Echelon Wealth Partner Blog

Is it over?

Mon, 17 Jun 2024 16:30:43 GMT

Is It Over?

It seems like just yesterday that you could buy a pint of Stella for $7 or so. Now, more often than not, it is closer to $10. Yep, inflation. It is kind of like a tax on doing things, as just about everything has cost more over the past few years. Hop on a flight, eat at a nice restaurant, refinance your mortgage, the list goes on. With the benefit of hindsight, the current higher inflationary

environment can be blamed on a few pretty big factors. Changes in behaviour during and coming out of the pandemic blew up supply changes, as capacity was unable to keep pace with demand. Then, of course, unprecedented money printing magnified the situation, as it made everyone wealthier and more willing to pay $10 for a pint.

Of course, the textbook solution is to raise interest rates, which is clearly occurring around the world. These monetary policy shifts are effective but do work with variable lags. Making those lags longer, or even temporally offsetting them, was fiscal policy. It doesn’t take an economist to understand if the monetary policy is trying to slow the economy to tame inflation; materially

elevated fiscal spending in an economy that is still growing at a decent pace is counterproductive for the inflation fight.

Despite contrary policies, perhaps motivated by short-term thinking (or upcoming elections), inflation has taken a decent turn down and continues to cool – but clearly, not in a straight line. You can note a quicker decline in the greenish line tracking U.S. year-over-year core inflation with the latest reading after a period where little progress was made. This chart really goes back to show how inflation got started. It was initially called ‘transitory,’ and then, finally, central banks jumped into action coincidentally when inflation had already peaked. Rarely ahead of the curve, those central bankers. Inflation declined a good amount in 2023, but the previous few months in 2024 showed it picking up or being much more sticky. This latest reading has things cooling again, which is good news.

The above is U.S. inflation, but the pattern is similar around the world for the most part. Inflation and the economy in Canada have cooled enough to open the door for the Bank of Canada to cut. In fact, the number of central banks cutting rates has been on the rise, including some of the biggies like the BoC and ECB. We will talk more about U.S. inflation simply because that is what moves global markets more.

The fast or early movers in the CPI data have been improving for some time. These are the categories of CPI that simply change faster, as other components are much slower to react to changes in behaviour. Many goods categories, such as hotels, autos, and restaurants, are examples of areas of the economy that change prices rather fluidly. Rent, owner-occupied rent, and insurance are examples of areas where prices change very slowly or are even lagged in their reaction. Rents often don’t reset until the end of a lease and are further slowed by rent controls. Insurance, too, doesn’t reset often, so changes in actual prices take time to show up in the aggregate data.

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Crisis Alpha

Mon, 10 Jun 2024 15:41:27 GMT

Crisis Alpha

If the wealth advice service were in the manufacturing industry, the portfolio would be akin to what we make. Sure, there are many value-added services in addition to the portfolio, but it’s the portfolio that has to succeed for the client to reach their long-term goals. So, the more we can think about portfolio construction, the better.

One challenge is that while portfolio construction is often based on as long a historical time period as possible, things never remain static. Markets evolve and change over time, relationships change, and the available tools in the portfolio construction toolbox also change over time. One recent change that has been a challenge is the bond/stock correlation. After a couple of decades of very low or even negative correlations between these two core building blocks, correlations are back to being positive.

The following chart shows the 2-year monthly correlation between Canadian equities and bonds. It looks rather similar for the U.S. and global markets, but we just thought some Canadian content would be nice. The higher correlation means that, more often, equities and bonds are moving in the same direction. Nobody complains when both are moving higher, like in the past 12 months, but when they move lower together, everyone starts getting grumpy, like in 2022. The 2nd line, beta, measures not just the direction of the two asset classes but the magnitude of the relative move.

This chart goes back to the 1950s, and clearly, there have been many periods of positive equity/bond correlations. But the recent memory of 2000-2020 was a really sweet spot. Equity/bond correlations were low or negative, which enhanced the benefits of diversification between equities and bonds. Now, this diversification benefit is more muted. As a possible silver lining, given yields are higher now, the return assumption for bonds is higher. So perhaps a bit less useful as a volatility management tool and a bit more on the return side – a decent trade-off.

This higher correlation has many portfolio construction practitioners looking for different sources of diversification. Of course, the proliferation of different tools has augmented this behaviour as well. Many have lower correlations, but we would caution this as the main driver of a decision.

Why do we care about correlation? In 2022, you couldn’t go a day or two without seeing an article talking about the 60/40 being dead due to higher correlations between bonds and stocks. And yet, the correlation is higher today and much fewer articles. That’s because nobody cares when equities and bonds are moving higher in unison, only when moving lower together. So, maybe we need some additional measures to augment correlations.

Here is a good lens. Using data back to the 1950s, we looked at the one-year returns for global equities and broke them down into return range buckets. Truthfully, who cares what their bonds are doing when stocks are up 20 or 30%? But we do care much more when stocks are down -20 or -30%. More impactful – bond returns were further split from periods with negative bond/equity correlations and those with a positive correlation (last two columns).

No denying periods with a negative bond/equity correlation that bonds are a better stabilizer during down markets. Eyeballing it, one could argue twice as good. But even when positively correlated, bonds, on average, are a decent stabilizer. Of course, these are averages that can hide a lot of information. There were 103 instances in which global equities were down on a 1-year basis simultaneously when the bond/equity correlation was positive. Bonds were higher in 77% of those instances. That hit rate moves up to 86% if you include periods when bonds were down minimally (less than -2.5%). Bonds, not broken.

Another useful lens is ‘Crisis Alpha.’ This is looking at an asset class or strategy’s performance during periods of stress in the market. Could be a short-term correction or a longer-term bear market. If you can add value during these periods, or at least stability, that has positive attributes for portfolio construction.

The reason we expand and show all the different instances is because each has its ideal period of market weakness, and each has episodes in which the strategy falls short. For instance, market neutral typically does well but is completely wrecked during the credit crisis. Managed futures (often a momentum strategy) did really well in 2022 but not great in a number of other periods of market weakness.

Based on this, one could make a case for managed futures, more market neutral, and a splash of gold to better diversify a portfolio. But don’t forget these are crisis periods, and there is a whole lot of time between crises. Global stocks suffer, yet over the past 20 years, they have compounded around +8%. That market neutral index has only grown at a 0.8% annualized pace over the past two decades. And the managed futures index is a bit better at 3.6%. Defence often comes at a cost.

Final Thoughts

Investors should start to think differently about portfolio construction and diversification. We do believe correlations may remain elevated for some time (a future edition will tackle this), and looking to expand sources of diversification appears prudent. Call it diversifying your diversification.

But don’t get too carried away. The simple fact is when correlations are higher, it is harder to reduce portfolio volatility. Something we may have to live with. If you go too far in trying to smooth out the ride, you may sacrifice long-term returns. Would be a bit of a pyrrhic victory to enjoy a vol of 5% if the end nest egg is smaller.

Everything in moderation – bonds still work, and some defensive diversification is clearly warranted in a more positively correlated world.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only. This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

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The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Echelon Wealth Partners Inc. or its affiliates. Assumptions, opinions and estimates constitute the author's judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

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Forward Looking Statements

Forward-looking statements are based on current expectations, estimates, forecasts and projections based on beliefs and assumptions made by author. These statements involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. Neither Purpose Investments nor Echelon Partners warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. These estimates and expectations involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional

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This Ain't That

Mon, 03 Jun 2024 16:53:45 GMT

This Ain't That

The US market is up a little over 10% this year, Canada +6%, Europe +10%, and Japan +15%, while bonds are down about -1%. Huh, that sure does look like asset allocation is working well again after the car crash of 2022. Even better news is that the market is moving higher thanks to good fundamental news, not simply because central bankers are jamming more money into the financial system.

Recession risk has continued to fade, as evidenced by the survey of economists. For the UK, Canada, US, Eurozone, China & Japan, the average probability of a recession hit a high in late 2022 at about 60% and has fallen down to a mere 25% of late. The UK, which was as high as 90% and suffered two negative quarters of GDP growth, is now down to 30%, winning the most

improved ribbon. Even Canada, which is clearly struggling with higher rates, has improved from over 60% to 30%. Most are clustered around the 30% zone.

The data has improved, with both markets and economists celebrating. This is good news, and perhaps this better economic data will make its way into improving earnings expectations – that’s what counts more. There has been some minor uptick of late, so again, it is encouraging. In addition to this, inflation continues to cool, for the most part, so more central banks should start to walk rates back down in the quarters ahead.

Add that all up – can we justify most equity markets sitting around fresh all-time highs? Or, even more importantly, can we expect

more gains to come if this is the start of a new cycle? Fueling the optimistic view is the rising price of copper and other commodities. Copper carries an honorary PhD in economics because of its widespread use in manufacturing, often implying a rising price coincides with rising broader economic activity. And copper has been on a tear.

New cycle? This ain’t that. We would agree with the group view from economists that recession risks are diminished compared with past quarters, but would temper enthusiasm or talk of a new cycle for a number of important factors.

1) Delayed and variable confusing lags or policy

Rate hikes have slowed down economic growth, but that relationship remains intact. But this drag has been muted thanks to accumulated savings during the mobility-reduced period following the pandemic. And from very aggressive fiscal spending just about everywhere in the world, led enthusiastically by the US. The concern is these buffers are starting to roll over or become depleted, which will temper growth going forward.

2) Goods spending, then services spending, now what?

As we highlighted last month, during the stay-at-home period, we all spent money on goods. This blew up supply chains and also supercharged economic growth in 2020-21. In 2022, we all pivoted, to a degree, back to more service spending on travel, eating out, experiences, etc. This made it appear as if a recession was coming since goods spending, manufacturing, and global trade slowed. But alas, it was just a tectonic shift in spending behaviour. Now, goods spending is recovering, but is this robust demand or is it just normalizing from the depressed levels of 2022? Time will tell on this one, but our base case is this is more normalization and not the start of a new cycle.

Normalization is good news but not great news. And with accumulated savings largely depleted due to inflation and a desire to ‘live’ despite the costs, the longevity of this improved economic activity may not endure. Just look at the US consumer. We are not concerned about the level of credit card debt, given that societies are moving towards a cashless world. However, the delinquency rate is concerning, as is the same-store sales at restaurants, which are just a notch above fast food.

Not denying decent employment and wage gains are positives, but it would appear inflation has taken a toll. And those accumulated savings appear to be largely depleted. This is not the behaviour one would expect during the start of robust economic growth; in fact, it is the behaviour often seen near the end of a cycle.

1) And then there is what is priced in

I won’t harp too much on valuations, as everyone kind of knows the deal. The S&P 500 at 21x forward earnings is on the high side, but this has been the case for some time. 15x for the TSX and International equities is not cheap either. The vast majority of market gains this year have come from multiple expansions.

We are not overly negative and currently are carrying just a moderate underweight in equities. However, for this market to move higher, we would need to see continued improvement in global economic growth, which may be challenging. Or inflation to come down materially, alleviating the pressure higher yields elicit on the equity markets. Possible, but not our higher probability path.

Given this we are comfortable with our moderately defensive stance.

Revising cyclical yield in the Canadian dividend space

When it comes to dividend investing, interest rates play a rather large role in determining the relative winners and losers. Not only are dividend stocks sometimes viewed as bond proxies, company earnings can also be quite rate-sensitive. It is through this lens of rate sensitivity that reveals the full spectrum of dividend stocks. On one hand, you have the highly rate-sensitive industries such as Telcos, Utilities and Pipelines and on the other are industries that are much more cyclical. We’ve long used the term

cyclical yield to define these companies whose earnings depend much more on the economic cycle compared with the much more defensive rate-sensitive stocks.

Our scoring or ranking system uses a combination of an industry’s correlation to bond yields, sensitivity to bond yields (think like Beta, but instead of relative to the market, it’s relative to yields) and an out-of-sample score for periods over the past decade of

rising yields. The chart to the right depicts the full spectrum of sectors/industries within the TSX. The top grouping, Cyclical Yield, are those that we would expect to hold up better in a rising yield environment. The bottom grouping, Interest Rate Sensitive, are

those that we would expect to perform best in a falling yield environment.

We’ve long had a tilt across our dividend mandates towards cyclical-yielding dividend payers. Given the chart below, the cyclical yield has handily outperformed the rate sensitives over the past few years. The outperformance typically comes when yields

have been rising. Looking back in the 2010s, there were brief periods when cyclical yield outperformed, but overall rate sensitives did quite well with the tailwind of falling yields. That all changed in late 2020, and cyclical yield has really not looked back.

Deciding when to switch or actively tilt between rate-sensitive vs more cyclical stocks boils down to a few key considerations.

Economic Indicators - Cyclicals have thrived during periods of accelerating GDP growth. The resiliency of the US economy has surprised many, and the soft landing has benefited cyclicals. Rates remain stubbornly high, along with inflation. While the path to 2% inflation and how long it will take to get there remains one of the most important macro questions out there, interest rates remain near cycle peaks. Higher-for-longer should hurt cyclicals the longer rates remain restrictive.
Business Cycle Phases - The business cycle remains healthy and in expansion territory. Margins have remained historically healthy, and based on the latest earnings quarter, both sales and earnings growth remain strong. While the business cycle remains healthy from a 10,000 ft perspective, when digging into the specific sectors, we do see an interesting trend developing. The chart below aggregates total net income from continuing operations across for both cyclical yield and the rate sensitives. Cyclical earnings peaked back in 2022 and have been trending lower. Conversely, rate-sensitive net income bottomed in late 2022 and has begun to recover. Relative earnings growth favours the rate sensitives, which has been aiding the lower beta tilt seen in the market of late.

3. Market Sentiment - Risk appetite in the market remains strong, and investor sentiment remains decidedly bullish. The AI story continues to drive strong relative performance as investors remain guided by the urge not to miss out. While the relative performance this year has certainly benefited cyclicals over the past few months, rate-sensitive stocks have actually begun to do quite well. In May, the Utilities sector was the second-best performing sector in both Canada and the US Staples, too, have been solid relative winners. This could, in fact, be an early sign that investors are increasingly looking to diversify into lower beta names.

4. Fundamentals - Valuations can sometimes take the back seat to investment decisions, especially in a new ear investment environment. Investors would be wise to remember that excesses are never permanent, and past trends don’t have anything to do with future performance. From a traditional valuation standpoint, certain cyclical sectors (Energy) still appear somewhat cheap, as the average P/E across our cyclical industries is still just 15.3x, compared with 19x for the Canadian rate sensitives. For cyclical companies, a low P/E doesn’t necessarily mean a stock is cheap because the P/E ratio can be misleading. During boom times, earnings tend to be high, which can make the P/E ratio appear low. During downturns, earnings drop significantly, and the P/E goes parabolic or even nonexistent. Low P/Es across the cyclical space can reflect the peak of the business cycle. Rate sensitives might have a higher P/E, but they are also, on average, trading at a sizeable discount to their average valuations. Telecom and Utility sectors, in particular, are trading at nearly a 20% discount. Undervalued assets offer a margin of safety, reducing potential downside risk.

Bond yields have had an extended trend higher, and dividend strategies, especially those tilted more so towards interest rate-sensitive sectors, have had a difficult go. Being active managers, we’ve had a definite tilt towards cyclical yield, which has helped. Looking ahead, the future path of the rates trajectory certainly isn’t as clear as it was back in 2020/2021. The growing consensus believes rates have peaked, and with growth rates slowing, cyclical yield may not be the best place to be. The relative cheapness and recent earnings growth trends in favour of rate-sensitives also make this space more attractive. The recent rise in global

interest rates approaching cycle highs, alongside a US market trading at a high valuation (21.4x forward earnings), presents a potential challenge for the stock market. However, this environment can also be viewed as an opportunity. By strategically adding investments with higher interest rate sensitivity and inherent defensiveness, investors can position their portfolios to benefit from falling rates in the same way as increasing duration in a fixed-income portfolio.

Market Cycle

After many months of steady improvement, we have seen the Market Cycle signals take a small step lower over the month of May. Market Cycle indicators are comprised of over 40 indicators that have, in the past, proven to be a good forward-looking signal for the broader economy.

Among the 19 US economic signals, two slipped from bullish to bearish. The Citigroup Economic Surprise index turned negative, as the data has generally been coming in softer lately. And NAHB housing activity soured. Two signals also flipped to bearish among the global economic signals. Baltic Freight rates declined, but you could put a positive spin – this is just cooling off concerns about Red Sea travel. DRAM prices fell as well. Rates and Fundamental signals remained stable.

On a sobering note, you can see a score for ‘Better/Worse’ in each category, with either ‘+’ or ‘-’ next to each signal. This measures the direction in which the data has travelled over the past month. Is it getting better or worse? Compared with last month, rates got worse from 3/0 to 0/2. The US economy was stable from 7/12 to 6/13, more worsening than improving but roughly the same as last month. The global economy stayed at 3/5. Fundamentals, following the earnings season, have dropped from 10/2 to 4/8, which is not good as this is a material swing in momentum.

Overall, it just highlights some deterioration in direction, but that does change often.

The only change we have made from a strategic allocation perspective is increasing exposure to emerging markets. After being underweight emerging markets for many years, we are now back to neutral. This was predicated on an elevated valuation spread between emerging markets and developed markets. Plus, improving global trade and relative earnings growth.

Outside this change we remain moderately underweight equities, holding a bit more bonds and cash. Among equities, we are a bit underweight in US equities and overweight internationals. Bonds have us carrying a bit higher duration.

Final thoughts

Maybe the summer months will see quiet markets, or maybe this lack of volatility across many asset classes is the calm before a storm. One thing is certain: gains have been good lately, and becoming or remaining defensive feels appropriate. The back half of this year certainly has more challenges than the first half. We are going to see a big US election. We will also likely see if this uptick in global growth is a bounce or the start of something sustainable. And maybe there will be a broader central bank pivot.

The only certainty is that this calm won’t last.

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements Forward-looking statements are based on current expectations, estimates, forecasts and projections based on beliefs and assumptions made by author. These statements involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. Neither Purpose Investments nor Echelon Partners warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. These estimates and expectations involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional

The Calm Before the Calm

Mon, 27 May 2024 21:12:17 GMT

The Calm Before the Calm

Should it be any surprise how calm markets have become? Global equities are up 9.2% year to date. Apart from a 2% decline in January and a 5% drop in April, the trend has been steadily up to the right on the chart. We can easily slap a financial narrative on this, such as improving economic growth globally, a decent Q1 earnings season, or maybe it's just the AI frenzy. More than a

third of the advances in global equities are attributed to Nvidia, Microsoft, Amazon, Meta, and Alphabet. Whatever the cause, equity volatility has been very calm so far in 2024. But it is more than this, as it isn’t just equities.

The volatility in the bond market has gone super low (2nd panel in chart). The MOVE index measures volatility in U.S. Treasury Bonds [actually at-the-money options on interest rate swaps, but let’s not go down that rabbit hole]. Even though bond yields moved higher this year, the 10-year started at 4%, gradually up to 4.75%, then back down to 4.5%; these moves pale in comparison to the last couple of years. In case you forgot, the same bond in 2022 went from 1.5% to 4.0% and in 2023, yields oscillated between 3.5 to 5.0%. Looking beyond Treasuries, credit spreads are back down to or close to historical lows. Investment Grade spreads in the U.S. are 50bps. Lows in past mini-credit cycles have been 40-60bps.

Then, finally, there are currencies. Again, volatility has been sitting near or at lows for the past number of years. After the rollercoaster currency rides in 2020-2022, a calmness has returned. The U.S. trade-weighted dollar index has been sitting in a channel between 100 and 107 for a year and a half. The Canadian dollar, too – 72-75 cents has been the range since the end of 2022.

Yawn.

Or consider this: the S&P 500 has not had a 2% down day in 316 trading sessions dating back to February 2023. Third longest streak this millennium. Given this, it is not too surprising the VIX, which measures the implied volatility of S&P index options, is sitting down at 12 ½. The VIX uses near-term options for its measurement of volatility; even more surprisingly, the six-month VIX is dormant. Over the next six months, we will have endured a U.S. election (if it ends as scheduled) and perhaps a pivot from the Fed on interest rates. Even 5-6% out-of-the-money puts for December are only pricing in 16% volatility.

Insurance is cheap.

There is likely some downward pressure on option volatilities due to the proliferation of option strategies, especially those that write options. But given volatility has become so calm across so many markets and asset classes, we can’t really blame those yield-hungry investors.

