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Skeptics will be confounded! - 2020 Year in Review

Quarterly review

Richard Morin

Update :
Update :
January 14, 2021

Against all expectations, and for the second year in a row, financial markets generated returns above their long-term average. After fees, a Canadian balanced portfolio generated approximately 8% return in 2020.

Driven by technology stocks, the U.S. stock market is up 18.4% (16.5% in CAD), despite the uncertainty and losses related to the pandemic. On our side of the border, weighed down by oil and resources, the Canadian stock market still managed to give a return of 5.6%.

Equally remarkable, Canadian bonds generated a return of 8.7%, thanks to a sharp drop in short and long-term interest rates. Not too shabby for an asset class that the "experts" were sending to purgatory at the beginning of the year. As Captain Bonhomme would say: the skeptics have been confounded!

Speculative bubble or rational behavior?

Year of all extremes, 2020 also saw oil traded - very briefly - at a negative price, a large bankrupt company (Hertz) climb in the stock market by more than 500% and a company that produced barely 500,000 cars (Tesla) valued more than the 9 largest manufacturers combined, yet producing 100 times more!

Asset classes Returns in $C
  4th quarter YTD
Bonds[1] 0,6% 8,7%
- Canadian women[2] 9,0% 5,6%
- Americans[3] 7,4% 16,5%
- International (EAEE)[4] 11,1% 6,1%
- Emerging markets[5] 14,4% 16,3%

No one predicted such returns. While we cannot predict market movements, we can try to explain them and draw lessons for portfolio management strategy and financial planning. Here, 2 visions oppose each other.

On the one hand, there are those who claim that the markets are in a speculative bubble: the NASDAQ 100 Index doubling in 2 years, the price/earnings ratio (P/E) at an all-time high, Bitcoin up 700% since its March 2020 low, and IPOs running amok. This bubble would be the result of ultra-accommodating monetary and fiscal policies: central banks are printing money and keeping interest rates extremely low, while governments are sending checks to individuals and companies to help them through the pandemic. Much of this money is saved rather than spent and is invested in the markets where - again according to the bubble proponents - it pushes prices to unsustainable levels in the long run.

Chart S&P 500 vs Nasdaq 100

Those who hold the other view explain the rise in NASDAQ prices and the attractiveness of IPOs by the potential for exponential earnings growth in technology and new economy companies. For them, the price/earnings ratio is at a reasonable level when adjusted for interest rates - the controversial Fed model to which Jerome Powell himself referred in December. In short, investors would accept lower future returns (a logical consequence of today's high prices), considering that the high returns of the last few decades are a thing of the past, given the aging population and slowing global economic growth. The fact that USD 18 trillion (18 trillion) of government bonds are trading at negative rates would support this view.

Regardless of who is right, it is reasonable to expect lower returns over the next few years. If this is indeed a speculative bubble - we will only know after the fact - it could continue to inflate for some time. The eventual return of the pendulum, however, would be abrupt and completely unpredictable. If it did, part of the returns of the last two years would be "put back on the table". Bonds would cushion the decline and there would be an opportunity to buy stocks at a discount when Archer systematically re-balances the portfolio.

If, on the other hand, current prices reflect the rational expectations of investors, then medium-term gains can be expected to be rather limited since future earnings growth is already factored into prices. You will have to be satisfied with the dividends on stocks and the meager interest on bonds. This would not jeopardize the achievement of your financial goals, as long as your plan is based on realistic assumptions.

Have the right plan and manage the risks

At the risk of repeating ourselves, we cannot "manage" the performance of a portfolio because we cannot predict market movements, while trying to beat them is a futile and costly exercise. We can, however, manage the risks that we expose ourselves to in the construction of the portfolio as well as in the development of our financial plan. This is what Archer is all about.

Happy New Year 2021!

Market Review

Canadian Equities: The Shopify Year

In order to understand the 5.6% return of the Canadian stock market in 2020, we must focus on two sectors: technology and energy. The technology sector contributed 8.3% (excluding dividends) to the return of the S&P/TSX Composite Index, while the energy sector subtracted over 4%.

S&P / TSX Composite S&P 500

(in USD)

Energy -30,8% -37,3%
Materials 19,5% 18,1%
Industrials 15,3% 9,0%
Consumer Discretionary 14,4% 32,1%
Consumer Staples 2,8% 7,6%
Healthcare (including cannabis) -23,6% 11,4%
Finance -2,9% -4,1%
Information Technology 80,3% 42,2%
Communication -8,3% 22,2%
Utilities 10,6% -2,8%

Shopify stock - up 178% - alone accounts for nearly all of the tech sector's 2020 performance.

As we pointed out in a previous letter, these two sectors are what differentiate the American and Canadian stock markets - the former having returned three times more than the latter in 2020. As a reminder, technology dominates the American stock market (27% of the index) while energy weighs less than 3%. In Canada, it is 10% technology and 11% energy, a world of difference.

