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Virus + Vaccine = Volatility. After surging and retreating in the spring and the summer, the Covid-19 pandemic has worsened in recent months but the approval of several very effective vaccines should allow life to mostly return to normal by the fall. The second quarter of 2020 suffered the most severe recession since World War II. Subsequently world economic activity surged to its best quarterly growth on record. The job market is still recovering and should continue to recover as vaccines are deployed. Stock market profits have turned a corner and are expected to continue to recover in 2021 but will not likely surpass their 2019 peak until 2022. Central Banks will remain accommodative with interest rates remaining at near historic lows for even longer.

Financial markets are looking past the pandemic and are instead focusing on the recovery; despite valuations that are well above historical averages. Investors have recognized that earnings are likely to grow quickly in the year ahead and support stock markets. Stock markets around the world surged in the fourth quarter, propelling performance to near record highs for the year, despite the cataclysmic rout earlier in the year. Emerging Markets and U.S. stocks lead the way gaining 17.1% and 16.8%, respectively in 2020 (all return figures in Canadian dollar terms). International stocks climbed 6.7%, which was closely followed by Canadian stocks ending up 5.6%. Bonds rose 8.7% for the year, well ahead of the weak 0.4% cash yielded.

Canada is expected to experience its largest recession on record in 2020 with GDP falling 5.7%. Although Canada’s economy rebounded strongly in the third quarter, a fresh surge of Covid-19 is hampering growth prospects in the near term. The public sector, as well as the professional, scientific, finance and insurance sectors were the largest contributors to third quarter. Conversely, accommodation and food service industries fell as rising virus cases prompted closures. The expectation is that a successful vaccine rollout will open the door for a potentially sharp rebound as Canada is expected to see 5% GDP growth in 2021 and 2022 growth of 5.2%. To overcome the worst impacts of the crises in 2020 the government increased the deficit from $39 billion to a $381 billion or about 20% of GDP. Interest rates are currently so low that currently only 7% of the Canadian government’s revenue went to pay interest costs on the federal debt versus 35% in the 1990s. Long periods of low rates allow the government room to invest in the economy which promotes growth.

The U.S. is expected to experience significant policy changes from President Biden. However, the Federal Reserve will continue to try to stimulate growth with the few remaining tools they have. U.S. economic growth is moderating as fiscal help fades and some workers whose jobs are permanently eliminated will face an especially tough recovery. Government support has resulted in fewer business bankruptcies relative to 2019. Vaccine approvals and rollout will likely accelerate an economic recovery and a relatively quick rebound is anticipated at the end of the tunnel.

For Europe it is two steps forward, one step back. Near term European growth outlook has darkened due to a resurgent Covid-19 outbreak. Major fiscal stimulus is greatly needed and on its way; but will not be widely disbursed until the second half of 2021. Still, it is a major step as it enables countries to borrow from financial markets by issuing bonds and directing support to the most hard-hit sectors.

In a turbulent year dominated by an unprecedented crisis, the continued uncertainty surrounding the pandemic certainly stands out. Financial markets are in a tug of war between near term downside and medium term upside. Recent developments from the U.S. election, new Covid-19 cases and vaccine news will exaggerate both upside and downside volatility. 2021 will be full of opportunities.

The Canadian economy, along with its global peers, navigated a difficult 2020 amid one the most severe health and economic crisis in decades. Covid-19 was initially found in a few Asian countries but quickly spread to the entire world within weeks and morphed into a global pandemic. Canada, like many countries, faced two stark choices: shut down most of the economy to save lives and plunge into a recession or keep business as usual and put thousands of lives at risk. Canada moved ahead with the first choice and, as expected, the first quarter saw one of the swiftest economic downturns on record. The response to ease the downturn was astonishing as Canada ramped up an aggressive fiscal package with billions of dollars of stimulus spending along with the Bank of Canada’s historic commitment for lower interest rates until the economy rebounds.

The recession in the first quarter was short-lived thanks to the armada of ammunition deployed in Canada. GDP responded very positively in the second and third quarters, although they were still far from pre-pandemic levels. The Canadian market experienced one of its most volatile sessions in generations initially with about a 21% decline in the first quarter but then had a remarkable rally by year-end. Investors who held their nerves recouped most of their losses as the Canadian main index, the S&P/TSX, ended the year with a decent 5.6% total return. While these returns are modest compared with its U.S. counterpart, (the S&P 500 had an impressive 18.6% total return in Canadian dollars), Canadian investors can find some solace given that expectations were already low during this challenging year.

