Heading into the third quarter of 2023, the outlook for the economy gave investors a few reasons for a little optimism. Inflation had fallen very consistently for a year and measured 2.8% by the end June, not all that far off from the Bank of Canada’s 2% target. The economy, although slowing (GDP growth decreased to 1.8% for the prior 12 months by the end of Q1, and to 1.1% by the end of Q2) was still producing positive output. In addition, the unemployment figures remained surprisingly robust, with the unemployment rate at 5.5%, the net change in the labour force remaining positive (employers were adding to their payrolls), and average hourly earnings measured above 5% (meaning wages grew at a rate greater than 5%).

After a strong first half of the year, global stock markets took a breather during the third quarter. Equity market indexes were down across the board during Q3 with the S&P 500 returning -3.7%, the STOXX Europe 600 index returning -2.5%, and the Nikkei 225 returning -4.0%. Despite the weakness experienced in Q3, global stock markets have generated respectable gains throughout the first nine months of the year. On a year-to-date basis through September 30, the Nikkei 225 has returned +22.1%, the S&P 500 has returned +11.7% and the STOXX Europe 600 index has returned +6%.

Last quarter we discussed the likelihood of a soft economic landing given that economic growth was slowing but likely not turning negative, and the earnings outlook was improving in the back half of 2023 and 2024. Since then, a few positive data points on the inflation front have come in over the summer months to support that hypothesis, and these have been enough to shift market consensus to the soft-landing from recession camp.

Each quarter, our Investment Management teams publish their key observations and portfolio updates across Global Equity and Fixed Income markets. This is a summary of our views for the Second Quarter of 2023. You can download the full reports via the links shown below.

KEY OBSERVATIONS

“The US government won’t default on its debts. There are plenty of jobs. Unit-labor-cost inflation is moderating. The banking crisis is abating. The recession is still a no-show. Earnings were better than expected during Q1 and are probably bottoming during the [second] quarter. The FOMC likely will pause its rate hiking for at least one meeting (they did). Summer is coming. No wonder the S&P 500 sailed to a new 2023 high yesterday.”

That is a summary of “what’s going on” according to respected market-watcher Ed Yardeni, and it’s generally music to our ears, even if it’s not coming from Marvin Gaye…  In other words, his views closely match our own. On June 8th, less than a week after Yardeni wrote this, the S&P500 officially entered a new bull market, up more than 20% from its 52-week low in October 2022. 

During the second quarter, the S&P500 total return was +8.7% in US dollars or +6.4% in Canadian dollars, as the Canadian dollar appreciated about +1.5 cents. The TSX total return was +1.1%. While given technology stocks continued to dominate the performance of the S&P500, we saw considerable widening in the breadth of performance late in the quarter as the market began to price in the possibility of a soft landing rather than a recession.

In terms of valuations, the TSX and the FactSet European index are trading at 10% and 5% discounts to their 20-year averages, respectively. The S&P 500 is trading above its historical average, but this is arguably skewed by a handful of large companies.

Indeed, the 10 largest S&P 500 companies by index weight have outperformed by almost 4x over the past 12 months, and we own five of them (Apple, Microsoft, Alphabet, Facebook and United Health Group). We are balancing these higher-growth holdings against attractive value-oriented names like GM, Elevance Health, Royal Bank, and Rogers Communications, among others.

Overall, we remain constructive on the equity market, notwithstanding the recent rise in prices. While corrections commonly occur during bull markets, we believe that the positive economic fundamentals that we observe should limit the downside. The earnings outlook is improving and, with economic growth slowing but likely not turning strongly negative, interest rates are closer to a peak than a trough, suggesting that equity market valuations are also less of a headwind going forward than they were in early 2022.

Peter Jackson, HBSc, MBA, CFA

Chief Investment Officer

Portfolio Manager, North American Equities

During the quarter, our overall equity exposure was unchanged at 94%. Within the North American investments, our US equity exposure increased from 40% to 42% while our Canadian exposure decreased from 54% to 52%. Cash was unchanged at 6%. 

Currently, our portfolio is positioned toward value-oriented stocks (including financials, consumer discretionary, industrials, energy and materials), which make up 58% of the portfolio, although this has declined from 63% on December 31st. Exposure to growth stocks (including healthcare, information technology and communication services) increased to 34%, up from 29% on December 31st. 