The question becomes, will this calmness persist? Maybe. There is no denying that, on average, markets tend to be relatively calm during the summer months (June through the end of August). All the traders/investors off in the Hamptons, Muskoka or wherever the Londoners go could make volumes lower and have fewer folks making big changes to their portfolios. Of course, averages can be very misleading and much variation can occur. With data back to 1970, the summer months are roughly flat on average for the S&P and the TSX. A seasonal chart for the VIX also shows this calmness as volatility falls in the summer months before moving

materially higher in the often challenging September/October period.

Not surprising that markets are gently trending higher with limited volatility; investors have become rather calm as well. In the latest survey, 47% of folks are bullish (AAII survey). Meanwhile, 26% are bearish, and 27% are neutral or undecided. We would highlight that from a sentiment perspective, when this many folks are bullish, future returns tend to be a bit on the lower side. But we will also point out that sentiment is much more reliable at market bottoms than trying to call market tops.

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More Bad News S'il Vous Plait

Tue, 21 May 2024 16:12:14 GMT

More Bad News S'il Vous Plait

I think we might be in that very unique market mood when bad news is good news. The equity market weakness in April can probably be attributed to bond yields moving higher, so any economic data on the weaker growth side is welcome news at the moment. The S&P started to recover on May 3rd , rising 1.3% when the ever-important non-farm payroll labour report came in softer than expected, helping 10-year yields fall back down to 4.5%. Then, over the past few weeks, we have seen generally weaker economic data for the ever important U.S. economy; bond yields have continued to come down, and equity prices have

moved up.

Of course, all eyes were on the U.S. inflation print for April, which was marginally softer than expected (soft CPI is truly good news), helping bond yields fall and pushing the S&P 500 to a new all-time high. But really, 0.3% vs. expectations of 0.4% is not huge, especially given that the core reading was in line at 0.3%. This still has the annualized 3-month change running a hot 4.5%.

To be fair, there was some good news beneath the surface on the CPI print. But on that day, helping, and less talked about, was a really weak Empire manufacturing survey and weak retail sales.

So, weak economic data helps bond yields come down, softens inflation fears, and opens the door a little more for central bank rate cut optimism, which allows the stock market to trade at a higher valuation multiple. Stocks up, bonds up—perfect! The problem is that this will work until bond yields have cooled enough, and then the market may start to fret about a lack of economic growth.

The U.S. economy is about 25% of the global economy, and the U.S. consumer is about 70% of the U.S. economy. So, with some rough math, the U.S. consumer is about 18% of the global economy, which is kind of important. We are well versed in never betting against the U.S. consumer, but what is not being talked about much is some clear signs of erosion. No denying past rate hikes are starting to take a toll. As is inflation, that has been making everything cost much more than before. For the past few quarters, the consumer has been complaining about the higher prices of everything from vacations to goods but still paying the tab. This is mainly because of some positives. Good gains in labour over the past few years, wage gains too, and don’t forget all those accumulated savings that built up during the pandemic period when mobility was restricted.

Unfortunately, those positives appear to be fading while the consumer headwinds remain. Wage growth has slowed, as have job gains. But this erosion may be more apparent in behaviours. Walmart just posted stronger numbers, helped by higher-end consumer shopping at the big box. When the wealthy start showing up at Walmart, this could be evidence that higher prices are causing consumers to start downshifting their spending habits.

It is not just trips to Walmart; instead of higher-end retailers, look at the restaurants. Dining-out options vary greatly from those Michelin-star restaurants all the way to picking up a happy meal at McDonald’s. It is hard to get data on Michelin-star restaurants. Still, it continues to be challenging to get reservations, so high-end consumers still appear confident. First, popping into Walmart, then off to Le Bernardin. However, there is a quality of restaurants just above QSR (Quick Service Restaurants) that may be showing signs of softening spending choices. We created a basket of seven publicly traded sit-down restaurants that are a notch above McDonalds, Chipotle or Wild Wings. The list was created by asking one of our team members where his family

eats when travelling in the U.S.

We cut off the peak and trough caused by abrupt changes brought on by the pandemic, but you can clearly see that same-store sales at these restaurants have been slowing and starting to turn negative. Even more impactful is that same-store sales are a nominal measurement, which means if volumes remained steady, then this would be higher, given that the ‘food away from home’ component of CPI is up 4.1% over the past year. Adjusted for inflation, the consumer appears to be slowing their spending habits in this very discretionary category.

Then, there is how people are paying for things. During the pandemic, consumers were spending less and still earning well. This helped them pay down debt, including credit cards. But look at the trajectory or slope of credit card debt accumlation during the past few years, even as rates rose. Maybe we could argue that society has gone more cashless, leading us to use cards more. Fair point. So then look at the delinquency rates, ticking over 10%. Of that big pile of credit card debt, over 10% is beyond 90 days delinquent. A level not seen since early in the financial crisis of ‘08/’09.

Trends are very similar for the Canadian consumer as well. Job gains slowing, wage growth slowing, spending slowing, we are not that different.

Final Thoughts

Fortunately, all this is good news today. Because this is how it is supposed to work. A central bank raises rates to slow inflation, causing slowing economic activity. Now, this mechanism, which operates on slow variable lags, has been further delayed due to aggressive fiscal spending. But it does appear to be starting to show up, at least in some of the more discretionary categories or behaviours. I'm not betting against the consumer yet, but they are certainly on a fragile-looking footing.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers - Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

Is It Time for Emerging Markets?

Mon, 13 May 2024 16:59:13 GMT

Is It Time for Emerging Markets?

The normal narrative for encouraging investors to look at emerging markets typically goes like this: The valuations are cheap, the demographics/rising incomes are supportive of growth, and they offer diversification. Perhaps this is more the marketing narrative. Kind of how, like for infrastructure strategies, they always talk about how many bridges need repairing. We are not refuting any of the above reasons, as they have been rather perennial for many, many years. And yet, for those who know us, we have been rather negative or at least cool on emerging markets for a long time. How long? Well, this negative view persisted for well over a decade. This is us giving ourselves a pat on the back since Emerging Markets (EM) have done roughly nothing for the past 12 years as Developed Markets (DM) have charged higher (chart).

So why are we turning more positive now after so long? First off, it is not all rosy, as there are some big headwinds as well as tailwinds. If everything were positive, EM would have already ripped higher. Investing is probabilities, with an eye on risk to

both the upside and downside. Today, we feel there is a good tilt in favour of EM. But first, we will talk about the negatives.

Trade restrictions – For EM nations, exports make up a larger portion of their economies than developed markets, so any increase in tariffs or trade restrictions is negative. Given that China comprises a bit over 20% of the EM universe, the escalation of the China/US trade conflict is a clear risk. When the U.S. raised China tariffs from 3% to 12% during Trump’s presidency, trade gradually adjusted.

Exports out of China bound for the U.S. fell from 21% to 14%. Other countries, such as Mexico, experienced increases in their economy.

We are not going to try to guess who wins the election or to what degree campaign boasting actually affects policy. However, the escalation of trade restrictions, or Trade War 2.0, if you prefer, is a risk for China and other EM nations.

Polarization – The world has become marginally more polarized over the past years. This has led to increased geopolitical conflicts, or geopolitics have led to increased polarization, which is a bit of a chicken-and-egg question. Regardless, this trend is away from globalization, which is not great for emerging markets.

China – When talking EM, you can’t ignore China. Now, China used to have about a 40% weighting in EM, but this has fallen to around 22% as their market has suffered and other EM countries, including Mexico, Brazil and India, have risen. China is very cheap for some clear reasons, including the trade war risk, the fact their index has a strong technology weighting, and, of course, the ongoing property crisis.

As we said, if everything were positive, there wouldn’t be much of an opportunity. The real question is whether these negatives are bigger than the positives, given the current entry point available. We think the positives are great, and the low entry point offers enough of a margin of safety. Here is the other side, and we are skipping over the standard demographics and diversification arguments.

Valuations – Yes, EM is almost always cheaper than DM, mainly because of greater earnings variability. A dollar of more cyclical earnings is simply worth less. Normally, this would not be a reason, in our opinion. However, the price-to-earnings spread between EM and DM is over 6 points, which is historically very high. Developed markets globally are trading at 18x while EM is around 12x. That kind of spread does have us talking about valuations as a reason to be more positive EM, or at the very least, less fearful of the negatives.

Economic momentum – Everyone knows the U.S. economy has been the more resilient over the past year or two, while other economies have suffered. Today, we are seeing a broadening of economic improvement, including EM. Broader growth and less risk of global recession is good news for both DM and EM, just more so for EM. Notably, global trade is improving. While it is still being influenced by pandemic-induced behavioural changes, rising trade and higher manufacturing activity favour EM. The chart below is global trade, and it is clearly turning up (black line). It hasn’t reached the key 4% growth pace but is moving in the right

direction. When global trade is higher, EM tends to outperform DM.

We would add to this central bank activity. Broadly speaking, EM nations raised rates before DM in the past rate hiking cycle. And they have started to cut rates sooner. Again, a positive impact on EM.

Earnings Growth – The relative performance of EM vs DM tracks very well with the relative earnings growth in EM vs DM. Whichever market grouping has better growth normally performs better. In fact, for much of the past decade, during which EM underperformed DM, earnings growth in EM was below that of DM. With forward earnings growth rising back close to parity, this is good news for EM vs DM that we do not believe has been reflected in the relative performance between the two.

While China used to be a much, much larger weight in EM, it is still the biggest single country weight, at just under 25%. The chart above outlines the current weights in one of the larger EM ETFs available. So, let’s talk China a little. The trade war risk is certainly real, with some of the risk mitigated by their gradual migration away from trade bound for the U.S. But the big risk is their real estate crisis. This has really been going on for about three years, and part of us wants to believe that after such a period, much of the bad news has become widely known. There is too much inventory, developers are going bankrupt, soft sales, etc. Often, the cure for a crisis is the passage of time. We’re not saying that ends a crisis, but markets will move on long before it's all over.

So, is it over from a broader market perspective? Economic data from China is always a bit questionable. When Evergrande first surfaced as posterchild for this crisis (like Lehman Brothers for the GFC), we started tracking developers’ share prices. Creating an equal-weighted index of real estate developers listed in China and Hong Kong. Our view was long before the data started to improve, this group of companies would start to recover. Call it our good news canary for China’s real estate crisis. We ignored the move higher in late 2022 as it was driven by some government intervention. And there have been many mini false dawns. Maybe the current uptick will fail again, yet we just don’t think there are many more shoes to drop that haven’t dropped in the

past three years.

Final Thoughts

Add all this up, and emerging markets aren’t filling us with jubilation. For the first time in many years, though, we are less fearful and believe the risk/return balance is tilted more toward return.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers - Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

Lots of Bulls & Bears

Mon, 06 May 2024 19:09:17 GMT

Lots of Bulls & Bears

Take your pick. There is no shortage of both good and bad news floating about the financial markets. To be fair, this is always the case. The hard part is understanding which side is stronger today and which side will be stronger tomorrow. With markets up low to mid-single digits following a very strong Q4 finish to 2023, most would agree the optimists are carrying the day at the moment.

It is not just rose-coloured glasses; there is good news out there. Economic growth signs or momentum appear to be improving year-to-date. Dial back a few quarters, and the U.S. economy remained resilient while other economies softened or were rather lacklustre, including Canada, Europe, Japan, and China, to highlight some of the biggies. Today, while Canada is struggling, momentum in the U.S. has moved even higher, and there are signs of improvement in most jurisdictions.

Consensus estimates for U.S. economic growth in 2024 started rising a year ago and accelerated this year. Now when the largest economy in the world is accelerating, that certainly alleviates many of those recession fears (ourselves included; we’re still fearful but less so). Consumer confidence has been rising in the U.S. and elsewhere. Purchasing Manager surveys that track manufacturing activity have been firming up and becoming expansionary in many countries.

This good news has not been lost on the market. The S&P 500 has just posted back-to-back +10% quarters. The chart below is a bit selective on the time period, but a 5-month return of over 20% has rarely been seen outside of market recoveries from recessions. The market has clearly responded to the better news in fine fashion.

This move higher in the markets, which extends beyond the S&P to Japan, Europe and Canada, has pushed valuations higher. As we have harped on many times before, this market advance has not enjoyed any follow-through from earnings expectations. S&P 500 earnings estimates for 2024 have risen by a mere 1% so far his year and 2% for 2025 estimates. That’s not terrible, but given the market rally, it’s not great either. Global earnings outside the U.S. are worse, seeing 2024 and 2025 consensus estimates fall by 4%.

Higher markets with no follow-through on earnings does make for a weak foundation. Perhaps the uptick in economic data will

make its way to corporate bottom lines… maybe. But it would really have to get going soon to start catching up.

A very different cycle

Every market or economic cycle is different, this one even more so for obvious reasons. Trying to ascertain what is really going on or what is most likely to happen next has become even more challenging due to the continued reverberations of the pandemic. Many long-standing relationships have been tested or even negated. Just look at the yield curve, which was all the talk a few years ago and now few pay it much mind. Has that relationship of an inverted 3-month/10-year yield stopped working as a precursor for a recession? We are seeing rising U.S. economic activity as the inversion is now a record at 19 months.

Broken, slow, distorted—take your pick. Only time will tell. Or how about fiscal spending, with the U.S. running its largest deficit outside war/pandemic/recession periods? Unemployment is near record lows. Is this really the time for aggressive fiscal spending/stimulus? Oh, and the monetary policy of raised rates is trying to fight inflation. If you want to lower inflation, fiscal spending levels are clearly counterproductive.

Perhaps one of the longer macro factors that can do much to explain everything for the economy and markets is money. Little eco101. Normally the money supply and the economy expand at roughly the same pace, with minor divergences. The money supply ballooned to combat the impact of the pandemic. There’s no question that that was the correct response. But when you create a bunch of new money much faster than the economy requires, well, weird stuff happens. More money than required results in an increase in savings. Add to this an economy that slows due to shutdowns and people unable to spend on things like travel and fancy restaurants, and well, that savings spike even faster.

As the economy and personal mobility return, all that money flows into an economy. Add lingering shortages, and presto, here comes inflation. Price inflation sucks; everyone complains about it, but have you noticed many people changing their behaviours? That trip to the South of France costs too much… still going, though. That is because there is too much money.

This didn’t just cause price inflation, more money leads to asset price inflation as well. That has helped stocks and real estate rise. But something is nearing inflection. Firstly, the saving rate has been falling fast, probably because price inflation is eating into disposable income and the first behaviour that suffers is savings.

Or on a more macro level, the gap between the amount of money out there and the economy is narrowing. It was that gap that fed inflation, both price and asset price inflation. When that gap closes, well, it sure isn’t good news for prices. And that gap is closing pretty fast.

Then there is what we will call the echo in global trade. As we have pointed out, there is good news on the global trade front; it appears to be improving. Exports from Korea and Taiwan, historically early leaders in changes in the direction of global trade volumes, have been rising. Global manufacturing has been improving. So, the question is whether this is the start of a new healthy trend or is it an echo caused by some of the previous pandemic-induced gyrations?

When the pandemic hit, we all had way too much money and couldn’t spend it on fun travel/eating, so everyone bought stuff. Cars, home renovations for that walk-in wine cellar, then some wine, new TVs, etc. Add logistic and supply chain bottlenecks, and we kind of blew things up with this changed behaviour. As supply gradually caught up with demand, the global economy enjoyed the best of times, factories humming, ships full of stuff on their way to consumers. Evidence of this can be seen in global container volumes dropping in the 1st half of 2020, then increasing well above trend in 2021.

We all know how this story unfolded. Once mobility returned, revenge travel became the rage and people slowed down buying stuff. Cars, TVs, renovations had all finally been done or the latest version purchased so as we pivoted our behaviours and global trade fell back down. Planes and restaurants filled up, and inflation took off. During this period, our team debated whether this drop in trade and manufacturing activity could cause everyone to ring the recession warning bell while it was just another pandemic pivot of behaviour. In hindsight it does look like that was the case.

Now we see trade and activity turning back up, and everyone is convinced that global economic growth is on its way back up. Maybe. Or this move up is just another pandemic reverberation. As revenge travel fades and normal spending returns, it could easily look like growth given trade/manufacturing has fallen so low… the echo.

Dividend divergence

Higher yields in the bond market have weighed very heavily on dividend-paying equities; after all, bonds are a clear competing investment for investors looking for income, and those bonds pay more now than before. This weakness in the dividend space has created a potential opportunity given valuations and rather juicy dividend yields (before or after tax). However, higher yields, inflation, and growth gyrations have increased performance dispersion in the dividend space. We believe a more active or rotational approach to dividend investing has become more optimal. But first a bedtime story.

You hear the word Goldilocks a lot at present. It’s the phrase used to explain the perfect environment, when markets just go up with no solid reason, except for everything is “not too hot, not too cold, but just right.” We all remember the fairy tale. A girl wanders through the forest and into a bear house. She’s rather picky but tries all the food, the chairs and the beds looking for one that is ‘just right.’ The tale has been around for at least two centuries. The traditional story concludes with Goldilocks running away from the bears' house after they discover her sleeping in Baby Bear's bed. Goldilocks was a fussy home invader who would very likely meet her demise in the shadow of the bears' wrath. In the true-to-life version, her actions lead her into a very serious situation. In every perfect Goldilocks environment, the situation can change in an instant when the bears return home and discover that someone has eaten their dinner.

In 2024, inflation is the big bad bear coming back home. Its steady easing has halted, even reversed somewhat, and this has reduced the odds and timing of global central banks cutting rates. Bond yields have risen considerably, approaching their 2023 highs. The current level of Canadian and U.S. bond yields is not crippling high but high enough for investors to reevaluate their options and expectations. The buy-anything period is likely over, at least for now, and markets are entering a more volatile period; perhaps by circumstance, the timing also aligns with weaker seasonality. While the round trip of rate expectations has

only recently impacted broader equity markets, the dividend space has been feeling the impact of higher bond yields for some time. Higher for longer, brings with it a unique set of risks to the dividend space. This has made the dividend space more challenging, and we believe increases the need for a more active management approach.

The dividend factor (aka dividend stocks) has lagged other factors all year. While unfortunate, this has also created a bit of an opportunity. There are now many companies carrying dividend yields of 6% or 7%, that are pretty safe dividends. The challenge has become not just whether to add to dividend strategies, but how. Divergence in performance within the dividend space has increased, which means it's no longer best just to add anything with a yield to a portfolio. Not all yields are created equal, and the winning or losing factors keep changing.

We believe the more flexible approach, or a more active management approach, can better adapt to these changing market conditions. Especially compared to a more passive or index-hugging strategy.

Index misallocations – Let’s face it: The TSX is concentrated on Financials and Energy. Passive funds screening on yield amplifies the concentration risks. One of the more popular dividend ETFs has 56% of the fund allocated to Financials. These misallocations expose investors to higher sector-specific risks. Active management done right improves diversification and can reduce this concentration risk.

Dispersion – Active managers are particularly challenged in periods when dispersion is low and market leadership comes from extremely large stocks. When all the dividend stocks move together, who cares how you get exposure? But when the performance dispersion is high among dividend stocks, it matters how you are exposed. Dispersion across the dividend space is quite high and variability among dividend strategies in Canada is also on the rise. In the chart below, we look back at the Dow Jones Canada Select Dividend universe and plot the monthly return difference between the 25th and 75th percentile. Outside of the crisis

period in 2020, the average dispersion this year is near the highs.

Volatile periods – Higher rates tend to increase volatility. Passive indexing tends to struggle when markets get choppy, whereas active managers can be nimble. Raise cash or actively increase company exposure to more defensive sectors. This proactive approach allows managers to manage risks, especially when it’s that most rate-sensitive sectors that are under pressure.

Unusual macro forces – Higher rates create market tension, especially for high-duration assets and highly leveraged companies. Active managers can identify and avoid companies that may have a high dividend yield but are vulnerable to rising borrowing costs. When rates are high, market inefficiencies tend to arise.

Canadians love dividends, but most active funds aren’t very active

There are dozens of dividend and income-focused funds and ETFs in Canada. Within the Morningstar Canadian Dividend and Income Equity category, there is no shortage of options. Among them are the bank-owned behemoths, with the top four funds managing over $50 billion dollars. When dissecting the universe an important metric to look at is the active share, which establishes the percentage of holdings that differ from the benchmark index. A portfolio with an active share between 20% and

60% is considered a closet indexer. Among these behemoths, the active share is as low as 35%, and the highest is just 53%. The category average active share for funds over $200 million is just 50%. In effect, the category is rife with closet indexers, as seen in the chart below. Most ‘active’ managers tend to look very much like the index. Liquidity also plays a part. The bigger the fund, the more difficult it is to look very different than the index, but that’s not the only reason. Career risk for portfolio managers is also a consideration. Our view is that it’s impossible to beat the market if you look like the market. Managers must strive to earn the fee they charge. For example, the Purpose Core Equity Income fund has an active share of 72%, the third highest in the category, along with a strong performance record.

