The Market

US markets pushed higher during the second quarter of 2023 on continued optimism that the end of the Fed’s aggressive rate-tightening cycle is nigh and a “soft landing” may still be possible.  US equity gains were driven by the technology sector rally led by the back-in-favour MAAMA stocks (Meta, Amazon, Apple, Microsoft, and Alphabet) + NVIDIA.

Domestic market performance was relatively muted with financials, energy, and utilities/telecoms under pressure due to the impact of rising interest rates on the businesses within these sectors.  The Bank of Canada surprised investors with a 25bps interest rate hike in June and another surprise 25bps hike in July, culminating in a policy rate of 5% as of this writing; the highest since 2001 in an attempt to slow stubborn inflation. 

The table below shows the market performance as of market close on June 30, 2023, in Canadian dollar terms:

Performance

The table below compares the YouFirst portfolio composites with their respective FPX Benchmarks:

Both YouFirst Growth and YouFirst Conservative Growth composites underperformed their respective benchmarks, attributed to the following factors:

• The Canadian dollar appreciated this quarter against many currencies, reducing the return of global equities and other foreign assets.
• Canadian large cap dividend stocks (typically considered a safe haven investment during periods of volatility) were affected by higher interest rates
• Much of the growth of the S&P500 since the start of the year is attributed to another bubble-like frenzy of technology and AI (Artificial Intelligence) related stocks of which eight companies (out of 500) have accounted for over 75% of the gains in the S&P500. We hold Microsoft, Amazon, and Alphabet which added to our performance but we do not hold Meta, Apple, Tesla, nor NVIDIA which hindered performance relative to the indices
• Higher cash balances in portfolios relative to the FPX benchmarks which do not hold cash, however cash in portfolios is currently yielding 4.6% – 4.75% in various Series F high interest savings accounts (HISA) which is a good risk adjusted return relative to bonds. Holding cash also provides flexibility for us to take advantage of opportunities in the market when they become available.
• Finally, fixed income holdings, specifically minimum rate reset preferred shares have fared poorly due to retail investor sentiment driving down price returns on these securities. A corollary is that many of these holdings now have dividend yields up to 11%, which adequately compensate investors while waiting for rationality to return to the income oriented marketplace.

Portfolio Activity

During the quarter we purchased shares of CVS Health (CVS: US) for applicable portfolios.  CVS is a vertically integrated health care services provider, combining one of the US’s leading pharmaceutical services company with the US’s largest pharmacy store chain.  With recent share price weakness due to management’s meagre outlook for 2024, we believe that the price of entry was justified, given CVS’s excellent balance sheet, free cash flow yield, and above-average sustainable dividend yield as well as a promising 3-5 year price appreciation potential for patient investors.

Outlook

Year to date, markets are betting on expectations of a soft landing and that the rate tightening cycle is close to an end.  However, any deviation from this thesis would likely result in more volatility for equities. The elephant in the room is that almost all macroeconomic indicators we are tracking in Figure 1 below, are pointing to an impending recession, with the length and severity unknown.

The effects of an aggressive rate tightening campaign are now starting to appear, with slowing economic activity as shown by the eight consecutive month of declines in the ISM Manufacturing Purchasing Managers Index, falling energy prices, and a continued drop in the US Leading Economic Index (LEI).  Note that persistent declines in the LEI have always preceded a recession since the index was introduced in the early aughts.

Contrary to this, the housing market in Canada has curiously picked up steam again after a stall in 2022, with new construction and retail listings unable to keep up with excess demand for housing in certain markets (the usual suspects Toronto, Vancouver, and Calgary to name a few).  In addition, the labour market remains tight and wage growth appears to be persistent.  We attribute this anomaly of the strength in house prices and the labour force due to a record amount of immigration in 2022 and 2023 thus far which has a double edged sword of easing the shortage of workers while boosting consumer spending and adding to the demand for housing.

Although the YouFirst portfolio composites have underperformed in the short term we believe that our more conservative stance is warranted given the excess optimism baked into the current prices of global equity markets. We continue to closely monitor developing economic conditions and will adjust portfolios accordingly should changes to our investment thesis materially change.  In the meantime, with recession uncertainty still clouding the outlook, we will continue to maintain current portfolio holdings and weightings as is and sticking with the key pillars of our investment philosophy of being focused, methodical, and prepared for various scenarios coming down the pipeline.

Please let us know if you have any questions about the material contained in this newsletter.

Doug Garner, P.Eng., CFA
President, Portfolio Manager

Jane Garner, BA, EPC
VP Operations and Client Experience

Simon Chun, P.Eng., CFA
Director, Portfolio Manager

Sources:

1. Adapted from Manulife Capital Markets Strategy, Q2 2022 and Bloomberg Capital Markets Strategy.
2. The Conference Board US Leading Indicators. (https://www.conference-board.org/topics/us-leading-indicators)
3. US Department of the Treasury (https://home.treasury.gov/).
4. ISM Report on Business (https://www.ismworld.org/supply-management-news-and-reports/reports/ism-report-on-business/).
5. Board of Governors of the Federal Reserve System, FOMC Minutes (https://www.federalreserve.gov/monetarypolicy/)
6. Trading Economics US Housing Starts (https://tradingeconomics.com/united-states/housing-starts)
7. Koyfin Global Economic Data (https://www.koyfin.com/data-coverage/global-economics/).