The TSX clawed back its losses from the first quarter with positive returns in the last three quarters. In particular, the fourth quarter was strong with a 9% return after one of the largest momentum shifts on record in November. One sector in the headlines was Technology as many Canadians reverted to working and shopping from home. Not surprisingly, that sector has been on a tear, up an outstanding 54.6% for the year. The materials sector was the second best performer with 19.46% gain. Investors found some assurance in gold amid pandemic concerns. Consumer discretionary was also a great sector performer with a 15.95% gain as the lockdown saw Canadians switch to alternative physically distanced recreational activities usually found in the cyclical consumer goods sector. On the flip side, energy was the worst performer with 35.65% loss. The beleaguered sector, already under pressure in previous years, took another hit in 2020 with an unparalleled slump in global demand and supply, coupled with a price war between some major players. The second worst performing sector was paradoxically health care with a 21.29% loss. Though some individual names such as Trillium Therapeutic posted massive returns, losses in cannabis-related stocks, as well as in long-term care stocks weighed more on the overall health care sector. Noteworthy is the performance of financials which posted a modest 2.2% loss, which is far from the catastrophic result investors might have expected in this environment of mounting consumer debt and bankruptcies.

Financial history is familiar with a lot of cyclicality. About once a generation there are major events that erupt and set the tone for the future. More than a decade ago it was the 2008 global financial crisis which some analysts characterized as the “New Normal”. The current health crisis along with its devastating economic consequences will need its own characterization. Governments around the world and especially the Canadian government seem to have understood the enormity of the challenge and have responded strongly. Also, the announcement of an effective vaccine on November 9th has revived a lot of optimism. In the Canadian markets, the S&P/TSX has managed to stay positive in 2020 even though it was a very difficult year. The index, known for its value bias, saw a strong rally in the hard-hit value names in the last few months but there is still a lot of room for upside as the Canadian value benchmark remained behind its growth peer by more than 15% for the year.

The Canadian FTSE TMX Universe Bond Index gained 0.6% in the fourth quarter of 2020 and was up 8.7% for the year. The Bank of Canada maintained its key policy interest rate at 0.25% and reiterated its pledge to keep the rate at this level “until economic slack is absorbed so that the 2% inflation target is sustainably achieved” which, based on its latest economic projections, is not expected until 2023.

The central bank noted that the pandemic put a significant dent in Canada’s economic potential. In its recent quarterly Monetary Policy Report, the bank said that it does not expect the Canadian economy to return to full capacity until 2023 on the expectation that business investment will remain subdued and exports will only gradually recover. It sees inflation remaining well below its 2% target through 2022, essentially confirming the market’s expectations that rate increases will remain on hold until 2023. It said “Persistent scarring effects of the pandemic on the labour force, investment and the structure of the economy will lower potential output growth considerably.” The bank projected that Canada’s economy contracted by 5.7% but that is a substantial upgrade from its mid-year forecast of a 7.8% plunge. The key to this improvement was the rapid rebound in the third quarter as GDP expanded by 40.5% annualized. In level terms GDP was still 5.3% below it’s level in the fourth quarter of 2019.

The central bank’s Governor Tiff Macklem was fortunate to have a plan based on the 2008 crisis, only this time it was implemented more quickly. In a matter of weeks, new federal programs were set up to funnel hundreds of billions of stimulus dollars to Canadians, notably the Canada Emergency Response Benefit, the Canada Emergency Wage Subsidy and the Canada Emergency Business Account, which provided small-business loans. Looking back, it seems to have largely worked out. While some economic sectors are still suffering, mainly those that are service oriented, the S&P/TSX Composite Index is back to record highs and Canada’s banks have barely been hit. While there are numerous reasons to doubt that the bank would hike before the start of 2023, a strong recovery would contribute to upward pressure on bond yields and to the loonie so there is potential for Canada to start raising rates before central banks of other advanced economies.

The federal government projected a $381 billion budget deficit for 2020, which represents 20% of the country’s total output. The general government debt burden, which includes provincial and local debt, will rise to about 104% of GDP in 2020, up from 79% in 2019, and remain around that level until gradually declining over the medium term as the government winds down emergency spending. Since the Canadian dollar is among the world’s reserve currencies, Canada has the capacity to carry a larger debt burden without significantly affecting its debt rating. In July, Fitch Ratings downgraded Canada on concerns over the spike in spending, however other rating agencies have upheld Canada’s top credit rating. Moody’s Investors Service affirmed the Aaa rating with a stable outlook due to the country’s economic strength and policy effectiveness. Moody’s said historically low interest rates have helped mitigate the impact of the sharp rise in spending to counter the pandemic, which will produce the largest budget deficit since World War II.

