Let’s talk investing: Q4 2023 in review with the Multi-Asset Management Team

Speaker Key:

GS Gregory Sweet

CM Craig Maddock

WB Wesley Blight

VO Voice over

00:00:00

GS Welcome to our listeners. I’m your host, Greg Sweet. Today, we’d like to bring you a new podcast, to continue empowering our clients, helping you make important financial decisions.

2023 is behind us, and financial markets provided great results, in addition to lots of excitement. After an up and down first three quarters, Q4 provided solid returns, providing a significant amount of total return for the calendar year.

Right around now, Canadians are receiving their fourth quarterly statements. This is a great time to check in and see how things are going. We always like to hear what’s happening directly from our Portfolio Managers.

Once again, we’ve called on our Multi-Asset Management Team. Today, our special guest is Craig Maddock, Senior Portfolio Manager and Head of the Multi-Asset Management Team, as well as Wesley Blight, a Portfolio Manager on Craig’s team. Welcome, Craig and Wes. Let’s get started.

We just finished a year with plenty of uncertainty and volatility. Pretty deep into the year, it looked like market performance might not be that hot in 2023.

00:01:04

But after the year wrapped up, when you look back, market returns turned out quite well. It was a good year for disciplined investors. So, what are we to make of all that?

CM Hello, Greg. You’re right, 2023 was an outstanding year, with a particularly strong finish. Stocks were up, yields were down, credit spreads tightened. Almost everything rallied. Investors were rewarded really nicely for investing in stocks, bonds, or in our case, a combination of stocks and bonds, like in our Multi-Asset Portfolios.

2023 was a great year for investors. However, it wasn’t always comfortable, but it did give us some good returns. What do you think, Wes?

WB That’s certainly true, Craig. For the year, we saw broad market gains. The S&P/TSX Composite Index, Canadian Equities, were up 11.8%. The S&P 500, US Equities, were up 22.9%. And the MSCI World Index, so global stocks, were up 20.5%.

And while equities performed really well, bonds did, too, with the FTSE Canada Bond Index up 6.7%. That measures the universe of Canadian bonds.

00:02:15

And as we’ve talked about, the journey wasn’t smooth. We saw a few headwinds throughout the year for investors, with the US Federal Reserve and the Bank of Canada having raised rates dramatically in 2022.

They continued on that path in 2023, and borrowing costs reached the highest levels they’ve been in more than two decades. Rates were so high, that borrowing was incredibly expensive for both businesses and consumers. That’s a real tightening of financial conditions. There were other issues, too. There was a regional bank crisis in March. There was a continued increase in geopolitical tension. But the markets were able to overcome these headwinds, and moved significantly higher.

GS So, those are some pretty impressive returns, gentlemen. What really drove these markets higher?

CM I think you can boil it down to three factors. One, inflation. Two, growth. Three, monetary policy. So, inflation continued its downward trend. The most recent inflation readings were 3.4% in Canada and the US, still much higher than would be ideal, but clearly trending down from its peak.

On growth, the economy has been moderating, but continued to grow. The much-anticipated recession that we expected to happen in 2023, quite frankly, failed to materialise.

00:03:34

However, the biggest driver seemed to be this pivot in monetary policy expectations.

There was a rising expectation that central banks would cut rates this year, in 2024, and that view became increasingly popular in the fourth quarter, driving that huge rally that we spoke of. To me, Q4 was particularly notable, and I’m sure Wes feels the same way.

WB Absolutely. It was really interesting what happened with the bond markets. So, the FTSE Canada Index that we talked about, the Canadian Universe Bond Index, that’s what it’s measuring, was up 8.3% in the fourth quarter alone. That was the best quarter we’ve seen in 25 years.

Now, in September, when you think back to that period, and even into early October, we experienced a selloff in the bond market. That was driven by investors’ fears of higher-for-longer. So, there was an expectation that monetary policy rates were going to remain higher and more restrictive for a longer period of time than had been anticipated.