We added the following new stock positions during the 2nd quarter: 

Quebecor Inc. is a Canadian diversified media and telecommunications company based in Montreal. The acquisition of Freedom Mobile has opened a large avenue of growth for a company that has been traditionally restricted to the province of Quebec. We see a long runway ahead for Freedom that is not reflected in the present share price. 

Novo Nordisk is the world’s leading diabetes and obesity pharmaceutical company with a market capitalization of approximately US$360bn. Its Ozempic drug is now the most prescribed GLP-1 product. The company has demonstrated high margins and free cash flow, and a ~45% dividend payout while continuing to invest in its drug pipeline. 

Applied Materials is a leading supplier of advanced equipment, tools, inventory, and maintenance services to logic, memory and analog semiconductor companies. We see the company benefiting from the growth in digitization, automation, and AI, plus onshoring of semiconductor supply chains and a rebound in capital spending.

A detailed review of each company can be found in the full report per the link above.

GLOBAL EQUITY UPDATE

Phil D’Iorio, MBA, CFA
Portfolio Manager, Global Equities

After generating strong gains during the first quarter, global equity markets also continued their upward climb during the second quarter. On a total return basis, the STOXX Europe 600 index returned +2.7%, the Nikkei 225 index was +18.5%, and the Nasdaq gained another +13.1%, taking its year-to-date gain to more than 32% –  its best first half of a year since 1983.

Despite these returns, a great deal of pessimism remains in the market. Several commentators continue to warn about a forthcoming recession. Most are concerned about the potential for a recession in the US given elevated inflation, aggressive monetary tightening, and the fallout from the collapse of several regional banks. Despite these concerns, the U.S. economy has demonstrated remarkable resilience and consumers continue to spend. 

US housing was one of the hardest hit sectors in 2022, but recent data suggests that we could be on the cusp of a rebound. New home sales jumped 12.2% to the highest level since February 2022. A potential rebound in U.S. housing is significant given that the housing sector is one of the largest and most important sectors of the U.S. economy, contributing an estimated 15-18% to GDP.

Inflation continues to move in the right direction as measured by the consumer price index. According to recently published data from the U.S. Labor Department, the inflation rate for the month of May cooled to its lowest annual rate in more than two years.

The global economy is growing at a modest pace, inflation has been moderating in both the U.S. and Europe, and consumer confidence has recently improved in the US. Corporate earnings have proved to be more resilient than the market was expecting. Taking all of this together, we remain cautiously optimistic as the second half of the year gets underway.

During the quarter, we initiated several new positions. In portfolios invested in our Global strategy, we added Applied Materials, Deckers Outdoor, Novo Nordisk, RELX, and YUM! Brands. In the International strategy, we invested in ASML, Hoya, Sony, and YUM China.

A detailed review of each company can be found in the full report per the link above.

After generating strong gains during the first quarter, global equity markets continued their upward climb during the second quarter. On a total return basis, the S&P 500 was +8.7%, the STOXX Europe 600 index returned +2.7 %, and the Nikkei 225 index was +18.5%. The Nasdaq was particularly strong with the index generating a total return of +13.1% during the second quarter. For the first six months of the year, the Technology-heavy Nasdaq index soared by more than 32%, which marks the best first half for the Nasdaq since 1983 when it rose by 37%. The strong gains in the Nasdaq have largely been driven by the excitement surrounding artificial intelligence (AI) and the potential productivity gains that AI could generate for the global economy.

In a reverse from Q1, the Canadian yield curve level (the general, reflecting overall value of interest rates across the curve) shifted higher in Q2, with the more pronounced moves occurring in the short to medium term tenors (encompassing the 3 month to 7 year bonds). This is shown in the Canada Yield Curve chart below. Rates moved higher by an average of almost 60 bps across the curve. As bond investors, you know that when interest rates (yields) rise, bond prices fall, albeit modestly in this case.

So “What’s Going On” according to Ed Yardeni June 2nd, 2023.
This quote was music to our ears even if it was not from Marvin Gaye. It is in line with our current thinking at Cumberland and pretty much summed up what happened in the second quarter. In fact, the S&P500 officially entered a new bull market on June 8th, up more than 20% from its 52-week low of 3577.03 on October 12th, 2022.

