MONTHLY MARKET MUSINGS

February 2024

New Year's Resolution: Stay Active

2024 has kicked off and along with the new year comes the resolutions. Resolutions most often are tied to adopting a healthier lifestyle whether it be a new diet, exercise regime or just staying active as a beneficial habit. This year, staying active can be applied to both one's health and one's portfolio. So far, the markets are tracking higher in line with our broader thoughts and the year-end rally has rolled into 2024, challenging the belief of many that it would simply fizzle out. We continue to expect gains in the coming months in general, but see 2024 as a year where stock picking is likely to be more important than it has been in the recent past.

Rates have risen from historical lows over the past two years and more than a decade of quantitative easing has stopped, we have transitioned into a different environment. Previously, low volatility and low interest rates created a situation where passive investing could easily keep up with active by virtue of the disbursement of returns being relatively low. Now, money is no longer cheap and businesses have inflated costs. This means that success from a business standpoint should become less universal and more concentrated in select companies that have been able to adapt and reflect the discipline and qualities needed to operate efficiently. Volatility has also increased which creates more opportunities for active investors to find good opportunities. With the development in the economic environment still unclear and the end of the hiking cycle, many investors will likely opt for quality characteristics when looking for equities. These characteristics tend to be strong balance sheets, consistent and ample free cash flow, and the ability to manage expenses effectively. Historically, quality has outperformed following the end of a U.S. Federal Reserve hiking cycle and there is no real reason to think that this time would be any different.

Recently, BlackRock, the world's largest asset manager, touched on their expectations for the widening of market breath this year[1]. Market breadth refers to the number of stocks increasing in price relative to the number of stocks declining in price. Last year, the S&P 500 Equal Weight Index underperformed the market-cap-weighted S&P 500 Index and historically, the equally weighted index has been the consistent outperformer. This led Blackrock to conclude that there could very well be a mean reversion where the S&P 500 Equal Weight Index would outperform, and this would cause market breadth to widen as the market would be less driven by the largest top-performing names (in 2023 the top seven names were dubbed the Magnificent 7 and accounted for a significant portion of the S&P 500 Index's total return[2]). The mean reversion thesis is supported by the wide valuation gaps seen right now between the two indices and additionally by the fact that the S&P 500 Equal Weight Index has performed better when there was a potential or actual recession. A broader market (wider market breadth) typically not only signals a continuation of a market rally but also tends to favour active investing relative to passive investing as the dispersion of winners and losers becomes less concentrated and this allows active managers to capitalize on a larger abundance of discrepancies and opportunities.

While the active versus passive investing argument has been long debated, we believe that a sensible "passively active" approach which incorporates a long-term horizon, position management and risk mitigation can outpace many strategies. Active investing is too often viewed as large, concentrated bets on a small number of names managed within a short time horizon and is actually closer, at times, to trading than investing. This can result in high portfolio turnover and lower returns in many cases. Meanwhile, passive investing is a pure index replication strategy with a perpetual time horizon and the returns reflect that. "Passively active" can be viewed as making active calls on preferred stocks and sectors but with a passive view in terms of timing, in other words, buying quality names for the long haul and holding on to them. This is how we prefer to view investing. In years where the breadth is widening creating more dispersion and opportunities and the economy remains in flux, having the ability to remain agile can be a huge advantage to positioning for the long term.   

JAY SMITH, CIM ®, FCSI

Senior Portfolio Manager & Senior Wealth Advisor          
 

BRAD BROWN, MBA, CFA
Portfolio Manager & Associate Investment Advisor