The balance sheets of most households have certainly improved as compared with the first year of the 2008 recession. The household saving rate in Canada has jumped more than in most countries, hitting a record 28% in the second quarter and 15% in the third, five times the pre-pandemic rate. Canadian households are set to save an extra $200 billion in 2020 relative to 2019 and $50 billion more in the first half of 2021. Restrictions that limit spending could remain in place well into 2021 and could induce households to hold on to their money.

Rich world central banks are committed to keeping monetary policy extremely loose. Investors will buy new bond issues and roll over old ones if only for the lack of alternatives. One thing is sure, cheap money will help economies and firms endure this difficult period.

The Standard & Poor’s 500 index skyrocketed 12.1% in U.S. dollar terms over the fourth quarter. In Canadian dollar terms the index was up a healthy 7.6%. For the year the U.S. equity benchmark climbed 18.4% in U.S. dollar terms and was up 16.8% in Canadian dollars.

To say 2020 was a year unlike any other is an understatement but despite it all stocks closed out the year with solid gains led by the technology heavy Nasdaq Composite Index which notched its best annual performance since 2009. Within the broader S&P 500 index, health care shares outperformed and consumer discretionary shares were also strong buoyed by consumer spending and the addition of electric vehicle maker Tesla to the index. There now exists light at the end of the tunnel that did not exist before November 9th. Pfizer and then Moderna both announced vaccines with 95% efficacy propelling the S&P 500 to record highs on the days of the respective announcements. The bulk of the 2020 gains for the S&P 500 came during the fourth quarter despite the yearend haggling over the pandemic relief bill. By comparison, the Nasdaq index, which closed up more than 40% in 2020, benefited from a number of factors over the course of the year including a rapid shift to digital shopping, working from home and learning from home.

In the initial lockdown’s immediate aftermath the damage was indeed severe as U.S. GDP fell 5.0% in Q1 and 33.1% in Q2 on an annualized basis. In quarter over quarter terms, GDP fell by 10.1% from Q4 2019’s high to the end of Q2 2020. That is the worst two quarter contraction in terms of magnitude since quarterly data begin in 1947 but it wasn’t on the Depression scale level. Q3 then saw an historic rebound as GDP leaped by a record 33% annualized pace as Americans spent more in September on goods and services, a fifth straight monthly increase that supported the economy. One key element that was noted early in the pandemic was the surprising double-digit level of consumer savings which was more than double the pre-crisis level. The high savings rate has and will enable consumers to spend more as Covid-19 subsides. It also had implications for the market as investors shifted assets away from money market funds and towards the stock market as confirmed by November’s record flows into all equity funds which totaled $127 billion, topping the previous monthly record set in January 2018 by $17 billion.

Looking forward there are some positives as the U.S. election has passed with a market-friendly outcome and we now have three Covid-19 vaccines in initial distribution. The Biden Administration’s success may depend on its ability to deal with Covid-19, climate change and China. The first order of business will center on Covid-19 test and trace initiatives, as well as vaccine distribution and logistics management. Bipartisan support is more likely to focus on infrastructure spending by revitalizing the country’s roads and bridges. President-elect Biden has consistently emphasized the importance of climate issues for his economic plans. Also, the U.S. policy for China is unlikely to change meaningfully, although the approach will. Biden is known to be a China hawk on both economic and humanitarian grounds. A key early decision he will face is what to do about billions of dollars in tariffs on Chinese producers. Rather than eliminate them wholesale, Biden’s team is likely to use them as leverage to accomplish other negotiated policy objectives.

The strength of the underlying economy is a credible explanation for the market’s surprising strength. The Institute for Supply Management said its manufacturing index rose to 60.7% in December marking the highest level in almost two and a half years. New orders, the most forward-looking component, jumped to its highest level in 17 years. New home sales, a big driver of the economy, have remained steady as ultra-low mortgage rates and a lack of properties for sale have spurred demand. Corporate America also appears to be getting ready for a stronger economy. While capital spending dropped 7% during the first six months of the year and stock buybacks fell by 20%, cash acquisitions rose 45%, research-and-development spending increased by 10%, and dividend payments rose by 7%. Cash spending by S&P 500 companies has held up much better than expected.

2020 was an extremely difficult year. For investment management decisions, there was no historical playbook to guide us given the global pandemic driven disruption. Last year began with optimism, ran straight into the fear, anxiety and isolation of a pandemic, then ended with the optimism of vaccines. The once in a century global pandemic triggered a month long cyclical bear market fuelling a preponderance of negativity leading to massive amounts of fiscal stimulus. The world’s economic recovery is expected to gain strength starting in mid-2021 as Covid-19 vaccines become more widely available.

