Currency & Sector Liquidity Analysis Report: Q2 2021

October 25, 2021

North American markets have continued to scale new heights as the major North American indexes are up in excess of 15% for the year to date to Oct. 15, with S&P/TSX Composite Index leading the way, up more than 20%. It definitely has been a long time while since the TSX has outperformed the likes of the S&P 500 Composite Index and the Nasdaq Composite Index. As such, we observe some small geographic rotation among funds, with Canadian dollar cash being raised. United States dollar cash shows an increase at the end of the second quarter, with many managers taking profits while forecasting a hawkish Fed policy in the coming months.

It is very intriguing to see the Canadian market outperform the tech heavy Nasdaq. Why is this happening? To answer this, we need to really look into the constituents of the index.

The S&P/TSX Composite is weighted to commodities and financials and has performed very well in a time of low rates and accelerating growth in commodities. The price elasticity of these end goods is less than the more service-based constituents on the Nasdaq. Consequently, we see everything from financial services to oil and gas performing exceptionally well on the TSX, helping propel the index to new highs, now well above the 21,000 level.

On the other hand, the major holdings underlying the Nasdaq are very technology oriented and a low interest rate environment in the U.S. is a key condition for continued momentum of these companies. The heavy premium valuations of these companies are now undergoing increasing investor scrutiny as central bankers become more hawkish on monetary policy.

On the international front, China achieved in excess of 12% GDP growth in the first half of 2021. While this is expected to slow, the probability of China ending the year with GDP growth in excess of 8% remains very high, and would overshoot the pessimistic predictions at beginning of the year. London’s FTSE 100 Index has also enjoyed a little bit of a positive return, and the whole European area has been bouncing back from pandemic lows.

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 2021 to June 2021.

US and Canadian cash on hand

Chart 2 illustrates the mean cash dollar value in sequential order from January 2021 to June 2021. The United States dollar had a net position of $2,942,971,050 for June 2021. The Canadian dollar had a net position of $4,090,971,747 for June 2021.

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.

Red shading 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.

Green shading 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

Looking at Table 2, we can clearly see portfolio managers have very effectively reacted to the price appreciation in commodity markets, and seem to have a bullish outlook on the sector. Canadian equity is a key area of potential growth in the closing months of the year. As the uncertainty of the pandemic continues to fade, managers are looking to jump back into some other geographic regions that have been seen as too risky until now.

Another major concern is inflation. Recent spikes in Canadian and U.S. inflation rates will have an impact on nominal and real yields. Currently, many analysts are predicting an increase in real yields, which would be more detrimental to some fixed-income products. While bank accounts are cash rich, wage growth has been abysmal. For now, it seems as if markets are shrugging off the flashing caution lights of rising yields and lower participation rate in the workforce and moving ever higher. This is unlikely to last. We’ll be keeping a close eye on the yield curve as way to predict the short-term outlook for equities.

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