Market Commentary: A Rebound Amidst Several Dark Clouds


By Rob Edel, CFA

 

Highlights this Month

 

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August In Review 

After an exceptionally strong July, markets continued to melt higher last month in what Goldman Sachs described as one of the strongest August rallies in 35 years. By mid-month, in fact, the S&P 500 topped its February 19th all-time high for the first time since the start of the pandemic and ended the month up 7.2% and +9.7% year to date.

From its low on March 23rd until the end of August, the S&P 500 has rallied 57.7%! The tech-heavy NASDAQ, which recouped its COVID-19 losses in early June, has been in record-setting territory for a couple of months now. It did even better at +9.7% in August and +32.1% so far in 2020. From its March 23rd low, the NASDAQ is up a remarkable 72.3%.

Results for Canadian stocks are not quite as spectacular, but impressive none the less. The S&P/TSX gained 2.4% last month and is still down 1.1% for the year, but has gained 49.3% from the March 23rd low. The rebound in global equities has far outpaced past bear market recoveries in both speed and magnitude. What’s even more impressive, however, is how markets have done this despite several dark clouds overhead, most notable being the pandemic and the economic fallout from efforts to contain it. This month we try and make sense in what the market is seeing versus progress being made in the real economy. We still think the market is a bit crazy given the magnitude of the move, but perhaps not bat sh*t crazy. Let us explain why.

What do the spectacular overall market averages mean?

The first step in determining whether the rally has been justified, and perhaps more importantly whether the market can continue to melt higher, is to dig a little deeper beyond the headline performance numbers. While overall market averages look spectacular, they are just that, averages. Not all sectors and companies have enjoyed equal success. Consumer Discretionary and Information Technology have done very well, while Energy and Financial have faired poorly.

Growth stocks, which include a lot of Consumer Discretionary and Information Technology sector names, have also done well, while value stocks, like many Energy and Financial sector stalwarts, have underperformed and still find themselves well in the red for the year. Geography is also a differentiator. While many US stock indices are back into the black and hitting new highs, others, like Canada, are still trying to get back to even.

The biggest attribute working in the US market’s favour.

Probably the biggest attribute working in the US market’s favour is the weight and influence of technology orientated companies in the major US stock indices. According to Goldman Sachs, the Technology and Communications sectors have grown to comprise 40% of the US MSCI index, up from only 22% 10 years ago. In Europe, by comparison, technology and communications represent only 12% of the MSCI European index. Big tech is the real driver of returns in the US. According to a Financial Times article last month, the top five stocks in the S&P 500, Apple, Microsoft, Amazon, Alphabet, and Facebook, comprise over a fifth of the S&P 500, the largest top five concentration in the index since at least 1980, and have accounted for a quarter of the post-pandemic gains in the S&P 500.

Case in point, Apple alone now has a larger weight in the S&P 500 than the entire Consumer Staples sector, and it is closing in on the Industrial sector as well. Apple is a great company that makes great products but now trades at a price to cash flow that defies gravity.

Valuation is a major concern for investors

Valuation is a major concern for investors given the S&P 500 price-earnings ratio based on next year’s earnings has risen to levels last seen during the Dot Com bubble. According to the total stock market value as a percentage of GDP, Warren Buffet’s favourite market valuation indicator, stocks are even more expensive than during the early 2000s. Again, however, the numbers are skewed by a relatively concentrated number of highly valued tech stocks. Take out the five largest stocks mentioned above, and according to Strategas, the S&P 500’s trailing 12 month PE ratio falls from 22.3 to 20.5, still expensive, but less so. Perhaps more importantly, stocks look a lot less expensive when compared to bonds. Taking the S&P 500 trailing earnings yield (the inverse of the PE multiple) less the 10 year Treasury yield and valuations are right around their average over the past 15 years. Stocks are expensive, but record low-interest rates mean bonds are more so.

Low-interest rates are one of the biggest factors driving stock valuations higher.

