Market Commentary Q3 2020

This article is a transcript for the Q3 Portfolio Update Webinar that was conducted on October 8th 2020.  If you would prefer to watch the accompanying video then you can do so here:

Today’s focus is on the performance of financial markets for the third quarter of this year and to address the impact of changes that have been made to the Portfolio Stewards portfolios.

This is your Investment Review for Q3 2020.  Please note that this is a review of our portfolios and performance for a specific period of time and that none of the information contained within is a recommendation of any of the securities discussed.  Please consult your Wealth Stewards or advisor at a firm of your choice before implementing trades in your portfolio.   Performance of your personal portfolio may differ from the numbers stated in this presentation as there are many factors that the performance of individual portfolios.  ​

2020 has been a tumultuous year for investors but no more tumultuous than the effect that COVID 19 has had on the lives of people around the world.  As I was preparing this presentation, I heard a speech from Joe Biden in which he made a statement that COVID 19 has had a positive impact on many of the rich and a devastating effect on the poor.  The same can be seen in financial markets as stocks like Apple, Microsoft and Amazon have seen their market values soar.  Apple’s market value has soared from $1 trillion to 2.3 trillion.  Microsoft’s market value has increased from $1.15 T to a peak of $1.75 trillion and Amazon’s value has jumped from just under $1.T to $1.6T, whereas many companies are experiencing major losses and are holding on to their survival by the tips of their fingers.   ​

An Update on the Markets

Let me begin this presentation by looking at the major financial indices starting with the S&P 500 benchmark.  Recovery from late March lows continued to be strong for Q3 and the S&P 500 produced a total return including dividends paid of 8.93% which was reduced somewhat by a strong Canadian Dollar bringing the return to Canadian investors down to a respectable 6.83%.  ​

On a year-to-date basis, losses of almost 34% have been totally recovered and at the end of September, the S&P 500 is up 8.75% or 5.57% in Canadian Dollars.  ​

In Canada, the TSX Composite had strong performance turning in a 4.73% return in Q3 but it is still under water by 3.09% YTD.  

Indices are a great way to track overall market trends but they don’t always tell an accurate story​. Indices, like the S&P 500 are “Cap Weighted”, meaning that the bigger companies make up a higher percentage of the index​. In fact, The 25 biggest companies make up 41% of the index​, the top 10 companies make up 28% of the index​ and Apple & Microsoft alone make up 12% of the index​.

In this chart, you can see how the rich are getting richer and the poorer are getting poorer.  If you owned only Apple and Microsoft and failed diversification rules, your portfolio would have returned over 44% in a tumultuous year for stocks.  If you owned the 10 biggest companies, you would have returned over 33% but if you owned the S&P 500 or the market, you only returned 6.5%.​

Now digging even deeper, if we looked at the S&P 500 and took the average performance of the 500 stocks, we see a very different story.  YTD, the average company on the S&P 500 lost about 3.5% but had a pretty good Q3.  ​

As a result, for investor’s balanced portfolios where your portfolio manager cannot simply make a big bet on two or three stocks but must diversify to protect you from when a combination of Apple & Microsoft fell by almost 30% in March, returns are buffered on the downside but can’t match concentrated portfolios on the upside.  It should be noted that this is not an excuse for performance but simply an educational moment.

The TSX Composite Index is a completely different story.  If you look at the chart on the right, you can see a breakdown by sector of the TSX.  Notice first of all Financial Services – that sector is mostly made up of Canada’s major banks – Royal, TD, Bank of Montreal, etc.  That sector makes up 32% of the index.  Next look at Energy.  Energy makes up 12% and that is a bit deceiving.  Large energy companies like Imperial Oil have dropped from a 2020 high of $35 to $16 currently and Suncor from $45 to $16.  And finally metals and mining make up 13%.  As a rule, we steer away from these sectors because they fail our consistent and predictable earnings growth test. Looking at the the chart on the left and you will see Shopify makes up 8% of the TSX and is now Canada’s largest company.​

Notice in the chart on the left how Shopify has pulled away from the TSX Composite Index and how in the chart on the right although their price has risen exponentially, they have still not turned a profit.  Just another educational moment showcasing how indices can be deceiving.  A stock like Shopify does not pass our tests but does have a significant impact on indices.​

How did the average stock on the TSX perform?  Not as exaggerated as the S&P but you can see that the TSX Composite is down 5% YTD but performed well in Q3.​

The second thing that makes portfolio performance difficult to measure against indices is that most investor portfolios contain an allocation to both stocks and bonds or what is called fixed income.  ​

Interest rates are at a historically low level, near zero and bond investors make money when rates fall so there is little chance of making money by buying traditional bond funds. Instead, we have turned our attention, like the major pension plans (including Canada Pension Plan) to private debt or alternative investments. This will be discussed in more detail later on.

Let me turn our attention to our portfolios.  ​

In March/April, as we came to grips with the impact of the pandemic we began a process to assess and reconstruct our portfolios to mitigate risk and take advantage of opportunities presented by the pandemic.  We shifted our equity focus from a value approach tilted toward smaller cap companies, to specific sectors we felt would thrive through the COVID pandemic.  This allowed us to target companies, like Amazon, that would benefit from the pandemic as more and more people got comfortable buying online and to avoid companies, like energy that would struggle during a pandemic. ​

Following a major decline, large companies with strong balance sheets generally perform best in the early stages of a recovery and small cap stocks do better in the later stages. ​ Our new individual US stock portfolio targets 14 large cap companies, like Microsoft and Home Depot and is diversified by sector so we can keep a close eye on risk​.

