Hello everyone! I hope this blog post finds you all in good spirits. As spring begins to bloom around us its hard to not feel a sense of rejuvenation and excitement for the months ahead. A lot has transpired over Q1 of 2023. Below is a summary of the main points covered in this article. For those who want to learn more the detailed posting is below.

 

Executive Summary

• Optimism at the start of the year was fueled by strong economic data and the notion that central bankers were nearly finished the rate hike cycle.
• The early year stock market rally paused in February as it became clear central bankers were not finished fighting inflation.
• Heading into Q2, The Greenwood White Group continues to hold our cautiously optimistic stance on equity markets
• Dividend growers are particularly attractive at the moment, as they have historically outperformed non-payers over the long term, and are able to do so with less volatility
• The macro factors that punished equities last year (inflation, higher interest rates, Russia-Ukraine,) are still at play in 2023, but the actions taken by world leaders, policy makers and monetary authorities continue to mitigate these challenges.

 

Building on the momentum into the end of last year, global markets began 2023 on a strong note with January experiencing the fifth-best start for Global stocks in the last 50 years (Source: Guardian Capital).

 

Optimism was fueled by the following factors:

1. Strong economic data, coupled with the notion that central bankers were done (or near finished) hiking borrowing rates to tamp down inflation (and growth).  
2. Evidence that inflation had peaked last year and was heading lower.
3. China’s re-opening, and overall easing on what had been a strained global supply chain the last few years.

The early-year stock rally paused in February as global central banks made it clear that they were not done fighting inflation.   Bond yields jumped higher, weighing on stocks as investors preferred the certainty of 4-5% returns on government bonds to the potential for higher returns from stocks.  Moreover, investor fears that central banks would go “too far” and unintentionally trigger a recession came to a head yet again. These fears found their expression in the failure of two U.S. regional banks as well as concerns about the fate of Credit Suisse, a 150-year-old bank that had once been at the core of the European banking system. While unsettling, we are encouraged that the risks did not spread to other areas of the banking sector, and that regulators moved quickly to support depositors and other regional banks.  Of note, both bonds and stocks finished March on a positive note as bond yields fell back to their January lows. 

Heading into the summer, we maintain our cautiously optimistic stance, weighing the risks against the potential rewards across various types of investments, and building resilient, diversified investment portfolios that align with your long-term plans.

 

Here’s where things stand today:

• Government bonds in North America offer yields in a range from 2.9% - 4.7%, with the higher yields in shorter maturities and lower yields in longer maturities.  This reflects expectations from the bond market that central banks will need to cut rates to stimulate economic growth in the next 2 years.  Of note, government bonds have re-asserted their role as portfolio diversifiers while providing  income, with bonds rallying during stock market corrections and vice versa.  
• The “spread” or additional compensation paid on investment grade or high yield (“junk”) corporate bonds for the risk of default has returned to long term averages of 1.8% and 5.1%, respectively, while default rates remain below average.  The credit market is reflecting expectations that default rates will rise if the economy slows in the months ahead.
• Broad measures of U.S. stocks have returned to long term average valuations, though this metric is skewed by safe-haven sectors that are less sensitive to economic cycles like consumer staples, utilities and health care, which are all trading above long term average valuations. Canadian, International (Europe, Australasia & Far East) and Emerging Markets stocks remain relatively inexpensive to their U.S. counterparts and their historical average valuations.  In short, the margin of safety built into these regions is higher than the U.S. at a time when expectations for future growth are relatively low.  This is a positive set up for long term investors. 
• Publicly available measures of real estate valuations such as REITs (Real Estate Investment Trusts) and CMBS (Commercial Mortgage Backed Securities) have fallen sharply over the past year, reflecting heightened risks in Office and Retail (Mall) segments, which have both seen downward pressures for several years.

(Source: Bloomberg)

In short, while storm clouds have gathered on the horizon, investments across a variety of asset classes are offering healthy returns to compensate for those risks for those willing and able to ride out the storm. 

 

In Canada, we would highlight dividend growers as a particularly attractive investment group. Dividend-paying stocks have historically outperformed non-payers over the long term, and are able to do so with less volatility (exhibit 1). And companies with a propensity to grow their dividends outperform those that pay dividends, again with lower risk.  Management’s decision to hold dividend policy steady and reward shareholders in times of uncertainty is a sign of resilience by quality firms with excellent pricing power that are built to weather adverse markets. Stocks with a history of dividend growth also have tended to fare better in a rising-rate environment versus the highest-yielding stocks (essentially “bond proxies”) that tend to follow bond prices down as rates rise (source: Blackrock).  An additional bonus for Canadian investors is the preferential tax treatment of eligible dividends to other sources of income such as rental or interest income.  Right now, you can add blue-chip dividend paying stocks with a history of regular dividend increases to your investment portfolio with yields ranging from 3.5% on the low end to 6% on the high end.  In our view, this is attractive compensation for any downside risks that may materialize in the short term. 

(Source: Connor Clark & Lunn)

Ultimately, stock prices are a function of the earnings of a company x the “multiple” one is willing to pay for every dollar of that company’s earnings.  This “multiple” most often takes the form of price to earnings valuations, though investors also measure how companies trade relative to the amount of free cash flow and sales they generate or the book value or original cost of their assets.  When we reflect on the earnings backdrop, we see a more encouraging picture than the media is trying to paint. Many firms have levers to pull that will help their “bottom line” and stabilize their earnings, even if end market demand slows.  Supply chains are normalizing at a time when companies are rationalizing their cost structures by lowering headcounts, as well as unneeded real estate footprints and infrastructure. Also, robust consumer balance sheets, buffered by high savings rate and pent up demand from the COVID lockdowns, has allowed end market demand to remain stronger for longer even in the face of rising borrowing rates and 40-year highs in the cost of living. 

Turning to multiples, assuming labour and inflation data continue to soften, this should give central banks the latitude to lower rates heading into 2024.  All else equal, stock market multiples should be a function of “risk free rates,” or government bond yields (the lower the risk free rate, the higher the multiple, and vice versa).  So lower rates should place upward pressure on multiples.

The macro factors that punished stocks last year (inflation, higher interest rates, Russia-Ukraine,) are still at play in 2023, but the actions taken by world leaders, policy makers and monetary authorities continue to mitigate these challenges. Although the increase in borrowing costs over the past year was sharp, investors have accepted that rates are going to be structurally higher for a longer period, and the interest rate historians out there will tell you that current rates aren’t that high in relation to the early ’90s!

 

 

We have all had a lot to absorb since the COVID lockdowns of 2020, and the new normal feels different today in some intangible way than it did before we collectively agreed to put our lives on hold a few years ago.  But, in many other ways, life is much more “normal” now than it was back then.  In 2019, $17 Trillion or 40% of global government debt had a negative yield to maturity, where investors were paying governments rather than being paid by them for lending them money.  This was the end-result of a decade’s effort to create the inflation that we are now working so hard to bring back under control.  The household savings rate in Canada hit a 50-year low of 0% in late 2019; it now stands at 5% after jumping during the pandemic and settling out near long-term averages.  The average Canadian was simply not saving any of their take home pay at a time of record low borrowing rates and strong market conditions.  Take a moment to absorb that. That was not normal. 

We have all been through a lot these past few years to test our resolve.  While the near term feels uncertain, that should be nothing new.  It remains our belief that you can find peace of mind and navigate the uncertainty by forming and sticking to a solid long-term plan.  And the good news is that a diversified investment portfolio of high-quality stocks, bonds and real assets like real estate, infrastructure and commodities provides an attractive level of compensation to you for that uncertainty.   Maybe the new normal isn’t that bad after all.