Because the value of a company is the present value of future cash flows (earnings), the lower the rate the cash flows are discounted, the greater the present value. The other main driver is the growth of the cash flows themselves, which is why technology companies like Apple keep going up. In a world where it’s hard to find growth, investors are willing to pay more for companies that are able to deliver, and technology companies have been delivering. Revenue growth for the sector is forecast to continue to exceed most other sectors as companies continue to divert more capital spending toward IT and software over the next few years, and technology company earning’s continue to exceed expectations. Despite their size, the top five S&P 500 companies have been able to maintain superior earnings growth, a rare feat given their size. According to Bernstein Research, however, it’s a feat they expect to continue, as high ROE companies are exhibiting an ability to maintain their profitability for longer periods of time. So yes, they are expensive, but they are also exceptionally profitable companies.

Monetary and fiscal Stimulus: the good and bad news.

The strength and leadership of large-cap technology have helped the market recover and remain resilient, but it is less an indicator of the overall health of the economy than it is a result of the stimulus deployed to get us through the pandemic in one piece, more or less. Essential in this process of ensuring there is an economy to go back to has been monetary and fiscal stimulus, and on this front, we had good news and bad news last month.

Bad news first. After successfully bridging partisan divides and passing three important fiscal stimulus packages totalling around $3 trillion earlier in the year, Congress has stumbled and reached an impasse on the fourth and latest package, also known as Cares 2.0. The Democrat-led House of Representatives passed a bill valued at a mammoth $3.5 trillion, but have signalled they would be amenable to a scaled-down $2.2 trillion package. Republicans originally started out at $1 trillion, but Treasury Secretary Steve Mnuchin indicated that the White House would agree to $1.5 trillion in spending. Senate Republicans recently tried passing a “skinny” package in the $300 to $650 billion range to help Republicans in tight Senate races give their constituents some relief while also placating deficit hawks who worry about debt levels, which have spiked to levels not seen since WWII.

Their concerns appear valid, given the current trends in economic and population mean America is unlikely to dig itself out of the deep debt hole like it did post WWII. Also, a concern is generous unemployment benefits, which might be incentivizing workers from re-joining the workforce. Positive recent economic numbers have strengthened Republican lawmaker’s resolve, but many worry the economy could suffer permanent damage if more aid is not forthcoming. Morgan Stanley still believes we will see a Cares 2.0 deal in September and thinks it could be in the $1.5 to 2.0 billion range. Without it, Morgan Stanley sees a recovery to pre-pandemic levels being delayed by two quarters to Q4/21. This remains a looming threat to the economy and the market.

The goods news, the Federal Reserve suffers from no such partisan conflicts and continues to support the economy and markets. The Fed quickly cut overnight interest rates to zero and aggressively expanded it’s a balance sheet, stuffing it full of Treasury Bonds and Mortgages, helping drive yields lower. We believe this has been one of the biggest drivers for risk assets as markets have largely drunken the Fed’s Kool-aid.

At last month’s annual Kansas City Fed’s annual economic symposium at Jackson Hole, Powell upped the ante and announced the conclusion of the Fed’s policy framework review that has been a year in the making and released a new framework called flexible average inflation targeting, or FAIT. While the Fed has communicated they see rates staying low for an extended period of time, the Fed’s 2% inflation target still preyed on traders’ minds as hitting this threshold has historically been a signal it was time to tighten monetary policy. Now, however, Chairman Powell and the Federal Reserve have refined the 2% policy to be an average rather than a threshold, meaning if inflation runs below target for a period of time, it can also run above target in order to compensate and get to the 2% average over a period of time. What the Fed did not do, however, is clarify how high and how long they are willing inflation to run, though they did acknowledge the inverse relationship between low unemployment and inflation (known as the Phillips Rule) would no longer dictate their thinking. The Fed is going to let the economy run hotter without worrying about the potential negative future consequences of a tight labour market. Strong growth and low-interest rates, it doesn’t get any better than this for investors, in the short term at least.

Much of what the Fed discussed last month did not surprise the street.

Chairman Powell has been telegraphing a change in its inflation targeting policy for months. Given inflation is well below 2% presently and more strategists are focused on deflation than inflation right now, investors could also be justified in dismissing the move as meaningless. Perhaps what is more meaningful right now is not so much what they agreed to do in the future but what they didn’t agree to do.