Each quarter, our Investment Management teams publish their key observations and portfolio updates across Global Equity and Fixed Income markets. This is a summary of our views for the First Quarter of 2023 You can download the full reports via the links shown below.

KEY OBSERVATIONS

It’s hard to believe that we saw positive returns from both the S&P 500 (+7.5%) and TSX (+4.6%) during the first quarter. After all, inflation is still high, the Federal Reserve continued to increase interest rates, consensus earnings declined, and we witnessed the second largest bank failure in US history.

The bank failures in the US and Europe may be a drag on growth going forward, but we do not anticipate a wider crisis. We currently have no exposure to US banks, little exposure to European banks and some exposure to Canadian Banks. Canadian Banks are consistently more profitable than US and European banks and carefully regulated, so when problems do occur, they can usually manage without the need for external capital. 

Despite the banking turmoil, the Fed increased rates 25 basis points or +0.25%, bringing the upper end of the federal funds rate to 5.0%. They maintained their 2023 target rate of 5.1% and raised their 2024 target to 4.3% from 4.1%. In contrast, the fixed income market seems to have priced in about -0.85% of rate decreases this year. The question now is whether this reflects an expectation of lower inflation and slower growth, or a recession. Either way, it’s clear that the rate hiking cycle is virtually over.

We continue to believe that, if a recession does materialize, it will be relatively mild. Global banks are well-capitalized and businesses and consumers are significantly less exposed to credit and leverage risk than they have been historically. In addition, unlike a year ago, with interest rates now higher the Fed now has some room to maneuver its policy. In other words, if the economy slows too quickly, they can cut rates.

Consensus S&P 500 corporate earnings estimates for 2023 and 2024 have fallen nearly -12% and -11%, respectively, from their peaks in the spring of 2022. However, valuations (the price investors are willing to pay for a dollar of a company’s earnings) are now much more reasonable and almost two-thirds of S&P 500 companies are showing positive 3-month percent changes in forward earnings. Both of these factors are positive for stock prices.

We remain confident in the long-term outlook for our portfolio holdings given their robust free cash flow and strong balance sheets. We believe that these types of companies are best positioned to weather any storm that might arise.

Peter Jackson, HBSc, MBA, CFA

Chief Investment Officer

Portfolio Manager, North American Equities

We have continued to position our portfolios toward value-oriented stocks. Value stocks now make up 61% of the portfolio. Our exposure to growth stocks increased slightly to 31% of the portfolio. Staples, which we don’t classify as either growth or value, make up the balance of our equity exposure.

We added a number of new stock positions during the quarter, including: 

BCE Inc. represents a stable and defensive investment in uncertain times, where you are “paid to wait” with an excellent dividend that currently yields about 6%.

Canfor Corporation is a contrarian deep-value cyclical investment. Their lumber operations stand to benefit from eventual declining interest rates and higher housing demand as a result.

General Motors Company has made significant investments in R&D and supply chain. Based on this, among other positive factors, and given its current valuation, we expect GM stock to perform well.

Avery Dennison Corporation is a global materials science and manufacturing company that we believe will grow earnings faster than the market, which provides good share price appreciation potential for investors.

Meta Platforms has over 3 billion monthly users across Facebook, Instagram, and WhatsApp and we expect strong earnings from cost cuts and rebounding ad sales. In addition, Meta has invested heavily in the Metaverse over recent years, and these capital expenditures are virtually complete, allowing the company to profit. 

A more detailed review of each company can be found in the full report per the link above.

GLOBAL EQUITY UPDATE

Phil D’Iorio, MBA, CFA
Portfolio Manager, Global Equities

After a challenging year in 2022, global equity markets more broadly also generated positive returns during the first quarter of 2023 with all the major geographic regions in the green. In addition to gains in the US and Canada, the STOXX Europe 600 index climbed by +7.8%, the Nikkei 225 increased by +7.5%, and the Emerging Markets collectively generated a positive return of +4%. 

Some of the factors driving these returns include falling inflation, better than expected economic data in the US and Europe, as well as enthusiasm related to the reopening of China’s economy.