The Canadian Ten-Year Bond Yield peaked at 4.2% in the middle of October. Starting from there, the rally began. We saw job markets and inflation starting to show evidence of moderating growth, and as a result, expectations of easier monetary policy started to seep into the investor’s mind. The Canadian Ten-Year Yield declined and closed the year at 3.1%. That is a massive move.

00:04:54

And that strong rally that we saw in November and December caused the Canadian bond markets to finish the year, overall, up 6.7%.

Then you move outside of Canada. US bonds also up sharply. The US Aggregate Bond Index, so that’s the core fixed-income benchmark for the US, was up 6.8% in the fourth quarter alone. That was the best quarter that we’ve seen since June of 1989. 34 years.

US High-Yield Bonds, the most credit-sensitive segment of the Public Bond Market, did extremely well, up 7% in the fourth quarter and 13.4% for the year. It outperformed all other bond markets in 2023.

Now, the main takeaway here, at least from my perspective, is that all the bond indices that we were tracking posted strong returns, outperforming cash, outperforming GICs.

If you think back to January, and after a tough year that we’d seen in 2022, some investors were sceptical and believed that money market funds and GICs were the places to hide.

Cash-like instruments saw massive inflows throughout 2023 and, ultimately, investors were rewarded in 2023 for investing in bonds alone.

Now, these results reinforce, in our view, the value of staying invested and staying with long-term investment plans.

00:06:13

GS Those are some pretty impressive numbers in the fixed-income market. You can almost call them equity-like returns. So, nice to see that recovery in the bond market, and the good returns that it was able to deliver. But what about equities? What was really the story, and what was happening there?

CM Well, like bonds, all the equity indices delivered strong returns in Q4. US S&P 500 Index led the gains, up 8.9% in the quarter alone. Now, that index beat most developed and emerging market economies. In fact, in 2023, the S&P 500 was up 23.2%.

The strong performance was largely delivered by an excitement over AI, especially the AI players that we call the enablers, and that’s the sort of first wave of hardware, software companies that will play on that AI excitement.

Emerging Market Index, while still delivering positive results, was the weakest performer, and that’s mainly due to weak performance coming out of China. Chinese reopening, which we expected to have, you know, pretty strong legs in 2023, really faded quickly, early on in 2023. And that’s because consumers and investors lost confidence.

China’s facing a three-D challenge. Deflation, debt, demographics. And in addition, the Chinese market’s also facing increased geopolitical tension and large outflows from global investors.

Canada, all the sectors were up in Q4, with the exception of energy. And that’s not surprising, as the price of oil was down 15% in the quarter. The top-performing sectors included IT, financials, real estate.

00:07:43

Over one year, the technology sector in Canada was up 69%. Of course, the main driver behind that was 119% gain in Shopify.

On the flipside, energy, utilities, they did post negative gains in 2023. The declining energy prices are also one of the main reasons why the Canadian markets underperformed the US last year. You dig deeper, dividend yield and quality outperformed momentum and small caps this last year, and that’s similar to what we experienced in 2022.

In the US, in Q4, we did finally see market leadership move beyond technology and the Magnificent Seven. Industrials, real estate, and financials outperformed. Defensive sectors, like consumer staples, healthcare, and utilities, all underperformed in the fourth quarter.

And this fact underscores that Q4 was very much a classic risk-on period. Value outperformed growth in Q4, finally catching up, after lagging badly in the first half of the year. And as interest rates moved lower, it gave cyclical, value-tilted sectors a much-needed tailwind. Still, year-over-year, growth did outperform value

Now, we believe that 2024 performance will continue to be driven by growth, inflation and, of course, monetary policy.

00:08:59

GS You mentioned inflation, and I think that’s really been a big part of the story over the past 24 months or two years. While not in a straight line down, we’ve been getting a little bit of encouraging news recently. As we look forward, where do we see this going?