With government debt at all-time highs and likely to go even higher, it becomes imperative interest rates remain low, and not just overnight rates. It’s the only way the Treasury Department can continue to borrow money and pay interest on the growing pile of outstanding debt. Because of this, many believed the Fed would also announce yield curve controls, or yields caps, promising to buy whatever amount of government bonds it takes to keep yields at predetermined low levels. The fact the Fed declined to do this, for the time being, could be a sign the Fed is trying to steepen the yield curve and is fine to see longer-term rates move moderately higher. They control shorter-term rates with the overnight rate anyways, so it’s really only 10 years and out they would likely actively try and control.

Currently, there is no urgency to cap 10-year rates as yields have been falling, with many investors beginning to view longer-term Treasury’s as dinosaurs, but why would they want a steeper yield curve? Last month we discussed how an expanded central bank balance sheet doesn’t increase the money supply and ultimately inflation if banks don’t lend out the excess reserves they accumulate as a result of the central banks’ bond purchases. A flat yield curve makes the business of lending money less profitable when you are borrowing short term and lending long term. A steeper yield curve, however, helps Bank lending become more profitable, and a healthy banking system is essential for a healthy economy. Now there is a limit as to how high the Fed will let long rates go. Yield curve control is still very much a possibility if animal spirits get the best of bond traders and rates spike higher. For now, however, a steeper yield curve would be welcomed, especially given this is normally what happens at the end of a recession as investors shift out of Bonds and into Stocks.

The fact the yield curve steepened in August is a good thing, but when will we know it has become a bad thing?

To answer this question, we first need to understand inflation, namely what causes it to increase, when will it start to move meaningfully higher, and how much is too much? These are the key questions for investors in our opinion, and unfortunately, one of the least understood subjects in economics. Last month Bloomberg published a useful article highlighting some of the issues, keying on four main areas of disagreement between forecasters trying to understand what inflation will do in the future. One the one hand, the money supply has spiked higher, but the velocity of money has likewise plunged lower. There is more money but it is not being circulated. Next, Government support to households has skyrocketed during the pandemic, but households are saving more.

Interest rates are at rock-bottom rates, which could stoke demand, but so are employment levels, which should have the opposite effect on demand. And finally, while supply chains are fragile, with more companies planning to move production away from China and back to the US (which could increase costs), more American factories are idle so new domestic production might not be more expensive.

One indicator to watch as a sort of inflation barometer is the US dollar.

Currencies tend to move inversely to inflation, meaning stronger relative inflation should weaken a currency over time. Case in point, Japan, which has suffered from a deflationary environment and a strong currency for years. Also, the US dollar tends to be a countercyclical and safe-haven currency, meaning when global economic growth is strong, the dollar tends to weaken. Same for commodities, higher commodity prices and a weaker dollar go hand in hand. Moves by the Fed to strengthen the economy and increase inflation is seen by traders as bearish for the dollar and one of the reasons many are shorting the greenback.

We suspect inflation in the short term will remain subdued and its path longer term will depend on the continued recovery of the global economy. The same can be said for stocks. The Fed and US Treasury can support the market for only so long. In order for the rally to continue it needs to broaden beyond Technology stocks, and for this to happen, we need a sustainable economic recovery.

The shape and pace of the recovery has been hotly debated. Is it a V, U, or L shaped recovery? Some believe it will be W shaped, or perhaps V then W (so-called Volkswagon recovery). Recently, some forecasters have proposed a new letter to describe the path of economic growth, the K shaped recovery, in which growth goes down sharply at the start of the pandemic as the economy is shut down, partially recoveries (halfway?) nearly as quickly, but then diverges into two different paths. For those fortunate to be able to work from home and keep their jobs, the recovery continues to trend higher. For those less fortunate, government stimulus eventually runs out and they either lose their support or the business they work for losses their support. Either way, for them the economy looks pretty bleak. Eventually, the two paths will have to converge, and the key will be the trajectory in which they converge. The current recession has certainly been one of the most severe in recent history in terms of the speed in which the economy has contracted, but recent data has surprised to the upside giving hope it might be one of the shortest as well.

The future course of the pandemic will play a large role in determining the strength of both inflation and economic recovery.

The good news on the COVID-19 front is new cases in the US have started to recede after spiking in July. Even with the increase in cases, deaths have remained relatively contained, likely because hospitals have become better at treating severe cases, and over 50% of new confirmed infections are now under the age of 40 years old and less likely to end up in the ICU. Still, US new cases appear to have plateaued around 40,000 a day, which is arguably too high, especially going into the Fall with schools reopening and colder weather forcing people indoors.

