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December 2020 Market Update – Fading FAANGM? and 2021 Portfolio Positioning

Hi folks. Brett Girard here, Portfolio Manager at Liberty, coming to you with another Liberty market update. This one for the month of December 2020.

I’d just like to first take the opportunity and wish you and your families a very happy New Year. And with that, the disclaimer. Please give this a read.


The information presented herein is for informational purposes only and does not constitute financial, investment, tax, legal, or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this article should consult with his or her advisor. The information provided in this recording has been obtained from sources believed to be reliable and is believed to be accurate at the time of publishing, but we do not represent that it is accurate or complete and it should not be relied upon as such.


Okay, so let’s turn our minds to December 2020 and more broadly the entire year. What we’ve put up here is, is we call it the snapshot of 2020, but it’s the four major indices—stock market indices—that we follow. So, the TSX, the S&P 500, the NASDAQ’s, and then the STOXX Europe 600, all down the left-hand side.

Those bars in the red represent the maximum drawdown over the course of the year. And that’s the peak to trough level, from—we’ll call it the highs of February through to the lows of March. And there you can see that across the board, 30 percent to 37 percent was the drawdown from peak to trough. So that’s quite significant, anything north of a 20 percent drop is a bear market. So, we were in a bear market across all four of the indexes presented.

Then on the green what you can see is the total return for the year. So, from the depths of March, back up to where these indices started the year, through to where they finished the year, is represented by the green. So here we can see the best performing name was the NASDAQ, up more than 46 percent from its initial value at the start of the year. The S&P 500 was up about 17 percent. TSX was up around 5 [percent]. And then the STOXX Europe 600 was up—actually down—about 2.3 percent.

So varying performance on the way up, although similar on the way down. And NASDAQ’s really the one that sticks out because of the significant return last year, but if you actually look at the course of the year—and we’ll do that next—you’ll see that the finish, into the end of 2020 through Q4, wasn’t that strong.

So here, just breaking down the specific performance of the NASDAQ, we can see that from the beginning of the year through to mid-February, NASDAQ was up about 9 percent. From there, it fell 30 percent and that was that drawdown from peak to trough. Then from the lows of March, it was up about 62 percent all the way through till about the second of September.

And that last little part that you can see right at the end before the sort of top is met in the month of September, the NASDAQ really went straight up. Almost asymptotic, and that is what we call a blow-off top. So, from there you can see that it fell back down into the month of September, and through to the end of the year, and then forward into the couple days into January 2021. We can see it’s only up 6 percent. Now, 6 percent in a normal year would be a great return, but we compare that to 62 percent in the prior two quarters, it seems like something’s up.

So, what’s the case? What’s going on?

Well, here you can see the big contributors to the NASDAQ performance is the FAANGM stock. So, this is your Facebook, your Apple, your Amazon, Netflix, Google, and Microsoft. And here—this really paints the story—that big black line across the solid, or the solid black line across the middle of the graph is zero. So, any color line above that is a return that’s positive, any color below that is a return that’s negative.

And here what you can see is of the FAANGM of those stocks, really only one name is positive over the last three and a bit months. So, this just gets back to the point that we’ve been talking about throughout the year, that it’s really important not to chase performance. And if you looked at the NASDAQ in Q2 or Q3 and said, “You know what? This is where I have to be,” and you ended up shifting your funds over there, you’d be subject to some underperformance and really some flat performance in Q4.

So, it’s important not to chase, it’s important to have a portfolio set up so that you can be diversified across a number of different sectors. If any one sector does well, you’ll benefit, if any one sector drags behind, in our view, that’s a buying opportunity.

Now let’s move on to 2021.

The bottom line here is that uncertainty is high. We’ve characterized with the two opposing arrows that there’s some positives and there’s some negatives on the horizon, and it’s yet to be seen how things are going to shake out going forward. So, headwinds to the market; things that might cause the market to lose value from where we are today. Number one, the increasing and continued COVID lockdowns. And number two, uncertainty around the timing and the quantum of fiscal and monetary stimulus. And then three and four together we’re increasingly seeing headlines around the weak U.S. dollar and inflation as something that might hurt stocks, in particular, going forward.

On the positive side, if we think about the impact that the vaccines could have in terms of reopening and getting a lot of those sectors that have been struggling, back on their feet. We’ve talked a little bit about the tech stocks, but we’ll have to see if the tech stocks can regain their footing into 2021 and continue to propel the market like they did last year.

And then the IPOs are the Initial Public Offerings, and the SPACs are the Special Purpose Acquisition Corporations. Those are really two mechanisms to take private companies public. And generally speaking, we saw a huge increase in both IPOs and SPACs through 2020—that’s a very positive sign for the markets because that means people are willing to take risk, and to go public with companies to try to get listed and have more liquidity for their shareholders.

The important thing I think for everyone to realize though, is that we’re not in a position to make a prediction, right? If we rewind to 12 months ago, I don’t think there’s anyone who could have accurately predicted the spread of COVID-19, the lockdown that followed, how the stock market reacted, or the fact that we had vaccines discovered in really less than 12 months before the pandemic became a big thing.

So, we don’t know what’s going to happen in 2021, and I don’t think anyone does. But, at the same time, it’s not about prediction, it’s about preparation. So, we have a plan to go forward. And the plan really revolves around protecting the downside and taking advantage of opportunities when they’re presented.

