Overview
- Portfolio and Market Performance
- Market Commentary
- Portfolio Update
- Portfolio Allocation
- Market Outlook
Portfolio and Market Performance
Year-to-Date (YTD) Performance as of the close on March 31, 2023
- S&P/TSX Composite Index: 4.6%
- S&P 500 Index: 7.5%
- NASDAQ: 17%
- Conservative Equity Portfolio: 12.5%
On a longer-term basis, the Conservative Equity Portfolio has returned 12.8% over 3 years, 9.8% over 5 years, and 11.7% since inception (October 2015).
The Diversified Income Portfolio, which is our balanced portfolio used for many of our clients’ registered accounts, returned 5.3% YTD, and returned 13.1% over 3 years, 9.2% over 5 years, and 9.2% since inception (July 2017).
The Focused Total return portfolio, which is our focused growth strategy for smaller accounts, IE TFSAs, returned 19.5% YTD, and averaged 16.8% since inception 3 years ago.
Interesting side note. Three years ago, was when the markets bottomed during the pandemic, so naturally our numbers look very good this month.
Our fixed income managers – Fidelity, Pimco and Manulife – have also been positive. YTD, they’re returning 3.5% on average and almost 10% since the lows in October. As a reminder, we lost 6-10% on our bonds last year.
Your own returns will vary depending on the amount of fixed income you hold, cash flows in and out, and management fees.
Market Commentary
We’ve been talking about inflation for the past 18 months, more specifically, how the factors that caused it would eventually dissipate. We said that when the U.S. Federal Reserve Board (Fed) finally pivots on its interest rate stance, the markets would take off. We watched the first sign of this in the currency and bond markets. In October, the U.S. dollar peaked, and bond prices bottomed. The bond market is much larger than the stock market, as is the foreign exchange market.
So, what does this mean? We believe the bear market that started in late 2021 came to an end in October of last year. To be clear, that does not mean that there will be no more volatility. Think about 2008-2009. The bear market ended in March of 2009, and for the next 10 years we experienced a bull market despite many concerns in the mainstream media. And markets did not go straight up. In five years, they went up, then corrected, then went up more, then corrected, and then the market was up over 150% from its low.
Key takeaway: We believe the Fed is done tightening and will need to lower rates by year-end. We believe that this year, the markets will trade off technicals, not fundamentals. Historically, that’s how new bull markets trade. Next year in 2024, the markets will trade on fundamentals.
Last year, the markets sold off because the Fed raised interest rates aggressively. It had nothing to do with the economy or the economic impact of the businesses we own. The economy did great! Employment was great! Yet the markets sold off roughly 20% last year. Now, to be fair, the markets overshot towards the end of 2021 and probably needed to give back some returns in order to stabilize, but the majority of the volatility last year was due to the Fed’s aggressive tightening.
The irony in all of this is that it could have been prevented had our governments not spent so aggressively on stimulus post-pandemic. Even today, our government is running large deficits while handing out large tax incentives. In the U.S., this was done as part of an “Inflation Reduction Act”. This causes more inflation. As a result, the Fed raises rates to slow down the inflation that the government creates.
This would be the equivalent of turning up the thermostat in your home when winter comes. Then your home becomes too warm, so you turn the temperature down a bit. Instead of waiting to see the impact, you do it again, and again, and again, until it’s completely off. It doesn’t matter how many times you turn down the thermostat; it takes time for the effects to take be felt. It doesn’t matter if you put the thermostat to 0; the house will only cool down one degree at a time. So now you are trying to cool down your home yet not allowing enough time for the effects to take place. At the same time, your spouse likes it warm in the house so he or she has the fireplace going at full blaze. You now open the windows to cool the house down. It’s very difficult to heat and cool at the same time. This is how we freeze and bust pipes in Montreal.
In the case of our economy, something did break – several banks.
If we want to stop inflation, our government must stop printing so much money. It’s that simple. If governments stopped running a deficit, inflation would go away. No one needs 6% mortgages. Housing affordability was already at an all-time low before the pandemic.
Raising rates will not help the inflation pressures caused by the war in Ukraine. Neither will it solve the bird flu that killed millions of birds and caused an egg shortage. Raising rates will not stop people from buying food. People need to eat.