We hope what we saw in July (and are experiencing in B.C. right now) is the second wave and there won’t be a third wave, but a key risk for the economy would be school closures and the re-imposition of restrictions. We don’t think complete lockdowns and stay at home orders are likely again, but curtailing and dialling back certain activities are possible. Recent bar closures in B.C. are a perfect example. The bottom line, we see the pandemic finish line, we just don’t know whether we are going to sprint or stumble across the line.

What gives us confidence lockdowns will be avoided, which would be a complete economic disaster, is we now have a better idea of what works to contain the virus and what doesn’t. Masks work, and more and more people are wearing them, with over 80% of the US now under a mask mandate. Bars, parties, and any place large groups of people congregate without masks, especially indoors, does not work. Throw alcohol into the mix and you have the perfect recipe for a second or third wave.

The big hope is a vaccine will make all of this go away. This is certainly President Trump’s hope. The question is whether this will happen before the election on November 3rd. Last month the CDC advised states to be prepared for a vaccine by November 1, but this looks overly optimistic. We will likely have Phase 3 trial results by the end of 2020, maybe even by November 1. If all goes well, the FDA might approve one or more vaccines for emergency use soon after, but front line workers and those most at risk would get priority. The FDA will likely want longer-term data before making the vaccine available to the masses, meaning we are still looking at mid-2021 before social distance rules are largely eliminated.

This is a risk for the economy, especially if Congress is unable to pass another aid package. That the market appears to be ignoring this risk is because traders are either betting this won’t happen, or even if it does, monetary stimulus, low-interest rates, and plenty of liquidity will protect the downside. We suspect the latter.

The outcome of the November 3rd election will play a key role in the future economy

Looking past the pandemic, the outcome of the November 3rd election could play a key role in determining inflation and economic growth over the next few years. Given the excess capacity in the economy right now, we don’t see inflation being a problem any time soon. Jefferies, in fact, believes it will take four years before the Fed will need to start worrying about inflation, especially given their new flexible framework.

If Joe Biden becomes President and Democrats take the Senate, however, we would suggest Jefferies timeline gets accelerated. Though Biden is a moderate, his party is becoming more and more progressive, and a Democrat sweep will be seen as an opportunity to tilt the playing field in favour of Main Street America and away from Wall Street. This is certainly the story the Trump campaign is peddling, and why the market has a bias towards Trump, despite all the baggage he brings to the table.

Perhaps the most market-friendly result would be Biden becomes President but the Senate stays Republican. The instability Trump brings to the White House is removed, but the Democrat’s progressive agenda is thwarted by the Republican Senate. According to the betting odds, Trump has narrowed the gap with Biden, but this is to be expected right after the Republican National Convention. Biden still has a sizable lead in the polls and a Democrat sweep or a Biden win and split Congress are still the most likely outcomes. The path of the virus over the next couple of months could determine if a Trump comeback is in the cards. A second (third) wave and its negative impact on the economy would most likely sink his re-election hopes. Alternatively, a poor performance by Joe Biden in the first Presidential debate on September 29th could give the Donald new life. Normally the market wouldn’t care, but there is more than normal riding on the outcome of this election.

Why the disconnect between the market and the “real” world?

The bull market is riding a wave of liquidity, not all of it, but enough of it. This is especially the case for the technology sector. Will the liquidity wave created by the Fed take us safely to shore, at which point sustainable economic growth can lift the fortunes of the broader market, even if we lose the support of government spending? It could, though the Fall is going to be tricky as we try and avoid a second wave while enduring a contentious US election. With a K shaped recovery and low-interest rates, it’s entirely possible current market trends can be maintained. With expensive COVID winners continuing to be bid higher, and only if growth surprises to the upside would investors rotate towards more cyclically orientated sectors and stocks. We are concerned about valuations and the potential for economic growth to stall until a vaccine is widely distributed, but with the Fed providing the market liquidity and rates at near zero, we don’t see a major downturn in the near term. A short term correction relieving pressure from an overbought market, sure. That would actually be healthy for the bull market. Longer-term, we believe inflation is the rocks the liquidity wave will eventually crash against, we just don’t see it happening in the near term.

