Currency & Sector Liquidity Analysis Report: Q4 2019

February 18, 2020

Marking the end of 2019, stock markets have enjoyed one of the greatest bull runs of all time. Remember the rhetoric at the beginning of 2019, when prominent CEOs and portfolio managers were calling on cash to be a better performer across most asset classes? They could not have been more wrong. Yes, 2018 was a rough year for asset managers, and while the deep red of that year prompted more pessimistic estimates for 2019, we can explain this deviation fairly well. We understand now with actual results that the pessimism that kicked off 2019 was overblown. If you had actually held only cash in your portfolio, you would be kicking yourself at the close of 2019, as the main big stock indices turned in stellar performances.

For the first time in 2019, all major currencies posted month-over-month declines in December, with the exception of the yen. This is quite a phenomenal event. As seen in Chart 1, the portion of U.S. dollar cash to the portfolio was at an all-time low for 2019 and was the second lowest point for the Canadian dollar. What this means is that portfolio managers allocated a significant chunk of deployable cash into securities, which helped buoy overall market returns. But how much institutional cash is now left to keep buying pressure constant? Profit-taking in several of the top-performing asset classes is almost certain in the coming months.

North American stock indices continue to rally into the new year, with many companies reporting earnings that exceed estimates, across all sectors. Canadian equity markets have been propelled by strong performance in mining stocks, which, as part of the resource sector, have a heavy weighting TSX. South of the border, more economic stimulus and infrastructure spending is expected, especially during this election year. U.S. GDP growth remains above 2%, unemployment rates are at all-time lows below 3.5%, and job growth continues, but at a decelerating rate.

Bond yields are dropping globally, and investors wait anxiously to see how the coronavirus will impact the economy. Canada’s Finance Minister Morneau has stated that it will have a significant impact, while U.S. Federal Reserve Board Chairman Jerome Powell is less certain of its severity. Debt markets usually lead the way for equity markets, so we will be watching the movement of yields closely over the next few months for clues on the direction of broader equity markets.

Average portfolio weights for world currencies

This analysis focuses on the Canadian investment fund industry, and how portfolio managers are allocating capital in major currencies. The currency analysis excludes all cash equivalents, such as bonds with less than one year to maturity and collateral cash held to fulfill debt covenants. We believe by excluding these items, we can home in on the deployable cash in investment funds and assess the street’s market sentiment. We then further analyze the liquidity of investment funds on a cash and cash-equivalents basis, categorized by sector, to help us understand which verticals portfolio managers are currently overweighting and underweighting.

Table 1 illustrates the month-over-month growth rates for the world’s major currencies.

Chart 1 illustrates the mean cash percent in investment funds for nine major currencies in sequential order from January 2019 to December 2019.

U.S. and Canadian cash on hand

Chart 2 illustrates the mean cash dollar value in sequential order from January 2019 to December 2019. The United States dollar had a net position of $2,646,255,540 for December 2019. The Canadian dollar had a net position of $3,527,876,854 for December 2019.

Investment Fund Liquidity Ratio

The Investment Fund Liquidity Ratio is calculated as the amount of cash in a fund relative to its total assets. It is important to assess this ratio when analyzing investments and allocating capital. It has the power to give incredible insight into the overall flow of capital into specific verticals and the bullish or bearish sentiment in these investment categories. Listed below are the top and bottom 10 in applicable sectors based on the mean ratio of over 3,000 investment funds with a mandate to invest in the corresponding sectors. The table lists the most bearish to most bullish sectors in descending order.

The red highlights the sectors with the highest ratio, which translates into underweighting their respective indices. This could mean that portfolio managers are expecting negative performance in these categories.

The green highlights the sectors with the lowest ratio, which translates into overweighting their respective indices. This could mean that portfolio managers are expecting positive returns in these categories, in the short term.

Review and outlook

Fixed income continues to be a repeating theme for investment fund categories with the highest amount of cash on hand. Natural resources equity is also an important sector to watch, as oil prices could be in for more downward momentum this year.

It is interesting to see Asian equity portfolio managers bullish at year-end as the Chinese Securities Index moved toward yearly highs towards the end of 2019. This optimism may have been short-lived as Chinese markets fell sharply in January because of anxiety about the new coronavirus. Indian securities could also be set for a bounce, as many observers think growth will bounce back from the six-year low of 4.5% posted in the third quarter of 2019. The Canadian economy seems more robust than ever, with the central bank holding interest rates steady for quite some time. With only geopolitical risks as the biggest threat on the horizon for markets at this point, analysts are predicting modest returns for 2020. We will revisit this narrative in coming months to see how accurate they are.

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