Making sense of the markets this week: March 15, 2021

Each week, Cut the Crap Investing founder Dale Roberts shares financial headlines and offers context for Canadian investors.

It’s been a year since the stock markets crashed

In March 2020, the longest-ever U.S. stock market bull market ended. And its comeback since then has been nothing short of astounding. 

We experienced the quickest, most violent stock market correction, followed by a tremendous recovery that also set speed records. The tale of the tape says it took just 126 trading days to fall some 35% and to then execute a full recovery. That is, the stock markets got back to where they were, near all-time highs. 

U.S. markets then went on to still greater all time highs in 2020, and continue to do so in 2021. 

Canadian and international markets followed the same general trends, though it took longer to get back to all-time highs. The chart below is courtesy of portfoliovisualizer.com.

Here is a very good summary of where we’ve been in the last year, from the often controversial Michael Santoli. From that post… 

“The collapse reset the clock on the economic cycle and policy stances. From 2019 into 2020 Wall Street was caught in a late-cycle vigil, with the economy near peak employment, the Treasury yield curve flat, corporate profit margins near peak, earnings projected to be flat.”

Essentially, the markets appeared to be tapped out in late 2019. They enjoyed a long run and were perhaps a bit tired. It is quite strange and more than tragic that a pandemic was just what the markets needed. It was a reset button. 

And the markets found another wall of worry to climb: 

The black swan

The first big lesson might be that of the black swan—that is, a rare (like a black swan) event that comes out of nowhere. No one could have predicted that we would experience the first modern-day pandemic, nor that it would devastate the global economy and so many lives. 

The greatest risks are often the risks that are nowhere in sight. That’s why we always have to be prepared for severe stock market corrections, and a change in economic cycles. 

A depression? Stagflation? Sure, that could happen. 

Existing trends were accelerated

During the pandemic, many existing trends were accelerated. For example, tech stocks became defensive stocks during the stock market correction. Due to lockdowns, our dependence on technology and technology-enabled communications took centre stage. 

The stock market recovery was led by these stay-at-home stocks, which included technology giants. Other sectors that joined in were consumer discretionary, some consumer staples (remember the hoarded toilet paper and household cleaners?) and healthcare. 

Fellow MoneySense columnist Jonathan Chevreau looked at stay-at-home ETFs and stocks. You’ll see that those COVID-19 stocks went on quite a run, even into 2021. 

It was in early November 2020 that I had the pleasure to write on the success of the Pfizer vaccine trials. It was then that we gained a glimmer of hope. We started to look to the other side of the pandemic. 

That post outlined, to November 2020, the performance of sectors that benefitted from that work-from-home and stay-at-home economy. I also made this column’s first mention of the potential for the great stock rotation (which we discuss next).

The great stock rotation

Now that we are eyeing the other side of the pandemic, we can see that rotation out of work-from-home to recovery stocks and sectors. In fact, the tech stocks recently moved into a bear market. (We’ll look at that event in this column’s next topic.) 

Recovery stocks are now, well, recovering. They had been hit hard, and they represented a considerable amount of potential value for investors. 

If you look at the one-month and year-to-date columns in the following table, you’ll see that stock sector rotation at work. 

Energy and financial services are leading the charge in 2021. Communications services have been a steady contributor throughout the year. 

Today’s stock market was ready for the pandemic

Traditional index-based, cap-weighted stock market ETFs were well-positioned heading into the pandemic. (Again, a pandemic no one knew was coming.) 

And that makes perfect sense in an environment where existing trends are accelerated. A cap-weighted index rewards positive momentum. As a stock or sector of stocks is performing well and is rewarded with higher stock prices, they have a greater weighting within the total stock index. Tech stocks were already doing well heading into the pandemic, with the largest weighting in the S&P 500. 

Those U.S. tech stocks did most of the heavy lifting in the stock market recovery. 

In Canada, Shopify carried the Canadian stock markets at times and became the most valuable company in Canada. Shopify was already a top stock with a generous weighting in the TSX Composite. Given the weighting, Canadian investors benefitted greatly from the incredible success of Shopify, which was accelerated by the pandemic. 

An investor certainly could have profited by shifting or tilting the portfolio toward stay-at-home stocks and then recovery stocks. To my eye, they were obvious trends to predict. But that might be a dangerous “game” for many. And we’ll leave that to experienced investors. 

The core index stock ETFs delivered and they continue to perform. If you look at the one-year sector returns, you see most sectors are doing very well. 

Go figure, you’re holding stay-at-home and recovery stocks. The index is covering the bases. 

Why are tech stocks selling off?