However, we forget how much these sectoral weights vary according to the successes and failures of each sector. At the beginning of the year, technology weighed less than 6% of the Canadian stock market index, compared to 10% today. Twenty years ago, during the technology bubble, this sector represented 50% of the Canadian stock market, with one stock, Nortel, accounting for 35%. Let's hope that history does not repeat itself!

Oil and resource prices - particularly copper - have risen sharply since November, which could signal a swing back in favor of the Canadian stock market over the medium term.

S&P/TSX Composite Sector Weight Chart

U.S. stocks: the billionaires' club

A handful of U.S. companies are in the trillionaires' club (one trillion = one trillion): Apple ($2.2B), Microsoft ($1.6), Amazon ($1.5) and Alphabet/Google ($1.2). They could soon be joined by Tesla (800 billion) and Facebook (750). It is these and other new economy companies that explain the extraordinary rebound in the US stock market after the February/March plunge. U.S. stocks generated a 16.5% yield in CAD in 2020, including dividends.

Tesla's stock is a good example of the apparent changing of the guard in some sectors of the economy. How can an automaker be worth more than its 9 major competitors combined, who collectively produce 100 times more vehicles? The answer is that the market believes that Tesla is to cars what Apple is to phones. Like your iPhone, a Tesla car would be a "device" that sells you a multitude of content and services that generate revenue and profits for Elon Musk and his investors. Some are skeptical, but in the meantime, one thing is certain: its market capitalization gives Tesla virtually unlimited resources to develop its products, something none of its competitors can claim.

Good news: although Tesla's shares didn't enter the S&P500 until late 2020, our clients have been holding them since Archer launched in January 2017. That's because we invest in Vanguard's U.S. Total Market Index ETF, which holds the 3,500 largest stocks in the U.S. stock market.

The rise in long-term interest rates - which began with Joe Biden's victory in the U.S. presidency and accelerated with the Democratic takeover of the Senate (see the Bonds section) - could spell the end of the leadership of new economy stocks in the stock market. We will then be happy to hold our good old Canadian stocks.

International equities: the (long) decline of the British Empire

After years of drama and existential questioning, the British - led by the populist Boris Johnson - have finally completed the absurd project of withdrawal from the European Union, the Brexit. Absurd, at least that's what the financial markets think: for the past 5 years, the return on the British stock market (expressed in USD) is almost 10% lower annually than that of the world's stock markets (2.6% vs 12.2%). In 2020, the British stock market has suffered a 10.5% decline. Unfortunately, it seems that the decline of the British Empire is still not over.

However, other global stock markets did better, so overall they generated a 6.1% return (in CAD, including dividends).

Japan led the index, while European stock markets experienced mediocre or even negative returns. Only the rise of major foreign currencies - notably the Euro and Yen - against the Canadian dollar generated positive returns.

Emerging markets: Asia leads the way

The top 4 emerging markets by market capitalization (China, Taiwan, Korea, and India) contributed significantly to the index's performance in 2020. The remaining countries - including Brazil and Russia, which have been in the news for all the wrong reasons - made a negative or no contribution.

Overall, the index generated a return of 16.3% in 2020 (in CAD, including dividends).

China is now the world's second largest market with a capitalization of over USD 10 trillion. Its weight in global stock market indices - notably MSCI's All Country World Index - and consequently in Archer portfolios, however, is significantly lower due to the lack of transparency and limited access to its market for foreign investors. It is also for these reasons that it is referred to as an "emerging" rather than a "developed" market.

Moreover, strong economic growth is not reflected in China's historical stock market performance: its cumulative return since 2011 is about 60% (in USD) compared to 180% for the US stock market. This trend was reversed in 2020, when its return of over 30% is almost twice that of the US stock market.

Bonds: rates are rising

We started the year with an interest rate on Canadian bonds maturing in 10 years of 1.6% and ended it at 0.7%. This decrease in rates has led to an increase in the value of the bonds in our portfolios, so that the return for the year is 8.7%. Obviously, this is well above expectations and above the long-term average. We cannot anticipate such returns for bonds in the medium to long term.

In fact, long-term interest rates have already begun to rise in the United States following the election of Joe Biden as President. This rise accelerated in the early days of 2021 when the Democrats also took control of the Senate and thus the U.S. Congress. It is expected that this change of guard will lead to an increase in the fiscal deficit and an increase in the issuance of Treasury bonds to finance it. All of this causes a drop in the price of bonds already in circulation.

If the outlook for bond returns is poor, why do we keep them in the portfolio? Because they are our only insurance policy in the event of a major economic slowdown and/or stock market downturn.

1] FTSE TMX Canada UniverseXM Bond Index

2] S&P/TSX Capped Composite Index[3] S&P 500 Index

4] MSCI EAFE Index

5] MSCI Emerging Markets Investable Market Index