Digging deeper, in the chart below we have the sector allocations across the category. The vertical bars represent the range from maximum to minimum allocation for the sector, with the category average as well as the sector weight of the Purpose Core Equity Income Fund. By and large, most sectors have a somewhat limited exposure range, with the real major differences coming largely from the Energy and Financial sectors. These two sectors are where active managers can make a meaningful distinction from both the index as well as peers.

Building a sustainable and high-performing dividend portfolio in Canada requires a keen eye and strategic selection. Active management empowers managers to go beyond the limitations of passive indexing, seeking out hidden gems, prioritizing quality over just high yields, and adapting to changing market conditions. Canadian dividend-paying companies make up the core of many advisor models and investor portfolios. Passive strategies play a key role in building robust portfolios to help reduce costs and provide broad market beta, but active management best suits the dividend-focused core, especially in present market conditions.

Final thoughts

There is lots of good and bad news these days. Challenges are this pesky inflation, stubborn earnings growth, valuations, and still lingering impacts of pandemic-induced behavioural changes. On the good side, there are some pockets of really attractive valuations, such as in the dividend space, an economy that appears to be gaining a bit of momentum that could help address the lack of earnings revisions. While our fear of a recession has diminished over the past few months, the risk of a price correction remains elevated. It has been a good start to the year, and very likely many twists and turns remain.

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

Earnings Optimism

Mon, 29 Apr 2024 19:00:10 GMT

Earnings Optimism

There are three things you should rarely ever bet against: the Leaf’s opposing team in the playoffs, the American consumer’s ability to spend, and corporate profits. As we are now about halfway through U.S. earnings season, once again, positive surprises remain the norm; 81% have beaten. It's a bit better than the 20-year average of 75%. The fact is that companies are good at

managing analysts’ expectations. At least enough to beat them when the numbers hit the tape. The size of the positive surprises have been encouraging as well, at just under 10%. The highest surprise magnitude in some time.

One of our reservations on the sustainability of this market rally over the past couple of quarters has been the flat earnings revisions. In other words, global markets are up over 20% but earnings estimates have remained flat or tilted down slightly. More often than not, markets trend in the same direction as earnings revisions. Earnings get revised up when companies raise guidance

and/or analysts become more encouraged about growth prospects. That is a good thing for markets. Obviously, downward revisions are bad. Yet estimates have remained very flat as markets marched higher, a challenging combination.

Of course, the reason earnings matter so much is they are everything in the longer term. Sure, the market can move up a lot or down a lot as the optimism or pessimism about the future waxes and wanes. But all this tends to average out, leaving earnings growth as the real driver of market performance. We have used the chart below a few times over the years, but it really does highlight where market returns come from. In any single year, the red bar dominates as fear/greed causes the market multiple to rise or fall. Yet once you look at 10 or 20-year periods, the red bar disappears as it is all about earnings growth (yellow bar), plus some dividends.

Given the importance of earnings, a good earnings season is a welcome boost to markets. The question is whether this good season will translate into rising revisions for forward estimates. So far, it has not. Global earnings from the earlier chart show 2024 still trending ever so slightly lower and 2025 more stable to ever so slightly higher. Looking at just the U.S. market, it is rather similar. 2024 earnings are forecast at $243, the same number as of January 1st. 2025 looks a bit better, with consensus estimates of $270 rising to $275 so far this year.

Digging down to the sector level, it seems just a couple of sectors, including Energy, Info Tech, and Communication Services, are lifting the overall market earnings. Energy makes sense as commodity prices have been trending higher, tech too, given the excitement spending around AI. Communication Services is an odd one on the surface but is mainly Alphabet. Traditional telcos are seeing estimates fall.

So where do earnings go next? There are some decent headwinds for U.S. earnings. One is a higher U.S. dollar, running a bit higher than last year. Given the amount of earnings that come from overseas, once translated back to USD, a strong dollar is a negative. The bigger drag may be interest expense. Last quarter, S&P 500 companies paid $68 billion in interest expenses, which is up from $59 billion a year ago. Variable interest obligations have already adjusted to the higher rate world, but the fixed-term obligations will only reset once they mature. In other words, even if yields/rates start to come down later this year, interest expenses will likely keep rising for many quarters to come.

Wages and other corporate input costs are also a negative for future earnings. On a positive note, wage pressures have been trending lower. The Atlanta Fed Wage Growth Tracker peaked at 6% in 2022 but has been steadily falling for over a year down to 4.7%. That is not bad, considering that historical norms were in the 34% range.

Despite these headwinds, there are some very positive factors as well. U.S. earnings tend to be highly correlated to manufacturing activity. S&P 500 year-over-year earnings growth tracks PMI (Purchasing Managers survey) with a six -month lead. Which means the uptick in PMI data we are seeing today bodes well for earnings growth in the coming months.

The economic data, globally, has been improving. This should result in further earnings growth and upward earnings revisions. The Citigroup economic surprise index for the world has been positive for most of 2024 so far. This means that economic data is coming in better than consensus estimates. And if you ask copper, with its honorary PhD in economics, maybe things are even heating up more so. Given how many areas of economic activity consume copper, its price moves are often a precursor for the move in the economy. Copper prices have recently risen through $4/lb, a level not seen since 2021/early 2022 as the economy emerged from the pandemic.

The final good news may be inflation. Inflation sucks; it is a tax on your future spending power or the value of your wealth. But for earnings, inflation is good. It means companies are able to raise prices, and when Producer Prices (PPI) are rising slower than Consumer Prices (CPI), that is an earnings-healthy combination.

Final Thoughts

Earnings probably have more going for them than against them these days, which is a good news story. Hard to say if it will be enough to maintain the gains of the past few quarters, but it certainly would be helpful. The U.S. earnings season is halfway through the Q1 season and it has been good. Hopefully this trend persists. And, hopefully, the Leaf’s playoff trend doesn’t.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

Energy Stars Align

Mon, 22 Apr 2024 16:44:52 GMT

Energy Stars Align

The oil market has been interesting lately and, to the surprise of many, has been the biggest silent outperformer this year. There is no shortage of geopolitical events to choose from that’s leading to a higher risk premium in oil with Brent breaking $90, whether it’s the Houthis missile attacks in the Red Sea leading to a massive re-route of trade, Ukraine’s drone strikes on Russian refineries, and the latest escalation between Israel and Iran leading to some news outlets using WWIII as click bait-y headlines. Given the run-up in oil prices, Canadian oil equities have clearly benefitted from the much higher torque. But there is a layer of even better news: The Transmountain Expansion (TMX) continues to look to be in operation by May, which would lead to much better pricing on the Western Canadian Select (WCS). With the current setup for the oil markets, some key questions that we often get from investors are: How sustainable is the rally in Canadian energy names?

To determine if the oil equities are overstretched, we can look at the debt adjusted cash flow (DACF) multiples of the major integrated oil names and see how the valuation has shifted in light of the recent oil move. From Exhibit 1, the DACF multiples for the Canadian integrated have been fairly range-bound over the last year, also in line with WTI, which has been in the $70 - $85 range. As a starting point, we can infer that the valuations of the companies have been commensurate with the movements in the

underlying oil price deck and in line with where the equities should trade in the cycle historically over the last couple of years. Typically, in the commodities cycle, higher prices are usually coupled with lower multiples as market participants will usually price in lower normalized prices and vice versa, so a cause of concern would be if valuation starts trending towards the 6.5x

– 7.0x+ area if oil prices continue to stay in the upper bounds of the $70 - $90 range or higher.

To gauge the broader valuation in the Canadian energy space further, we looked at the valuation of larger-cap integrated oils versus the intermediates and juniors. Interestingly, the valuation gap between the intermediate producers versus the large caps has widened since the 2021 lows. The valuation gap for junior producers is even more pronounced, with multiples virtually unchanged over the last few years, and the valuation spread to larger caps is the widest it has been in 25 years, excluding the COVID-19 years, as shown in Exhibit 2. We speculate the main reason for this valuation gap is due to many institutional investors divesting their oil & gas investments during COVID-19 in chasing clean energy/ESG names, so oil & gas specialists either were

repurposed to other sectors or left the industry altogether.

Fast forward to 2022, when the energy crisis was already happening even before the Russian invasion of Ukraine, and now we’re seeing a rush from investors to get back into the space as it becomes harder to justify to your constituents why you’re underweight energy. Given the need to get back into the space quickly, we can see the path of least resistance from many funds to simply buy into more liquid, larger cap names to capture the beta. As the saying goes, no one gets fired for buying Microsoft. The same is probably now true for Canadian Natural Resources or Tourmaline in the energy space. The key takeaway is while we think larger cap oil equities will likely be steady as she goes, given the numerous tailwinds in macro, we think investors will get

paid with asymmetric risk-reward if they do the work on some of the intermediate and junior names in the space.

Some have questioned whether the valuation gap between Canadian E&Ps and US E&Ps will tighten over time as we’ve seen a structural discount since pre-COVID. We certainly think there is a case to be made here given the impending commercial operation of the Transmountain Expansion pipeline, which will significantly increase the egress of Canadian oil, a pain point for many years that’s self-inflicted by Canadian politics. Improving egress means better pricing of WCS on the world stage, and lower volatility as a function of WTI price means investors will underwrite higher valuation multiples. Canada’s oil reserves, on a proven and probable basis, span decades. Sustaining capital expenditure to maintain an oil sands project is significantly lower than U.S. shale, where you’re on a constant treadmill to find new acreage and drill high-decline wells.

Despite all this, we don’t think Canadian E&Ps should trade at parity to U.S. E&Ps. While TMX is certainly a positive, we take stock in the fact that the pipeline will likely be full by 2027 and we end up having to ship the marginal barrels via rail once again. We will certainly see a few optimization/compression-type projects along the way that improve capacity incrementally, but only time will tell whether we will get another huge step function in Canadian egress in the coming years. TMX project was first submitted to the regulators in 2013, so it’s been a long time coming, with the latest cost overrun estimate at $30B+, or ~$800 per capita.

Final Thoughts

The bottom line for those looking at the Canadian energy space is to invest for the right reasons, and those are

step function increase in production
lower volatility from better-realized pricing of WCS
attractive (but not firesale) valuations for steady returns
outsized opportunities in the intermediates and juniors.

Betting on the direction of oil, in our view, is not amongst the top reasons to invest in Canadian energy names, and we would rather focus on a sustainable approach where we pick producers that can generate outsized returns on a full-cycle basis at reasonable valuations.

— Jeremy Lin, CFA is a Portfolio Manager at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

Value in the Canadian Dollar

Tue, 16 Apr 2024 19:34:17 GMT

Value in the Canadian dollar

The CAD vs USD exchange rate has certainly been on the move over the past few months, to the detriment of the loonie. After rising into year-end to finish 2023 at about 75 ½ cents, the CAD has fallen down close to 72 ½ cents. The CAD is trading near the lower end of its recent range. Ah, remember the days when the loonie was on par with the U.S. dollar? Disney trips felt cheap,

cross-border shopping was all the rage, and oil carried an average price of $96/bbl. Huh, with oil moving from the $70s to the high $80s, that sure doesn't match a 72 ½ cent loonie. Are we no longer a petrol currency? Maybe a decade of underinvestment and uncertainty around takeaway infrastructure can change a currency's stripes. Or there are other factors that are bigger than the oil impact on our currency exchange with the almighty dollar.

The weakness in the Canadian dollar is pretty easy to explain. U.S. inflation has ticked higher, as has the American economic data. Meanwhile, in Canada, the opposite trend is apparent. Just look at the Citigroup economic surprise indices for each country. This rolling index measures economic data releases relative to consensus forecasts, weighted based on the importance of each data release. Canada has averaged about -36, while the U.S. has been +40 so far in 2024. Not surprisingly, this has translated into a widening spread of 2-year yields, the tenor of yields most impactful on spot currency exchange rates. U.S. 2-year yields are 4.89% compared to 4.17% in Canada, roughly the widest spread over the past decade. This has also translated into expected central bank rate cuts. In January, the market consensus was pricing in a whopping seven cuts (25bps each) for the U.S. Fed Funds rate, while Canada was forecast to cut five times. Fast forward to today, they are tied at 2 ½ cuts each.

Yet flying in the face of a weaker CAD is commodity prices. While perhaps not as strong as it was historically, the CAD dollar usually does well when commodity prices are rising, and global economic growth is improving. That is clearly not the case of late, and I would even argue this is a material disconnect. The chart below is the CRB commodity index and the price of oil compared to the CAD/USD. Normally, there is a pretty decent correlation between these factors, but not lately.

One important consideration is that the recent currency move in the loonie is more about USD strength than CAD weakness. While the CAD has lost about 5% against the USD so far this year, it has been relatively flat against other major currencies, such as the yen and euro. This really points to USD strength due to higher inflation, tempering of rate cuts, and better relative economic growth data.

But at 72 ½ cents, is there value in the loonie? It is starting to look that way. There is no denying the CAD is undervalued, as highlighted in the purchasing power parity chart below. This doesn’t mean it will fix this undervaluation anytime soon; there are fast drivers of currencies (most of the previously mentioned factors), and then there are slow drivers. Valuation is a slow driver, as are deficits. Sure, everyone runs deficits; that isn’t anything new. But the U.S. has taken deficits to new levels outside a recession/war/pandemic environment. At some point, that will be a negative for the USD relative to more fiscally responsible national currencies. We’re not saying Canada is fiscally responsible, but it is on a relative basis compared to the U.S.

Final Thoughts

Currency exposure is an important component of managing multi-asset portfolios. We remain largely unhedged with our USD exposures, which has been the right call. Generally, we like being unhedged, as the USD can be a powerful diversification tool for Canadian portfolios. However, our conviction on this is waning; the further the CAD depreciates, the better the risk-return trade-off for hedging. We're not there yet, but it is starting to look rather interesting.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

Dividend Depression

Mon, 08 Apr 2024 15:47:48 GMT

Dividend Depression

Dividend investing is supposed to be easy. Find quality companies with long track records of paying or even increasing their dividends, buy some shares, collect your regular tax-advantaged payments over time and watch the share price go higher. Maybe in a strong bull market, dividend companies don’t rise as much, but they have better stability in down markets as most are lower beta than the overall market. Well, over the past year, the TSX has been up about 13% while the Dow Jones Canada Select Dividend Index (a good proxy for dividend investing) has been up 3%. Trailing in an upmarket is fine, but not by that much.

The DJ Select Dividend Index was created in the late 1990s and this is only the fifth time that it has lagged the broader TSX by more than 10% on a trailing one-year basis. Interestingly, most of the previous occurrences coincided with brief periods when a non-bank became the largest weight in the TSX. In the late 90s, it was Nortel; in 2007, it was Encana, Potash, and Blackberry. The 10% threshold was almost reached in 2015 when Valeant became the biggest company in the TSX. And in 2019, it was Shopify.

This makes this recent bout of underperformance of dividends vs the broader TSX rather unique, as the biggest stocks in the TSX remain dividend payers, including Royal Bank and TD Bank. Plus, the banks have been doing ok. It is other dividend payers that have dropped considerably that are dragging down the dividend space. Communication Services (aka Telcos) are down 24% over the past year, and Utilities are down 15%, two areas that are fertile with dividend-paying companies.

This has the valuations in the overall dividend space at roughly 10.5x forward earnings estimates, while the broader TSX is closer to 15x. That is an historically widespread. It was wider in 2020, but that is because the TSX’s earnings almost went to zero during a pandemic; it was not because of a higher index price. While dividends may be cheap vs the TSX, the real crux of the weakness stems more from relative yields. Bond yields moved higher in 2022 and have been maintaining at historically high levels compared to the past decade. This is a clear competitive investment for those looking for yield.

One could even argue that dividend yields need to increase more to remain competitive against yields available in the bond market. This isn’t an apples-to-apples comparison. Bonds benefit from greater stability as a true risk-off asset class. Dividends benefit from a history of growing the dividend rate over time and some rather appealing tax treatment. Plus, the stock price could go higher while bonds mature at 100. However, dividends can also be cut, and companies can even go bankrupt. We will assume the five-year government of Canada bond has a low default risk.

Yet, while the overall DJ Canadian Select Index dividend yield may not look overly enticing compared to bond yields (above chart), digging into specific sectors does show a different picture. The chart below shows the current dividend yield across various dividend-heavy sectors compared to the five-year government of Canada bond yields, plus the 10-year average spread and the nominal dividend yield. The overall dividend space may not be hugely enticing on a relative yield basis, but telcos and pipes sure are, each yielding about 7%.

Final Thoughts

The dividend space has clearly become rather challenging over the past year, given higher bond yields. But it isn’t just bond yields. The increased popularity of other sources of yield has certainly risen over the past number of years, from the structured notes space to covered call strategies that are being applied to just about anything with a live option chain. The search for yield has never had so many choices. So what could turn this tide and help the performance of dividend payers close that gap with the broader market? We’re not sure; maybe a broad market sell-off that cools the more aggressive risk-on behaviour. Maybe central bank rate cuts or lower bond yields. Or maybe just the realization that buying operating companies with decently safe dividends in the 5-7% range and attractive valuations offers a good risk/reward combination and a decent income stream as you wait out this dividend depression.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

Why?

Mon, 01 Apr 2024 16:56:39 GMT

Why?

Financial literacy is predicated on asking the question, “Why?” Why does this market keep moving higher? Why is inflation fading so slowly? Why are home prices high given low affordability? A stronger financial literacy or understanding likely leads to fewer investing mistakes; nobody likes mistakes. Our weekly publication often attempts to answer questions on various topics, dive into them, explain them, provide some context and share our views on what could happen next. In the past few weeks, we have talked about IPOs, gold, and inflation – hopefully improving our readers’ financial literacy and our own in the process of researching and writing.

Sometimes, the questions being asked are not macro topics such as the economy, or inflation, or upcoming elections, but more focused on portfolio construction and positioning. Why are our portfolios overweight Japanese equities? Why did we add preferred shares? Why is our credit exposure low? Why are we moderately underweight U.S. equities? To answer these questions,

we created the WHY Report, which is a monthly chart-heavy report that shares most of our current multi-asset portfolio tilts, explaining our rationale for that tilt. Most are working out well, some not so much. Even with strong financial

literacy, mistakes still happen.

With the first quarter of 2024 now in the rearview, today’s report dives into a number of portfolio tilts and sections from our monthly WHY Report. Why are we positioned the way we are? If you would like to receive the WHY Report on

a monthly basis, along with any changes to our positioning over time, there is a sign-up at the end of the report. Now, let’s jump into it.

There is very little to complain about in Q1. Bonds were down a smidge, but really only on the longer end of the curve. Add some credit, or shorter duration, and returns were roughly flat or up a bit. Hey, a boring bond market is actually kind of nice, given what we have experienced over the past few years.

All the real excitement was in the equity markets. The S&P 500 is up over 10%, an impressive feat for a mere quarter. But it wasn’t just America; Europe and Japan both rose even more during the quarter. Japan was especially notable, making a new all-time high, something not accomplished since its bubble high of 1989. Just to bring back memories, in ’89, National Lampoon’s Christmas Vacation was the top box office hit… oh, the Griswolds. Canada’s TSX was a bit of a laggard, up less than 10%.

Even more impressive is that the equity market advance is rather broad-based. The S&P 500 still has a concentration problem, with the top ten names representing 33%, levels not experienced outside the dotcom and nifty fifty bubbles. There’s perhaps even higher concentration today. Some of those megacaps certainly helped drive performance in the first quarter of 2024, including Nvidia, Microsoft, Meta and Amazon. Yet, which companies do you think were the biggest drags on Q1 performance? Apple and Tesla were the biggest detractors; it is almost as if the Mag 7 has been split.

AI remained all the rage in Q1; in fact, you would argue the separation of the Mag 7 is sort of based on those companies that appear to have an edge in AI so far compared to others. But make no mistake, this market advance was broad based and it was helped by the economic data. The U.S. economy, which had already been proving very resilient continued in a similar fashion. It was more on the global economic data front that improved in Q1.

Market Cycle

The improved economic data has been picked up in our Market Cycle framework, potentially alleviating broader near-term recession risk. The Market Cycle is comprised of over 40 indicators, all of which have historically had some efficacy in showing turning points in the economic cycle. Some signals are from the bond market, U.S. or global economic data, some from sentiment, fundamentals, etc. The view is that not ever signal works in each cycle, so we have a diversified approach with many signals.

Equally important with the total bullish signal trend is what is happening underneath. It has been a big improvement from indicators associated with the global economy that has led to the more recent improvement in signals. Global manufacturing surveys, copper prices, semiconductor price trends, commodities and emerging market price behaviour are all bullish now. These were all bearish six months ago.