WB I’m glad you said not in a straight line down. So, inflation peaked in June 2022, and it has generally been trending lower. That is clearly a global theme, with that decline being consistent across many countries, albeit not in a straight line, as you pointed out.

We see it in the US. We see it in Canada. We see it in Europe. Back to June 2022, inflation was 9% in the US and 8.1% in Canada. At the end of 2023, inflation was down to 3.4% in both the US and in Canada. And that easing of inflation gave the US Federal Reserve and the Bank of Canada some breathing room to start thinking about cutting back on their tight monetary policy rights.

And we think that inflation is going to continue to go down from where it is right now. That’s largely going to be driven by shelter prices easing, and wage growth softening from where we are right now. We expect that annual inflation’s going to go down towards 2%, 2.5%, broadly aligned with Central Bank targets, by the end of 2024.

Now, interest rates, as you know, are closely connected to inflation, and in 2023, the US Federal Reserve hiked their interest rates four times. The Bank of Canada did three, and that was on top of seven rate hikes that we already had come to, to realise in 2022.

00:10:36

And now the tide has turned. At the Fed’s meeting in December, their policymakers signalled a major pivot.

Not only did they signal that the tightening cycle was over, but they also started to indicate that there was going to be a rate-cutting cycle, likely to begin in 2024. The Fed Dot Plot, so that’s really the projection of where rates are heading, it projected three rate cuts. They acknowledged the improvement in inflation, and that, as we talked about, is moving towards the 2% target.

Now, when it comes to the market’s expectations of rates, the market, in our view, is ahead of central banks. It’s not, it’s not even in our view. It’s just, it’s just fact. The market is ahead of central banks right now, as they are expecting five rate cuts in Canada and six rate cuts in the US.

Our view is that the markets are too optimistic at this point in time. They’re too aggressive in pricing in those rate cuts. And the pricing in the charts is for almost a hard landing scenario.

When we think about our view, we’re expecting there to be three to four rate cuts in 2024, and we think that these cuts are going to be proactive to help normalise rates from today’s restrictive levels, and to reduce the chance of the economy realising that hard landing.

00:11:50

So, against that backdrop and despite the returns that we had in 2023, which were really strong, we still think that bonds can continue to perform well in 2024.

Key reasons? Investors are still earning high starting yields, and there is also the potential to benefit from price appreciation, if those rates do come down from where they are right now.

GS I don’t think, when you look back at 2023, what happened was really in line with what our investors’ expectations would have been earlier in the year. And we saw investors really struggled to trust the process in 2023. What’re your thoughts around that?

CM Well, Greg, we did see some clients redeem funds, moving into GICs or even at the sidelines, completely, in 2023. And I get it. It’s rational to be concerned about some of the market headwinds we saw. We were also cautious.

But it really wasn’t the environment where, you know, like, full steam ahead, where we could get really aggressive with chasing returns. But 2023 provided a good reminder that it pays to have a disciplined process.

And with the portfolio solutions we manage, we have some leeway to make tactical trades, to respond to short-term risks or opportunities. But we set limits on them, and we’ve built a very disciplined process.

Now, our decades of experience remind us that it’s prudent to pay attention to our strategic asset allocation first, and only spend a little bit of active risk on tactical decisions.

00:13:13

So, ultimately, while we did get cautious at times throughout the year, we stayed invested, we kept focused on the longer term, and that really paid off for our investors.

At the end of the day, we beat the performance of GICs, high-interest savings accounts, and cash. So, it’s understandable that clients might have taken some risk off by moving part of their portfolios to the sidelines, but in the end, ultimately it feels like that would’ve been a mistake. And usually, when investors try to do that, it’s unfortunate, but they move way too much.

I mentioned us having a disciplined approach. I think that’s critical because it’s really hard to figure out, when’s the right time to put money back in the market? Well, quite frankly, at the beginning of Q4 would’ve been that time, but if you’d locked into a GIC, it was a little bit too late.

