Barita Insights: Weekly Newsletter November 23, 2020

Analyst Insights

Over the last two weeks, we’ve witnessed markets display increasing uncertainty as several news and factors came to the fore. On Number 9th, the world was made aware of Pfizer and BioNTech‘s vaccine candidate which, at the time, boasted an efficacy rate of more than 90% based on the first interim efficacy analysis (the efficacy was subsequently increased to 95%). The vaccine came with the caveat of a very low-temperature requirement (around -75° Celsius) which created questions about its ease of distribution. Nonetheless, markets welcomed the positive news and, in response, for the first time since March, the 10-year treasury yield curve rose above the 0.90% mark. We also saw increased optimism as capital began to flow into value, small-cap, and cyclical stocks – all of which would be the primary beneficiaries of a more potent recovery.

Within that same week, however, new COVID-19 cases began rising exponentially across Europe and the US, resulting in stay-at-home orders and other measures being taken to control the second wave. This, of course, reminded investors that the pandemic was still “in-session” and the vaccine would (i) require months to be ready for large-scale distribution and (ii) enough persons would first need to be vaccinated to indeed quell the spread of the virus. Given this realization, capital flow again displayed a preference for “stay at home stocks” and sparked a rotation into companies that would benefit from more pandemic mitigating decisions.

Exactly one week after the Pfizer efficacy announcement, on November 16th, we received more positive news – Moderna, reported its vaccine candidate with an efficacy rate of 94.5% which, unlike the Pfizer drug, could be stored at normal refrigerator temperatures. Fast forward to the end of the week, however, and the S&P 500 declined week-over-week by -0.77%, the DJIA fell –0.73% while the Nasdaq rose 0.22%. Among these three most-watched US Market Indices, the Nasdaq has the highest technology company weighting, which indicates that over the last week, the market has fled back to safety (stay at home stocks) despite the Moderna news. This comes on the heels of school closures in the US, the lockdown of some states as COVID-19 cases worsen far beyond the first significant spike during July and August, implementation of curfew orders, amongst other mitigating steps.

In addition to the growing cases, the US Treasury Secretary, Steven Mnuchin, reported on Thursday, that the treasury would not allow the Federal Reserve to continue five of its corporate credit facilities once they expire in December. To date, these facilities have helped to create stability for markets since the Fed acts as a backstop and consistent support for the bond market by lending to corporations and buying corporate bonds in the secondary market. This kept prices elevated and rates subdued, which enabled many companies that needed it, to access capital cheaply and maintain liquidity. The importance of this cannot be overstated since it has been a key pillar that has supported the going concern of many companies whose balance sheets lacked the working capital to maintain operations in the face of decreased business activity.

In light of this change, the Federal reserve correctly stated the following, “The Federal Reserve would prefer that the full suite of emergency facilities established during the coronavirus pandemic continue to serve their important role as a backstop for our still-strained and vulnerable economy.” With the help of the Fed, markets have significantly reversed course from the extreme panic seen in March. As such, investor confidence has grown, and the demand for bonds has kept prices up. We can make a note of the high yield bond spread over the 10-year treasury which has narrowed from as much as 11% in March to just over 4% as of last week. Nonetheless, there is a precedence of what happens when accommodative economic support is stopped prematurely. If we go back to 2011 (two years after the Global Financial Crisis), the ECB tightened policy prematurely which resulted in their double-dip recession and taught the importance of maintaining an accommodative policy stance long enough for economic growth and recovery to be robust. At present, as the Fed alluded to, the economic backdrop remains far too fragile to remove these credit facilities.

Given these factors, portfolio positioning over the near to medium term should be weighted to benefit from near term capital rotation and medium- term eventualities (a vaccinated future). In the short-term, capital will favour assets that benefit from lockdowns so tech companies will continue to benefit, especially as we approach the peak winter season. That said a larger weighting to tech leading into the end of the year provides some exposure to companies that will continue to benefit from elevated new cases and a stay-at-home economy. As we enter the end of the year, the Fed’s inability to continue bond-buying may remove some confidence from the bond market, which typically leads capital into treasuries so front- running this migration has merits.

Finally, this leads us back to the beginning – the value, small-cap and cyclical stocks have, in aggregate, been the most beaten down by the surge in COVID cases. Consequently, many remain relatively cheap and will benefit significantly from the recovery once it becomes less murky. Therefore, taking a long position within the materials, industrials, financials, energy sectors, etc. allows one to benefit once the recovery really sets in.

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Written by Awah Muirhead, Senior Investment Strategy Analyst

Conclusions

Given these factors, portfolio positioning...

Given these factors, portfolio positioning over the near to medium term should be weighted to benefit from near term capital rotation and medium-term eventualities (a vaccinated future). In the short term, capital will favour assets that benefit from lockdowns so tech companies will continue to benefit, especially as we approach the peak winter season. That said a larger weighting to tech leading into the end of the year provides some exposure to companies that will continue to benefit from elevated new cases and a stay at home economy. As we enter the end of the year, the Fed’s inability to continue bond- buying may remove some confidence from the bond market, which typically leads capital into treasuries so front-running this migration has merits.

Finally, this leads us back to the beginning...

Finally, this leads us back to the beginning – the value, small-cap and cyclical stocks have, in aggregate, been the most beaten down by the surge in COVID cases. Consequently, many remain relatively cheap and will benefit significantly from the recovery once it becomes less murky. Therefore, taking a long position within the materials, industrials, financials, energy sectors, etc. allows one to benefit once the recovery really sets in.

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