This year has brought about the largest economic shock in modern history as well as the largest stimulus response in history. Cambridge Canadian Equity Fund began the year with a cyclical bias, but as the pandemic gained ground, we began reducing our investment in the energy sector and cyclical exposure. Thanks to an aggressive federal stimulus package for businesses and individuals, we have begun to see a significant risk rally in the markets. But while an economic recovery is beginning to be seen in the markets, we are still a long way from prior peaks we have seen in past years. We’re also seeing new and old market participants express a willingness for significant risk taking during this crisis, due mainly to the influx of monetary stimulus.
Going forward, COVID-19 will continue to impact the world, at least until we have herd immunity, or an effective treatment or vaccine has been discovered and put into production. In addition to the pandemic, we have an impending U.S. election on the horizon, which could bring the presumption of risk-free investing that could drive more irrational behaviour. In my opinion, this will not end well. Fiscal policy is the most aggressive we have seen. Deficits are the highest outside of war time. The amount of debt outstanding is at an all time high versus gross domestic product. And maybe, most importantly, the monetary policy leaders are more committed than ever to avoid market disruptions and bankruptcies. The Fed Put is in full force today and it seems across investors and asset classes behaviour has changed to reflect this belief. This markets may feel crazy now, but they could become crazier before this is over.
Some of you may be bullish (free money forever and the party is just beginning) and some may feel bearish (it’s all built on sand and will collapse). No matter which side you sit on today, the most important thing is to remember what game you are playing. It's fine to speculate on a melt up in asset prices, if you accept you are speculating. It’s fine to sit out the hand because you don’t like the fundamentals (beware the dreaded FOMO – fear of missing out). Either way, the most important thing for success from here is to remember which game you are playing.
Principal and Portfolio Manager
Area of Focus: Asset Allocation
A look back
This has been one of the most remarkable years in history. The economy and the market have experienced the most dramatic pull back since the great depression, only to stage one of the biggest comebacks in decades. Given the advanced stage of the latest economic expansion, we entered the year cautiously. The ensuing market sell-off validated our cautious positioning, only to prove us wrong just two short months later. Given the magnitude of the business interruption and layoffs, we maintained our conservative positioning. The markets reacted enthusiastically to the corresponding record level of monetary stimulus provided by central bankers around the world. While we are uncertain of the path toward economic normality, the markets have assumed the stimulus will have an immediate impact.
Given the uncertain nature of COVID-19 and the equally uncertain timing of a vaccine, we anticipate ongoing bouts of business interruption leading to greater market volatility. The market has recovered to pre-COVID-19 levels, in some cases exceeding those previous highs, thus it has likely priced in most of the good news coming from central banks efforts to maintain economic and market stability. We would anticipate that the new normal economic growth rate would be slower than historical precedent, not unlike the pace we witnessed after the 2008-09 recession. While the valuation spread between defensive and cyclical issues is approaching extreme levels, we would not advocate rushing headlong into cyclical shares, but perhaps a gradual blending of more economically sensitive business into a core portfolio. From an asset allocation perspective, we continue to adhere to a more conservative stock/bond blend.
Mr. Robert Swanson is associated with CI Global Investments Inc., a firm registered with the U.S. Securities and Exchange Commission and an affiliate of CI Investments Inc.
Principal and Portfolio Manager
Area of Focus: Canadian Equity
In the first half of 2020, the macroeconomic environment has been far more volatile than at any point in modern history. In Canada, while we have been spared from the worst from a casualty perspective given relatively aggressive containment measures versus our neighbours to the south, this has come at a material economic cost. Decisive action from policy makers has prevented the Canadian (and the global) economy from seizing up; however, this is not a long-term solution and it comes at a cost - delayed financial pressure. Enabling mortgage deferrals does not lower the burden, it postpones it. Recent government programs (such as the Canadian Emergency Response Benefit (CERB)) are very expensive. When these costs are combined with lower gross domestic product, the impact to government debt balances is material. In the short-term this is very manageable, but in the long-term, these costs are significant. While these programs have prevented the system from collapsing, there are other issues, including fraud and misaligned incentives (for example, there are employers who cannot find staff because the CERB supplement provides a higher income than some jobs). Time will tell if this was the best course of action.
Given significant spikes in infections for countries that have been quick to reopen, a prudent approach to reopening could end up being the correct course of action. People discuss “pent up demand” but the real question is how things will look when we are beyond the honeymoon period. To what extent have individuals’ financial situations changed? How have people’s habits changed? What industries will return? As the sugar high from these programs and other support mechanisms wear off, and as the economic reality begins to sink in, we think it makes sense to remain prudent.
