Q4 2020 Market Review
ECONOMIC COMMENTARY
Global equity markets recorded strong gains during the fourth quarter. Specifically, the MSCI All Countries World Index[1], S&P 500 Index and S&P/TSX Composite Index advanced 13.48%, 12.01% and 8.97%, respectively. The principal catalyst came from the announcement by Pfizer and BioNtech SE that their vaccine candidate had demonstrated evidence of efficacy against COVID-19 in a Phase 3 clinical study on November 9, 2020. In contrast, the US presidential election and the chaotic weeks that followed had a minimal impact. Admittedly, pollsters correctly anticipated the results this time around, which partly explained the lack of surprise. Financial markets were delivered further positive news on Christmas Eve when the United Kingdom and the European Union signed the EU-UK Trade and Cooperation Agreement, thereby averting a worse case scenario no-deal Brexit and lifting markets further while putting an end to a seemingly never-ending saga.
Not only did the vaccine development news give an additional upward impulse to the financial markets, it also had an impact on the type of stocks that appreciated the most. Since the beginning of the pandemic, cyclical stocks had been significantly lagging the market, but saw their fortune improve in the 4th quarter. For instance, the MSCI All Countries World Value Index recorded a gain of 15.73% or 3.18% better than the 12.55% gain posted by the MSCI All Countries World Growth Index. It is worth noting, however, that for the calendar year 2020, the MSCI All Countries World Value Index was modestly down and trailed its growth counterpart by 34.99%.
On the fixed income side, the prospect for post Covid-19 reflationary deflationary environment led the riskiest segments to outperform noticeably government bonds. To this point, the ICE Bank of America Merrill Lynch Global High Yield & Emerging Markets Index and the ICE Bank of America Merrill Lynch Global Corporate Bond Index appreciated by 6.09% and 2.62%, respectively. In contrast, the ICE Bank of America Merrill Lynch Global Government Bond Index recorded a modest loss of -0.01%. We highlight that all it took for this index to turn negative was an increase of barely 0.20% in the yield of 10-year US government bonds. We further underline that even after that increase, the yield to maturity of the ICE Bank of America Merrill Lynch Global Government Bond Index at the end of 2020 was a meager 0.28%. With that in mind, we continue to believe that government and quasi-government bonds provide little compensation in light of the risk they face should rates increase even modestly.
Commodities as proxied by the S&P GSCI Index posted a return of 14.49% during the quarter led by industrial metals and crude oil while precious metals improved only modestly. In fact, commodity-related equities such as copper miners and oil & gas equipment and service providers outperformed the sub-sectors like hotels, casinos and cruise line operators who were the most hurt by the shutdowns. Notwithstanding recent performance, we believe that commodities and commodity-related equities provide indirect inflation protection benefits and remain significantly under-owned. Furthermore, the new U.S. administration has been promising large infrastructure programs. This should continue to support the sector. We are exploring solutions that could provide exposure to the space.
THE MANY LIVES OF BITCOIN
A recent survey[2] indicated that Bitcoin had become the most crowded position amongst participants. Indeed, Bitcoin’s price appreciated in excess of 500% in 2020, including an increase of nearly 200% during the quarter. As a result, many observers are calling Bitcoin and other cryptocurrencies like Ethereum a bubble. What is unique about Bitcoin is that unlike all other major bubbles in recent history like Japanese stocks in the late 1980s, internet stocks in early 2000 and US housing in late 2008, Bitcoin survived two drawdowns of more than 50% before recovering to new highs relatively quickly. The others didn’t recover after bursting the first time.
Bitcoin is viewed by advocates as a hedge against what is seen as a debasement of government issued currencies. Because the quantity of Bitcoin is programmed to grow asymptotically towards a finite number, the argument is that since its supply is finite, it is bound to appreciate, especially now that it is gaining acceptance from investors who were previously skeptical. That may very well be true. But as far as currencies go, Bitcoin does not meet some of the basic criteria necessary to make it valuable, i.e. acceptability as a means of exchange in transactions for goods and services and price stability. Additionally, while Bitcoin’s ultimate supply is finite, we should not underestimate human ingenuity and dismiss the possibility that more cryptocurrencies will be created and gain market share.
We do not know what comes next for Bitcoin but history reminds us that it is highly improbable for an asset to appreciate exponentially over a relatively short period of time without experiencing a significant correction at one point. We also note that Bitcoin’s recent price trajectory has closely followed that of other market segments whose valuation is derived from the expectation of an exceptional outcome in the far distant future, like electric vehicle start-ups or operators of online logistic platforms which are praised by a new generation of investors who may not know yet the difference between investing and gambling.
At Patrimonica, we choose not to gamble. In fact, the last quarter’s surge in the most speculative growth stories has convinced us to start de-emphasizing such exposures in discretionarily managed portfolios and to start rotating into more relatively unloved, less fashionable value strategies. At the same time, as speculative flows are predominantly crowding large cap US stocks, we are starting to favor non-US (including emerging markets) and small capitalization stories, first through passively managed mandates but soon through actively managed strategies too.
[1] Index returns refer to the net total return series in local currency terms, unless specified otherwise.
[2] Bank of America Merrill Lynch Fund Manager Survey, December 2020