This doesn’t mean the market will keep going up. The market cycle is not a market timing tool; it is more of an indicator of recession risk. If it’s healthy during a period of market weakness, it's safer to view that as a buying opportunity. Now we just need some market weakness.

Why Moderate Underweight Equity and Holding More Cash

There is no denying that we are a bit more cautiously tilted, even with improving economic data. Our analogy is that we are still at the party, just not cutting a grove on the dance floor and instead standing closer to the door. We do not believe this market advance of late has the foundation to prove resilient.

Earnings are a concern. If the economy were truly improving, why has this not translated into earnings forecasts? The chart below is global developed markets and headline consensus earnings estimates for 2024 and 2025. Earnings revisions and the market often move in tandem. Yet over the past year, we have seen market up and earnings flat, which means this is almost all multiple expansion.

We believe there are a number of headwinds for earnings growth. Higher rates and yields have a delayed impact on companies' income statements, which are starting to bite. Two years ago, S&P 500 companies paid about $50 billion in interest expenses during the quarter. In the latest quarter, that has increased to $70 billion. This is likely going to keep rising as fixed-term debt matures and is refinanced at higher rates.

Wage growth also remains elevated. The Atlanta Fed Wage Growth tracker is running at +5%, which is higher than inflation as a proxy for the company’s ability to raise prices. In fact, if inflation continue to cool, this too will be negative for earnings growth as a sign the ability to pass through higher costs is hitting some resistance.

Our other near-term concern is liquidity. The Federal Reserve is steadily reducing its balance sheet (quantitative tightening), and bank loan trends have been anemic. This should have resulted in less liquidity in Q1 had it not been for the draining of the reverse repo market. The repo market has fallen from almost $3 trillion to $750 billion over the past year, helping inject liquidity into the market. Now, there are many moving parts in these liquidity flows, but it is safe to say it has been positive for markets over the past couple of quarters. The problem is this may start to reverse in Q2 as the repo dwindles, and QT and other negative

factors will likely become more impactful.

Add this to sentiment that appears extremely bullish (often a contrarian indicator) and very quiet market volatility. Plus valuations everywhere have become rather rich. The rapid rise in prices without earnings growth has pushed valuations higher. Not just in the U.S., even markets that had been on the cheaper side have become less so.

Put all this together, it remains prudent, in our opinion, to maintain a more conservative asset allocation. Including holding some extra cash as dry powder, should we run into market weakness in Q2.

Why We’re Warming to Emerging Markets

We’ve been underweight emerging markets in our multi-asset portfolios for some time. Our reasons were simple: the risks didn’t seem worth the reward, given global growth concerns. Over the past three years, emerging markets have lost 17%, while the S&P 500 has gained 38%. It gets worse the longer you look back. The performance spread over the past decade is over 200%. Because of this, emerging market equities remain markedly under-owned while at the same time becoming attractively valued and perhaps mispriced.

The whole purpose of our WHY Report is to consistently evaluate our positions and monitor the data. This monitoring is essential to prevent status-quo bias and remain entrenched in our view. As John Maynard Keynes said, “When the facts change, I change my mind- what do you do, sir?” Well, the facts are beginning to change, and the position is worth a deep re-evaluation to consider increasing exposure to emerging markets within our multi-asset portfolios. While the past decade saw a lacklustre performance in EM compared to developed markets (DM), several factors suggest that a potential reversal is nearing.

Reasons for optimism

Central bank pivot: After a period of tightening liquidity, central banks in developed economies are nearing an inflection point, potentially shifting towards rate cuts in mid-2024. This shift from monetary tightening to easing typically benefits emerging markets. It can help stimulate global growth, and with inflation falling, financial markets are stabilizing. In addition, many emerging markets have already begun their easing cycles as inflation measures across emerging markets continue to trend lower thanks to lower commodity prices and support from currency appreciation and tighter monetary policy.

Undervaluation: Valuations in emerging markets are currently at a significant discount compared to developed markets. The valuation gap recently reached a 6-point spread, historically a good indicator of future outperformance for EM.

Earnings growth: In the coming years, emerging market companies are expected to see higher earnings growth than developed markets. While this hasn't translated to price performance yet, it suggests potential for future appreciation.

Recovering global trade: Global trade growth, which has been sluggish, is starting to show signs of improvement, particularly in export-driven economies like Korea and Taiwan. This trend is positive for emerging markets that are heavily reliant on trade. We expect the positive trend in global economic momentum to continue, although top-line U.S. GDP growth will likely moderate from its recent very strong pace. Global PMI continues to show signs of stabilization and is on the cusp of re-entering growth once

again. The key factor for capital markets will be the improving breadth of global growth, encompassing not only the three major economies of the U.S., the euro area and China but also the bulk of the emerging economies as global trade recovers.

Currency appreciation: Local currency debt should get an added boost from EM currency appreciation this year. The MSCI Emerging Market Currency Index sets the weights of each currency equal to the relevant country weight in the MSCI EM Index. It’s seen considerable appreciation recently, which historically coincides with EM outperformance, but this has not been the case recently.

There is no question that emerging markets have experienced considerable challenges recently. But the key question is whether EMs offer better growth prospects than DMs. There remain big questions surrounding the direction and magnitude of global growth, especially with key developed countries in a technical recession. By contrast, EMs have shown considerable resilience, weathering higher borrowing costs, strong USD, inflation, and worsening trade conditions.

China – The shrinking elephant in the room

From a granular standpoint, many emerging markets have done quite well, including India, Taiwan and Brazil but China has held down the index. It’s impossible to hide the elephant in the room when considering emerging market exposure. Within the MSCI EM Index, China represents 26% of the index, including Hong Kong. A considerable amount of direct exposure. Indirectly, it also carries significant influence due to its influence in Asia and its impact on global commodity markets. Back in 2020, China peaked at nearly 44% of the index; its weight has shrunken considerably since then. Conversely, India is now up to 18%; ten years ago,

it was just 7.2%. If these trends continue, India could overtake China in the EM index. This is noteworthy, considering it overtook China in terms of population a year ago.

So, what could turn China around? Unlike the U.S., Europe, and Canada, changes in China’s economic policy tend not to be communicated prior to implementation. Within Asia, Japan and Indian markets are flying, but China is the exception. Their stock market is among the weakest, and the economy remains under pressure.

Coming out of Covid, the market expected a big rebound from China that never materialized due to the imploding property market along with the crackdown on big tech. Most of the recent pressure began when the government tried to crack down on the buildup of leverage in the housing industry. The result starved developers of capital, and the reverberations continue to be felt today. Though recent announcements have tried to stimulate the economy, it’s been more of a few warning shots compared to the bazooka credit impulse we’ve seen previously from China. Simply put, government efforts to reignite the growth engine have

been insufficient, and the country, which increasingly relies on the consumer, still has very low consumer confidence.

But this is beginning to change. While the Chinese consumer may not be buying Chanel handbags or iPhones at quite the same pace, gaming revenues in Macau have rebounded nearly back to 2019 levels. This is a positive development. Good spending may still be hampered, but experiential spending is healthy. Chinese air travel has already recovered and will likely extend its growth in 2024.

Chinese growth will lag peers like India. However, it’s very cheap, approaching near historic multiple spread to developed markets and stands to potentially rapidly benefit from any shift in government policy or inflection point in consumer spending. In addition, bearishness around Chinese equities may have reached a local peak. While far from uninvestable, the climate remains challenged, especially with the prospect of Trump returning to the Oval Office. Investors have tempered pessimism on China recently. Over the past couple of months, Chinese equities have matched the S&P 500. This is a good first step, but a full-on bullish tilt remains a bold contrarian call. But, like all contrarian calls, it can pay off generously to get in before the rest of the crowd.

Portfolio thoughts

Overall, we believe the potential benefits of emerging markets are beginning to outweigh the risks. The combination of attractive valuations, improving economic fundamentals, and a potential shift in global monetary policy creates a compelling opportunity for investors seeking long-term growth.

We think China has promise and presents one of the few contrarian opportunities in global markets right now. However, for some, it is simply uninvestable. If this is the case, there are EM ex-China funds that would also be attractive. India, Taiwan, and South Korea combine for 64% of this index but are all positioned favourably to benefit from strengthening economic prospects.

How to Use the WHY Report

‘Just trust me’ isn’t good enough

Over the years, our encounters with advisors and portfolio managers have often led us down a familiar path paved with a single query: "Why?" No, it's not the existential pondering of the universe but rather a pragmatic inquiry into our portfolio construction choices. It's a fair question, really. Looking back on discussions surrounding portfolio positioning, in our minds, the rationale behind our moves was crystal clear. But should advisors take the plunge and determine if the position makes sense for them? Well, that requires a bit more than a casual conversation. Enter the “Why Report,” an amalgamation of charts, graphs, and commentary that specifically apply to the positioning of our model portfolios. Because pairing investment decisions with a

little visual aid helps clarify complex concepts and addresses skepticism. After all, who doesn't love a good chart and rationale before diving into the financial deep end?

There are numerous portfolio positioning commentaries available for managers to review, and it's important to recognize that the Why Report isn't the definitive document among them. The report does not have a specific target audience, meaning whether you agree with the portfolio tilts or not, the report can have a use case within your practice. Its purpose is to create a report that maintains consistency, allowing it to be seamlessly integrated into the investment decision-making process.

While having an investment process framework is not a new revelation in portfolio management, any process should be open to improvements along its lifecycle. Our intention is to provide an optional improvement to the maturation of the process.

While conducting research and analysis to make a portfolio decision, the Why Report can be an excellent resource for sparking portfolio ideas . Perhaps you are considering investing in US equities. After reading the rationale for our portfolios being focused on equal-weight US equities, you find yourself in agreement or disagreement, which may result in a portfolio position change. This will naturally carry over into determining your asset allocation tilts within the portfolio. Clearly, being overweight in US equities over the last decade has been the correct investment decision, but has it gone too far? The report zeroes in on our portfolio tilts, offering insights that can guide decision-making for any portfolio. If our positioning aligns with yours, the report provides additional justification for your tilt. Conversely, if our positioning differs, the report offers contrarian perspectives that can ultimately benefit the overall portfolio.

As the portfolio decision-making lifecycle progresses, it necessitates ongoing reviews and adjustments . Whether evaluating performance, reacting to shifts in the macroeconomic outlook, or making rebalancing decisions, the consistent availability of the Why Report provides a reliable resource to lean on.

The report also equips advisors and portfolio managers with visual aids and speaking points to use in conversations with clients. Not all of the content will apply to discussions or communications, perhaps none of it will, that will of course depend on the client. Also, this is not solely intended for portfolio managers. Clients are also able to benefit from this report, providing them with material to ask the right questions when it comes to how their investments are being managed by their trusted advisors.

If you are interested in improving your investment management process, we encourage you to sign up for Macro Strategy and Portfolio Construction Insights. Every month, we will provide subscribers with the Why Report (latest edition HERE ). The content will not change drastically from month to month to be consistent, but any adjustments will be well reflected, and all charts will be updated to the most recent date. Additionally, we will include our monthly update surrounding our multi-asset portfolios, which will provide an in-depth commentary on the previous month and how those portfolios are positioned. Outside of the monthly distribution, subscribers will receive trade alerts and due diligence reports on the underlying holdings. Trade alerts will be paired with an in-depth rationale to provide insights into our thought process and portfolio evaluation.

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

IPOs - Where art thou?

Mon, 25 Mar 2024 16:40:17 GMT

IPOs - where art thou?

No denying the equity markets are in the throws of a strong advance. The S&P is up 21% over the past six months, Europe is up 19%, Japan 25%. And given the even stronger gains in pockets such as AI, there is no shortage of people talking bubbles. Ourselves included (Ethos from a few weeks ago) but it isn’t a system wide bubble, more isolated mini bubbles in our opinion.

Doesn’t mean it won’t hurt at some point, yet unlikely to be overly destabilizing. Fact is, a number of key ingredients are missing to label as a major bubble. Equity flows is one as there isn’t really a rush of cash coming into the market as measured by fund & ETF flow data. And another crucial ingredient is the IPO market.

Yesterday Reddit IPOed (Initial Public Offering) with an offer size of $748 million and closed on day one at $1.25 billion. That gives the company a total value of $7.5 billion, not bad given $800 million in sales during the last 12months. IPOs doubling on the first

day of trading was a weekly occurrence in the tech bubble, yet this was anything but regular. The IPO market has remained very

quiet. In North America $5 billion of IPOs began trading so far this year, on pace for the bleak annual pace for the past two years

of $17B in 2023 and $22B in 2022. Even more anemic is Canada, with virtually no IPOs in 2024 so far.

Markets strong, lots of indices making new all-time highs, so why is the IPO market so dormant? 2021 was an investment bankers dream, fuelled by strong equity markets and lots of mini bubbles in things like clean tech, profitless tech, digital assets….the list goes on even including the non-fundamentally driven rise of Gamestop, coincidentally fuelled by the Reddit crowd. To be clear, Reddit announced its IPO in 2021 and didn’t start trading till just now.

It is not just the IPO market that is eerily quiet, mergers and acquisitions (M&A) have also been rather subdued. The normal playbook is later in a bull market, corporate leaders start getting more aggressive. And to fuel growth faster than normal organic initiatives, they turn to buying one another. Helping this process is high valuations for the buying company’s equity or easy access to credit. Perhaps we are not seeing as much M&A activity as the availability of low cost credit appears to be over, making it more expensive to lever up and buy one of your competitors. Yet no denying the valuations among many equities are at historically high levels.

Of course the question is why. There are likely a number of contributing factors to the dearth of IPO and M&A activity. As we pointed out the higher cost of capital has made it more challenging, the greater the cost of doing a deal the higher the expected rate of return must be. Strapping on more debt to buy a competitor or other business now requires a lot more expected benefit than it did when capital was cheap and plentiful.

No doubt the rise of private equity has played a part. Companies are now staying private much longer in their growth stages and using private funding sources. If the equity market environment isn’t just right, many companies may continue to opt for private funding over tapping a less receptive public market.

One of the other missing ingredients may be confidence. Chief Executive magazine has a monthly survey of CEOs asking how they would rate the economic outlook for the next year on a scale of 1 to 10. Confidence obviously falls during recession and it also fell in 2022 during the battle against inflation. And while inflation has calmed, markets have recovered and even financial conditions have returned to normal levels, CEO confidence is still on the lower side. Perhaps the uncertainty of recession risks and lingering inflation are weighing on their minds. Nonetheless, lower confidence equals less M&A and fewer IPOs. On a positive note, this confidence survey has been gradually improving.

Final Thoughts

If this were a broader bubble market environment we would be seeing a lot more corporate activities from mergers, acquisitions or tapping the public market for dollars. Yet, it also demonstrates the challenges companies are facing with the higher cost of capital due to higher yields. And given executives lack of confidence about the future, it likely encourages more of a cautious or wait-and-see attitude.

Maybe the Reddit IPO will become infections and inject some optimism for those waiting to hit the market. Or maybe the new highs of markets will help. Or stabilizing of bond yields. There is likely a lot of pent-up demand for raising capital or doing deals or going public. Another factor that may encourage an end of this IPO drought is performance of those that had the guts to IPO. The Renaissance IPO index tracks the performance of IPOs for two years. A bumpier road yet IPOs have certainly been beating the broader market. Maybe the deal drought is coming to an end.

Inflation - Not going quietly into the night

Mon, 18 Mar 2024 18:04:15 GMT

Inflation - Not going quietly into the night

The primary cause of the market declines in 2022 was inflation and the subsequent response by central banks. Rates higher, yields higher, stock prices lower… yuck. The stock market rally in 2023 was a bit more complicated but a big driver was inflation coming back down, opening the door for central banks to stop raising rates and for bond yields to stabilize. Yay. Now with 2024 well underway and the equity market up smartly, should we be concerned that inflation doesn’t seem to be going quietly into the night?

Last week, the U.S. Consumer Prices Index (CPI) data came in a bit warmer than expected by the consensus. The month-over-month change was 0.4%, both headline and core, excluding food and energy; this brought the year-over-year to tick up a b it from

3.1% to 3.2% and the core from 3.7% to 3.8%. This probably wasn’t a big deal; the equity market shrugged it off, and bond yields

moved a bit higher in response. We could argue the finer details, such as insurance moving higher or shelter, but really, it was a lack of price deflation in goods. Good prices had been falling for the past six months, helping overall inflation come down. There

was further evidence goods deflation may be waning in the Producer Prices data released later in the week. The market had more of a negative reaction to this information.

It gets a bit more challenging as well due to base effects. Given more folks pay attention to the year-over-year inflation reading, this is poised to move higher. It had been moving lower partially because, for the past six months, the monthly number being dropped from a year ago averaged 0.4% (high-ish). So, any monthly reading below this 0.4% would result in the year-over-year reading falling. However, we are about to drop a number of months that averaged much lower inflation, so future months will need to be below 0.2% to see headline CPI fall.

A resurgence of inflation, even if partially due to base effects, will likely see more folks talking up similarities with the 1970s. The 70s saw an initial move higher in inflation, which faded and then rose again. Please note I just jammed an entire decade of inflation into one sentence, which is an oversimplification. In reality, there were many twists and turns along the way. While this is certainly possible, we would point to a major policy mistake in the 1970s. The Fed started cutting rates even before inflation peaked. Of course, hindsight makes it easy to say this today. Recently, the policy mistake was to wait too long before raising rates and then to maintain a restrictive level as inflation has come down. Worth noting a recurring trend has been for the market

to keep pushing expectations of rate cuts further out.

Also, it's fair to say this just isn’t your 1970s economy. Even if inflation does pick up in the near term due to base effects, the trajectory should remain to the downside over the next year. Shipping prices have ticked higher, which feeds into goods pricing. Commodity prices have moved up recently as well. On a positive, if you look at factory pricing in China, this continues to be disinflationary. Yet most developed economies are more tilted to services than goods. U.S. CPI is broken down into 14% food, 7% energy, 19% goods and 60% services. The good news is services inflation doesn’t move around nearly as much as other components; the bad news is that it moves very slowly.

Despite goods inflation ticking up of late, investors should not read too much into this as it tends to be more volatile. More importantly, the lagged inflation components are starting to roll over. The two biggest drivers of services inflation, rents and wages, are cooling. Small business wage and price intentions are softening. This should help inflation continue to cool as 2024 progresses, albeit not in a straight line that can include some countertrend moves, like the one happening right now.

Why All This Inflation Talk?

Inflation is essentially a tax on wealth; higher inflation makes everything worth less in real terms. This includes your portfolio. Even though we believe inflation is likely going to become lower, it may flare up further downfield. Many of the factors that helped keep inflation lower or moving in a downward trend during the past couple of decades have softened. Inflation may well become a recurring risk to portfolio and financial plans. Ensuring a reasonable allocation to asset classes that can help offset will likely become a larger allocation in the years ahead. This includes equities, more on the value factor, and real asset exposures.

More importantly, for today, any variation in the path of inflation can quickly translate into bond yields. The recent CPI and PPI prints triggered the 10-year U.S. Treasury yield to move up from about 4% to 4.3%. That may not sound like a big deal, but over the past year or so, the equity market has been very sensitive to bond yields when above 4%. What does that mean? Well, when bond yields have been below 4% since the start of 2023, there has been a weak relationship between the movement in bond yields and the stock market. However, when it was over 4%, this relationship became much stronger and more reliable.

This relationship will not endure as other factors will become more impactful. For now, though, the equity market does not like yields moving higher when above 4%. The good news is that when yields fall, the equity market will potentially rejoice, as it did when yields fell from 5% at the end of October to 4% by the end of the year.

Final Thoughts

Given our current view that this recent uptick in inflation will prove to be a short-term counter trend, we don’t believe the rise in yields will persist either. And should it move further, that may create another bite at the apple to add duration. Or even add equities if it translates into equity market weakness. For now, we are not getting concerned over the uptick in inflation data.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

A Bubbly World

Mon, 04 Mar 2024 19:01:44 GMT

A Bubbly World

The history of markets is filled with examples of bubbles, creating great wealth on the way up and subsequently destroying much wealth on the way back down. Some date back centuries, such as the Mississippi Company, tulip mania, South Sea trading or the railway bubbles. Some are more recent, such as the nifty 50, dotcom, housing in the early years of this century and marijuana in the 2010s. In each instance, there was always a solid foundational case supporting the bubble because the world was changing in one way or another. Yet, in each instance, markets became over-enthusiastic and went too far, inevitably resulting in the popping of the bubble.

There are two constants investors should remember when investing in potential bubbles – markets always go too far, both up and down. And gravity exerts its force, inevitably.