Throughout this period, we remained committed to our process and approach. By remaining consistent during the depths of the March lows, we held on ( and in some cases added) to companies we believed had limited downside and good upside opportunity. Acting emotionally would have meant selling at the low. Instead, we continue to stress-test businesses while also keeping an open mind to the upside. We are finding that while everyone was worried about risk in March, prices have recovered meaningfully. Instead of concern regarding fundamentals, investors seem to be more concerned with missing out. Our approach is therefore causing us to pull back.
Principal and Portfolio Manager
Area of Focus: Global Equity – Small/Mid-Cap
Within Cambridge Global Smaller Companies Fund, we came into March with about 5% cash. Having seen what happened in Asia in the first quarter of 2020, we swiftly responded by selling a couple of the holdings we believed would not be as resilient as we wanted during lockdown. We also sold about 1/3 of our U.S. software holdings as they had been very strong relative performers and we were worried that expectations had gotten too high for the next six to 18 months. This gave us close to 15% cash to deploy into world class cash machines that had been undervalued through the significant correction in March. To date, we’re seeing the greatest opportunities in retailers with large and successful e-commerce platforms or those remaining open during lockdown (RH, Aritzia, Floor and Decor, Byggmax). Another focus area has been on European distributions of niche industrial products where they are supporting mission critical applications for their customers and this demand would remain resilient.
The key during these uncertain times was for the entire fund to avoid leverage and focus on high returns on invested capital with strong balance sheets in cash generative and fragmented industries. This is one of our core philosophies and has helped us protect and grow capital this year. From a macro perspective, we believe that any of the big beneficiaries from COVID-19 will find it more difficult to achieve growth in 2021, so we are ensuring we are reducing positions or selling ideas that we believe no longer have attractive long-term risk rewards.
One of the benefits of our small-cap focus is the size of the pond. With so many fish in the sea we see opportunities everywhere. However, the big risk that we remain focused on is leverage. There are many levered companies that earn low returns on capital. These will present issues in an uncertain economy and are poised to suffer earnings and cash flow growth headwinds when interest rates rise to non-critical levels.
On an internal note, our team conducted our first work-from-home on-boarding. We’ve welcomed Equity Analyst Alex Simotas to the team full-time after a very successful internship with us last summer. He will be covering Asia and has already hit the ground running.
Area of Focus: Global Equity – Large-Cap
COVID-19 led to different challenges and opportunities for nearly every company in the global equity portfolio. When the world changes so drastically we bring out our microscope and re-examine the fundamentals across every stock in the portfolio to ensure that the business model is not impaired and to see if there are potential opportunities. There were a few select instances, such as Melrose Industries in the U.K., that we believed were not prepared for the slowdown in the global economy and we sold out of this investment.
We have seen pockets of opportunities in the market where COVID-19 is temporarily disrupting profitable business models with durable competitive advantages. The healthcare industry is ripe with examples of businesses that provide innovative and life changing products for surgeries that were delayed due to COVID-19. Our research has identified Boston Scientific as one of these durable businesses with life-saving products that should see a strong rebound as governments around the world begin to ease restrictions on elective surgeries.
Fixed Income Portfolio Manager
Area of Focus: Fixed-Income
The global pandemic is far more than an economic event and our thoughts go out to all the families effected by COVID-19. We also thank all the front-line workers for their dedication and hope everyone is staying safe and healthy.
Global governments having to make the difficult decision to constrain business activities to contain the virus was a tremendous shock to the global economy. High leverage levels in the global economy entering 2020 made the economy even more vulnerable to this economic shock. Many economic indictors have fallen to levels never seen before, therefore strong and immediate central bank action was needed and provided.
Risk assets came roaring back after bottoming in late March as unprecedented liquidity was added by the central banks. It remains uncertain whether the strengthening market is a sign of presumed future growth or simply a liquidity rally. It’s hard not to credit a large portion of the rally to liquidity when the Fed is now a top five holder of more than ten very large exchange-traded funds.
Economic indicators have improved from very low levels, but we feel it is still unclear if a sustainable economic recovery has begun.
As such we remain very cautious about the corporate names in the fixed-income portfolios, both investment grade and high yield holdings. Fixed-income funds continue to be long duration, and with most of the duration risk now in U.S. treasuries, we have removed both British and German government bonds. We continue to feel Canadian Bank Preferred Shares offer great absolute and relative return opportunities; Cambridge Fixed Income Fund continues to hold these.
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Published August 13, 2020.