Keeping You Informed: Signature Update

Speakers
Eric Bushell, Chief Investment Officer
Jeff Elliott, PhD., Vice-President and Portfolio Manager1

The backdrop

  • The U.S. Federal Reserve’s interest rate cuts of summer 2019 were a classic example of the playbook successfully used to inflate markets. That action drove down volatility and compressed credit spreads, which had widened out in the tail end of 2018 and drove equity markets up as well.
  • With the yield curve flat, investors had little option in seeking higher rates of return but to pursue leveraged strategies. Right into the end of February, it felt like we were reaching a risk crescendo with markets hitting all-time highs.
  • In March, markets were rocked by the energy price collapse as the virus simultaneously accelerated through Europe and entered the U.S., having already gone through much of Asia.
  • A liquidity crisis happened first and morphed into a bit of a credit crunch, with stocks falling about 30%. Strong central bank intervention has helped to mitigate the first two problems effectively.
  • The economic crisis coming out of this is still ahead, and a lot remains unknown. Overall, however, we give high marks for the impressive government fiscal response to the crisis in terms of income supports and support for business in unprecedented circumstances.
  • We cannot return to normalization of our lives and our work, and the economy and markets, until we get a better grasp and control over the virus. This can only come through public health policy, and through innovation.

How we see the pandemic developing

  • We think we're pretty close to peak pessimism and peak panic regarding the virus, but it is likely that there will be some more bad news, particularly coming out of the U.S. But we're a bit more optimistic than you would expect based on what you are reading right now.
  • First, the virus is likely more widespread than people understand, and that's important because it means that more people have probably recovered than have been identified, and that the virus may not be as deadly as it appears based on headline numbers. Ultimately, the mortality rate could be lower than many models suggest. However, it is still serious because our health care systems can be overwhelmed and result in more deaths, as we are seeing in New York and Italy.
  • Secondly, physical distancing does work. We have seen its effectiveness in China, South Korea and to some extent in Europe to slow the spread of the virus. If continued it will allow for the development of both therapeutics that can make a difference and the ability to put testing infrastructure in place.
  • There have been mistakes, particularly with respect to testing at the early stages, but continental Europe seems to be reaching its peak of new cases. The U.K. is earlier in this process and the U.S. is even earlier, largely because they didn't impose physical distancing measures earlier. Canada implemented restrictions early and we are a bit further ahead.
  • Much of our thinking on this can be found in our blog post from March 27, COVID-19: Public Health Strategies and the Capital Markets. Once cases peak and countries gain some control over the spread, they can begin to selectively lift restrictions.
  • Although it is difficult to say how long the functional lockdown of the economy will last, with widespread testing and tracking of the virus there will also come a greater understanding that we can get through this and return somewhat to normal.

Is the policy response adequate?

  • As credit markets came under pressure with the economic shutdown, within the space of about two weeks, we saw an almost US$1 trillion quantitative easing (QE) program deployed by the Fed, and through the U.S. government fiscal response, the Fed was given a US$500 billion line that it can lever 10 times for an effective US$5 trillion in incremental capacity.
  • Our April 1 blog post, Policy Responses Bridge the Pandemic Crisis, outlines how changes to banking regulations following the 2008 Great Financial Crisis left credit markets vulnerable to a liquidity crunch, making the current central bank backstops to stabilize credit markets amid the coronavirus crisis inevitable.
  • Having supported markets though the 2008, the Fed was able to act quickly to backstop markets. Credit should go to former Fed chairman Ben Bernanke, and former U.S. Treasury Secretary Tim Geithner, for developing the programs which have been re-launched by Jay Powell.
  • Because we don't know the size and the duration of this downturn, there are a lot of questions such as, who gets to stand underneath that umbrella, and for how long? And with what conditions attached? Will it be enough?
  • I think it will be enough, but there will be exceptions to who can be sheltered. The ECB is committed to a €750 billion pandemic purchase program, which will provide a backstop to the fiscal plans in southern Europe. Likewise, municipalities and states in the U.S. that are losing their sales tax bases will be clamoring to receive shelter from the storm.
  • Emerging economies are very concerning. There will continue to be downgrades of certain governments that do not have the fiscal capacity to undertake quantitative easing. Some are suffering massive outflows from the capital markets, and they don't have the capacity to respond to the health challenge.
  • Will the non-investment grade market and the levered players who took more risks be given shelter? It's harder for governments to argue that they should show the same amount of sympathy. They're in for a challenge to restructure balance sheets and try to raise capital and use markets to do it.
  • We are moving from the historical world of monetary policy to a fiscal monetization, and a marriage of central banks and the treasurers in a fusion of policy. Expect the Fed balance sheet to surge from about US$4.5 trillion to maybe upwards of US$9-10 trillion. The same goes for the Bank of England, the Bank of Japan, the ECB, and even the Bank of Canada, which for the first time launched a QE program.

Signature’s portfolio positioning

  • At Signature, we recognize credit markets and banking systems are integrated, and they must be functioning well for us to own securities at the bottom of the capital structure, which is equity. As we grew more confident in the liquidity risk backstop, the more confident we became in deploying our cash into equities. We also gained confidence that the outbreak can be effectively managed through physical distancing and lockdown measures.
  • In Signature Global Income and Growth Fund, for example, we raised our equity weighting over 10% from around the 53% level, where we were at the outset, to 64% today. That was funded primarily from selling down our government bond positions, mainly U.S. Treasuries, from around 24% to about 11%.
  • Our exposure to investment-grade credit has not changed – it is still around 7%, but we will likely reduce our government bond positions further to rotate into investment grade, where we think spreads are quite attractive.
  • The portfolio remains underweight high-yield bonds at about 9% vs. a benchmark weight of 15% – we have been underweight since the beginning of the year.
  • We took our gold weight from 5% to 7%. Anytime we see rates trending to zero, we want to own some gold in case confidence in government as a counterparty begins to falter. Cash remains at around 2% as an operational buffer.
  • We came into the year underweight the Canadian dollar, and as the Canadian currency came under pressure, we bought Canadian dollars, and we are slightly overweight. The dollar is trading at about 70 cents U.S. right now, and we would buy on further weakness.
  • We are going through all our sector reviews and will also be doing some fine tuning in some of the different sub-sector weights, looking at companies that may be beneficiaries and some of the industries that will see big changes as a result of this crisis.
  • Our theme of deglobalization relative to the U.S.-China relationship and supply chain will take another step forward with this event and may take cost structures up as we near-source more product.
  • We see energy prices as below levels that make a sense for any of the producers globally, which is not something that can persist for very long.

Sources: Signature Global Asset Management and Bloomberg L.P. as at April 2, 2020.

1 Jeff Elliott has a PhD in molecular biology and biochemistry.

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Published April 8, 2020