Europe’s economic rebound in the third quarter was stellar. Then the bad news came. In the summer, investors were under the illusion that the pandemic beast had been tamed. Unfortunately, a devastating second wave has forced reluctant governments back into lockdowns and inflicted fresh scars on the economy. Overall, the European economy is expected to shrink by more than 7%. On a more positive note, a post-Brexit trade agreement has been achieved. Also, Europe and China have agreed on an investment treaty after seven years of talks. To augment the prospects of recovery, the European Central Bank pumped lavish amounts of liquidity into the market and pushed interest rates to record lows. In addition, a new government-sponsored €750 billion recovery fund was launched.

Japan’s industrial output growth was flat in November. This reflects a resurgence in the number of new coronavirus infections worldwide which has crimped demand. Japan’s economy is in a fragile state such that further aggressive government spending measures are expected to bolster public sentiment. The Bank of Japan’s move to negative rates was an effort to try to lift consumer prices which have been on the decline for 20 years. These steps are harming corporate revenue; stalling wage increases and investment in new projects. The result is many potential borrowers are telling bankers to keep their cash which can only further exacerbate growth prospects.

Britain’s economy has been hit harder by Covid-19 than many other rich nations. The U.K. is the world’s sixth biggest economy and likely shrank more that 11% in 2020; its biggest contraction since the early 1700s. Nearly 56,000 Britons have died from Covid-19, the highest death toll in Europe. As a result, the government has extended its strictest restrictions such that 75% of the country is now locked down to curb a surge in infections and deaths. While the new Brexit agreement will eliminate some uncertainty, it is the prospect of widespread protection from vaccines that is likely to improve the economy.

Even with recent positive vaccine news, it is the massive fiscal and monetary response which has supported continued stock market gains. While stock valuations appear stretched at first glance, corporate earnings growth is poised to recover sharply from pandemic lows in 2021. Most equity markets began 2021 at record highs with International equity markets climbing 16.1% for the final quarter and 8.3% for the year (all returns in U.S. dollar terms). Japan led the way gaining 14.9%; Europe finished up 11.7%; Australian stocks grew 8.9%; and the U.K. had the worst stock market performance falling 10.4% for the year.

2020 has left a permanent mark on many families that have lost loved ones, jobs and so much more. The pandemic has exposed fragilities that had been overlooked for decades. Governments have responded with both fiscal and monetary policy tools. The past year has been tumultuous but there is a light over the horizon. Market conditions should slowly transition back to normal throughout 2021 but the path is unlikely to be smooth.

Emerging market equities have been insulated somewhat from global shocks in 2020 and may benefit further from a return of money inflow in 2021. Emerging market stocks outperformed their large cap counterparts over the last six months as part of a catchup from the sharp underperformance in the first quarter. Despite the Covid-19 pandemic, Emerging Markets have shown a continued appetite for structural reforms that could lay the foundation for lasting economic recoveries. The next year will likely be dominated by the recovery from Covid-19, especially since it now seems that viable vaccines will be widely distributed shortly.

The financial markets have continued climbing a wall of worry in the fourth quarter by looking past the concerns of the today and towards a brighter future. While fears of a second wave of the Covid-19 threat are surging, an incredible feat has emerged as biopharmaceutical companies began distributing vaccines in December. They were developed in only 11 months, the fastest ever. For example, the previous shortest timeline was for the Mumps vaccine, 4 years; Polio, 7 years; Measles, 9 years; and Chickenpox, 34 years. 2020 has truly been an unprecedented year. Investors that have stayed the course have been rewarded.

In other good news, 15 Asian nations which represents 30% of global GDP have completed a pan-Asian trade pact to reduce carbon emissions to fight global warming and China has agreed to an investment agreement with the European Union. The Asian agreement includes tariff reductions and regional supply chain facilitation, both of which could create major boosts to participating economies. The trade pact which covers 2.2 billion people, will bolster pandemic weakened economies.

Buoyed by an accelerating economy, China became the first major country to successfully contain Covid-19. As a result, China’s economy is expected to show positive growth in 2020. China is placing greater emphasis on the quality of its growth in an effort to reduce pollution and health problems. China continues to make efforts to change internal laws and procedures so that companies from around the world can function more effectively. Furthermore, there has been improvement in the bankruptcy courts and cases are being dealt with faster. On the geopolitical front, how China adapts to the Biden Administration will be its biggest challenge.

