Alaris and American Hotels.