Raising rates did, however, cause the most recent banking crises, and the collapse of Silicon Valley Bank (SVB) and Signature Bank. The irony is that those who regulate the banks caused them to fail.
For context, we’ve included an interesting graph by the Fraser Institute that gives a great visualization of the amount of government spending in Canada per person since the Second World War. All numbers are inflation adjusted and strip out extra COVID-19 spending. Interesting to note the two periods of rapid growth in government spending. Like father, like son. High inflation followed both periods.
Banking Woes
Last month we saw the failure of a few regional banks, the largest of which and most talked about was SVB. These issues, while alarming, could very well be deflationary enough to cool the economy as other banks will likely exercise more caution and lend less money over the coming months.
Most headlines discuss things like bond sales causing the collapse as interest rates increased. Yes, this is the straw that broke the camels back because they were forced to sell bonds at a loss after they decreased in value. However, on a broader term we think the answer is far simpler — poorly run institutions.
SVB saw significant changes in its balance sheet between 2019 and 2022. Assets tripled (+200%) at a time when the assets of Bank of America Corp. (NYSE: BAC) and Royal Bank of Canada (TSE: RY) went up about 25%. Loans more than doubled, going from $30 billion to $70 billion, while Bank of American’s loans went from $960 billion to $1 trillion. Now, the most staggering number at SVB over the last three years were deposits that rose from $55 billion to $185 billion, more than tripling. Meanwhile, both Bank of America and Royal Bank’s deposits increased by around 40%, with Bank of America’s deposits increasing from $1.4 trillion to $2 trillion. Deposits at SVB were mostly uninsured commercial deposits specifically from the tech sector. Bank of America and Royal Bank’s deposits are spread more evenly between commercial and retail and on the commercial side they are well diversified by different industry sectors.
Why then did SVB reach the point of failure, when under normal circumstances, financial institutions in trouble can access help to course correct. In this case no one wanted to touch SVB for a simple reason — they wrote bad loans. They loaned money based on future IPO prices and on the number of subscribers a business had. They took risks to grow the firm; a lot of risks. Those risks caught up with them. As a result, they couldn’t raise capital and went under.
Credit Suisse Group AG (CSGN) was in trouble for a long time. They lost $5.5 billion when Archegos Capital Management defaulted in 2021, incurred a half-billion-dollar penalty for fraud committed by a trader in March 2022, and had an employee convicted of money laundering for a Bulgarian cocaine trafficking ring in June 2022. They seemed to be involved in scandal after scandal.
Credit Suisse was poorly managed for a long time. It had been known as a safe haven for those who didn’t want their information known and they didn’t need to compete with other global banks. However, over the past two decades the Swiss government and banks were sharing account information with global tax authorities, and now the party is over. Credit Suisse was forced to compete on a level playing field with the likes of Goldman Sachs, Morgan Stanley, and JP Morgan, and they are getting their lunch eaten at every turn.
We have long said that European banks, such as Credit Suisse and Deutsche Bank AG (ETR: DBK), are a mess. We believe that the current banking issues are related to poorly run firms, not systematic issues, and that the best protection is to own well-run institutions. Our strategy of owning quality tends to work well in this environment.
Portfolio Construction
First, we’d like to provide a high-level, top-down view of our portfolio. The Conservative Equity Portfolio can be broken down into three different equity categories: growth, value, and defensive.
Over a five-year period, we expect our growth names to outperform the market, our value names to deliver market-like returns, and our defensive names to deliver slightly below market returns but with lower volatility. In effect, we are trying to balance the volatility with equities that have different market characteristics.
We are currently invested in 37% growth names. These businesses should deliver above-market returns over time. We call them “alphas” and they include names like Microsoft Corp. (NASDAQ: MSFT), Amazon.com, Inc. (NASDAQ: AMZN), NVIDIA Corporation (NASDAQ: NVDA), Tesla Inc. (NASDAQ: TSLA), Visa Inc. (NYSE: V), Google (Alphabet Inc., Class A; NASDAQ: GOOG), and Apple Inc. (NASDAQ: AAPL).
Of the portfolio, 30% is invested in defensive names. These businesses’ cash flows tend to be more stable in recessions. They include Metro Inc. (TSE: MRU), UnitedHealth Group Inc. (NYSE: UNH), Johnson & Johnson (NYSE: JNJ), Fortis Inc. (TSE: FTS), Telus Corp. (TSE: T), Medtronic PLC (NYSE: MDT), Brookfield Renewable Partners LP (TSE: BEP.UN), and Intact Financial Corporation (TSE: IFC).
