The Waypoint All Weather Strategy was up in 0.5% in June vs. 2.4% for the S&P/TSX. Strength in our equities were offset by erosion in the volatility position on the overall index.
It is evident that COVID-19 cases are on the rise as businesses begin to open up. Given the market momentum we have seen over the last few months we are taking a cautious approach. We continue to deploy our volatility strategies in this market given our belief that markets will remain in a range for the next several years.
Over the past 5 years, the S&P/TSX Composite is flat versus the S&P 500 which has gained 44%. Index investors who have favored the US market over Canada have benefited from its superior fundamentals. Specifically, this US index has greater exposure to the high ROE / high margin technology sector, has greater revenue diversification globally and overall higher revenue and earnings growth rates. However, since the drawdown in markets in Q4 of 2018, the correlation between the two markets has been on the rise, reaching a high of 90% in the past 2 months.
The All Weather Strategy decreased in the month of May due to an erosion in the volatility position held on the overall index. This was offset by a positive gain on the risk reversal position held on the Canadian banks. Shopify, Gold and Energy stocks accounted for 75% of the market’s performance during the month. All sectors in which the fund does not hold positions.
The TSX has rallied approximately 30% since the March 23rd low with Information Technology and Materials stocks leading this rebound. Within those sectors, Shopify and the gold miners account for the majority of the appreciation. We recognize this defense tactic given that gold stocks are being potentially viewed as hedges against inflation as well as technology stocks which are benefiting from secular tailwinds –many which have been brought forward by the recent pandemic. The All Weather Strategy avoids resource stocks and therefore is not going to participate in the appreciation of gold securities as well as our fundamental value bias has kept us away from richly valued technology companies in the Canadian market.
One observation that has led to us keeping a high cash balance in the portfolio is the relative performance of the financial sector in the Canadian market. Canadian bank stocks, although off their bottoms, have materially lagged the broader index in this rebound. Indications from our US counterparts suggest that earnings will be impacted in the upcoming quarter. Until we have more visibility on the health of the Canadian consumer and Canadian business in general –we believe this higher than average cash balance is prudent. Bank stocks report towards the end of May at which point we will re-evaluate our positioning.
The Waypoint All Weather Alternative Fund currently holds 30% cash and has approximately 30% equity exposure at current market levels. Further moves downward in the market will bring the fund back into a short position which we will likely use as an opportunity to further reduce fund gross exposure. Additionally, in the case where markets rebound rapidly (central bank intervention, positive news on a vaccine, etc.) we have begun adding a small long position.
Since the start of 2018, we have seen markets fall 10%, rise 20% and now decline almost 10% from their peaks. The result of this move is little profit for Canadian investors. I’m sure this is hard for many to believe given how positive managers were last year after a 20% rise in the market –all but forgetting the previous years decline. Well, it seems we are back to where we started, once again. For those looking for a different path to investment returns, the Waypoint All Weather Alternative Fund should be under consideration.
The All-Weather Strategy performed in line with expectations in January. The Fund’s equity positions gained with the broader market versus the modest decline in the mark-to-market value of our options positions. This period of performance is more in line with our general expectations for the Fund –generating positive equity returns in rising markets less the historically low cost of put protection. One month certainly does not indicate a trend, but we are pleased to see our equities begin to perform after being flat all of last year.
Evidence continues to build that the Canadian market is vulnerable to a domestic slow down. The Fund is positioned to protect capital if such an event occurs. Ironically, investors appear to agree as evidenced by a continued appreciation of stocks in defensive sectors (Utilities, REITs, Staples). The Canadian yield curve remains inverted and general economic growth (measured by GDP) is weak. Valuations for the largest market constituents have disconnected from the market as a whole as investors choose liquidity over fundamentals; we do not believe these disequilibrium’s will persist.
Throughout history, volatility has been a mean reverting asset class. We continue to see exceptional value in these instruments and believe patient investors will be rewarded.
For 2019, the top quintile of the TSX index by market cap outperformed the bottom quintile by over 10%.The magnitude of this divergence can be compared with three prior periods over the past two decades. We observed similar behaviour at market peaks in 2000 and 2008. The other period occurred in 2011 which coincided with a 20% correction followed by a flat market for approximately two years. Although this was an unfavourable outcome for 2019, these divergences tend to occur over the short term and correct themselves throughout the cycle.
We continue to position clients to take full advantage of the attractive spread that exists between the dividend yield of our favourite companies and the cost of a fully insured portfolio.