In terms of inflation, the headline figures continue to fall in both Europe and the US. Preliminary readings showed that Eurozone headline inflation fell to 6.9% during the month of March, down from 8.5% in February. In the US, the consumer price index increased by +6% from a year earlier, a decline from 6.4% in January and down from the 40-year high of 9.1% in June of 2022.

We remain cautiously optimistic in our outlook for 2023. Given last year’s significant market declines, stocks are trading at more reasonable valuations. In addition, inflation measures have been falling and the red hot job market is finally showing signs of cooling. When combining these developments with what’s happened in the banking sector, we believe that central banks are nearing the end of their interest rate hiking cycle.

During the first quarter, as described above we re-initiated a position in Meta Platforms. We had previously invested in the company, but sold our entire position back in February of 2022 when Mark Zuckerberg gave specific guidance on how much money it was going to spend on the Metaverse. Since we sold it, the stock fell by 70%. 

Fast forward one year later, the company announced a strategic pivot in terms of its capital allocation. In addition to the tailwinds from its cost reduction efforts, Meta also has a potential opportunity should TikTok get banned in the United States. We also believe that Meta will benefit from the boom in artificial intelligence that will play out in the years ahead.

A more detailed review can be found in the full report per the above link.

The drivers of positive fixed income returns for Q1 2023, in no particular order, were the effective management of the isolated bank liquidity crisis, the central banks’ (Canada and the US) higher interest rate policies and the increase in corporate interest rate spreads (incremental return over government bond yields). After this positive start for fixed income investors, based on the fundamentals we continue to see, we retain our positive bias for income investments for the remainder of the year.

Each quarter, our Investment Management teams publish their key observations and portfolio updates across Global Equity and Fixed Income markets. This is a summary of our views for the Third Quarter of 2022. You can download the full reports via the links shown below.

KEY OBSERVATIONS

We have just concluded another year of tremendous volatility, although it finished on a positive note. The S&P500 total return for the fourth quarter was +7.6% in US dollars or +6.3% in Canadian dollars. The fourth quarter TSX total return was +6.0%. For the year, the S&P500 total return index was down -18.1% in US dollars or -12.5% in Canadian dollars. The TSX total return was -5.8% for 2022.

While it’s never fun to have a down year, the previous two years featured strong gains. Between 2020, 2021 and 2022, the average annualized total return for the S&P 500 was approximately 9.6%, which is close to the average of the past 50 years.

The losses of 2022 were almost entirely comprised of a forward price/earnings (P/E) multiple contraction of -22.07%, and were slightly offset by a positive contribution from dividends (+1.33%) and positive forward earnings per share of +3.37%. In other words, most of the decline was a result of people willing to pay less for every dollar of earnings in 2022 than they had been previously, mainly as a result of higher interest rates and perceived risk.

Two-year stretches of P/E multiple contractions are rare, and 2021-2022 ranks as the greatest two-year P/E multiple contraction of the past 38 years. Meanwhile, earnings themselves have not collapsed. Current forward earnings growth is still positive for 2023 and 2024 at +5.1% and +10.1% respectively, such that the forward P/E multiples are starting to look reasonably attractive at 16.7x and 15.2x compared to the historical 10-year average of 17.3x. Our experience is that the market begins to look forward to the next year (2024) usually by the second quarter of the current year.

While there are no shortages of negative economic forecasts for 2023, we think there is a reasonable chance for the Federal Reserve to tame inflation and for the economy to remain resilient. Even if we are wrong and we do experience a mild recession, our best guess is that long term interest rates will fall, which would lead to P/E expansion and support for market valuations – potentially reversing the historic P/E contraction of 2022. 

Peter Jackson, HBSc, MBA, CFA

Chief Investment Officer

Portfolio Manager, North American Equities

During the quarter, our overall equity exposure decreased by 6% to 96%. Our US equity exposure increased from 37% to 38% while our Canadian exposure increased from 53% to 58%. Cash decreased from 10% to 4%. It is important to keep in mind that many of our clients’ portfolios are invested in equities globally, through our North American plus International Equity strategy, meaning that the actual weights of US and Canada within their equity holdings will be proportionately less than this given the 15-20% allocation to international companies.

