I was a one-person department at a boutique brokerage firm during the financial crisis, tasked with helping financial advisers understand market volatility. I have often said that I have never learned as much, as fast, as I did in 2007 and 2008.
There was an advantage at the time though – markets kept going down. If something weird was happening, the market was likely to be down 10 per cent by the time you figured out what was going on. As such, there were no buying opportunities.
This time is much different because stocks are rallying. The longer it takes to comprehend the drivers of the rally, the more upside is missed for those holding cash.
So, what do we know about what’s pushing equity markets up?
As Credit Suisse strategist Andrew Garthwaite points out, ultra-low interest rates are a key driver behind the equity rally.
In the U.S., for example, inflation-adjusted 10-year bonds yield negative 0.40 per cent, which means investors lose value over time. This forces large portfolios to reallocate funds from bonds to equities.
B of A Securities’ equity and quant strategist Savita Subramanian estimates that the S&P 500 rally is 90 per cent explained by new money - in other words, liquidity, which fits with Mr. Garthwaite’s thesis. “If the rally were from economic recovery inklings, the distressed, GDP-sensitive cohort of the benchmark would have [outperformed]." But this subset of the market has not rebounded until recent weeks. “Instead, liquidity looking for a home settled mostly into secular growth/stay at home beneficiaries.”
Morgan Stanley strategist Michael Wilson sees the current rally following the same patterns as markets after March 2009. He points to the rising cyclicals/defensives ratio – the relative performance of economically-sensitive stocks versus defensive sectors like utilities and consumer staples – as proof that a durable, long-term market rally has begun.
Ms. Subramanian and Mr. Wilson appear to be at odds over the returns for economically sensitive stocks. Ms. Subramanian emphasizes the high correlation between the Federal Reserve balance sheet and the dominance of FAANG stocks in the S&P 500 to show that secular growth companies are benefiting most from monetary stimulus.
Mr. Wilson, on the other hand, focuses on the 88 per cent rally in the S&P 500 Energy sub index from the March 23 lows to argue that industries dependent on economic growth are leading the market recovery.
These perspectives indicate that investors should pay very close attention to bond yields, specifically the 10-year U.S. Treasury yield. The 10-year benchmark steadily climbed last week and is flirting with 1 per cent, almost double levels of the end of March.
Rising yields would support Mr. Wilson’s forecast of resurgent growth and cyclical stock outperformance of both defensives and the market leading technology stocks.
However, if yields climb to levels high enough to attract equity investors back into bonds, this threatens the asset class reallocation Mr. Garthwaite describes, and the higher levels of liquidity Ms. Subramanian sees driving the rally.
-- Scott Barlow, Globe and Mail market strategist
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Ask Globe Investor
Question: You mentioned recently that Bank of Montreal is now offering a 2-per-cent discount on shares purchased through its dividend reinvestment plan. How do I enroll in the DRIP and get the discount?
Answer: Bank of Montreal (BMO) isn’t the only bank offering a DRIP discount. When Toronto-Dominion Bank (TD) released quarterly results in May, it also announced a 2-per-cent discount on shares issued from its treasury under its DRIP. Both banks are hoping to attract more investors into their DRIPs, which are a convenient way for the banks to raise capital at a time when their earnings are under pressure from the economic ravages of the novel coronavirus.
There are two ways to sign up for a DRIP. The first is to enroll your shares in the company’s own DRIP through its transfer agent. The advantage of going this route is that every penny of your dividends will be reinvested, because company-operated DRIPs support the purchase of fractional shares. However, you will first need to ask your broker to register the shares in your name (for which there will be a fee) before you can enroll them with the transfer agent.
The second – and easier – way is to enroll your stocks with your discount broker’s DRIP. You can set this up with a phone call and there are no fees, but the downside is that broker-operated DRIPs do not support the purchase of fractional shares. This means that, when you reinvest your dividends, you can only purchase whole shares and will typically have some cash left over. You will also need to have sufficient shares in your account so that the dividends received are enough to purchase at least one new share, or the entire dividend amount will be received in cash.
Most discount brokers will honour DRIP discounts offered by companies such as BMO and TD, according to dripprimer.ca/canadiandiscountbrokers. However, before taking the plunge, you should verify this with your own broker.
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What’s up in the days ahead
Rob Carrick will present a new way of looking at mutual fund performance that will illustrate why ETFs aren’t always the better choice.
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Compiled by Globe Investor Staff