The remaining 33% is invested in value names, such as Royal Bank of Canada (TSE: RY), Toronto-Dominion Bank (TSE: TD), Canadian National Railway (TSE: CNR), Canadian Pacific Railway Limited (TSX: CP), Berkshire Hathaway Inc. Class A (NYSE: BRK.A), Brookfield Corp. (TSE: BN), Bank of America Corp. (NYSE: BAC), Walt Disney Co. (NYSE: DIS) and Home Depot Inc. (NYSE: HD). These are all great businesses, but cash flow tends to fluctuate depending on the economy.
We are usually invested in around 30 companies, each serving a unique purpose in the overall portfolio.
Most of the changes we make start with the Conservative Equity Portfolio. Sometimes they are passed down to other portfolios based on consensus.
Company News
Microsoft received permission from European Union regulators to acquire Activision Blizzard, Inc. (NASDAQ: ATVI). Regulators also approved the merger of CP and Kansas City Southern (NYSE: KSU). We believe that both were great deals for our companies Microsoft and CP Rail.
Portfolio Changes
We sold our position in Brookfield Asset Management Ltd. (NYSE: BAM) and used the proceeds to purchase more of the parent company Brookfield Corp. (NYSE: BN). BAM was spun off from Brookfield a few months ago and we decided to wait before making any decisions. What we’ve now seen is that the price of BN has come down significantly in the last few months, so we were looking for areas to raise capital to buy more of it. BAM was trading at a fair price at 24 x price/earnings, while BN was trading at 8 x forward earnings. It should trade for at least double that, so we took advantage and added to BN at a historically low price versus its cash flow.
We also sold half of MDT and purchased iShares US Medical Devices ETF (NYSEARCA: IHI) with the proceeds. When the economy weakens, medical device companies tend to do very well. We’ve owned MDT for almost 10 years but lately it has not been performing well and losing market share to the competition. The effects of COVID-19 hurt as well.
With over 20 years of industry experience, we’ve learned that we cannot be experts in every field, and medical technology and devices is no exception. It’s complicated, and the more analyst reports we read, the more we realize that we’re out of our depth and cannot add much value. We do, however, believe in our thesis that as a society, we are living longer, more people are becoming wealthier, and we tend to spend more money on our health every year. So, for these reasons we decided to diversify our risk in medical devices.
iShares U.S. Medical Devices ETF holds a basket of U.S. medical device companies. Its top 10 names represent 70% of the holdings. Its top 5 are Thermo Fisher Scientific Inc. (NYSE: TMO), Abbott Laboratories (NYSE: ABT), Medtronic, Stryker Corp. (NYSE: SYK), and Intuitive Surgical, Inc. (NASDAQ: ISRG). Despite being down 20% last year, the ETF has averaged 13% over five years and 17% over 10 years.
Market Outlook
By the end of the year, we expect the Fed will be done tightening and need to lower rates. We believe the beginning of a new bull market will take shape this year and the markets will trade off technicals, not fundamentals. Expect volatility. In 2024, fundamentals will be the driving force.
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We wish you a wonderful start to spring.
Simon & Michael
Simon Hale, CIM®, CSWP, FCSI®
Senior Wealth Advisor,
Portfolio Manager
Wellington-Altus Private Wealth
Michael Hale, CIM®
Senior Wealth Advisor,
Portfolio Manager
Wellington-Altus Private Wealth
Hale Investment Group
1250 René-Lévesque Blvd. West, Suite 4200
Montreal, QC H3B 4W8
Tel: 514 819-0045
Returns for the Conservative Equity Portfolio, Diversified Income Portfolio and Focused Total Return Portfolio represent the returns of model portfolios only and do not represent the returns of any client. Individual account performance may differ materially from the representative performance history, due to factors including but not limited to an account’s size, the length of time the strategy has been held, the timing and amount of deposits and withdrawals, the timing and amount of dividends and other income, trade execution timing and pricing, foreign exchange rates, and fees and other costs. This is not an official statement from Wellington-Altus Private Wealth (“WAPW”). WAPW cannot verify the accuracy of these performance numbers. Please refer to your official WAPW statement for your specific performance numbers.