So, while the stock markets can get it right, they can also get it wrong. They can get a little too excited. They can get over their skis, goes the expression. And that may have been the case recently with U.S. tech stocks, and even Shopify in Canada. 

There was too much enthusiasm and investors drove the stocks to incredibly high prices. So much so that the P/E ratios simply did not make sense for many investors. In fact, U.S. tech stocks even moved into bear market territory this week. 

Shopify has fallen by more than 30%. (Back on Feb. 19, I questioned the stock’s valuation. Oops, sorry about that, Shopify shareholders.) 

From that CNN Business post… 

“Apple (AAPL) shares are down more than 18% from their January high. Amazon’s stock is off 12% from a recent peak in early February. And chipmaker Nvidia (NVDA) has seen its shares plunge 24% since the middle of last month.

“What’s happening: Tech companies are getting hammered by the recent sell-off in markets. Many stocks in the sector have entered a correction, logging declines of at least 10% from their recent peaks. Nvidia, falling more than 20%, is in bear-market territory.

“The tech-heavy Nasdaq Composite joined the correction club on Monday, finishing the trading session 10.5% below the record it notched in mid-February.”

From The New York Times, here’s a very good post that explains the valuations of stocks and markets and the CAPE ratio that is a cyclically-adjusted price to earnings measure. 

The stock market-makers likely fear another lost decade for U.S. stocks caused by a run-up in tech stocks that dominated the S&P 500 weighting. The result was the stock market correction known as the dot-com bust. I think it’s a healthy event if the tech stocks come back to earth. They can then grow into their valuations. 

Keep in mind that tech is still where they keep the growth. The long-term trends are still in force. We simply don’t want to overpay for that growth potential. 

The market move to stocks with more current earnings is a much needed reset. Recently, Royal Bank of Canada reclaimed the title from Shopify as the most valuable company in the TSX Composite. Once again, earnings and dividends trump growth and growth prospects. 

Economic statement from Canada

The Bank of Canada has kept its key interest rate target on hold at 0.25%, saying economic conditions still require it even if things are going better than anticipated.

In a statement released this week, the central bank says it expects economic growth in the first quarter to be positive. In January, they predicted an economic contraction to kick off 2021. 

The bank says its key policy rate will stay at 0.25% until the economy recovers and inflation is back at its 2% comfort zone, which the bank doesn’t see happening until 2023. 

There is still considerable slack in the economy. The labour market is a long way from recovery, with employment still well below pre-pandemic levels. As we’ve covered in this space on a few occasions, it is low-wage workers, younger workers and women who have been hit the hardest financially by the pandemic. 

The wild card? COVID-19 variants that might derail any economic opening. Those variants are racing against our effort to vaccinate the public to some level of herd immunity or protection. 

A market risk might be the commitment to these lower rates that are fuelling the housing boom and bubble that we are experiencing in Canada, especially in major cities. 

The Bank of Canada is scheduled to release its updated economic outlook in late April as part of its quarterly monetary policy report. 

Canadian stocks continue to fly

Canadian stocks have greatly underperformed U.S. stocks, and that dates from 2009, during the recovery from stock market crash caused by the Great Financial Crisis. 

But now Canadian stocks continue to charge back on the strength of potentially offering more value during the recovery. And the Canadian stock market is benefitting from the over-weighting to financials that might gain from a rising-rate environment. Add in the oil and gas stocks, and gold and other commodities that are benefitting from inflation fears, and we get conditions that set up well for Canadian stocks. (In last week’s column, we touched on inflation and assets that might perform well.) 

Canadian stocks are outperforming U.S. stocks, with gains year-to-date that double up on U.S. stocks, using the TSX Composite and S&P 500 as benchmarks. 

This can be an opportunity for rebalancing and shoring up any portfolio holes. We know that Canadians have a terrible home bias—that is, too great a weighting in Canadian stocks and Canadian bonds. If the outperformance in Canadian stocks continues, you might use that as an opportunity to sell the Canucks to add to your holdings of U.S. and other developed or developing markets, REITS, or shore up on the risk side with bonds and commodities. You might even take a position in bitcoin. 

If you manage your own stock or stock and ETF portfolio you might take advantage of this long-awaited opportunity. 

As the Beatles sang over 50 years ago, in 1967, “I’m fixing a hole where the rain gets in.” 

Dale Roberts is a proponent of low-fee investing who blogs at cutthecrapinvesting.com. Find him on Twitter @67Dodge. 

About Dale Roberts

Dale Roberts is a former investment advisor and proponent of low-fee investing. He created the Cut The Crap Investing blog in 2018. Find him on Twitter for market updates and commentary, every day.

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