In the past few years, one could argue that bubbles have become more widespread, albeit smaller in size. For instance, clean energy (ETF proxy), up 312% from the start of 2020 to the peak in early 2021, was followed by a -83% decline over the past three years. Now we have _______________ (insert whichever rapidly rising industry or sector you like). Could it be crypto (again),

Artificial Intelligence or a fat bubble (companies with drugs that combat obesity)? Of course, you can also argue that things are changing, and companies or investments positioned to benefit from those changes are simply enjoying rising future prospects. It is usually a combination of both.

Markets change over time and we would contend many of the changes in the past decade have contributed to a market more susceptible to forming bubbles. Not the same as some of those past ‘mega bubbles’ that can rock the entire market, smaller ones that don’t seem to last as long but still share similar characteristics. Below are some of the contributing ingredients or seeds that are contributing to a more fertile market for growing bubbles:

Too much money - The money supply has historically grown somewhat in line with nominal GDP. But in the 2010s, it started to grow much faster – a follow-up response to the financial crisis. This resulted in a rising savings rate as well. Both these trends exploded to the upside in 2020/2021 due to the pandemic. It was a period in which many mini bubbles inflated – crypto, disruptive tech, and even used video game retailers. The list was long.

In 2022, many of those mini bubbles deflated as money growth began to contract, central banks raising rates, etc. And also, many of those mini bubbles went too far. The gap between the economy and money supply is improving, which may be a risk to anything in bubble territory today. Yet there is still way too much money floating about, which is one of the fuels for a bubble.

Fearless investors – For investors who have only experienced markets after the 2008 financial crisis or for those with short memories, it has been a rather pleasant experience. From 2010 till 2020, declines in the equity market tended to be shallower and shorter in duration than in previous decades. Markets would drop and recover pretty quickly, encouraging the ‘buy the dip’ mantra. Then, the pandemic drop in 2020 solidified this view, as the drop may have been bigger, but the bounce back was incredible.

2022 threw some cold water on this strategy of buying any weakness, yet with markets now making new highs, the buy-the-dip mindset appears alive and well. Investors just don’t seem to be fearful anymore, which is another key ingredient for bubbles.

Less Fundamentals – Everyone probably believes the value of something is its price in the market. Apple closed at $179, making it worth $2.8 billion based on its price. Maybe. The price of any asset in the market is where the marginal seller and marginal buyer meet. If there are more motivated buyers than sellers, the price rises until the higher price entices more sellers.

Yet more and more volume is driven by passive investment vehicles that are simply transacting due to flows and give no thought to the price. Add to this trade flow momentum strategies, HFT, option book managers, etc. None of which will say Apple is worth more or less than $179. They are price acceptors, accepting whatever the price is.

Countering this group is active managers or investors, that have a view on the value of an investment and will often transact if that price gets too far away from their perceived value. They do not believe value equals price and attempt to profit from the discrepancy. The problem is over the past decade, the amount of money in price-accepting strategies has kept growing faster, and the active group has kept shrinking.

We are not saying the market pricing mechanism is broken. However, this increasing tilt has created a more fertile market for bubble formation. Price and value can become very distant from one another.

Access – One steady trend is the democratization of investment strategies. If you wanted to buy one of the nifty 50 stocks in the 1970s, you probably had to call your broker to instruct them to buy some shares of Xerox or Avon. Today, with a tap on your smartphone, you can buy shares of Nvidia, trade some bitcoin or buy an ETF that holds companies focused on cyber security.

Easier access is a sign of progress. Making things better, faster, cheaper or easier is how our economy progresses. Easier access has also made investing more fun and exciting. It has also given rise to more speculators or investors throwing a bit of money at a more speculative investment idea. Call it play money or mad money; there is a lot of it out there.

Social Media – Information travels faster than ever, which means ideas travel faster, too. The Reddit crowd lifted a near-bankrupt used video game retailer from a few hundred million market cap to over $20 billion. The company is back down to $4 billion and has been losing money since 2019. This is an extreme, but the speed at which ideas become mainstream has dramatically increased over the years.

The speed of ideas or thought dispersion across investors likely feeds quicker bubble formation than in years

past. Just look at the Google search trends for Artificial Intelligence.

Artificial intelligence is either a bubble now or becoming a bubble. Here lies the rub – bubbles are only bubbles after they burst, which clearly does little to help investors. There is lots of money to be made during inflation and lots to lose during deflation. But there is no standardization in how big they get, how long they last, or what causes them to start the descent. A bubble can occur in a narrow pocket of the market and may end without a broader recession or anything macro-oriented.

Before we dive into investment strategies for a bubblier world, let’s all just realize it is our behaviours that create these bubbles. Much about bubbles can be grounded in behaviour finance and momentum.

Biases & Bubbles

Market momentum refers to the tendency of asset prices to persist in their current trend. In essence, it's betting on the winners. While there isn’t a single individual credited with “proving” the momentum factor, it’s been widely documented by many academics across various markets for some time. This factor can be quite powerful, but it is also a double-edged sword. It contributes to the formation of bubbles, driving asset prices to levels that deviate significantly from their intrinsic values. There are many explanations behind market momentum as a factor. Some technical but most explanations rely heavily on the work of behavioural finance.

The behavioural biases behind momentum:

Anchoring and Underreaction: Tendency to overweight the importance of the first information that we learn. Social anchoring can also increase pressure toward conformity and acceptance of the status quo. It tends to anchor investor expectations to past performance, such as extrapolating past trends into the future. One way it can fuel momentum and contribute to bubbles is it causes investors to underreact to news initially, which keeps prices below fair value for too long. Once price trends do finally develop, they remain strong for some time as prices catch up to their ‘fair’ value, and often go beyond.

Confirmation Bias : Closely related to anchoring is confirmation bias. It’s the tendency to overemphasize the importance of information that reinforces our view while ignoring contradictory evidence. The bias can reinforce momentum by focusing investor attention only on information that supports the current dominant narrative, ignoring warning signs at their peril. In general, we look at price moves as representative of the future we want to see and may invest more in securities that have recently done well and less in those that have not done as well, thereby causing stocks to trend for too long.

” People can foresee the future only when it coincides with their own wishes, and the most grossly obvious facts can be ignored when they are unwelcome.” - George Orwell

Herding: Herding is a strong physiological as well as psychological bias. It’s primordial; we’re physically wired to prefer the pack, and it is associated with the release of oxytocin, reinforcing the positive feelings of trust and security. It’s far more natural as an investor to jump on the bandwagon and ride the wave with the rest of the herd, even if we see it fast approaching the rocky shore. As humans, we think in herds, go mad in herds, but only recover our own senses slowly, and one by one.

Overconfidence – This bias is simply believing your skill and ability are greater than they really are. We’re all prone to overestimate how much we understand about the world and to underestimate the role of luck. The sad reality is that overconfidence can lead to suboptimal outcomes; it is the strongest swimmers who are more likely to drown. Overconfident investors underestimate the risks associated with momentum-driven markets, leading them to engage in excessive buying without fully considering the fundamentals, which contributes to bubble formation.

Not only that, but overconfidence also triggers other biases, such as hindsight bias as well as self-attribution bias. In a raging bull market, it is easy to attribute success to skill, causing investors to buy more, which only pushes prices higher.

Disposition Effect: Investors tend to sell winners too early in order to lock in gains while holding onto losers too long in the hope they will make back what they lost. It also brings in ideas around prospect theory and mental accounting. How often have you heard that it is only a loss if it is realized? When negative news hits, investors can be reluctant to sell stocks that have had a strong run. This action delays the price discovery prices, which contributes to the momentum effect and continuation of bubbles until investors react all at once.

Besides the behavioural factors behind momentum, there are also a number of structural factors as well. These include liquidity constraints, transaction costs and a delay in adjustment to new information that leads to trends. Investors with different time horizons react to news and events at their own pace. The staggered approach can supply enough sustained buying and selling pressure to begin the feedback loops that the behavioural biases thrive on.

Reflexive Bubbles

For anyone who has read Soros, this theory should sound familiar. Positive feedback between prices, expectations and economic fundamentals prevents economic equilibrium. At its core, the theory of reflexivity offers a unique perspective on how stock market bubbles can develop. In an efficient market, bubbles wouldn’t exist. The Theory of Reflexivity focuses on the interactions between market participants' perceptions and reality. Here's a simplistic graphic on how it applies:

The key is the important role psychology and investor sentiment play in market movements. Bubbles are not just about irrational exuberance but also about the self-fulfilling nature of strong market narratives. By understanding the interplay between perception and reality, investors can be more mindful of the risks associated with bubbles and make informed decisions. Investing is hard. It might seem easy during a bubble, and the allure of easy money is strong but investors should remain diligent to avoid the eventual pop.

Investing in a Bubblier World

If we are living in a world more prone to bubbles (or mini bubbles), should our investment process change? And how do you make money from bubbles while protecting yourself from a bubble’s downside? We believe there are a few components that are crucial for success:

Early bubble identification
Prudent exposure – sizing
Rules

Early bubble identification – This is more challenging than you would think. There is a lot of content about how the future of society might look, and some of this is really well-founded. No doubt AI has taken off; what about nuclear fusion or quantum computing? You never know when the market is going to start getting excited about the next one. Or, in other words, when will a theme or idea start going mainstream, which is a prerequisite of a bubble?

One option is to do a ton of reading and research about future trends and become a futurist of sorts. And then place small exposures on many ideas. Call it diversification across ideas. Another option is to use momentum. You won’t be in before the bubble starts to inflate, yet price appreciation may identify a bubble early enough to hop on board. There will be false starts with using momentum, but much less reading is required.

Prudent exposure – sizing – If it goes up 50% in a year, it can just as easily go down 50% in a year. This is higher risk investing, which requires risk controls. One effective approach is sizing relative to an overall portfolio. Essentially, not risking too much. And while invested, revisiting the size or rebalancing can address portfolio drift risk.

In the very early days, sizing could be smaller. As a bubble continues to go mainstream, increasing and as the position becomes a size risk in a portfolio, begin harvesting.

Rules - The difference between a strong bull market and a bubble is not always clear at the moment. Only in hindsight does the bubble stand out. Feelings of regret are plenty. Regret of selling too early, or not selling all. In this aim, investors ideally ride the bubble all the way to the momentum battleground. It’s the area where market momentum encounters resistance either from investors employing contrarian strategies or simply from the gravity imposed by the dislocation of underlying economic realities and valuations. The battleground is where the tug of war begins and where astute investors can read the signs and see the tide of sobering rationality ahead.

There is no simple rule to put in place rather rules-based strategies using the power of trends, market technical and our behavioural biases can all add sell discipline and help provide an exit strategy. By taking profits when momentum begins to stall or sentiment begins to swing. Investors with a nuanced understanding of momentum, market psychology, risk appetite and the fundamentals can increase their chances of adeptly manoeuvring around the battleground. Some of the more useful strategies include:

Trailing stop-loss orders – Simple trailing stop-loss orders or selling targets based on deviation from recent highs can help lock in profits and limit losses as momentum wanes. Moving the stop-loss orders as prices move higher helps to mitigate the risk of holding onto a stock for too long during a bubble.

Contrarian Signals: Investors can incorporate contrarian indicators or sentiment measures to find potential turning points in market trends. By monitoring sentiment indicators for signs of excessive optimism or pessimism, investors can add sell discipline by exiting positions when sentiment reaches extreme levels, potentially signalling the peak of a bubble.

Technical indicators: These can be a useful way to measure trend strength and identify breakdowns, such as moving averages, volatility bands or relative strength.

Rebalance Discipline: The KISS principle stands for "Keep It Simple, Stupid." It is a widely recognized principle that suggests

simplicity and clarity should be always prioritized. Managing risk in an investment bubble doesn’t have to be complex. One of the simplest ways investors can manage risk is simply to rebalance. Portfolio rebalancing isn’t sexy, it doesn’t attempt to time the market, but rebalancing based on predetermined criteria whether time based, or value-based, trims overvalued positions and reallocates capital to undervalued assets. It adds discipline to the investment process, and discipline is a key ingredient to building long term wealth and not chasing short term gains.

Market efficiency would argue against the existence of momentum and even bubbles. Markets can be mostly efficient, but the argument that the price is always right is absurd. When you think about efficient markets, Markowitz probably comes top of mind, but I think about Bob Barker and Adam Sandler. Bob Barker always argues the ‘Price is Right’, while Adam Sandler aka Happy Gilmour famously noted “the price is wrong $!&@#”.

The Final Word

Bubbles are fun, exciting and dangerous. They also appear to be increasingly widespread. Having a thoughtful, disciplined approach that incorporates some hard trading rules can go a long way in enjoying success in our bubbly world. It does offer the potential for strong returns. We prefer using momentum as both a buy and sell signal. True, we blame bubble creation in part on momentum trading; the key is to avoid being late. Too late to hop on board and too late to exit are the biggest risks. Momentum can provide a defence against this risk.

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Greg Taylor and Derek Benedet Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

Cash vs GICs vs Bonds

Mon, 26 Feb 2024 18:35:22 GMT

Cash vs GICs vs Bonds

So far this year, investors have piled into cash, added into bonds and sucked money out of equities. Apologies, we are going to use U.S. listed data here for convenience and because larger numbers are more fun. Based on ICI data, investors have sucked $25B out of equities, added $122 billion to cash and added $52 billion to bonds. The chart below is the rolling 4-week average

flows into bonds and equities. Equities have remained sporadic over the past few years, with brief periods of inflows and outflows. In 2023, a solid year in the market, equity outflows were $133 billion, so the trend in 2024 remains much the same. Bonds, which experienced HUGE outflows in 2022 as yields rose, have been seeing more inflows of late.

While equity flows have been negative on aggregate, it does appear it is largely broad-based U.S. exposure that is being reduced. International is up a little, and if ETF flows are any indication, technology is attracting some flows. But we are going to pivot to cash and bonds. It shouldn’t be too surprising that the inflows to cash and bonds, with the most attractive yields in many years, are a strong lure.

The flows into cash vehicles have been incredible. Even more incredible is that cash inflows have historically coincided with periods of market weakness (see 2001, 2008, and 2020 in the chart below). Yet these current inflows are more about capital being

attracted by a decent yield as opposed to capital fleeing equity markets and looking for a place to hide. More of a pull compared to a push. It is also important to differentiate where the dollars are coming from. If simply moving from a bank account that pays very little to a higher yield vehicle, it is possible that money will never move into more risk assets such as stocks or bonds. But some will, and that is one pile of cash sitting there.

Higher yields everywhere, from cash to GICs, to bonds, and even to dividend-paying equities, have created perhaps one of the most recurring questions of the past year – which is best between cash, GICs and bonds? We will tackle the dividend equities in another instalment.

Cash, GICs or Bonds?

It is not a simple question as much depends on the purpose of the capital and what happens next in these markets. For simplicity, we are going to reference High-Interest Savings Accounts for cash, and we pulled a preferred GIC offering as our proxy for GICs. Naturally, these are just estimates or approximations.

The really interesting aspect today is how similar yields have become across the three options. HISAs, even after the changing legislations (an update on that HERE), are carrying a yield between 4.5 and 5%. GICs are a bit lower, at just above the 4% level. And Bonds, which do carry lower current yields in the 3-3.5%, have a baked-in gain given most are trading at a discount to par, which brings the yield to worst up to around 4.2%. So, really, they are all kind of clustered together, offering some decent yields.

Each of the three options do offer rather different characteristics that will behave differently depending on what markets and rates do in the coming quarters or years. The table below really tries to capture some of the more pertinent characteristics of each.

It really depends on what happens next. Here are three simplistic scenarios, with who wins or loses among HISA vs GICs vs Bonds.

#1 Inflation remains sticky

While not our base case expectation, what if inflation remains sticky or even accelerates? We have just seen

U.S. CPI tick higher over the past few months. In this case, central banks are unlikely to start cutting rates

anytime soon and could even raise rates. This would also likely translate into bond yields moving higher.

HISA wins as yields remain high, and any potential rate hikes would result in more yield with a stable value.
GICs do ok, given the high rate is locked in and while they would not capture any rate hikes the quoted price of the GIC would remain stable even if yields rose.
Bonds lose as higher inflation and yields result in lower bond prices.

#2 Goldilocks

Inflation continues its path down, allowing bank rates to come down a little. However, with a still resilient economy, central banks won’t be overly aggressive in cutting rates. All three options do ok under this scenario.

GICs win, given the coupon rate is locked in at what is now a higher level than the overall market.
HISAs do ok. The bank rate cuts result in a lower yield, but since there are only a few, the yield remains healthy.
Bonds do ok. Lower inflation and bank rates likely translate into bond yields coming down a bit, adding some capital appreciation to the current yield.

#3 Slow growth or recession

Inflation fades as the global economy continues to decelerate; this results in more aggressive central bank rate cuts. The recession also leads to a material fall in bond yields.

Bonds win as lower yields lead to healthy capital appreciation. There could be some credit risk, though, depending on the type of bonds held.
GICs do ok, enjoying the locked in yield. But in this case, the stable pricing of GICs is a weakness as their price would rise given lower bond yields.
HISA lags as the current yield comes down as central banks cut rates more aggressively.

These are very simple scenarios but clearly demonstrate some of the pros and cons of each option. Yet there are some even more important considerations. If the capital is just looking for a higher rate from, say, a chequing account, just lock in with GICs or go variable with a HISA. However, if the capital is part of an overall portfolio, it’s a bit more complicated.

Bonds tend to do well when the market goes risk-off (aka equities lower) – This is the reflexive nature of bonds & equities. While it doesn’t always work, like in 2022, it does work most of the time. Bonds provide a ballast for the portfolio and often will move in the opposite direction, especially when equities are falling. HISA and GICs offer price stability but not this reflexive behaviour.

Optionality – What if equities fall 20 or 30%? The ability to rebalance during more volatile periods in the market is a very important process that adds value over time. If too much capital is locked in, this reduces the ability to rebalance. Bonds and HISAs offer optionality.

Final Thoughts

There is no right or wrong answer to the original question; in fact, much depends on the purpose of the capital and what happens next in the market. And while that may complicate the process, at least today, there are many choices and options to find yield. A few years ago the demand for cash, GICs and even bonds was far less than today. It's nice to have choices.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax

advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

Nobody Controls Risk in an Index

Tue, 20 Feb 2024 20:20:28 GMT

Nobody Controls Risk in an Index

There has been much chatter over the past couple of weeks about the rise of passive investing distorting the market, increased concentration and resulting in less price discovery – I would certainly encourage folks to listen to the Masters in Business February 8 podcast with David Einhorn with the caveat that his views are certainly at one end of the spectrum, albeit with some rather

compelling points. The steady redemptions over the years from active managers and reallocation to passive have created more steady selling pressure in strategies that focus on value or fundamentals. Meanwhile, increased flows to passive are resulting in more of a momentum trade. Passive index strategies never met a PE ratio they didn’t like.

We don’t believe this has broken the market but would certainly concede it has made markets a lot more risky. You have likely read reports highlighting the concentration risk in the S&P 500, driven by the Magnificent 7 (or whichever moniker they are going by today). Today, these few names comprise about 30% of the largest equity market in the world. And over the past year, with the S&P 500 up 18.6%, 9.1% of this rise is attributed to those 7 names. Safe to say the S&P 500 is rather concentrated, and leadership is rather narrow.

In fact, this concentration, coupled with US equity market outperformance over the past decade, has really distorted even the global equity markets. If someone were to buy a capitalization-weighted index capturing all equities traded in developed markets, that does sound like it would be well diversified. Sadly no. The Bloomberg Developed Market index currently carries a 70% in US equities. Clearly, my old rule of thumb that global markets were 50-55% US, 30% Europe, and the rest spread out is antiquated.

Equally incredible – Nvidia is now roughly the same weight as Canada. Microsoft and Apple are roughly the same weight as all of Asia. This naturally leads to thinking this is tech bubble 2.0, referring to tech bubble 1.0 as the 1990s internet bubble. Concentration is similar, the US equity weight globally was also similar and performance being driven by a narrow handful of names is similar. However, the 1990s was dominated by telecom equipment names, the builders of the internet backbone. This was much more narrow than today. Simplifying each company’s many business lines, Apple is a device maker, Microsoft is software/cloud, Nvidia is a semiconductor maker, Amazon is a fulfillment/cloud company, while Google and Meta sell digital ads. It is a more diverse business than the 90s tech bubble leaders.

And let’s not forget, these companies have earnings, material earnings at that. Across the Mag 7, they have trailing pretax income of over $400 billion. That is a far cry from valuations in the late 1990s when new valuation metrics such as price to eyeballs were being bantered around given a lack of actual earnings.

