The Canadian market ended September down 2% for the month, after 5 consecutive months of strength following the March sell-off. The drivers of weakness included the energy, financial and materials sectors while staples, industrial and utilities produced positive results. The financials sector in Canada continues to work through deferral activity offered earlier this year. September marked the first month of a return to normal payments for many customers who were provided accommodation at the peak of the COVID crisis. Given this backdrop, we expect the financial sector to remain a “show-me story” for the remainder of 2020.
As we get closer to the election period in the US, we have taken steps to further reduce portfolio risk. Additionally, we expect that the end of the summer season to make it incrementally more difficult for businesses to remain open (servicing clients). Lastly, negotiations currently taking place to extend social programs are likely to result in market volatility. Accordingly we have increased our exposure to volatility instruments in anticipation of these risks.
Since hitting previous highs on February 19th, 2020, North American indexes fell 30‐37% in 23 trading sessions only to rebound
aggressively on the back of significant monetary easing from central banks. After six months and over four trillion dollars of
issuance from the Treasury, a passive investor with exposures to US equities is no worse for wear. Large cap technology stocks
have been the primary beneficiary of liquidity with the NASDAQ up over 31% YTD and the S&P 500 also positive for the year
In Canada, we have started to see investor demand spill over into mid‐small cap equities. The Waypoint All Weather Strategy
has benefitted from its 30% exposure to this sub‐segment. Our largest position remains AirBoss of America (BOS) which has
benefitted from improved fundamentals as governments continue to procure much needed supplies for frontline healthcare
workers. Our equity positions in the portfolio remain diversified amongst the GICS sectors with no one sector accounting for
more than 15% of the portfolio.
The options markets in Canada continue to forecast elevated levels of risk after the equity declines in March. A low for volatility
occurred in January of 2020, months before the March sell‐off. For the past two years, options volatility has been
extraordinarily low and is currently 3 points higher than a typical market average of 15 to 16. Currently it is almost double the
level witnessed in the last two to three years.
The March sell‐off changed the dynamic of “short volatility” strategies by reducing the appetite for Put selling. Instead, Call
selling has dominated the market resulting in underpriced Calls and overpriced Puts. At its peak, the options skew was at a 10
year high. Skew trades remain the most attractive in the Canadian market allowing investors to fund upside with considerable
downside protection at zero cost. Specifically, the Canadian banks offer the most compelling exposure given the strong investor
appetite to overwrite on these positions.
Third quarter bank earnings are coming in better across the board. Although still elevated from prior years, loan loss provisions
and deferrals are declining quarter over quarter. It is evident that government programs have had significant influence on the
Canadian consumers’ ability to meet their obligations. With approximately $260 billion of consumer loans in Canada still in
deferral, further government support will be instrumental as the economy continues to re‐open.
Despite higher levels of volatility than observed prior to March 2020, options pricing relative to dividend yields in our equity
universe is attractive. We are beginning to increase our gross exposure, taking advantage of dividend funded protection.
With investors benefiting from a recent rise in asset prices – we believe that now, more than ever, is a good time for those
looking to protect their capital and prudently compound over time to consider the Waypoint All Weather Strategy.
All‐Weather Strategy Net Exposure
XIU Index Vol (Hist & Implied)
The Waypoint All Weather Strategy was up an estimated 1.9% (+11.1% YTD), compared to 4.5% (-3.3% YTD) for the S&P TSX total return. We have witnessed continued momentum in equity markets in the month on the back of accommodative commentary from Central Banks. Precious metals companies have led index returns in the Canadian markets as gold touched all time highs.
A notable contribution to the performance of the Strategy in July was our position in AirBoss of America. AirBoss continues to be a beneficiary of substantial contracts as government’s look to procure supplies in order to protect front line healthcare professionals.
Although still elevated from pre COVID-19 levels, Volatility has dropped considerably over the month allowing us to once again purchase option protection as a form of insurance to protect investors capital. We remain cautious moving into the later half of 2020 as geopolitical and election risk remain evident.
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.