We have continued to position the portfolio toward value-oriented stocks. Value stocks now make up 63% of the portfolio. Our exposure to growth stocks was trimmed by about 1% to 29% of the portfolio. Staples, which we don’t classify as either growth or value, make up the ~8% balance of our equity exposure.

During the quarter, we added a number of new stock positions, including: 

Enghouse Systems Ltd. acquires and integrates technology companies. After a brief lull, it’s most recent quarter showed stronger revenue and EBITDA growth. This Canadian company also announced two acquisitions that should re-accelerate growth.

Arthur J Gallagher & Co is one of the leading insurance brokerage, risk management, and human capital consultants in the world. We like this business and consider it defensive, as most insurance purchases are non-discretionary. 

Eaton Corp. PLC is a power management company that benefits from the shift to renewable power. New orders and backlogs have accelerated, and secular tailwinds should support prolonged revenue growth at mid-to-high single digits.

Elevance Health Inc. is one of the largest health benefits companies in the United States. We like the demographic-driven stability and growth characteristics of health care, and believe the company is well positioned to benefit from this trend. 

A more detailed review of each company can be found in the full report per the link above.

GLOBAL EQUITY UPDATE

Phil D’Iorio, MBA, CFA
Portfolio Manager, Global Equities

Download Full Commentary

Inflation was percolating at the start of 2022, and the war in Ukraine served as a catalyst to drive it even higher. In response, central banks aggressively hiked interest rates as you have seen. Against this backdrop, both stock and bonds lost money. Since 1926, there have only been two calendar years when stocks and bonds were both down.

We believe that a changing of the guard may be unfolding in terms of stock market leadership. During the fourth quarter, the MSCI EAFE and MSCI Emerging Markets Indexes both outperformed the MSCI USA Index. This trend may continue after 15 years of outperformance by the United States, thanks in part to a fading US dollar.

We are cautiously optimistic about 2023. Inflation is showing signs of cooling, which means we may be getting closer to the end of rate hikes. We believe that the companies we own, with stable earnings, low leverage, and pricing power, are well positioned for 2023. And history suggests that forward returns are typically strong in the aftermath of a bear market.

We recently added several new stock positions, including Arthur J Gallagher & Co and Eaton Corp, which are highlighted on the previous page. We also added:

Avery Dennison is a materials science company specializing in labeling and functional materials with dominant market share, pricing power and economies of scale.

FinecoBank is one of the most established online banks in Italy and stands to benefit from the wealth transfer to younger generations and higher interest rates.

Keyera Corp is an integrated energy infrastructure business with extensive interconnected assets and a generous dividend yield.

Keysight Technologies is a global leader in testing and measurement equipment with exposure to several themes that we like, including electrification and reshoring.

A more detailed review of each company can be found in the  full report per the above link.

In December, The Bank of Canada made two statements that highlight recent uncertainty. First, the Bank noted that “its Governing Council will be considering whether the policy interest rate needs to rise further,” potentially signaling that the rate hike cycle is close to an end, then noting that the “annual run rate inflation is still too high, and short-term inflation expectations remain elevated,” leaving the door open for further hikes.

Like Canada, the headline economic story in the US was inflation. The market currently expects another 50-75 bps of overnight interest rate hikes in 2023, and for the rate to peak at 5.0% in June. We anticipate that, like the Canadian situation, the Fed will pause and watch the state of the economy in the second half of 2023 before making further moves.

Subtle shifts in the Bank’s commentary and five consecutive months of declining inflation in both countries have us feeling more positive than we have in months.

Firstly, we believe we are near the end of the rate hike cycle, and therefore the impact of higher rates on fixed income securities should soon end, barring any unforeseen shocks. Secondly, there is a risk of a recession in our view, but we believe it will be mild. Consensus forecasts of Canadian and US GDP expects positive growth in 2023 and the labour markets in both countries remain tight.

With a rate hike or two still likely, we maintain a shorter duration than the benchmark. Some of the investment opportunities in the 2-3 year range offer yields that are almost as attractive as those maturing 7-10 years out, and we don’t believe the relatively minor additional yield of longer bonds compensates us adequately for the additional maturity risk or remaining interest rate risk.

We believe the current yields are more compelling than they have been in many years. As a result, we are looking for opportunities to lock in investments for the benefit of our client portfolios. To get a deeper understanding, you can read the full report via the link above.