In fact, today’s market probably has more similarities to the nifty 50 than the 1990s tech bubble. For those not familiar, the nifty 50 was a bubble in high-growth stocks that ran from the late 1960s to the early 1970s. It was a decade led by growth over value (similar to today), and the growth names became dominant in the index as they grew faster over time (again, similar to today). The names in the nifty 50 were pretty diverse, including General Electric, IBM, Coca-Cola, Xerox and, of course, Avon Products & Polaroid.

The nifty 50 were called one-way stocks; you just had to own them, and valuations didn’t matter. Furthermore, portfolio managers had to own them to keep up with the index. Sound familiar? Today, there are more and more managers altering their strategies to incorporate some Nvidia or Amazon, simply trying to keep up with the index. And there is a cohort that believes these companies are recession-proof, given their handling of the 2020 pandemic-induced recession and strong balance sheets. We believe that view is misguided, and the pandemic recession was a unique confluence of events that hopefully won’t happen again during our investment lives.

So what ended the fifty 50 era? Two things: inflation and a recession. This combination dispelled investor’s view that these companies had such great prospects they had become immune to the business cycle. Given the high concentrated weight in the index of those growth names, it led to a seven-year drought without the index making a new high. Rather similar to the drought of new highs following the tech bubble of the late 1990s.

We like both active and passive strategies, really depending on the market and the desired exposure. Still, it’s imperative to know the underlying exposures in both active and passive strategies. Most passive strategies, often in ETF form, are tracking market capitalization-weighted indices. That means whatever trades on the market or sits in that index carries a weight, given the size of the company. There is no committee that says the S&P 500 has too much technology (29%) or too little energy (4%). Or for the TSX with 31% financials and 0.3% health care. Nobody controls the risk in an index, which is why it remains important to understand the exposures and how they combine with the rest of a portfolio. Hence, if you want more international exposure,

the World Index is not the answer.

Final Thoughts

This does have the characteristics of a bubble. The unknown is whether it has a few years to go before peaking, or a few months or only days. One could easily argue that the nifty 50 and tech bubble ended simply because they went too far. Expectations had become so high that any stumble would have a significant blowback on the share prices. Recession simply causes more companies to stumble around at the same time, even if in different industries. Whenever it does end, there is likely going to be a long hangover.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

American Exceptionalism

Mon, 12 Feb 2024 21:23:05 GMT

American Exceptionalism

Over the past month or so, the economic data from America has certainly turned up somewhat. A strong Q4 GDP print of 3.1%, two back-to-back months of 300k+ job gains, and even manufacturing activity has ticked higher. So, where is this recession that has been the talk of the town for the past year or even longer? It appears to be almost everywhere else. Maybe not outright

recession, but certainly weakness. The latest GDP readings are negative in the UK, Canada, Germany and Japan, leaving only two of the G7 members with positive economic growth.

Much of this divergence can be explained by two factors: economic sensitivity to interest rates and global trade. Countries that are more sensitive to rates and global trade are doing worse; those less exposed are doing better.

As we all know, rates/yields have moved substantially higher over the past couple of years, yet that impacts different parts of the economy differently. Based on different economic compositions from one country to the next, rate changes can hurt more

or less. The U.S., for instance, is less sensitive to rates given the structure of their mortgage market. Dominated by 30-year fixed mortgages, changes in rates don’t impact consumers’ mortgage payments as much. It is estimated the U.S. has less

than 10% of mortgages set to variable rates, compared to 30% in Canada. Furthermore, fixed mortgages in Canada max out at 5 years, meaning the resetting of higher payments is increasingly being felt as mortgages are renewed.

While encouraged, our view on manufacturing is tempered. Manufacturing activity exploded during the pandemic as we all wanted more goods. As the pandemic diminished, consumers returned to more normal spending patterns. So, that spike in 2021/22 was followed by a dearth in 2023. Global spending growth does appear to be slowing, likely a result of higher rates.

Wait for it, but we could be getting close to a period when good economic news stops being suitable for markets. This incredible run over the past three months has seen the S&P 500 rise 14 of the past 15 weeks – a feat not repeated since the early 1970s. The initial rise was from an oversold market that started celebrating more evidence that inflation was coming down, opening the door for rate cuts this year. This traversed from inflation optimism to optimism about U.S. economic strength. Unfortunately, strong economic growth does not give with rate cuts nor with inflation making a speedy decline down to the magic 2% realm.

Final Thoughts

The U.S. is the biggest economy in the world, and its equity market now carries about a 70% weight in the MSCI World Index. Yes, if you buy a passive cap-weighted global equity ETF, it's really just the S&P 500 plus some odds and sods. The U.S. economy could certainly remain immune to slowing growth elsewhere. Maybe the stock market can keep climbing with earnings growth slowing. However, the biggest constant for both markets and economies is often reversion to the mean. And both are well above their means at the moment.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

Conflicting Forces

Mon, 05 Feb 2024 21:04:13 GMT

Conflicting Forces

In the heart of every market lies a fierce clash between bulls and bears, where optimism battles pessimism and greed contends with fear. Buyers and sellers engage, and their sheer will is one of the most important factors driving the markets. The market itself is a complex ecosystem with many players, but at the end of the day, it’s fear vs greed that is a fundamental aspect of market dynamics. For every transaction, there is a buyer and a seller. The bulls are greedy and optimistic about the future growth outlook. The only reason they are buyers is that they expect to sell at a higher price. In contrast, the bears are a dour bunch. They’d rather sell now and get back in at a cheaper price.

This battle reflects the constant struggle between optimism and pessimism. As investors, we all know it well. Driving these emotional swings are market fundamentals, economic indicators, and geopolitical events, just to name a few. It's an essential aspect of price discovery, but drives volatility and creates opportunities for investors. At any point in time, there will always be

conflicting signals, either pushing markets higher or pulling them lower. Table 1 below summarizes just a few of these conflicting forces.

The dynamics of these forces, and which one is perceived as stronger, often create contrarian opportunities for investors. When market sentiment becomes excessively bullish or bearish, it may present opportunities to take the opposite stance and capitalize on potential market reversals. Embracing and effectively navigating conflicting signals can enhance investors' ability to achieve their financial goals in an ever-changing market environment. Unfortunately, reading the tea leaves is often more of an art than a science.

A clean slate

A week ago, the S&P 500 cracked through to a fresh record high. It took a total of 513 trading days to make the round trip. 195 days for the market to fall 25.4% and bottom on October 12th, 2022, and 318 days to claw its way back to the previous high water

mark struck just over two years ago. It then went on to set several higher highs in January. Despite the conflicting forces, the market has continued to run like a juggernaut. The historical precedents are promising. Forward returns are pretty decent on average after striking an all-time high, especially following such a long period between highs. Usually, once a new level has been hit, markets tend to cling to it. For those with cash on the sidelines waiting for a decent pullback, patience has not been a very profitable virtue. So, what do we expect next year:

The S&P/TSX Composite continues to lag but is a mere 4% away from its previous high set in early 2022. The NASDAQ, which continues to get most of the attention, rightfully so, thanks to its 53% rise from the depths of the 2022 selloff, is just 3% from its highs. Large-cap is winning over small once again; the Russell 2000 is still 20% below its 2021 peak. It would seem that there is a party in the market, but not everyone is invited.

Even the most ardent optimists have reason to be twitchy. Year-to-date attribution for the S&P 500 is quite thin and top-heavy. Most, if not all, of the heavy lifting is thanks to big names such as Nvidia, Microsoft, and Meta. The Magnificent 7 is getting culled, with members getting kicked out of the saloon. Tesla is down 26% YTD, Apple is negative and so is Alphabet following earnings.

The narrow breadth of a top-heavy market is not necessarily a problem. It is certainly not a brand-new phenomenon. But it does pose several challenges. We’re seeing concentration risk in action, and investors should be keenly aware of how quickly the positive tone can unravel.

Doves flying the coop

At the close of 2023, bond yields eased, and equities had a broad-based rally. The overwhelming narrative is that peak rates are in the rearview mirror, and markets were looking forward to a cut. It still seems like markets got a little ahead of themselves with this excitement. We’re in the plateau period of a rate hiking cycle. The plateau can continue for some time and is usually when previous hikes catch up to the economy and wallets of consumers.

Currently, there is a 66% chance of a rate cut in May and an 87% chance in June. The market is in the process of severely dialling back and delaying the cut timeline. It’s changing by the day. At the beginning of the year, the market was pricing in an 84% chance of the first cut happening in March. The odds of a cut in March have been all but eliminated by the market. It was trending in that direction, but Powell’s post-FOMC conference all but eliminated that chance. The first cut will likely be in June. The chart below shows the doves taking hold of the market from October to December but losing control at the turn of the year, with

rate-cut expectations being pushed further ahead.

Investors and analysts have been obsessed with guessing when and how many times the Federal Reserve would finally cut interest rates. All the guesses and market odds were largely wrong—and will probably continue to be. That doesn’t change the fact that these expectations have great power and have the ability to move the market.

Why cut when the economy seems to be doing better than expected, even with rates at current levels? For one, inflation does not seem to be a primary concern anymore; inflation swaps have fallen to nearly 2%. Inflation expectations are markedly lower than they were over the past few years. If the Fed were to keep rates where they are, in “real” terms it effectively means policy has continued to tighten the past few months. This isn’t necessary, as inflation is moving in the right direction. Politics, of course, also enter the conversation, with it being an election year in the U.S. Not to say anything about the Fed’s credibility, but we’re sure this enters the thought process. In their own words, rates are “sufficiently restrictive,” and a few rate cuts don’t mean they are afraid of a recession; it’s simply a return to what they view as a normal policy rate or R-star. They will, of course, carefully assess incoming data, the evolving outlook, and the balance of risks.

Expectations for the Bank of Canada are similar. They will remain quite restrictive for much of this year. Following the Fed is likely, but perhaps a few months delayed if inflation pressures ease as expected. Should the economy continue to slow, the cuts would be pushed ahead. Cuts, in this instance, would not be good if it were due to signs of economic distress.

From our perspective, the greatest peril right now is the assumption of a seamless transition or perfect landing factoring into market valuations. The markets have sailed full speed ahead; however, they might not have charted the waters for anything but smooth sailing. The data decidedly remains mixed; there are green shoots and darkening clouds. Markets remain focused on the positive for now. Even the credit market has seen spreads setting new lows at the end of January. The bond market is near sanguine, with the lowest credit spreads since the last time the S&P 500 made new highs.

However, our base case still points to a probable recession in 2024. If we put our Bayesian thinking caps on, the probability of this outcome is fluid and shifts as new information becomes available. The Teflon consumer has, for now, resisted any lingering residue from higher rates to sap demand. The economy can change quickly, as we’ve seen many times in the past. Below, we delve into the current earnings season to assess trends and what they mean for investors.

Earnings – paying up for poorer quality

Paying up for poorer earnings doesn’t seem like the optimal investment strategy. Regardless, that’s what investors are doing at the moment. Valuations for the S&P 500 are quite elevated. Looking back in history, valuations have been higher a few select times. But we’re talking about the highest valuations in the last 20 years, except for the post-Covid period, where earnings were still depressed, rates were at rock bottom, and QE was flowing like Niagara Falls.

At present, just under half of members of the S&P 500 have reported quarterly results. Including all of the Mag 7, which, by and large, posted broadly strong, but not blow-out results across the board like some of the stock prices would have suggested.

At this stage in the earnings season, the overall performance of the market continues to be sub-par. 230 companies have reported 4Q results. Reported sales growth has been +3.4% and earnings +4.0%. Despite the slow growth, we continue to see positive surprises generally across the board. Price action is arguably more important than actual stated results, and despite a +7.1% aggregate earnings surprise, the average 1-day price movement is just 0.1%. Suffice it to say that, on average, the market has not been rewarding the beats, but it has been punishing those who have missed.

Eight of the eleven sectors are reporting earnings growth, led by Communication Services, Utilities, Consumer Discretionary and Technology. Energy, Materials, and Health Care are thus far reporting fairly significant earnings declines. Looking ahead, analysts are calling for earning growth of 9.6% in 2024 and a whopping 13.0% in 2025. Headline EPS estimates for 2024 are, however, trending lower, down nearly a percent over the past few months. The abrupt shift in the 3M revision a few months ago conflicts with a massive surge in stock prices to close out 2023.

Markets didn’t take well to some of the big misses, including Microsoft and Google. Add in Powell’s unclear messaging during the FOMC conference, and markets saw a sharp reversal to close out January. Though analysts remain rather optimistic, they continue to dial it back. It appears falling inflation might be good for rates but not for earnings.

Broad themes & guidance

Recession fear has receded, and mentions of the dreaded ‘R’ word have been falling for the past few quarters. Another clear trend is the lack of mentions of inflation and interest rates. We’re seeing some lingering concern regarding commercial real estate, notably from some U.S. regional banks. Pandemic darlings continue to struggle (anyone interested in buying another spin bike for their basement?). One company in particular could really use the sale. Markets were looking for confirmation of sunnier times this earnings season, but, by and large, based on the guidance changes, companies on aggregate have missed the mark.

The number of S&P 500 companies issuing negative earnings per share guidance for the first quarter outnumbered those issuing positive guidance. In the chart below, we plot the trend of higher and lower guidance revisions over the past few years. With just 18% of companies guiding higher versus 38% guiding lower,˙ the ratio is now over 2-1, the highest we’ve seen over this period.

The Silent Winner

“Is Value Investing Dead?”... “The Demise of Value Investing”... “Value investing is struggling to remain relevant.” These are all headlines from the end of the decade after an incredibly strong period for growth stocks. Many would say that investors were happily dancing on the graves of value stocks as their portfolios climbed beyond their wildest beliefs. The media narrative has not changed much since the beginning of the new decade. Technology commentary continues to dominate the media headlines, and who is to blame them? The growth potential for A.I. is much more exciting to learn and read about than the fundamentals of CocaCola.

Investing in fundamentals has never been loud or exciting, but it has provided consistent returns over long periods of time. Over the last three years, we were aware that value was having a strong run, likely somewhere near growth equities, but growth was

likely winning due to AI, tech dominance, chip shortage, etc. While the narrative in the media may not have changed, the shift from growth to value has already begun. When discovering it was strongly opposite to what we believed, we decided to survey 31 financial professionals who deal with high-net-worth families throughout Canada. Our thesis was correct; even though value has

dominated the three-year period, a majority (71%) of financial professionals believe growth has been the stronger factor.

This is to no fault of the investor; there are many behavioural biases at play here, with the most dominant one being the ‘availability bias,’ also known as ‘recency bias.’ Our recent encounters with investing, especially over the past decade, and exposure to media content have heavily leaned towards discussions of growth. This has left the door wide open for value investors to quietly outperform. Given the inherent biases in investing, it is crucial to remain steadfast in your convictions and resist anchoring to media-driven narratives.

While the three-year view looks very strong for value (S&P 500 Value +44% vs S&P 500 Growth +21%), in two out of the three calendar years below, growth has outperformed value. Not by as much as you might think, but growth did outperform. 2022, the year rate hikes began, was a big reason for the outperformance over the period, with value outperforming growth by 24% (S&P 500 Value -5% vs S&P 500 Growth -29%). But that is what value is meant to do; when you get this larger pullback in the market, your blue-chip value stocks should hold up better. Lucky for us, calendar years are arbitrary; as long-term investors, we are focused on exactly that – the long-term – and this type of portfolio construction is proving to be beneficial given the current market environment.

For much of the current decade, we have been consistently overweight value, most notably in the realm of US equities. While the positioning has been successful thus far, the primary focus should be on what will happen in the future. There are a few key reasons that lead us to believe there will be continued outperformance of value.

Sustainability

The sustainability factor comes down to good old-fashioned diversification. Unsurprisingly, approximately 90% of the return for the growth index throughout these three years can be attributed to one sector: Technology. Flipping over the value index, to achieve the same 90% coverage for return, you must include the top seven performing sectors of the index. While there are certainly differing opinions in the investing world, there is likely a preference for investment growth to be diversified amongst seven sectors rather than depending solely on a single one. This type of investment growth does not feel particularly sustainable over the long run.

Valuations

Simply put, the US growth index is expensive, and as we learned in the last Market Ethos (Do Valuations Matter?), the more expensive the index, the lower the forward returns have been historically. The growth premium has made its way back to nosebleed levels last seen in 2021. While the markets did move much higher throughout Q4 of 2023, mainly due to multiple expansions, price does not entirely explain the quick shift in valuations that we saw at the end of December. The more impactful explanation for the return of the growth premium comes down to forward earnings estimates. The earnings estimates for growth companies in the S&P 500 pulled back while the forward earnings estimates for value in the S&P 500 strengthened. Therefore, a significant amount of the P/E growth premium climbing has to do with the “E” moving in opposite directions for both styles. We expect that trend to continue as some of the earnings estimates for the growth companies were/are certainly extended.

Higher inflation & rates

While the current inflation level has come back down, our view is that it will continue to flare up through the cycle and, on average, remain at higher levels than the last cycle. Looking back over the last 48 years, this has proved positive for the value factor. There was roughly the same number of periods when US CPI was greater than 3% as there was when CPI was less than 3%. Separating those two periods, value stocks outperformed on an average monthly basis by +25 bps in periods where US CPI was greater than 3%. The opposite can be said for periods where US CPI was less than 3%; growth outperformed value by +23 bps.

During a period of rate cuts, we can expect growth to outperform value. However, if inflation proves more volatile over the long term, so will the rate environment, meaning we may not be going back to the depths of interest rates. A more consistently elevated rate environment should prove to be a boon for value.

Recognizing new cycles early on is crucial for maximizing future returns. After a decade of underperformance in value, the time for value investors may have arrived. While the U.S. equity market has distinct value and growth factors, other markets, such as the TSX and international markets, appear value-heavy based on current valuations. This forms the basis for our underweight position in the growth-heavy U.S. market, market-weight in Canada, and overweight in international equities.

While we acknowledge the possibility of mixed performance between value and growth for the remainder of 2024, our preference leans towards value, aligning with our forward-looking strategy. Our stance doesn't imply a complete dismissal of the growth factor. We remain cautious about potential challenges, such as a recession, where growth may exhibit some resilience. However, our focus is on anticipating future trends, and currently, that points towards a value-oriented approach. Spread the word – value is on the rise, and we aim to keep this momentum for the dedicated value investor.

Portfolio Positioning

We continue to hold a portfolio position that we would characterize as moderately defensive. Bit of an overweight in cash, not

lured by the attractive yield, but more so for optionality. Our expectation for equities is tepid. The market is currently pricing in a

rather goldilocks scenario of a soft or no landing for the global economy with a potential lift from rate cuts. We don’t think it

will go that smoothly and have extra cash to buy on weakness. In the meantime, we are getting paid a decent amount to park.

On the bond side, we are moderately overweight. The current yield is attractive, and most bonds remain trading at a discount

to par, which should equate to a bit more upside as they gradually move closer to maturity. And since our base case is for economic weakness internationally to spread to North America, we do believe yields will grind lower, even after the decent drop since publishing our outlook in early December. From a duration perspective, we are just over 5. This is about the highest duration we have had since starting to manage multi-asset portfolios in 2015. Our credit exposure is light, as we believe spreads are not providing much of a safety buffer in case the economy does weaken and defaults rise.

On the equity side, we do remain moderately underweight in U.S. equities, which has not been the right call for the past year. However, offsetting this has been an overweight international with an emphasis on Japan. Japan is quickly becoming the talk of the town based on reports and articles; we were there over a year ago. We continue to be underweight emerging markets which has been a positive tilt for the portfolio, however, we have recently become a bit more intrigued.

Market cycle indicators remain stable on the lower side of healthy or neutral. We can never know fully what the future holds, but certainly down here does warrant a bit more defense.

Sticking with the party terminology, we are at the party, standing near the door, sipping a light beer.

The Final Word

The market's ongoing battle between optimism and pessimism, represented by bulls and bears, remains a driving force in the financial world. Investors navigate conflicting signals, concentration risks, and the recent shift in interest rate expectations, all within a market that, while hitting record highs, potentially overlooking forthcoming challenges. As uncertainties persist, staying vigilant, agile, and open to contrarian opportunities becomes paramount. The delicate balance between fear and greed continues to shape the market's trajectory, highlighting the need for investors to adapt to the ever-evolving landscape.

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

Do Valuations Matter?

Mon, 29 Jan 2024 19:12:44 GMT

Do Valuations Matter?

One could certainly question the importance of valuations in this market. If you were bold enough to buy Nvidia a year ago, ignoring the 60x price-to-earnings (forward earnings), you made money. Microsoft, too, sits at 33x and continues to go up even

though its forecast earnings growth is only about 15%. Or which pharmaceutical company would you like to own, the one

trading at 50x earnings or 12x? Surprisingly, the right answer was the 50x Lily and not the 12x Pfizer. Solving for a pandemic is nice, but solving for fat is much more lucrative.

