Currency & Sector Liquidity Analysis Report: Q3 2020

November 23, 2020

During the third quarter investors were not nearly as worried about market woes caused by the coronavirus pandemic as they were earlier in the year. With all major American markets trading at record highs, including the Dow Jones Industrial Average, S&P 500 Composite Index, and the Nasdaq Composite Index, investors continued to deploy cash and jump back into equities. It is important to note that until the pandemic woes were reflected in markets, stock market indexes were trading at nearly all-time highs. More importantly, U.S. dollar cash was at an historic low of 1.06% back in January 2020. From there, it steadily rose and now has come back to 1.10%, nearly at pre-pandemic levels. Canadian dollar cash is also back at pre-pandemic levels, at 1.54%.

When funds hold a significant amount of cash as a part of their portfolio, there is inherent buying pressure that helps give markets a boost. Quantitative easing and Federal Reserve buybacks have helped bring markets into green, but the uncertainty remains on how long this support from central banks is sustainable.

Every major currency, with the exception of the British pound and the euro, has experienced solid gains in their respective home markets. Lockdown measures in the United Kingdom and Europe have impeded stock market recovery and European indexes have not fully experienced rallies that their North American counterparts have. As a result, many economists and sector rotation specialists are calling on increasing exposure to the FTSE 100, as many believe it to be in a pre-recovery setting.

The decoupling of the stock market from reality is a big concern for many institutional strategists and investors alike. In a year when jobless rates hit highs not seen since the last major downturn during the 2008-09 financial crisis, does it really make sense for stock markets to be in an upward trajectory?

Analyzing sectors more closely would show that the hardest hit include leisure, hospitality, and retail to name a few. With the world moving towards the new normal of “working from home,” some of the biggest tech giants continue to take huge parts of this market with new products that enable the security of the home office as well enabling collaboration and teamwork.

Under President-elect Joe Biden, the potential for lockdowns is also higher, which would cause some serious pain for American markets. While we cannot judge how the new administration would respond in this environment, their platform appears to be more cautious than the Trump administration’s was.

Markets continue to rally as Pfizer Inc. (NYSE: PFE) and Moderna Inc. (NSD: MRNA) announced Covid-19 vaccines with 90% and 95% effectiveness during trials, respectively. However, getting these into widespread distribution will probably consume vast resources. Also, a major drawback for the Pfizer vaccine is the low temperature required for storage, particularly problematic for tropical emerging markets, entailing massive costs and manpower for storage and distribution.

Some of the biggest factors to watch would be whether the new U.S. administration continues the CARES Act, which since March has created nearly US$2 trillion in federal stimulus to buy assets, including purchases of major U.S. exchange-traded funds.

The sustainability of a stimulus package under the new administration, betterment in U.S.-China relations, and the deceleration of infection rates are crucial if markets are to retain the majority of their gains this year.

Currency analysis

Our analysis focuses on the Canadian investment fund industry, and how portfolio managers are allocating capital in major currencies. The currency analysis excludes all cash equivalents, such as bonds with less than one year to maturity and collateral cash held to fulfill debt covenants. We believe by excluding these items, we can home in on the deployable cash in investment funds and assess the streets market sentiment. We then further analyze the liquidity of investment funds on a cash and cash-equivalents basis categorized by sector to help us understand which verticals portfolio managers are currently overweighting and underweighting.

Table 1 illustrates the month-over-month growth rates for the world’s major currencies.

Average portfolio weights for world currencies

Chart 1 illustrates the mean cash percentage in investment funds for nine major currencies in sequential order from January 2020 to September 2020.

US and Canadian cash on hand

Chart 2 illustrates the mean cash dollar value in sequential order from January 2020 to September 2020. The United States dollar had a net position of $3,968,401,511 for September 2020. The Canadian dollar had a net position of $5,910,109,706 for September 2020.

Investment Fund Liquidity Ratio

The Investment Fund Liquidity Ratio is calculated as the amount of cash in a fund relative to its total assets. It is important to assess this ratio when analyzing investments and allocating capital. It has the power to give deep insight into the overall flow of capital into specific verticals and the bullish or bearish sentiment in these investment categories. Table 2 lists the top and bottom 10 out of applicable sectors based on the mean ratio of over 3,000 investment funds with a mandate to invest in the corresponding sectors. The table lists the most bearish to most bullish sectors in descending order.

The red highlights the sectors with the highest ratio, which translates into underweighting their respective indexes. This could mean that portfolio managers are expecting negative performance in these categories.

The green highlights the sectors with the lowest ratio, which translates into overweighting their respective indexes. This could mean that portfolio managers are expecting positive returns in these categories, in the short term.

Review and outlook

Ten-year government bond yields have moved lower in both the U.S. and Canada this year, with interest rates at nearly zero around the world. Some interesting areas of opportunity include the badly hit Energy sector, as well as the U.S. Small/Mid Cap Equity sector. Landlords have also had a difficult time with evictions and rent collection this year, causing some pain for REIT funds.

In the uncertainty that lies ahead, it is difficult to identify sectors that are poised for growth; however, with proactive governments addressing these issues and the approval of effective vaccinations, there is at least a glimmer of light on the horizon.

The above analysis should help illuminate how investment professionals are currently handling public equities, and which sectors may require additional due diligence in a portfolio. It is to be taken as just one more tool in your toolbox to help make strategic and informed investment decisions.

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