Nicola Wealth Portfolio – Investment Returns

Returns for the Nicola Core Portfolio Fund were +0.8% in the month of August. The Nicola Core Portfolio Fund is managed using similar weights as our model portfolio and is comprised entirely of Nicola Pooled Funds and Limited Partnerships. Actual client returns will vary depending on specific client situations and asset mixes.

The Nicola Bond Fund returned 1.2% in August. New issuance was very strong during the month with deals being met with high demand. Chair of the Federal Reserve, Jerome Powell spoke at the annual meeting at Jackson Hole, Wyoming, and revealed a new policy on average inflation targeting. We believe the end result will be lower interest rates coupled with a steeper yield curve, some of which has already occurred, as yield curves steepened during the month hurting fixed-income instruments with higher duration.

Our Nicola Bond Fund was mainly able to avoid the softness in the overall market, as we remain positioned with low duration and focused on credit. We believe that credit spreads overall remain supportive, they are starting to approach fair value and we may look to incremental positions in the medium term to provide a buffer if spreads widen out.

The Nicola High Yield Bond Fund returned -0.7% in August. In what generally amounts to a quiet period in the market at the tail end of summer with people on holidays enjoying warmer weather, August turned out to be a historical outlier and a very busy month in the high yield market as it was the second busiest month of high yield issuance ever. Default rates moved higher but the pace of movement has subsided. There was some recovery during August for the hardest hit lockdown industries but the market remains bifurcated with cruise lines, airlines, and energy still struggling while technology, homebuilders, and healthcare are doing well. Spreads may grind tighter but we remain cautious overall given potential risks.

We exited our position in the Picton Mahoney Income Opportunities fund and initiated a position in a special purpose vehicle focused on convertible bonds managed by Polar. Convertible bonds are currently attractive as spreads have not recovered as much as traditional high yield bonds. We are able to invest in securities that still have high yields while increasing our exposure to favoured industries such as technology and healthcare. Convertible bonds are complex instruments. Our investments will hedge out the majority of risk associated with equity exposure to concentrate on the bond portion of the convertible bond market. By doing so, we are able to benefit from the attractive valuations of convertibles while being agnostic to stock price with the potential of achieving higher returns if volatility picks up in the market through our stock hedges.

The Nicola Global Bond Fund returned -1.0% for the month. The Nicola Global Bond Fund benefited from the improvement in risk appetite as credit exposure in high yield corporates and U.S. mortgage-related securities added value. The Nicola High Yield Bond Fund’s underweight US duration added to relative performance as the 10-year UST finished the month 18bps higher at 0.71%.

Within Templeton Global Bond Fund, currency positions in most developed and developing markets except Latin America performed well against USD$; however, in Canadian dollar terms, Templeton’s safe-haven currency positions (Yen, USD, Swiss Franc) detracted from returns. Performance of our managers in descending order: PIMCO Monthly Income +1.2% and Templeton Global Bond -2.1%.

The returns for the Nicola Primary Mortgage Fund and the Nicola Balanced Mortgage Fund were +1.6% and 1.5% respectively in August. The Nicola Primary Mortgage Fund and The Nicola Balanced Mortgage Fund valuations have stabilized and are now priced at 99.4% and 99.6% of par, respectively. This had a positive impact on returns last month.

Current annual yields, which are what the Nicola Primary Mortgage Fund and Nicola Balanced Mortgage Fund would return if all mortgages presently were held to maturity, and if all interest and principal were repaid, would be 4.1% for the Nicola Primary Mortgage Fund and 5.6% for the Nicola Balanced Mortgage Fund. The Nicola Balanced Mortgage Fund funded two new loans in August, with additional loans scheduled to fund in September. We continue to review new loan opportunities. The Nicola Primary Mortgage Fund had 16.0% cash at month-end, while the Nicola Balanced Mortgage Fund had 15.9%.

The Nicola Preferred Share Fund returned 5.9% for the month while the BMO Laddered Preferred Share Index ETF returned 5.0%. Preferred shares continue to have strong performance as the new RBC note that was issued last month highlights the value proposition in the market versus corporate bonds. After launching, the RBC note traded well in the secondary market and Royal Bank redeemed $1.5B of perpetual preferred shares reducing supply in the market and causing a bid up of prices for existing issues as investors looked to other preferred shares to invest in.