For the S&P 500, the quartile of companies that were trading with the lowest valuation at the start of 2023 enjoyed an average return of 8.9%. Not bad. But the companies with the highest valuations returned 17.7%. It's not just within U.S. equities that it may appear valuation doesn’t matter. Emerging markets have been trading at very low valuations for years and have consistently lagged developed markets. Based on the Bloomberg Developed (DM) and Emerging (EM) markets indices, the spread is wide at about 18x vs 12x. Also of interest is that EM earnings are expected to grow at 28% compared to 18% in DM over the next couple of years. Or the TSX at 14x compared to 20x for the S&P, a longstanding valuation spread, yet the more expensive S&P keeps winning.

Now, comparing one market's valuations to another is like comparing apples and oranges. The composition of the market and different sector weights can often explain much divergence in valuations. For instance, the S&P currently has a 30% weight in technology, often a higher multiple sector. That compares to under 10% for the TSX. The S&P has more consumer staples, more health care, less energy, and less financials compared to the TSX. Staples and health typically carry higher valuations than the more cyclical energy and financials.

Yet valuations do matter. The chart below uses S&P 500 data back to 1950 and calculates the average performance for the S&P 500 based on starting point valuations. It is rather clear that higher valuations equate to lower returns going forward, on average. And that is the crux: averages can hide a lot of data. Sure, the average return from a starting point in the most expensive quartile bucket is rather close to zero, yet the one-year return ranges from +39% to -38%. That is rather wide. The 3-year return ranges from -17% to +18%. So, even though valuations are high, anything can happen.

Worth noting, the range of performance outcomes when the starting point is cheap (less than 11.4x), are rather compelling. The 3-year annualized worse case was flat, and the best case was +26%. Today, though, we are not in the bargain basement; we are in the valuation luxury penthouse.

Pushing the S&P 500 up to the penthouse of valuations is the Mag 7 or Enormous 8, or whichever funny label you prefer for the megacaps sitting atop the index. The concentration in the S&P 500 is at or near historically high levels, which is also pushing the valuation to the upper levels. To give an idea, the chart below shows the relative valuations of the S&P 500 (traditional market capitalization-weighted version) and the Equal Weight S&P 500 index. It is those megacaps making the S&P 500 expensive; the broader market is not nearly as elevated.

Final Thoughts

The Enormous 8 could very easily become more enormous in 2024, which would once again drive the most expensive part of the market higher. The average PE across the Enormous 8 is currently 36x forward earnings, but as we learned in 2023, a high starting valuation doesn’t guarantee anything as, in the short term, anything is possible. However, given concentration and given valuations, the odds are likely tilted in the other direction. Don’t lose sight of valuations; in the long run, they are one of the best indicators of performance and can offer a margin of safety.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

Moody Market

Mon, 22 Jan 2024 19:21:08 GMT

Moody Market

Markets certainly move around a lot. Last summer, the stock market rallied over a number of months into the end of July before going on a three-month decline due to rising bond yields. Then, from what were oversold levels, the market rallied for the last two months of the year. This put a cherry on top of 2023, which saw the S&P 500 gain 26% – a very impressive year.

So, where did those returns come from? The chart below decomposes the U.S. equity market performance into different components: dividends, earnings growth and multiple expansion/contraction. Of that 26% last year, 2.1% was thanks to dividends, 6.1% from earnings growth and the rest, 18.1%, was due to a rising market multiple. The price-to-earnings (PE) ratio for the S&P 500 rose from 16.8 to 19.7, about three points of multiple expansion. Hence, the red bar in 2023 is rather large, actually close to the same size in the opposite direction compared to 2022.

However, if you look longer term, the changing market valuation multiple quickly fades in importance and earnings growth becomes the key driver of performance, plus a bit from dividends. This makes sense as the market multiple fluctuates, given

investor optimism or pessimism about everything from the economy, rates, profits, war, elections, etc. It fluctuates in both directions and clearly exhibits mean reversion tendencies. Or, in simpler words, a PE of 20 does have a greater likelihood of declining than expanding in 2024… but of course, either direction is possible.

In 2024, there are a few things we can know with a decent amount of certainty. The total dividends paid by the index constituents do change over time, but usually very gradually. So, we are probably safe in expecting a little less than 2% returns from

dividends in 2024. Earnings growth does tend to be more volatile and uncertain, but if we go with consensus bottom-up analyst predictions, that is 10-12% earnings growth. Add those two together, leaning on the lower end of the range for earnings growth totals about 12%. That sounds pretty darn good; of course, that implies a stable market multiple… in a metric that is anything but stable. How unstable? Well, the previous chart looked at annual return decomposition; the next one breaks it down to monthly performance. You can’t even see dividends anymore, and earnings growth is still there, but the changing market multiple dominates. Some months giving, some months taking.

If you can figure out where the market multiple is going next, ring us, and we will create a fund/ETF for you. It is really trying to gauge the mood of the market, or more specifically, the direction in which the mood is changing. From pessimism to optimism, you get multiple expansion. From optimist to pessimism, you get multiple contraction.

What will the market mood be next?

There are some fundamental drivers. Higher bond yields are historically associated with a lower market multiple. The chart below uses valuation data for the S&P 500 going back to the 1960s. While there are clearly outliers, there does appear to be a long-term relationship between bond yields and stock market valuations. This is logical; everything is a competing asset class, so if bonds are paying more, equities, to remain competitive, must offer more compelling valuations. The big red dot in the chart below marks “today,” which appears to have only slightly elevated valuations.

Yet, as we demonstrated from our monthly return decomposition chart, it is more about changing moods. In November and December, the vast majority of the market’s move higher was due to an improving mood among investors, given the multiple changes added over 10% of gains. Worth noting, during that period, bond yields, as measured by the 10-year Treasury, fell from 4.9% to 3.9%. So yields do matter a lot, but so do so many other things.

If we suddenly had peace in the world’s major current conflicts, we would probably lift the multiple. If inflation continues to decline, that would be good news. If the economic data weakens, it likely lowers the multiple. Then again, if the economic data weakens (bad), bond yields would likely fall more (good). All these things and many more are happening at the same time, making it rather challenging to guess the next directional move of the market multiple.

Not fundamentals but sentiment and positioning can provide some clues as to the more likely next move in the market multiple. For instance, if everyone is bearish due to lots of bad news, what happens next? Well, if everyone is bearish, then there is nobody left to move from being bullish to bearish, as they are all already there. So, the more likely next step would be for one of those bearish folks to become bullish. This is why sentiment is a contrarian indicator. You are supposed to buy when everyone is bearish and be a seller when all are bullish.

Gauging investor sentiment is challenging. One of the longest data sources is the AAII investor sentiment survey, which asks respondents whether they believe the stock market will be higher or lower in the next year. When this is near an extreme level, either overly bullish or overly bearish, there is, on average, a strong determinant of stock market performance. When very bearish, the average future performance is well above average, and when everyone is bullish, future performance tends to be lower than usual.

While far from perfect, when the bulls vastly outnumber the bears (above the red line), the S&P 500 has typically seen weakness ahead. When most are bearish, the future returns are much better. So, while the S&P 500 may be somewhat euphoric, trading up to over 4,800, sentiment certainly should cause investors some pause as to what may be coming next in the near term. In addition to this, valuations are certainly extended after the strong market returns of late 2023 and the lack of earnings improvement.

Despite investors being rather bullish (which is bearish), portfolio positioning doesn’t exactly match this. Using CFTC non-commercial futures positioning in S&P 500 futures contracts still has more betting the market will decline than rise. But just mildly below neutral. Future market returns tend to be more strongly positive when positioning is very negative. And vice versa. Today, there are a few more positioned bearish, based on e-mini S&P 500 futures. We would not characterize this as extreme, though, which certainly means the market could continue to improve, especially if more start placing positions on the bullish side. It is certainly something to keep an eye on. Worth noting small cap futures, based on the Russell 2000, are actually very bullishly positioned (which should be bearish).

Finally, there is momentum. Momentum measures of the market don’t differentiate between economic news, changing yields, changes in geopolitical risk, valuations or ever explain why the market is moving. But when momentum gets overly strong or overly weak, it usually mean reverts. As a result, extremes in momentum can also highlight good times to reduce and good times to put money to work when very low.

While this is only a few years, the table below does look similar over longer time periods. Simply put, the average forward return of the S&P 500 is much higher when RSI is low. And it is lower when RSI is higher. It’s worth noting RSI was well over 70 in late December.

Final Thoughts

We are big fans of long cycles, positioning based on return expectations, valuations, and where we are in the cycle. Again, earnings growth, which is determined by the economy, is the longer-term driver of market returns. But when you look at shorter periods, the importance of earnings growth fades, and the mood of the market dominates. Or more specifically, the changing market multiple caused by the changing mood of the market. Today, with RSI over 70 a few weeks back, investor sentiment is rather bullish. We would say the short-term risks are likely higher than the short-term potential gains. But you never know; the market is always moody.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers Echelon Wealth Partners Inc.

Purpose Investments Inc.

Purpose Investments Inc. is a registered securities entity. Commissions, trailing commissions, management fees and expenses all may be associated with investment funds. Please read the prospectus before investing. If the securities are purchased or sold on stock exchange, you may pay more or receive less than the current net asset value. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated.

Forward Looking Statements

Forward-looking statements are based on current expectations, estimates, forecasts and projections based on beliefs and assumptions made by author. These statements involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. Neither Purpose Investments nor Echelon Partners warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. These estimates and expectations involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. The particulars contained herein were obtained from sources which we believe are reliable, but are not guaranteed by us and may be incomplete. This is not an official publication or research report of either Echelon Partners or Purpose Investments, and this is not to be used as a solicitation in any jurisdiction. This document is not for public distribution, is for informational purposes only, and is not being delivered to you in the context of an offering of any securities, nor is it a recommendation or solicitation to buy, hold or sell any security

Maybe It Was Transitory After All

Mon, 15 Jan 2024 22:08:46 GMT

Maybe It Was Transitory After All

The illusion of causality is a behavioural bias in which we believe there is a cause-and-effect relationship at work which just isn’t there. This bias is created because we humans love a simple causal relationship – rules make us feel like we understand the world better and are in control, to some degree. This bias is pretty prevalent in how people think about the markets and economy. Unfortunately, neither lends itself to simple cause and effect because both are such complex systems with countless moving parts. Those parts are the behaviours of all consumers, corporations, investors, governments, etc.; best of luck truly deciphering a simple cause and effect in such a dynamic, fluid system.

Rate hikes and inflation may be one of those illusions of causality that is pretty prevalent today among investors. The playbook is well known: Inflation is caused by too much demand compared to supply. To fight inflation, central banks raise overnight

rates, which slows the economy or aggregate demand, alleviating said inflation.

So that is clearly what has happened, right? On the surface, it sure looks that way. We focus on America, but it is similar in most countries. Inflation started rising materially in 2021, central banks started raising rates in 2022, and inflation peaked around the middle of the same year. As inflation has been trending lower for over a year, central banks have now stopped raising rates and are now expected to cut rates this year.

The bonus has been the absence of a recession. Historically, rate hike cycles like this one have been followed by some sort of recession. So far, that has not shown up, emboldening the soft landing narrative, which appears firmly baked into the markets as we start 2024.

What if the consensus has it all wrong? Or, more specifically, the consensus has the causal illusion that rate hikes solved the inflation problem, and since no recession is evident yet, it all worked out perfectly. Rate hikes are supposed to lower or slow demand, sometimes called demand destruction, to alleviate inflation pressure. Don’t think we have seen much of that for a few reasons.

Counterproductive

On its own, higher interest rates slow down demand or economic activity. But there have been other factors at work here that are diametrically opposed. Fed raising rates slow economic activity, but the Fed injecting liquidity to backstop the regional bank failures in March of 2023 was a quantitative stimulus. Add to this, the draining of the Repo market over the past six months was stimulus. Add to this, the U.S. government is running a deficit that rivals the stimulative spending usually only seen during recessions. The U.S. is not the only government. It seems if governments spend a lot of money, in the recent case to provide support for the economy during a pandemic, they sure don’t rush to reduce spending back to normal afterwards. This also fits

nicely with why no recession has started to show up.

It really explains why demand, measured by consumption and private investment, has remained pretty robust even with short-term rates rising from nearly zero to 5.5%. This measure of demand did slow a bit in 2022 but has largely turned back positive. You could say it is excess savings, government spending, and a splash of QE helping counteract the impact of higher rates. Clearly, trying to draw a simple cause and effect is challenging, given so many components in flux.

So why did inflation come back down from 6.5% to below 4%, and trending lower? It is clearly hard to argue that rate hikes have resulted in softer demand. Chances are it is on the other side of the ledger – supply. Capitalist economies work rather well. When there is not enough of something, people find a way to get it / make it and sell it. The pandemic messed with supply chains and changed our consumption behaviours. Ever since then, capacity has been expanding, relocating to better meet demand. The Fed’s rate hikes didn’t tame inflation – corporations did.

The chart below shows inflation lagged one year vs global supply chain pressure. Inflation peaked about a year after supply chain pressures peaked. Supply chain pressures have steadily improved and gone negative recently. Chances are prices will continue to follow.

We are not implying rate hikes had no impact on inflation. It is certainly a positive contributor to helping bring inflation down. However, other parts of the government have been operating in a counterproductive manner. And don’t underestimate profit-driven corporations for identifying and meeting demand in the marketplace.

Final Thoughts

It is challenging to try and draw causation in the economy or markets. Believing it has been the central banks that tamed inflation simply doesn’t add up when demand has remained robust. Likely it has been corporate capacity catching up with changing demand that has helped more so in bringing inflation lower. Dare we say inflation was transitory after all? Just maybe the time implied in being transitory was measured in years, not quarters or months.

This also should give some pause to the euphoric market view that cooling inflation will encourage central banks to start cutting rates. They will likely cut sometime in 2024, but there are many other moving parts. What happens when the Repo market is largely drained? Will QT be back on in full effect? The fiscal impulse from government spending is set to slow in 2024. Plus, don’t forget the impact of rate changes, which has large variable lagged impacts on the economy that are still percolating their way through.

A lot of moving parts really make drawing causation challenging.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

60/40 - The Reports of My Death Are Greatly Exaggerated

Mon, 08 Jan 2024 17:23:00 GMT

60/40 - The Reports of My Death Are Greatly Exaggerated

It was not that long ago, perhaps about a year at its peak frequency, that you couldn’t go far without coming across another report extolling the death of the plain vanilla 60/40 portfolio allocation. Time to rethink portfolio construction was the prevalent theme of the reports, often encouraging increased use of everything from commodities, market neutrals, CTAs, real assets, etc. The messaging resonated with investors, given their experiences of 2022 – a year in which that type of portfolio construction didn’t perform particularly well. But much like everything in the investment world, some strategies do better in some market environments and struggle in others.

We are not downplaying just how much portfolio construction using plain vanilla inputs sucked in 2022. The chart below is based on 73 years of calendar year returns for bonds and equities. That is a long time that encompasses many

recessions, inflationary environments, wars, etc. 2022 wasn’t the worst year on aggregate, but it was the worst year for both equities and bonds falling. Now, our equity proxy is a 50% TSX and 50% global equity; this would look a bit worse if you used less TSX, given our equity market held up better in 2022. However, 2023 did end up returning much back to normal right in the middle

of the cluster.

Adding to the frustration of 2022, your risk profile was largely meaningless. Given that stocks and bonds fell in similar fashion, it was a unique year in which your weightings across asset classes didn’t really have much of an impact on performance. Growth investors holding more equity and fewer bonds are generally more comfortable with market volatility as they see it as an acceptable by-product of greater return expectations over time. Yet Conservative investors are more comfortable sacrificing return expectations in return for less oscillation in the market value of their portfolio.

This is kind of key to portfolio construction and it did not work in 2022. The chart below is based on proxies for a Conservative, Balanced and Growth investor allocations using plain vanilla index returns. As you can see, in 2022, they all travelled together, from the young growth investor to the conservative grandparent. In 2023, asset allocation once again mattered. Dare we say back to “normal?”

One of the attributes of good investors is knowledge. Don’t worry, it doesn’t need to be knowledge of market cycles, the economy, corporate financial statements, manager selection, or portfolio construction; that is more of a team’s full-time job and why the majority of investors use advice. Don’t rush out to sign up for the CFA just yet. But a base understanding of how markets work and how your portfolio is allocated goes a long way. Sometimes, returns are scarce, sometimes abundant. Sometimes a portfolio’s construction will struggle in certain market environments and often bounces back in the subsequent. The balanced proxy from above returned about 12% in 2023. Knowledge helps keep investors calm and, most importantly, helps them avoid making knee-jerk reactions to market oscillations. Such as abandoning portfolio construction after 2022 to load up on commodities and CTAs [Bloomberg commodity index fell 8% in 2023 after gaining 16% in 2022, Barclay Hedge US Managed Futures, proxy of CTA managers, was down 1% in 2023 (end of November) after gaining 15% in 2022]

Asset allocation works and is still the best tool for constructing portfolios for various risk/return objectives. Sure, it doesn’t work all the time as expected, but markets rarely go as expected. The average annual return for global equities is about 11% over the past 70+ years. That is a long-term average. Care to guess how many of those years are within +/- 5% of that average. Or in other words, how many years are within +6% and +17%? About 30%, which means 70% of the time, equity returns were below 6% or over 17%.

2022, and to a certain degree 2021, were unique because of how things were set up beforehand and some pretty big macro drivers. The cost and availability of credit were reset from low cost and abundant to higher cost and less abundant. The cause is actually rather irrelevant; it was this changing dynamic that caused various asset classes to move together. The good news is that may be over. There will be reverberations that continue but it is safe to say capital now demands a certain return that is higher than before, and there does appear to be less capital to be accessible.

Understanding that when the risk-free rate (using overnight central bank rates as a proxy) moves very quickly from a really low level to, let’s say, a normal or slightly high level, the price of all assets tends to adjust together. However, rates can only go from 0.25% to 5.5% once. Now that things have “reset,” it has become a healthier market. It won’t be a pleasant journey to get there, and we may not be all the way there just yet, but it is certainly a key part of the foundation for the next cycle.

We Like Alternatives, We Just Like Plain Vanilla Asset Allocation as Well

The increased access to different asset classes, strategies, and vehicles is a trend that continues and gives investors many more choices. That is a positive and significantly expands the building blocks for portfolio construction. Volatility management, defensive strategies, income enhancers, real assets, privates, the list goes on and continues to expand.

In fact, we are increasingly inclined towards real assets as our longer-term view is that inflation will become a recurring market issue in the years to come, not just a threat to markets but to your financial plan. Privates also continue to gain traction as accessibility to capital changes. Diversification has become harder to find in an ever-increasingly connected world. The chart below shows the correlation and beta (measuring degree of move) between Canadian stocks and bonds. Periods when stocks and bonds move together are not uncommon; in fact, it has been more common than not over the past 70 years. Some of those periods, like during the 1990s, were a great time to invest. However, the positive correlation/beta does mean the diversification benefits of a simple asset mix may be a bit less effective. Alternative sources of diversification could certainly help.

But not so fast. The availability of different strategies in the traditional long-only (non-alternative) universe have also expanded considerably over the years. Certainly on the lower-cost side via the rise of passive ETFs, but also with different strategies developed to gain different performance exposures. Momentum strategies can be designed to produce a very different experience. Bond strategies can range from ultra-long duration government bonds to syndicated bank loans.

And let's not forget, even if the diversification benefit between stocks and bonds is lower today than in the past decade or so, there is a silver lining. Bonds have a yield again, meaning they are not simply for diversification anymore and can have a more pronounced positive performance contribution to the portfolio. The yield-to-worse for the U.S. Aggregate Bond index is 4.7%...

getting that kind of return from your bonds means that equities don’t have to do all the heavy lifting.

Final Thoughts

The positive of having more tools in the portfolio construction toolbox is that it offers greater flexibility in how to build portfolios. Alternatives certainly offer some very different investment experiences to address either opportunities or risk that goes beyond just expected returns and volatility. And the more plain vanilla long-only investment options now offer exposures at ultra-low cost to active strategies that can be very different than the overall market.

It may feel like choice overload, yet the good news is there are many different paths that lead to a successful investment journey. Traditional asset allocation will likely remain the core for most, yet there are many ways to enhance a portfolio, given ever-increasing options. Alternatives, combining both active and passive vehicles, and being more tactical with allocations all can help.