India’s sizable fiscal deficit has limited the government’s ability to spend on shoring up its economy. It is expected to privatize certain companies and initiate other economic reforms in order to attract investment. Brazil has also continued to pursue structural reforms despite economic disruptions and political noise. Officials recently passed new rules for the natural gas and sanitation industries in a bid to unlock hefty investments. A stronger U.S. economy is essential to Mexico’s interest, as its strategy has been to keep the Mexican economy open during the pandemic and to benefit from the U.S. recovery.

Emerging markets as a whole produced the best stock market returns in the world, 18.7% for the year (all returns are in U.S. dollar terms); but the distribution of the returns was based upon when the countries were hit by the Covid-19 virus and how effective they were in combating it. Korean stocks surged 45.2%; Taiwanese stocks jumped 42.0%; and Chinese stocks gained 29.7%. On the other hand, Eastern European stocks fell 11.3%; and Latin American stocks dropped 13.5%, which was paced by Brazil’s 19.0% decline. This performance dichotomy shows the potential for future gains once countries wrestle the pandemic to the ground.

Although the devastation from Covid-19 has been felt nearly everywhere, its effects are likely to persist much longer for emerging market countries as they wait at the back of the line for vaccines. Moreover, many of these countries do not have the same capacity as their developed peers for expansionary fiscal policy. The starting point for an economic recovery in emerging economies will be lower as a result. An economic and pandemic divergence is conceivable since developed countries can vaccinate citizens and recover, while the virus continues to rampage across emerging countries.

The world’s economy contracted about 4% in 2020, however it appears it could rebound in 2021 and grow by about 5%. This recovery will be determined by a number of things: the path of the Covid-19 crises; the deployment of the various Covid-19 vaccines; and the level of stimulus provided. Closer to home, Canadian households have emerged from the deep economic crisis largely intact cushioned by massive income support payments, a strong rebound in jobs, surging home prices and stock market gains. Despite a second wave of virus cases looming, Canadians can still see the light at the end of the tunnel.

There are few reasons to lament the end of 2020, but the housing market has been one bright spot in an otherwise bleak year. After a brief pause in the spring, Canadian home buying activity has come roaring back. This is by far the most housing market friendly recession in Canadian history. Sales have jumped nearly 9% from last year and the average price has climbed more than 12%. Household disposable income rose sharply in the second quarter thanks to government support programs. There has also been a full labour recovery in higher income brackets (90% of jobs lost during the pandemic were low wage ones), with the brunt of damage coming to low paid workers who are more likely to rent. Interest rates have dropped, and the Bank of Canada has pledged not to raise their interest rate until economic slack in the economy is fully absorbed. This has pushed mortgage rates to record lows. Low mortgage rates have stimulated demand and home building has flourished. However, one casualty will likely be condos as there is an immense level of supply coming and reduced demand by investors and buyers.

From office towers in New York and Singapore to high rises in Toronto and Vancouver, office tenants are trying to determine their future use of space. Since tenants are often locked into 5 year leases or longer, they are trying to sublease any unused space which is a sure sign of weakness in office real estate. As a result, the office vacancy rate reached 10.8% in Canada. The increase was overwhelmingly driven by the downtown markets, which contributed 60% of occupancy losses through new sublease vacancies and direct availabilities turning vacant. Although subleasing activity has increased since the pandemic, it still represents only a tiny segment of the office sector. However, the future of extensive office inventories in the urban centres is a growing concern for office landlords.

Commercial real estate investment activity dropped significantly in 2020. Retail real estate has been decimated by lockdowns. As a result, malls might convert into residential or mixed-use properties, possibly using some of that space for warehousing, distribution, or fulfillment. The largest growth in investments in real estate have been in warehouses and fulfillment centres. Logistics, warehousing, and fulfillment are the clear winners this year. This segment of industrial real estate has remained resilient throughout the pandemic in large part because of a surge in demand from e-commerce, food delivery services, lower-income apartments and home improvement retailers.

Real estate investments were amongst the worst performing asset categories in 2020. In fact, if it was not for the news on November 9th about the approval of the first Covid-19 vaccines the performance would have been significantly worse. Canadian REITs closed down for the year -13.1%, after gaining 12.0% in the fourth quarter (all returns in Canadian dollar terms). Global REITs decline was only -4.1% in 2020, after climbing 4.5% over the final quarter.

Investor optimism has skyrocketed following news that Covid-19 vaccines have arrived, particularly with regards real estate assets. The vaccines could start having a positive impact on economic activity within the first half of next year. Investors should actively position themselves for a broader and deeper global economic expansion in the coming years. The next couple of months will be challenging, balancing short term economic pain with the medium term expectation of a vaccine led recovery. The key question is how will the market look through the first to reach the second?