So, I think that’s one of the big challenges that, that face investors. If you think back, about 64% of the returns for Canadian stocks came in November, so therefore if you missed that November-December rally, well, you pretty much missed a whole year’s worth of returns.

I know it’s hard, but I think it really pays to ignore the noise and stay invested for the long term.

00:14:15

GS You know, this is a point we reiterate quite frequently with our clients. In order to achieve your long-term investment goals, you really do need to trust the long-term process and your long-term investment solutions, sticking to those principles of investing early, contributing regularly, staying diversified in your portfolio solutions. And really, making sure that we remain disciplined when our emotions sometimes want to get the best of us. Are there other lessons that we can learn from, from 2023?

WB Last year served up some really clear lessons to investors, and, and we think our, our clients should take careful note of those reminders that the market provided. There’s always something to worry about, and often it doesn’t alter the long-term path of markets. That’s lesson number one.

And I think lesson number two, it’s hard to time the markets. Sometimes things turn quickly, and it’s, it’s really easy to miss out on the benefit of those things turning positive.

The third one, and I think the most important one from our perspective, is to set up a plan for the long term and then to stick to it.

GS So, I guess the natural question is, what now? After what some would say was a surprising 2023, how should investors feel about 2024? It sounds like we’re in a bit of a better position than just a few months ago, but does that mean clear sailing ahead?

00:15:40

CM Given we just discussed how quick things can change, and investors can get caught off guard if they follow their feelings, our guidance is to think about the next ten years. And if you do that, I think you should feel great.

We know that markets and the underlying economy are going to have some dramatic ups and downs. The inflation and interest rate story isn’t completely finished. Geopolitical concerns remain.

However, we just completed our review of our long-term capital market assumptions, and the good news is we believe patient investors have the potential to make even better returns in the next ten years than we figured just one year ago.

But of course, in the short term, we keep a very close eye on markets and the economy. The outlook looks a little murky right now, and as a result, we’re still slightly defensive, but we can change that at any time.

So, for me, there’s three reasons to stay invested right now. Number one, fixed-income outlook looks particularly more appealing than it’s been for most of the past several years. For stocks, even after a nice run, valuations are starting to get a little high, but it’s a big market, so it’s very attractive for our long-term return assumptions, as we can diversify portfolios.

Now, there’s less uncertainty now than there was at the beginning of 2023, and for me, that looks pretty good for a well-managed, traditional 60/40 portfolio.

00:17:00

GS Craig, Wes, that’s a great summary. I’d like to thank you both, for me, and also on behalf of our clients.

This kind of conversation really helps provide our clients with the knowledge, maybe more important, the confidence to tackle these big issues, leading them to make smart decisions with their long-term investments, and ultimately helping to maintain the health of their long-term financial plans.

So, thank you so much for spending your time with us today. And to all the listeners of the podcast, I want to thank you for investing your time in this discussion, and thanks so much for spending your time with us today.

VO This audio has been prepared by 1832 Asset Management L.P., and is provided for information purposes only. Views expressed regarding a particular investment, economy, industry or market sector, should not be considered an indication of trading intent, of any of the mutual funds managed by 1832 Asset Management L.P.

These views are not to be relied upon as investment advice, nor should they be considered a recommendation to buy or sell. These views are subject to change at any time, based upon markets and other conditions, and we disclaim any responsibility to update such views.

To the extent this audio contains information or data obtained from third-party sources, it is believed to be accurate and reliable as of the date of publication, but 1832 Asset Management L.P. does not guarantee its accuracy or reliability.

00:18:18

Nothing in this document is or should be relied upon as a promise or representation as to the future.

Commissions, trailing commissions, management fees and expenses, all may be associated with mutual fund investments. Please read the prospectus before investing.

The indicated rates of return are the historical annual compound total returns, including changes in unit values, and reinvestment of all distributions does not take into account sales, redemption or option changes, or income taxes payable by any security holder that would’ve reduced returns.

Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.

00:18:56