As we move forward, we remain steadfastly committed to continual improvement. In this spirit, we wanted to use this opportunity to re-introduce Calendly. When you receive an email reminder of an upcoming Wealth Road Map Review Meeting or Wealth Strategy Call, we will include a link to a feature called Calendly. Calendly allows you to directly book a convenient time slot for your meeting or call without any back and forth. Bookings can be made anytime, and we hope that introducing this option will make the process more convenient. If you prefer to book directly with us by phone or email, we are happy to help.
In addition to Calendly we will also be starting to introduce a pre-meeting survey tool that we will send out prior to a Wealth Road Map Review Meeting – the objective is to allow for reflection and the construction of an agenda based on your areas of interest. Any feedback on this tool is greatly appreciated!
If you have any questions about the Quarterly Compass Newsletter or anything else in your financial life, please use the Calendly link below to set up a time to talk or reach out to Jordan or Scarlett, and they will be happy to set up a time!
For those that believe “brevity is the soul of wit”, here is the Quarterly Compass Newsletter in five key points:
- Canadian Equities slightly outperformed in a tough quarter. The energy sector was “the star” globally and the traditional defensive sectors underperformed: Utilities, Real Estate and Consumer Staples.
- Key measures of Core Inflation continue to fall in the U.S., whereas Canadian inflation was taken higher by mortgage interest costs.
- No recession yet despite warning signs. Economic slowdowns do not need to result in a recession.
- Have shifted more assets into the U.S. due to their diversified economy and market.
- Despite the usual seasonal drawdowns that accompany August/September, the outlook remains positive going forward into year-end.
Quarterly Compass Newsletter – Sept 30, 2023
Q3 2023 saw negative equity markets. In North America, the NASDAQ 100 and S&P500 pulled back with a drawdown of -2.86% and -3.27% respectively (in USD, total return). The Canadian S&P/TSX Composite fell -2.2% (in CAD, total return). International markets were also negative, with the MSCI EAFE Index down -4.04% (in USD, total return). (Refinitiv Icon). Q3 started on a strong note with a very positive July but turned down as a “laundry list” of fears (some contradictory) around rising rates, an economic slowdown, a potential U.S. government shut down etc. impacted markets. Unsurprisingly, there was almost nowhere to hide – in the U.S. only Energy and Communications Sectors posted positive returns. In Canada only the Energy sector had a positive return. Traditional defensive sectors such as Consumer Staples and Utilities underperformed in both the S&P TSX Composite and S&P500.
Per Refinitiv, key global Fixed Income benchmarks, such as the U.S. 10-Year Bond, saw yields rise substantially vs. the end of Q1 on a re-emergence of a “higher for longer” narrative after the September U.S. Federal Reserve rate decision (more on this below). In Canada, the Bank of Canada (BoC) raised rates by 0.25% in July. The bump in rates was a bit curious as the economic/inflation data coming in has not been strong and Canadian debt to GDP is amongst the highest in the developed world. This has led to some speculation that the hike was done to counter inflation being caused by deficit spending and carbon tax increases being enacted by the Federal Government. It is worth noting that a significant percentage of the CPI inflation in Canada is being driven by higher mortgage finance costs – i.e. rate increases causing inflation.
During Q3, commodity markets were ~3% higher driven by the price of oil per the Bloomberg Commodity Index. Furthermore, as per Refinitiv – market-based expectations of inflation remain well-contained with longer-term inflation “break-even” rates ranging from 5 to 30 years, all remaining near or below 2.50% at the time of writing.
Based on questions from clients I have collected a few thoughts.
First and foremost – there were a lot of questions about the market volatility that we saw in August and September. August and September are the weakest months of the calendar – this has long been attributed to lower liquidity over the summer period when many are away on vacation. It is usual to see some sort of market pause or temporary reversal during these months. This is especially true in recent years – as pointed out by Fundstrat – the last few Septembers have been quite volatile. From this perspective nothing unusual has happened this year.
Aside from seasonal factors the recent volatility that we have seen is also attributable in part to what seems to be a reaction on the part of “investors” who have very fickle macro-economic outlooks. At its September meeting, the Fed raised its long-term outlook for interest rates. This action in turn caused the rapid re-emergence of the “higher for longer” narrative around interest rates. This reaction does make some sense until one considers that historically, these Fed projections have not been reliable, and the Fed itself advises that they are not a policy forecast. Furthermore, recent data releases show that inflation in the U.S. continues to cool rapidly. The Fed favorite measure of inflation (Core PCE) printed at 0.1% for August (1.2% annualized) and the 6/3-month averages are down to 1.6% and 2.4% annualized respectively. From this lens it seems that the volatility that we have seen in August and September is a combination of the usual seasonal volatility combined with some knee jerk reactions to headlines.
The bottom line is that volatility aside (which is NEVER fun), I remain optimistic about the outlook. By and large, both individual and institutional investors remain underinvested and generally negative on the markets. Examples of this negativity include data reported by Goldman Sachs that shows very large increases in hedge fund short positioning. As reported by Fundstrat, cash/money market balances in the U.S. are nearing $6 trillion. This negativity has been and remains a significant contrarian positive – history is clear that extremes in sentiment and positioning in either direction usually resolve in the market moving in the opposite direction vs. expectations. The choppy advance of markets since October 2022 has allowed us to see this phenomenon in real-time. In the face of multiple stress events and a plethora of dire predictions, we have witnessed that markets (and your portfolio) have “bent but not broken” on several occasions and then resumed their uptrend.