So really, if you think about the plan at a high level, it’s important for us to be balanced. And what that means is, you know, in the examples that we talked about we don’t want to have too many tech stocks—we don’t want to have too much of anything, right? If we start to get over our skis in any one direction, it exposes us and exposes the portfolio. So, we’re going to stay away from the flavor of the day, we’re going to continue to invest in high-quality free cash-flowing businesses, and we’ll be able to hold those for the long-term.

So from here, let’s just walk through a high-level depiction of the asset classes and how we think about all of those as components of your portfolio.

Outlined here you’ll see our four major asset classes that we invest in. So, we have equities, corporate bonds and preferred shares, inflation-protected bonds, and cash. Now, these four different asset classes act in concert together to, A. Preserve capital, and then B. Grow ahead of inflation over the long term. So, let’s take a look at each.

Starting with equities, it’s important when we think about equities or the stocks that we’re going to buy that we want to have varying inflation sensitivity across sectors. So, what that means is that we don’t want to have all of our eggs in one basket. If we’re in a deflationary environment, like we were in last year with falling prices and people hoarding cash, you want to be in technology. If we transition into an inflationary environment, with rising prices, then financials will be preferred because, generally speaking, interest rates are going to go up and financials will benefit from that.

We want to think about different geographies. So, there’s going to be a different level of economic activity in the U.S. versus Europe. In Europe, for example, last week there were mortgages in Denmark that were issued at zero percent for 20 years. So, Europe is still in a tough, low-growth environment. Still tons of opportunity there, but that’s the case. Whereas if you look at the U.S. and the trillions of fiscal stimulus that should be coming down the pipe in the next little bit, there’s likely going to be more growth in the U.S. and probably in North America.

And then really it comes back to what we always talk about—we want long-term, free-cash flow, and dividend growth. That’s going to remain the focus for our equities, that’s what we’re going to stick in through different market cycles, and we don’t really need to reposition the portfolio based on underlying economics. Because those companies that we want to buy—that have the free cash flow and the dividend growth characteristics—they continue to do so through most, if not all, economic environments.

Moving on, we have the corporate bonds and preferred shares. So, really here these types of securities are in your portfolio for the return that’s provided through the income. So, whether it’s quarterly, monthly, or annually, there’s going to be some dollars flowing into your accounts, and that return’s increasingly important as you get closer to or into retirement. But from a corporate bond perspective, we employ a ladder. So, what that means is we have some bonds that are very short-term, that are going to mature soon; some bonds that will mature in the medium term, so say five to 10 years; and even some long bonds that will mature sometime in the next 30 years.

And the idea there is bonds are primarily driven, excuse me, the pricing of bonds is primarily driven by interest rates. So, if interest rates rise, then we want to have bonds that are going to mature so we can reinvest that capital at higher rates of interest. If interest rates fall, then we want to have bonds that we won’t need to take back the capital, or it won’t mature for a long time, so that we can continue to have the rate of interest that we have.

And then from a preferred share perspective, the rate reset preferreds will do very well if we do happen to have rising interest rates. And what happens there is they have a mechanism where, every sort of five years, the value of the amount being paid out—that dividend or that coupon—will reset based on an underlying rate. So, if we see that the Bank of Canada and the Fed in the U.S. start to increase interest rates, then these preferred shares with a rate reset function are going to do quite well.

Beyond that, we have the inflation-protected bonds. And again, if inflation does become something that is an issue into 2021 or beyond, then we have the inflation-protected bonds in the portfolio, which will pay not only a coupon based off of a certain amount prescribed at the time of issuance but then also an additional amount based on inflation.

These, excuse me, these securities are really important to maintaining your purchasing power. Inflation effectively means that products and services around us cost more. And if we have bonds that will increase in the payout as inflation happens it’s going to maintain your purchasing power, it’s going to mean that you will still have the ability to go out and purchase products or services.

And then last, but not least, we have cash. So, cash maintains value in a deflationary environment, so when the markets are falling, cash is a very helpful tool to have, because it doesn’t lose value. If there is inflation, cash is not going to have as much purchasing power, but at the end of the day we want to have some cash, and the amount of cash that we have will vary from time to time. We want to have it on our books because it dampens the volatility.

If we think back to that max drawdown—the maximum drawdown from those slides that we looked at earlier—having cash in your portfolio, limits the amount of drawdown that you have. And at the end of the day, if we can decrease the drops in the portfolio by holding cash, and then take advantage of buying opportunities like we did in September and October and November, then we can take that cash and put it to work for us when it makes sense.

So that’s kind of a high level of the different asset classes that we hold. The equities, the corporate bonds, the inflation-protected bonds, and the cash, and really I hope you can get an understanding that these all work in concert together. And it’s much like an orchestra in the sense that we have different sections that are going to do different things depending on what the underlying economic activity is. But it allows us the opportunity to not have to make big bets, number one. And then number two it means that we don’t have to go and change what’s going on in the portfolio. So, it’s not as though there’s inflation happening or there’s deflation happening and we need to go and sell everything and buy something else. That, you know, from a timing perspective becomes very difficult. And then also from a tax perspective, every time you sell something, you have to split your gains with the government.

So, what we’ve tried to do, is we’ve tried to set portfolios up that can maintain—broadly—the positions over the long term. We’ll always need to tweak it and monitor around the edge, but maintain the positions over the long term, and do well through most, if not all, economic environments.

So, thank you for much for your time. We really appreciate you turning, tuning into these videos. If you have any questions, please reach out to your portfolio manager, or you can send an email to the email listed there: Contact@libertyiim.com, and have a great day.