Overall, credit spreads tightened throughout the month. Banks reported at the end of August and for the most part, positively surprised. We believe that the quarterly results set the stage for more banks to issue Limited Recourse Capital Notes similar to Royal Bank and with fewer products in the market, scarcity will play a role as prices move higher. Element Fleet Management announced the redemption of EFN G. Element has been strengthening their balance sheet and in October last year received an investment-grade rating from S&P. We believe that current outstanding EFN preferred shares continue to have value. With an investment-grade rating, the corporate debt market is opened up for Element allowing them cheaper financing that previously was not available.

The S&P/TSX was up +2.3% while the Nicola Canadian Equity Fund was +3.3%. Strong performance in the Financials and Industrials were the largest positive contributors to Index returns in August. Consumer Staples was the largest negative contributor to Index returns. The outperformance of the Nicola Canadian Income Fund was mainly due to being overweight in Industrials and Financials and also a strong stock selection in the Utilities area. The top positive contributors to the performance of the Nicola Canadian Equity Income Fund were Pinnacle Renewable, Ag Growth International, and Canwel Building Materials. The largest detractors were Kirkland Lake Gold, Allied Properties REIT, and Interrent REIT. In August we added a new position: SSR Mining inc. There were no deletions in the month.

The S&P/TSX was up +2.3% while the Nicola Canadian Tactical High Income Fund outperformed with a return of +2.9%. The Nicola Canadian Tactical High Income Fund benefited from strong performance in Industrials and Financials offset by performance in the Materials and Real Estate sectors. The Nicola Canadian Tactical High Income Fund has a Delta-adjusted equity exposure of 87% and the projected cash flow yield on the portfolio is over 8%. In the month, we reduced our exposure to the Consumer Discretionary sector and sold our position in Gildan Activewear. We added to our Precious Metals exposure by initiating a position in SSR Mining.

The Nicola U.S. Equity Income Fund returned +5.6% vs +7.2% for S&P 500. The Nicola U.S. Equity Income Fund lagged the benchmark due to being underweight FAAMG stocks (Facebook, Apple, Amazon, Microsoft & Google) which contributed over 3% to the S&P 500’s returns. The Nicola U.S. Equity Income Fund had 12.6% in IT vs 28.7% for the benchmark. The Nicola U.S. Equity Income Fund wrote 1 covered-call on Boeing with a 25.9% premium with a 16.6% upside. The Nicola US Equity Income Fund ended the month 6% covered. The Nicola U.S. Equity Income Fund has a delta-adjusted equity exposure is 95.6% and the current annualized cash flow is 2.9%. During the month, we sold our remaining Disney position and we added to our existing names.

The Nicola U.S. Tactical High Income Fund returned +3.4% vs +7.2% for the S&P 500. The Nicola U.S. Tactical High Income Fund lagged the benchmark due to being underweight FAAMG stocks (Facebook, Apple, Amazon, Microsoft & Google) which contributed over 3% to the S&P 500’s returns. We had a lot of cash available to invest as a significant amount of our August Put options expired and we were assigned on a few call options as well. Option trading activity had picked up near month-end and early into September as option volatility had picked up especially around November when the option expiries. In August we wrote 24 Put options ($39MM notional amount) and 5 Call options. Option writing continues to provide double-digit annualized premium yields with attractive upside/downside break-evens. The Nicola U.S. Tactical High Income Fund ended the month having 36.5% of long positions covered and delta-adjusted equity exposure of 42.5%.

Portfolio activity: we added to Healthcare and IT (Thermo-Fisher, Merck, Pfizer, Nvidia and Accenture).

The Nicola Global Equity Fund returned +1.4% vs +3.2% for the MSCI ACWI Index (all in CDN$). Global markets rallied last month putting up one of the strongest August equity market performances on record. The Nicola Global Equity Fund underperformed the benchmark due to our relative overweight in Consumer Staples, one of the weaker performing sectors during the month, and our regional underweight to the United States. The performance was marginally offset by our regional overweight to Japan and our underweights in Energy and Utilities sectors which were laggards in August. Performance of our managers in ascending order: Nicola Wealth EAFE +2.8%, EdgePoint +2.8%, Lazard +1.8%, C Worldwide +1.7%, JP Morgan Global Emerging Markets +0.8%, BMO Asian Growth & Income +0.2%, and ValueInvest -0.4%.