Our Canadian portfolio is made up of seven companies and real estate is made up of a combination of private and public real estate investments.  ​

Our Global and Specialty Equities are managed by third-party managers that allow us to slant the portfolio in the direction of our favoured sectors.​

At the core of our balanced portfolios are our stabilizer positions.  Investments that pay high returns compared to fixed income, where we trade off liquidity to generate returns but in investments that have stable values and pay monthly or quarterly returns.​

Let’s look at each of these in more detail.​

​This slide graphically displays our strategy. ​

1.  It contains household names, like Adobe, Mastercard and Google.​

2.  It is well diversified by sector​

3.  They have returned on average 21.62% per year for the past 10 years​

4.  Earnings growth, which is the major driver of stock performance is expected to grow on average from 11.30 per share to 20.26 or almost 80%.​

5.  If we subtract out Sysco, a company that supplies restaurants, hotels, and schools that we have done very well on since our early pandemic purchase but with the second wave of COVID we are concerned and have decided to liquidate the position.  Without Sysco, the average PE of these stocks is 44 compared to a 5-year average of 50, so they are historically inexpensive​

This is a simple way for us to demonstrate our stock selection system.

Note that on average, Earnings are expected to rise from 3.123 to 4.708 for an increase of roughly 50% over the next two years and they are trading at an average PE of 36.63 compared to the 5-year average of 40.27.  CNR’s valuation appears expensive so we are looking for an alternative. ​

As we have done in previous portfolio review session, this is where we judge the performance thus far of our strategies.​

The US Strategy has performed well.  Although it beat the S&P 500 before fees, this does not account for the negative effect of holding defensive cash positions during a strong market.  So, we give this strategy a B+.​

The Canadian strategy has lagged the performance of the TSX Composite as we over allocated to two of Canada’s strongest banks, looking for stable returns and stocks like Shopify that does not meet our selection criteria helped push the TSX higher.  Our allocation to the US strategy is much higher than to Canada but not to make excuses, we rank our performance here as a C.  If you look at most recommendations from major bank owned firms, you would see a much stronger allocation to Canada.  The Canadian market is relatively small and the number of opportunities is much less so we prefer to significantly over weight the US strategy.​

In the real estate section of the portfolio, returns for Q3 continue to disappoint compared to equities but, a return of 1.4% is respectable for the public portion of the portfolio and Equiton did deliver 2.25% for the quarter. Our 6 month performance is in the 10% range for the public holdings and 4.25% for Equiton but YTD overall is still in the negative 15% range as public real estate has been slow to recover. 

In ranking performance, we need to look at two things:  The sector and the fund.  The public real estate sector has performed very poorly but we are not quite ready to pull the plug but we would score it a D.  Our investments within this sector have consistently out performed the benchmark so we would score them a C.​

Our Global & Specialty Managers performed well in Q3 turning in a return of 8.48% which beat the S&P 500 in C$ before fees.  We give this strategy a strong B+​

Performance reporting on many of the fixed income alternative investments is not available until later in the month but as these are relatively stable, we have estimated the YTD performance. 

The average return of the investments in this portfolio is 4.35% which annualized is 5.8%, which is more or less what we expected.  ​

As mentioned earlier, with bond yields at historical lows, we are pleased that we have largely moved away from the risk and returns of the traditional bond markets. ​

Although equity markets have recovered strongly driven by large cap companies like Apple, Microsoft and Shopify, our balanced portfolios which are much more diversified are still slightly under water for 2020 which is more in line with the more balanced equal weighted indices. 

COVID-19 has had a dramatic effect on public and private businesses and financial markets, not to mention people and families around the world.  Although we had a period when the rate of growth of new cases declined for a short period, rates have once again spiked higher as businesses and schools have reopened and leadership in the world’s leading economy has been downplaying the devastating effects of the virus.​

We have taken a more defensive approach as our primary job is to protect your capital so we have held off on some purchases to both reduce risk by holding some cash positions and to benefit from bargains should there be a second leg down in financial markets.  We have chosen to work with more defensive global and specialty managers as well to help manage risk.  We are in uncertain times and are working diligently, proactively and defensively.  In hindsight this may have cost us some performance but feel our performance is acceptable under the circumstances.      ​

To conclude, we made significant changes to the portfolios during the second quarter to reduce risk and to better position the portfolio to take advantage of opportunities presented by the COVID-19 decline and although performance is slightly negative YTD, our new strategies are performing well.  At this stage, we continue to manage the portfolios conservatively and will do so until uncertainties relating to COVID-19 and related stimulus packages and the US election.  ​

Thanks for taking the time to read this article or watch this video.  To keep up-to-date, we invite you to become a regular viewer of the Huddle webinars that take place every two weeks on Thursdays at 3PM ET.  For more information, please visit  Or you can always reach out to your Wealth Stewards advisor.​