Year End Reports

Enclosed in this YouFirst quarterly Portfolio Review package are your:

• Portfolio Evaluation Report
• Annual Performance Report(s)
• Annual Investment Management Fee Report
• For non-registered account holders. The following items should be given to your income tax preparer for inclusion on your 2022 income tax return (if applicable):
  • Annual Investment Management Fee Report
  • Summary of any capital gains or losses incurred during the year.

Important Reminders

• The start of the new year is a great time to top up your Tax-Free Savings Account (TFSA). The annual contribution limit for TFSAs is $6,500 for 2023.
• The RRSP contribution deadline for the 2022 tax year is March 1st, 2023. To ensure arrival in RRSP accounts before the deadline, please ensure that online bill payments are made on or before February 20, 2023.
• For other tax slips, please see the attached document from Fidelity Clearing Canada for the 2022 tax reporting timelines.

The Market

Global stocks and bonds experienced a historic year with both asset classes experiencing  declines across all developed and emerging markets due to central banker’s “resolute” hawkish policy stance to fight four-decade high inflation numbers.  In Canada alone, the Bank of Canada raised interest rates seven times this year to a 15-year high not seen since before the 2008 Great Financial Crisis, terminating at 4.25% on December 7 (rates were 0.25% at the start of 2022).  Statements made by global central banks imply they are not yet done with future rate hikes and may continue with a further 25-50bps in 2023 depending on how inflation readings evolve.

FAANG and other technology stocks, the Covid pandemic-era darlings, fared the worst in 2022 as rising interest rates lower the discounted value of future cash flows while simultaneously reducing corporate profits due to lower consumer demand and the higher cost of borrowing.  The tech heavy NASDAQ Composite index dropped 33% for the year compared to a loss of 20% for the S&P500. 

Canadian stocks performed slightly better due to exposure to energy and materials which were buoyed by macroeconomic shocks over the course of the year including Russia’s continued aggression with Ukraine which sent energy prices skyrocketing.

The table below shows the market performance as of market close on December 31, 2022, in Canadian dollar terms:

Moving forward in 2023, we will update the presentation of the global stock index from MSCI World to MSCI All Country World Index (ACWI).  The difference between the two indices are MSCI ACWI is a global equity index that measures the equity performance in both developed and emerging markets, where MSCI World only focuses on developed markets.  Thus, the MSCI ACWI provides a more comprehensive gauge of the global equity market as a whole.

Performance

Portfolios are largely positioned with a barbell approach: slightly overweight equities on one end and overweight cash/high interest savings account balances on the other side.  We are now holding excess cash balances in high-interest savings accounts (HISA) which yield up to 4.25% on an essentially risk-free basis.  This strategy will allow us to remain nimble to deploy cash into more attractive securities.

Over the year, the YouFirst Growth composite returned at par with its benchmark, while the Conservative Growth composite outperformed its benchmark due to the underweight position in bonds.  Both YouFirst composites are presented net-of-fees.

Portfolio Activity

Continuing from the previous quarter, we further sold positions in Mawer Global Small-Cap (MAW150) and bought units of iShares ESG Aware MSCI USA Small-Cap ETF (ESML:US).  A discussion of this trade can be found in our Q3 2022 Portfolio Review.

Over the quarter, we purchased shares of Medtronic PLC (MDT:US) on recent price weakness due to supply chain disruptions caused by persistent macroeconomic challenges.  Medtronic is the world’s largest manufacturer of implantable biomedical devices by revenues.  Medtronic develops and manufactures devices and therapies to treat more than 30 chronic diseases, including heart failure, Parkinson’s disease, urinary incontinence, Down syndrome, obesity, chronic pain, spinal disorders and diabetes.  We believe that the strength of the company’s product portfolio provides a strong competitive moat which positions it well for long-term earnings growth.  Shares are currently undervalued from a price-to-earnings ratio versus the company’s growth prospects.

As a result of disappointing third quarter earnings, Algonquin Power & Utilities Corp. (AQN:TSX) stock has been under price pressure.  We purchased additional shares of AQN on price weakness as we believe the long-term growth fundamentals for the company are still intact and consistent cashflows from renewable assets have not been impaired.  On the purchase of the shares, we understood that the dividend yield of 9.3% was unsustainable based on payout ratios at the time and expected a dividend cut. On January 12, 2023, Algonquin’s management indeed announced a 40% dividend cut and divesture of $1B of assets to pay down debt and focus on growth.  These updates are welcomed and we believe that shareholders will be rewarded in the long term as the renewable energy business further aligns with Canada’s very ambitious goals of “90% of Canada’s electricity coming from non-emitting sources by 2023.”

Outlook

The US leading economic indicators (LEI) suggest that the risk of a recession has now become elevated in the near term with long-term trajectories of the US LEI continuing to worsen.  This leading index has now declined for the last eight months, and since its inception from 1959, has never failed to signal inflection points in an economic cycle.

Figure 1¹: Typical macroeconomic signs of a US recession are becoming apparent with conditions continuing to deteriorate.

Economists now believe that a recession is likely, and few believe that central bankers can lead the economy into a “soft landing”, where inflation falls back to target levels (2-3% per year) without decimating the economy.  The light at the end of the tunnel is that due to aggressive monetary policy tightening over the course of the year, inflation numbers in the US have slightly retreated from 9.1% to 7.1% which may lead to less aggressive rate hikes in 2023 as long as inflation continues on a persistent downward trend.  

As we near an important inflection point in central bank policy action, fixed income, particularly investment grade corporate bonds are more attractive.  As our clients are surely aware by now, we have been underweight bonds for several years as stimulative interest rates since pre-pandemic days made bond yields unattractive relative to dividend paying equities and hybrid debt securities (preferred shares and convertible debentures).  Subsequently, as market interest rates have aggressively increased in the last year, bond prices have fallen in lockstep with some longer term bonds falling more so (this is called duration risk).  Over the next few months, for conservative growth and balanced clients, we plan to add to our holdings of short term investment grade corporate bonds which will allow us to capture yield as well as a capital gain. Over a medium-term holding period, should interest rates begin to drop again due to a stalling economy, bonds will increase in price.  For growth clients who have a stronger appetite for risk, we will begin adding to equity positions as some stocks are trading at an appetizing discount.

Of course, we acknowledge that our thesis could be incorrect and that inflation proves to be more persistent than anticipated which could mean central banks may continue raising interest rates and stay in restrictive territory with higher interest rates for longer.  If this is the case, then there will be further grief in stock and fixed income markets.

We wish our clients a healthy and prosperous 2023.

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. December 22, 2022 (https://www.conference-board.org/topics/us-leading-indicators)
3. US Department of the Treasury (https://home.treasury.gov/). January 10, 2023
4. ISM Report on Business (https://www.ismworld.org/supply-management-news-and-reports/reports/ism-report-on-business/). Jan 2023.
5. Board of Governors of the Federal Reserve System, FOMC Minutes (https://www.federalreserve.gov/monetarypolicy/) January 4, 2023.
6. Trading Economics US Housing Starts (https://tradingeconomics.com/united-states/housing-starts) November 2022
7. Koyfin Global Economic Data (https://www.koyfin.com/data-coverage/global-economics/).
8. RBC Global Asset Management. Charts of Interest, December 2022.