What’s New?

• The First Time Home Savings Account (FHSA) should be available to our clients at the beginning of December. More info on FHSAs here.
• An upside to higher interest rates are that High Interest Savings Accounts (HISAs) are now yielding rates of up to 5% and are a great way to park excess cash without being locked-in and are essentially risk-free. Let us know if you are interested.

The Market

The start of the third quarter of 2023 was met with further optimism leading into the summer months on the expectation that a soft landing could materialize even though central bank interest rates remain elevated at multi-decade highs.  Near the end of September, global stocks experienced a sizeable sell-off and heightened volatility due to waning consumer confidence, rising oil prices, and a continued increase in bond yields.  Of course, the global narrative of higher-for-longer interest rates and the potential ramifications on the economy still holds true this quarter.  All eyes are now on the next US Federal Reserve policy meeting in October with expectations that the Fed will raise another 25bps then hold at the range of 5.25%-5.50% until inflation returns to the target rate by 2026.

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

Performance

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

The YouFirst Growth and YouFirst Conservative Growth composites outperformed their respective benchmarks this quarter.  As a result, the gap between the benchmark and our composite performance is narrowing on a year-to-date basis.  Although bonds are typically seen as safe haven investments, investors continue to discount bonds, especially at the longer end of the yield curve which has put downward pressure on the returns of the bond benchmarks.  The YouFirst portfolios are underweight investment grade bonds and government treasuries and were spared this quarter as the 10-year US government bond yields spiked to 16-year highs.

We expect that fixed income performance will normalize once markets are able to price in central banks’ dovish sentiment, globally.  Until then, we expect that bonds will underperform in the short term.  Therefore, we continue to hold cash in HISAs which are now yielding 4.8-5% (up from 4.6-4.75% last quarter) 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.

Portfolio Activity

Rising interest rates have affected the bottom line of many Canadian companies particularly hard this year since the domestic economy is highly centred around debt-intensive sectors such as materials, energy, telecoms, and financials.  The stocks of these companies have been under pressure as the dividend yield no longer adequately compensates investors for moving up the risk curve relative to HISAs and government treasuries; as such dividend yields have increased (with a corollary of falling stock prices).  We see this as an opportunity to pick up great quality companies at a discount while locking in higher dividend yields and future capital gain potential when rates eventually stabilize.  We purchased additional shares for clients in Enbridge Inc. (ENB:TSX), Telus Corporation (T:TSX), TD Bank (TD:TSX), and Bank of Nova Scotia (BNS:TSX). 

As the allocations to the above stocks increased, we subsequently trimmed our holdings of Mawer Canadian Equity Fund Class-F (MAW106) with a two-fold goal, to not overweight the domestic market and to eliminate funds in portfolios that have underperformed and have higher MERs (management expense ratios).

For some clients, we purchased units of Vanguard ESG International Stock ETF (VSGX) to replace Manulife International Equity Private Trust (MMF3904).  VSGX is screened for certain environmental, social, and corporate governance criteria and excludes stocks of companies that do not meet these standards.  It invests primarily in international markets with no US exposure (Europe, Pacific, and Middle East) and has a larger exposure to emerging markets than MMF3904, all with a lower MER.

Finally, for our clients who are accredited investors, the NextEdge Private Debt Fund (NEC452) had recently decided to spin out their investment in RC Morris which was underperforming and a drag on the fund’s overall performance.  Clients with exposure to the fund will now notice a separate line item in the YouFirst and Fidelity Clearing Canada (FCC) statements tagged with fund code NEC524, representing 11.8% of the original amount invested in the NextEdge Private Debt Fund (which is now 88.2% of the original amount invested).  There should be no change in the total net asset values of NEC452 and NEC524 combined, and the YouFirst statements contained within this newsletter package reflect this.  FCC statements may reflect a discrepancy in the book values of both funds, however NextEdge and FCC back office teams are working to rectify this issue for future statements.

Outlook

Since the beginning of the year, markets have been in flux with contrasting narratives between recession fears, a hopeful soft landing over the summer, and now a higher-for-longer interest rate regime. Based on persistent, but softening inflation and a strong labour market, we believe that Central Banks will continue to remain focused on breaking the wage-price inflation spiral which likely means that interest rates will indeed stay elevated for the foreseeable future and are unlikely to be cut anytime soon for a still surprisingly resilient economy.  Our views are further reinforced by yields on benchmark 10 year US treasuries, which have now risen to 16-year highs above 4.5% further inverting the yield curve across important bond maturities.  As a reminder, when yields of bonds and treasuries increase their prices decline.

We continue to track macroeconomic signals (Figure 1 below), with the US Leading Economic Index (LEI) in focus. As a reminder to our readers, persistent declines in the LEI have always preceded a recession since the index was introduced in the early aughts.  With August’s decline, the US LEI has now fallen for nearly a year and a half straight, indicating the economy is heading into a challenging growth period and possible recession over the next year.  Historically, each time the LEI reached the current level, the economy was already in a recession.

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/).