Q1 2023 Strategy & Market Reviews
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.
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.
Owen Morgan, MBA, CFA
Portfolio Manager, Fixed Income
The drivers of fixed income returns in Q1 2023 were, in no particular order, the banking crisis, Canadian and US interest rate hikes (or pauses), and interest rate spreads, particularly the incremental return over lowest risk government bonds. In all, 2023 got off to a positive start for fixed income investors.
The Canadian yield curve shifted lower in most tenors, and remained inverted during Q1 2023. As you know, when interest rates decrease, bond prices increase, so this was a positive outcome for fixed income investors.
However, as a result of the interest rate volatility and the general “risk-off” tone of the market, corporate spreads widened modestly during the quarter. The level of corporate bond spreads are viewed as barometers for recession risk. While they currently suggest the risk of recession has increased, they do not, at present, indicate that a recession is imminent.
The Bank of Canada hiked rates by 25 bps or + 0.25% to 4.5% in late January, as expected. However, the Bank announced that it would pause, absent any material deviation from its economic forecasts, and it did just that at its meeting on March 8th, holding the rate at 4.5%. We do not currently anticipate further hikes here in Canada, but think there may still be one more increase in the US.
In Q1 2023, the trends for the US economy that were evident in late 2022 remained in place – high but declining inflation, very tight labour markets, and surprisingly resilient economic growth. The shock of the banking crisis caused rates to tumble, and the market believes the Federal Reserve Bank is tantalizingly close to the completion of its rate hike cycle.
We have not wavered in our belief that should a recession occur, it will be relatively mild. However, we believe the risk of recession has increased in the past three months as a result of tightened financial conditions, and the ongoing effect of the past year’s interest rate hikes.
We continue to favour government bonds and equivalents in our portfolio to buttress our defense against a potential recession. Having said that, bond yields remain compelling and we are modestly adding to the duration and average term to maturity of our portfolio. We will continue to seek strategic opportunities to add value through attractively-priced investments while carefully managing risk.
A more detailed review can be found in the full report per the above link.