Aside from the evidence presented by investor sentiment and positioning there is a lot of quantitative analysis that points to an optimistic outlook. Based on an analysis done by Wayne Whaley, there have been 8 years since 1950 where the S&P500 was up >10% at the end of July. In 6/8 cases markets drew down into August/September but in all cases the market then had a strong finish to the year. Similarly, a study by BMO Capital Markets, points out that in the post WW2 era, if the S&P500 has been up 10%-15% in the first half of the year, then the last six months return 11% on average. Again, any single statistical analysis can be wrong, but collectively and combined with other indicators, they present a pattern that has had a powerful tendency to repeat throughout many different historical circumstances.
Corrections like the one we have experienced to month end September, are never “fun”, but they are part of the process and do serve as an opportunity to potentially reposition portfolios and understand how current holdings will perform “under stress”. I do not expect this time to be different. As I remarked in last quarters note – in all the noise we have been hearing, it is easy to forget that since October 2022, we have seen portfolios rebound on the back of strength in both equity and bond markets. No one knows the future, but the best chance of success is to understand and make the types of decisions that have proven successful. Again, to paraphrase Warren Buffet – we want to be greedy when others are fearful and fearful when others are greedy.
Another question that came up frequently in the quarter related to our clear overweight of U.S. equities in the equity allocations of portfolios. The Financial Sector is the single largest sector in the TSX 60 index followed by the Energy and Basic Materials sectors. The Canadian banks are facing clear earning headwinds from borrowers who are under stress. Credit losses and loan modifications will likely pose an earnings headwind until interest rates return to much lower levels. At the same time Federal policy has not been conducive to growth in the commodity sectors and the Bank of Canada and the Federal Government seem to be working against each other. This combination makes ~60% of the TSX60 market cap less attractive to both domestic and international investors. U.S. markets on the other hand are large and broadly diversified from a sector level. The U.S. economy remains the worlds largest and is also broadly diversified between many different sectors. Given these domestic conditions and the myriad of high-quality companies available in the U.S. it only makes sense to allocate more capital to where it will likely “be treated best”. To give some perspective of where Canada fits into the global investment scheme please check out the following link: https://advisor.visualcapitalist.com/the-109-trillion-global-stock-market-in-one-chart/
Finally, over the course of the quarter I saw many questions around the potential replacement of the U.S. Dollar as the worlds reserve currency by a consortium known as the BRIC’s (Brazil, Russia, India & China) countries. At the current moment the USD is the fundamental asset of the global economy, and by extension U.S. interest rates and bond prices will reflect that. As of 2022, the Bank of International Settlements reports that 88% of global trade was conducted in USD and that this figure has been stable for the last 20 years. This is not to say that all parties like this arrangement – it inherently means that other nations are importing U.S. Monetary Policy (which may or may not be appropriate for their domestic economies) and are dependent on U.S. currency.
The key issue is that USD trade allows different parties to buy and sell good more easily – almost everyone everywhere will accept the USD for good or services. For example, a Brazilian soy farmer may want to sell his crop to China and buy a German made tractor. It is much easier and less costly to sell the soybeans for USD and use them to buy the tractor from Germany in USD than it is to accept Yuan and then try to find someone who will sell a German made tractor for Yuan. Alternative trade currencies make sense in some limited cases and the actions by the BRICs clearly show they want to find places where they can optimise e.g. Saudi Arabia selling oil for Yuan to China and then buying goods made in China with those Yuan. There may be a day where the USD is replaced by another reserve currency but that day is likely to be a long way off.
We have taken several actions in the portfolio entrusted to us since our last update. First, we have conducted our routine quarter-end review of all holdings and have adjusted the names in the portfolio to ensure that each one reflects our desire to hold a diversified basket of high-quality stocks in an uptrend. A key part of our process involves profiting from our successful names and looking at the worst-performing stocks with an eye to reduce or remove them in favour of stocks with a better fundamental and technical profile. As we have been doing all year we increased our weighting in U.S. equities as the U.S. markets have a better selection of high-quality stocks vs. International or Canadian markets. Finally, we took advantage of interest rate volatility to add an ETF in the fixed income allocation that focuses on government and highly rated bonds that are selling at deep discounts to “face value”. This allowed us to increase tax efficiencies of returns, lower fees and more precisely target the part of the bond market we believe has the best risk adjusted returns.
As always, the focus of the Kluge Wealth Advisory Group is on preparation and not prediction. Irrespective of any views, we always acknowledge and prepare for a wide range of events and outcomes. Despite very recent events, the picture painted by my Risk Dashboard remains cautiously optimistic about the path forward. As a result, we recommend that investors consider reducing cash and buying both high quality equity and fixed income, where risk tolerance and objectives allow.
The information contained herein has been provided for information purposes only. The information has been drawn from sources believed to be reliable. Graphs, charts and other numbers are used for illustrative purposes only and do not reflect future values or future performance of any investment. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance. This does not constitute a recommendation or solicitation to buy or sell securities of any kind. Market conditions may change which may impact the information contained in this document. Wellington-Altus Private Wealth Inc. (WAPW) does not guarantee the accuracy or completeness of the information contained herein, nor does WAPW assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Before acting on any of the above, please contact your financial advisor. WAPW is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada.
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