The Nicola Global Real Estate Fund return was -1.4% in August vs. the iShares S&P/TSX Capped REIT Index (XRE) -1.8%. The currency was a headwind as the C$ was relatively strong in August and over 50% of the Nicola Global Real Estate Fund is denominated in non-Canadian currency. YTD, the publicly-traded REITs have lagged the broader Canadian market by a wide margin. Our overarching view of the real estate complex is bullish in the long-term. We believe that the sector has significant valuation optionality and sustainable yields which is a very attractive combination. However, volatility for the REITs likely remain elevated in the near term as investors weigh the positives as the country eases lockdown measures versus the possibility and potential impact of a second wave of the virus. Overall we continue to favour the Industrial and Multi-family sectors and are overweight those areas in the Nicola Global Real Estate Fund portfolio. There were no new names added or subtracted in August.

The Nicola Sustainable Innovation Fund returned +5.9% (USD)/ +3.1% (CAD) in August and has returned +20.5% (USD)/ +21% (CAD) year-to-date. Two additional names were added to the Nicola Sustainable Innovation Fund portfolio this month: Ballard Power Systems a global leader in fuel cell systems with over 40 years of experience, and EDP Renewables the renewable energy-focused branch of Energias de Portugal (EDP Group) and the 4th largest producers of wind energy in the World. Sunrun Inc., Pinnacle Renewable Energy, and Ameresco were the top contributors to performance while Itron Inc., American Water Works, and Next Era Energy Partners were among the detractors to performance. In addition to the new names added, we took some recent profits from Pinnacle Renewable and Hannon Armstrong and we topped up a number of existing positions including Ormat Technologies, TPI Composites, and Xebec Adsorption. Cash levels drifted higher leading into month-end given recent in-flows from clients but have largely been deployed closer to a 3-4% level in early September.

The Nicola Alternative Strategies Fund returned -0.6% in August. Currency detracted -1.8% to returns as the Canadian dollar continued to rebound and strengthen through the month. In local currency terms since the funds were last priced, Winton returned -2.3%, Millennium 1.2%, Renaissance Institutional Diversified Global Equities Fund -1.1%, Bridgewater Pure Alpha Major Markets -0.7%, Verition International Multi-Strategy Fund Ltd +1.8%, RPIA Debt Opportunities +3.0%, and Polar Multi-Strategy Fund +3.0%. We believe that Bridgewater is well-positioned as a diversifying strategy for the current environment. Macro concerns remain on growth potential; however, with interest rates close to 0% and the potential waning efficacy of quantitative easing, there is the potential for significant coordination of fiscal and monetary policy in the future. Bridgewater is well-positioned for potential policies to reflate financial assets while remaining agnostic to economic growth.

The Nicola Precious Metals Fund returned -1.5% for the month while underlying gold stocks in the S&P/TSX Composite Index returned -3.3% and gold bullion was down -3.1% in Canadian dollar terms. Gold bullion and stocks took a breather from their torrid pace this year. RBC Global Precious Metals Fund outperformed the overall gold market as small-cap gold names outperformed larger-cap names, particularly large precious metals streaming companies such as Franco-Nevada and Wheaton Precious Metals.

 

This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information presented here has been obtained from sources believed to be reliable, but not guaranteed. Returns are quoted net of fund/LP expenses but before Nicola Wealth portfolio management fees. Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Please speak to your Nicola Wealth advisor for advice based on your unique circumstances. Nicola Wealth is registered as a Portfolio Manager, Exempt Market Dealer, and Investment Fund Manager with the required provincial securities’ commissions. This is not a sales solicitation. This investment is generally intended for tax residents of Canada who are accredited, investors. Please read the relevant documentation for additional details and important disclosure information, including terms of redemption and limited liquidity. For a complete listing of Nicola Wealth Real Estate portfolios, please visit https://realestate.nicolawealth.com. All values sourced through Bloomberg. Effective January 1, 2019, all funds branded NWM was changed to the fund family name Nicola. Effective January 1, 2019, the Nicola Global Real Estate Fund adopted a new mandate and changed its name from NWM Real Estate Fund.