Equally important to portfolio construction is portfolio understanding. Understanding the true exposures and how they will likely behave in different market environments is critical in avoiding making knee-jerk reaction mistakes. Or more directly, don’t make it too complicated. Simple may not be sexy, but when investing, it tends to work much better.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

2023 Year In Review

Tue, 02 Jan 2024 18:57:55 GMT

2023 Year In Review

Let’s just say it – despite all the headlines, twists and surprises along the way, 2023 was a great year for investors. The S&P 500 was the star at +23% (all returns are total return in CAD). Not to be left behind, Japan was up +19%, Europe +18%. Of course, we can shed a tear for our home market, up only +12% but let’s not forget in 2022 the TSX suffered much less damage comparatively. When +12% has you trailing the pack, it has been a good year to be an investor.

It wasn’t just stocks, bonds went up too, ending two consecutive down years. The Canadian aggregate finished up +6.5% while the U.S. aggregate was up +3.1%. A strong Canadian dollar sapped a couple points of performance for U.S. denominated indices. Bonds were helped by inflation starting to subside, central banks hitting the pause button. Credit spreads also came down materially in the final weeks, driving even stronger returns in more credit tilted parts of the bond market.

Despite the end point of the year being rather favourable, it certainly wasn’t a straight smooth line. Here is a brief walk down the investing memory lane of 2023:

Strong start - To say that people were bearish to begin 2023 is a bit of an understatement. Central banks were still hiking, inflation was still a problem and investors were still licking their wounds from 2022. If you could encapsulate the general consensus, it was cautious on the U.S. market, recession calls were abundant and yields would come down. And as potentially an omen for the rest of the year, January turned out to be the 2nd best month of the year as markets rallied to start despite all the bearishness.

With hindsight, 2023 had a decent setup for returns. Investor sentiment was already bearish, which is a contrarian indicator. VIX was elevated, valuations were low or at least reasonable. This certainly does make 2024 look more challenging from a starting point.

Bank failures - The early gains to the year were all given back in February and March as a number of U.S. banks failed. With total assets in excess of $500 billion, First Republic, Silicon Valley and Signature became among the biggest bank failures in U.S. history. Of course there were many moving parts including deposits being pulled in search of higher yields in money market vehicles and excess capital being investing in bonds which were now sitting in unrealized loss positions. Quick action by money center banks to provide loans and the Fed opening up a bank stability mechanism helped stabilize the situation. Amazing what throwing a few billion dollars at a problem can solve, or at least mitigate.

Artificial intelligence – As markets recovered from the bank scare, hype around AI really started to fuel the market rise. Opening up of large language models has increased accessibility and exposure from largely coders to the masses. Now the race is on for firms to re-characterize revenue with an AI label, the familiar dance has begun. Still, the potential applications are considerable and largely unknown. It will be exciting.

Barbie & Swifties save the economy – Of course an exaggeration, but as the market advance entered the summer months the resilience of the economy was on full display. The recession talk that became louder during the bank failures was giving way to first a soft landing and then a no landing scenario.

Too much good news – All this good economic news helped global equity markets rally into the middle of summer, before the good news became bad for the markets. Bond yields were on the rise and when the 10-year U.S. Treasury yield moved firmly above 4%, equity markets began to suffer. Yields didn’t stop rising around 4%, they marched up to 5% due to better economic conditions and a very heavy government issuance schedule following debt ceiling dances.

This led to three consecutive down months, dragging global equities down a bit over 10% from the high at the end of July. As it was primarily rising yields that was the culprit this was especially painful for dividend paying companies. More on that later.

But Santa delivered – Once yields started to come back down, thanks to some softer economic data and cooling issuance of bonds, it was an “everything up” rally. Bonds moved higher, credit spreads fell, equities rocketed higher. Let’s call it the cherry on top of a great year. Inflation data continued to improve and central bankers backed off their rate hiking ways. They were certainly late to start hiking to combat inflation, next year we will learn if they were late to stop as well.

For North American equities, this rally into year end has been 100% multiple expansion. Earnings estimates for the S&P 500 have not turned up at all and have actually been coming down for the TSX. Globally, things are a bit better with some positive earnings revisions but nothing compared to the rally in the market.

Multiple expansion can be expected when yields come down, expectations for overnight rate cuts build and inflation becomes more tame. The challenge is multiple expansion is a zero some game in the long run, some periods it goes up and then some it comes down. The market will need more positive earnings momentum to backfill this market advance, or it remains at risk in 2024.

Year of Surprises

It is challenging trying to look back and determine what was most surprising during the year. Below we have highlighted a few contenders:

War - Rising geopolitical risk was certainly a surprise in 2023. Equally surprising was the muted response by markets.

Economic resilience – The global economy proved to be more resilient to higher rates than most had expected. One would not expect to see mortgage rates where they are today paired with record home prices (U.S. prices, little bit weaker here in Canada). Or a consumer spending steadily despite higher rates and inflation.

Markets – Remember the adage don’t fight the Fed? Well, since the Fed started raising rates in March of ’23, the S&P 500 has annualized 8%. Global equities ex-US annualized at 6%. Perhaps the surprise of equity markets is greatest amongst those who attempt to forecast such things. The S&P 500 started 2023 at 3,840 and the average year-end target among strategists was a mere 4,078. Given the index finished at 4,770, that is a miss of about 700 points. Funnily enough, in 2022 they missed even more in the other direction with a year-end target of 4,950, which turned out to be over 1,000 points too optimistic. By the way, the consensus for 2024 year-end is 4,830 or only 50 points higher than current levels.

Whoops – No denying the destination of the majority of new money coming into the market in 2023 landed in the ‘cash’ bucket. Maybe it was just bank deposits moving to a higher yielding vehicle, but there was a common theme of new money being diverted into cash products. The attractiveness of a 4-5% yield, with virtually no risk was appealing. “Getting paid to wait” was the common statement. As it turned out, you got paid a bit to watch other asset classes rise more.

Digging deeper into the numbers

Let’s start with the leader, America. The S&P 500 posted a 26% return but there are some interesting takeaways beneath the surface of the headline numbers. The S&P 500 is more concentrated today than arguably any point in its history, or at least rather close to its record. The top 10 of the 500 carry a combined weight of 32% of the market capitalization weighted index, with 5 of those companies carrying valuations north of a trillion. Even more impactful, the top 10 contributors to the S&P 500’s return this year represented 17.5% of the 26.3% gain, or about 2/3rds.

If you weren’t in the mega-cap names in the U.S., you didn’t enjoy nearly as pleasant of a year. This can be seen, magnified, by comparing the S&P 500 vs the smaller cap Russell 2000 (R2K). The gap between these lines widened in 2023.

The TSX, which generally is less diversified than the S&P 500, also suffered from narrow leadership. The index returned 12% for 2023 and a little over 7% of that gain came from the top 10 contributors. The good news is that top 10 were from a variety of different sectors, unlike the U.S. with a big technology name dominance. The bigger story in Canada was the dividend factor.

The Dow Jones Canada Select Dividend index and the broader TSX were lock-in step until bond yields began to rise in August. Higher yields weighed on dividend companies to a greater extent, leading to the divergence. The fall in yields during the past couple months of the year saw this spread narrow a little, but not much. The dividend factor was a drag on performance in 2023.

2-year round trip

We all naturally suffer from recency bias. This year, for all those with not enough U.S. equity market exposure (in the right part of the U.S. equity market, that is), it’s been a drag. Too many dividend-paying companies lagged in markets. Or how about bonds? Sure they were up in 2023, but down big in 2022. We don’t need to look back far to see a very different environment. In fact, 2023 turned out to be kind of a mirror of 2022.

Looking at index returns for U.S., Canadian, and International equities plus Canadian and U.S. bonds, the biggest losers in ’22 were often the biggest winners in ’23. The biggest drop in 2022 was U.S. equities, which took the top spot this year. Canadian equities suffered the least in ’22 and gained the least in ’23 (+12% is hardly something to cry about). Bonds, too, bounced back, albeit not totally offsetting the declines of 2022.

So, whether you were growth, balanced or conservative, you likely ended up at the same place after two years. The chart below is based on a range of asset allocations using index returns. Those numbers at the end of each line are the two-year annualized return for each… meh.

This is how markets work; sometimes returns are abundant, sometimes not so much. Wen should also point out one other way in which 2022 was rather unique. It was unique as bond yields were resetting or, dare we say, normalizing. This made bonds and equities move together. As you can see, whether conservatively allocated or more growth allocated, the 2022 path was rather similar. The good news is in 2023, markets behaved more normally. Growth did better than balanced, which did better than conservative, with greater volatility for growth vs conservative. Asset allocation works, it may have taken a break in 2022, but it is back.

Final Thoughts

When the global neutral balanced fund/ETF category returns 9.8% (prelim), it’s a good year. The good surprises, such as inflation coming down, central banks pausing and a resilient economy were bigger than the negative surprises. Maybe 9.8% will be enough to lure some of that cash hoard sitting in money market funds into risk assets? Hope not as the performance track record of investor flows is more of contrarian indicator.

2024 will likely be another challenging year. Past rate hikes are still making their way through the economy, sentiment has turned overly bullish and valuations are elevated. This does leave the lingering question, did the rally to finish 2023 rob returns from 2024? We will see.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

2024 Outlook - The Great Reset Final Act

Thu, 07 Dec 2023 15:46:56 GMT

2024 Outlook - The Great Reset Final Act

Let’s start by taking a big step back. Over the past couple of years, we have been enduring a great reset following a decade-long period that was characterized by disinflation, lower economic growth, low yields and lots of monetary stimulus. Disinflation gave way to inflation. Low yields gave way to higher yields. Lots of stimulus has given way to monetary tightening. A period of steady asset price inflation, stocks, bonds, and real estate has given way to the repricing of everything. Credit has gone from widely abundant and very low cost to less availability and higher cost. The result: lower prices of assets.

Some prices adjusted quickly, as was evident in falling stock and bond prices in 2022. Some prices, that are more sticky due to greater friction in pricing and transactions, take longer. Such as with real estate. 2023, while not a fantastic year, has actually turned out pretty well. Some equity markets recovered well, including the U.S. and many international markets. Even the TSX, which lagged, has managed high single digit returns. Bonds too are up lower single digits. [at time of writing near end of November]

As we near 2024, has the great reset run its course? We don’t think so. While parts of the market react quickly to a new world (or, more aptly, a normal world after a decade of too much credit at too low a cost), such as the global equity market and bond market, other parts take time to recalibrate. The economy, corporate and consumer behaviour, and real estate all adjust more slowly and are likely still adjusting.

The good news is we are probably in the final act of the great reset (or 3rd act for any Shakespeare lovers). We believe it will include a recession, higher credit spreads, more bankruptcies, margin pressure and likely lower valuation multiples in the equity market. We are closer to the end and start of a new market cycle, but this act will likely be the most exciting (exciting when it comes to investing is usually not enjoyable).

So, what do we expect next year:

1) Recession in 2024

Yes, we are one of the many who are calling for a recession, part of the cohort of economists crying wolf and still no wolf in sight. This has become the most talked about recession. We would also point out that the market is very confused at the moment. Some equity markets are pricing in recession risk, just look at the dividend payers or Canadian banks. Some equity markets remain euphoric, such as the S&P. Credit spreads remain close to historical norms, clearly not signaling trouble. Bond yields, still kind of high due to inflation, don’t seem to be worried about economic growth.

Add to this an inverted yield curve that has now been inverted for 13 months, coincidentally around the

historical average lead time. Continued slowing global trade. Not to mention countries such as Germany, the

UK, and now Canada flirting with recession, China slowing, and the list goes on. But then there is America,

bucking the trend.

How to stave off a recession 101 – Let’s start by looking at the track record of policy. Governments around the world went to town implementing MMT to save the economy due to the impact of the pandemic. MMT, for those who hopefully have forgotten about this as it’s a terrible idea, involves the government spending money and the central bank buying government bonds to finance spending. It worked, protecting the economy, but it also created an inflation problem and likely many imbalances.

So now the monetary money printing has gone into reverse, BUT fiscal spending continued at levels rarely seen outside full-on recessions. Think about it: we have central banks trying to get inflation under control, and at the same time, the government attitude remains spend, spend, spend. So far in 2023, the average deficit (as % of GDP) across the US, UK, Eurozone, China and Canada is 5.6%, compared to 2.2% in the couple of years before the pandemic. This is anything but a coordinated response between monetary and fiscal policy. The fun part about economics is you really don’t know the impact or knock-on effects of policy for years.

How does this impact 2024? We believe the credit contraction, high rates, and past inflation will inevitably overtake fiscal spending… recession.

We are not going to bore you with a pile of charts that we have published over the past couple of quarters highlighting the recession’s early warnings. These include the inverted Yield Curve, Fed Recession Probability Models, Slowing global trade, the U.S. unemployment rate rising 0.5%, Negative Leading Indicators, and so on. Instead, let’s talk overnight rates. Most are aware of the historical pattern of the U.S. Fed raising rates, going too far, and presto, you get a recession. But it is not just rates, it's rates and lending standards. Fed hiking cycles that are not accompanied by a significant tightening of lending standards most often result in a soft landing. If lending standards are tightening, that leads to recession. Today, they are tightening.

Yes, continued fiscal spending may stave off recession, but our experience tells us relying on government policy rarely works out. In fact, this fiscal spending during past quarters of decent economic growth may help keep inflation higher than it could have been, which could keep overnight rates higher for longer as well.

The recession probabilities for the U.S. have been coming down over the past couple of months (currently 51% over the next year), but at the same time, have been rising in the UK (60%), Eurozone (65%), China (18%) and Canada (42%). We remain in the camp that preparing or positioning for a potential recession is the best path. And focusing market exposure in pockets that provide an added safety buffer from lower valuations.

2) Peak yields are behind us

It is not a huge leap of logic to connect our view that we have seen peak yields with our concern of a recession in 2024. We continue to believe, as we did a year ago, that inflation fears will soften, and this will lead to a rise in markets, both stocks and bonds. Yet this sweet spot for markets would pivot at some point as inflation fear would be gradually replaced by economic growth concerns. Today, we are still in the sweet spot. In 2024, we expect the pivot.

The naysayers of a recession continue to focus on the strength of the U.S. economy, helping offset global weakness. And the U.S. economy has proven very resilient, keeping U.S. yields higher. This strength is likely attributed to leftover stimulus or savings from the pandemic years, a decent labour market (which is weakening), and, of course, added stimulus following the regional bank funding mechanism. However, those savings are dwindling, labour is softening, and stimulus has turned in the other direction.

But you don’t need to look at the forward-looking recession warning signs any longer, as the real-time indicators are starting to pile up. U.S. unemployment has risen 0.5%, which has always been a threshold associated with the near onset of recessions. And then there are the Phili Coincident indicators. This index tracks multiple data points that have historically turned at the same time as the overall economy. It has never gone below zero without a recession in tow.

If this trend continues, yields will go lower.

3) Margins to come under pressure

Full disclosure: we have been expecting margins to come under pressure for a bit now [we are most often a bit early]. Rising wages, rising interest costs, and rising input costs certainly have risen over the past couple of years for corporations. But we underestimated how easily companies would pass on those rising costs, perhaps because for much of the past two decades, companies did not have much ability to raise prices. With inflation rampant, companies did not hesitate to raise prices; everyone just sucked it up and paid higher prices. $900 to fly to Montreal, really? And no, it wasn’t business class. But we all managed to save margins, keeping them high and healthy; go, team!

Here comes the hard part: if inflation fueled higher input costs and higher sales revenue, now that inflation is cooling, how does it all work out? Or, more specifically, will cost inflation for corporations slow down faster, the same or slower compared to output price inflation? This does become very company or industry-specific, but a couple of factors have us believing costs won’t slow down as quickly, leading to margin pressure.

Interest costs are on the rise due to higher rates and yields. A handful of companies that have net cash may benefit from this but the VAST majority are seeing rising interest expenses. Variable debt costs have moved quickly, but now fixed term debt is gradually rising as bonds mature and are refinanced. In Q3 of 2022, S&P 500 companies paid a total of about $51 billion in interest expenses. This latest quarter, $64 billion. And this will continue to rise even if rates/yields start to come back down given its lagged temporal dynamics.

Then there are wages. Not sure if anyone noticed, but when inflation jumped to 7%, not many employers opted to increase wages in line. That was the sweet spot for margins, keeping wages in check and raising prices. Well, labour now has more bargaining power, and wages have been rising, playing catchup. Given the lagged dynamic in wages, it too could continue rising even as corporate pricing power wanes.

Finally, the mother of all determinants of margins, sales growth. Sell more units, raise prices, it doesn’t matter which. Sales growth and margins move hand-in-hand. Simply because corporations are leveraged entities, both operationally and financially. So the question then is where are sales heading? Once again, if we are in the recession camp, sales growth is going to keep coming down, and this will drag down margins too.

4) Bonds outperform both cash and likely equities, too

The U.S. aggregate bond universe has a yield to worst of 5.3%; the Canadian equivalent is about a point less at 4.3%, while cash is hovering at about 5%. Let’s go through some scenarios. Cash wins if inflation reaccelerates, leading to rising yields. Or perhaps

strong issuance of bonds (supply) outpaces demand, leading to higher yields. While not impossible, we believe improbable. The

economy is slowing, which should put continued downward pressure on inflation and yields. If yields fall even just a little further

from current levels, which have already declined, bonds will perform better than the current yield to worst.

Cash rates are not likely to change in 2024. While the Fed Fund futures are pricing in 4-5 rate cuts in 2024 (11.25%), we remain

unconvinced. Inflation should continue to moderate, but inflation is pretty sticky and likely not to fall enough to warrant such

cuts. Of course, if the economy does weaken substantially, we could see more rate cuts, but this would also coincide with significantly lower yields, which would benefit bonds even more.

Put all this together, cash likely delivers about 5% in 2024, or a bit less if we get a few rate cuts. Bonds, using the U.S. aggregate, provide about 3.5% in coupon yield, plus 2% in price appreciation as most bonds are below par simply from moving one year closer to maturity, plus X% from a move in yields. A 0.5% move lower in yields across the curve would roughly add another 3% to returns given a duration of about 6. 3.5+2+3, sign me up. Double-digit bond returns in 2024 are not out of the question.

Equity returns, of course, will likely prove the most volatile and challenging, as they usually do. Global equities are currently trading at 17x estimated earnings for the next 12 months. It is a bit more expensive in the U.S. and less expensive in most other markets, including Europe and Canada. Meanwhile, earnings growth is estimated at about 10-12%.

Equity returns can be decomposed into three sources: dividends, earnings growth and a changing market multiple. Dividends will likely deliver about 2% of gains, and if earnings estimates prove accurate, markets would gain 12-14%, assuming a constant valuation multiple. These are big IFs. Since we believe a recession has a good chance of becoming a reality, the earnings growth could prove aspirational. And, if a recession starts to take shape, uncertainty about the future may have investors not willing to pay as high a multiple for estimated earnings. Also, let’s not forget that the longer-term average multiple is closer to 16. Many factors move the market valuation multiple, with rising uncertainty not being conducive to a historically elevated multiple. In short, this could easily lead to lower equity markets.

However, a full-year outlook for equities is challenging. The timing of this potential recession is very uncertain, and just as uncertain is when the market begins to price in the risk. Timing-wise, we could see a drop in equity markets and a subsequent recovery by the end of 2024. Of course, the depth and duration (or existence, for that matter) of a recession will be a huge determinant.

In short, expect a challenging year for equities and a bumpy ride. Add to this, the risks continue to rise as the current year-end rally, while enjoyable, further tempers our enthusiasm for 2024. There are some positives, though. If bond yields continue to come down, this is supportive of the market valuation multiple. And many pockets of the market are already pricing in some sort of recession, just look at international markets, the TSX at 12.5x earnings or those beloved dividend names that currently enjoy a solid valuation safety buffer.

We love bonds, we like cash, and we worry about equities. Hence our moderate underweight in equities and overweight bonds + cash. If it all works out, we will pivot to more equities on weakness. Timing will be everything, as Jack Burton often said – it’s all in the reflexes.

Finally,

5) 2024 will be an exciting year

View from the top

It’s probably safe to say that 2023 didn’t follow the script that most investors had envisioned to begin the year. Coming off a rough 2022 that saw almost all asset classes fall, the mood was very sour and not many investors were optimistic about the future. Consensus expectations at that time centred around the removal of Covid stimulus programs and higher rates, leading to a global recession that would take down corporate earnings and result in another negative year for equity markets. However, as is often the case when everyone is looking for the same thing, the opposite can happen.

Now, as we look forward to 2024, it feels like almost everything has reversed from a year ago. Central bankers are signaling that they are ready to pause their rate hikes, maybe even do some cutting. And while many are still calling for a recession, those predictions seem less dire. We are hearing more comments that it will be more of a mild recession than one that would shake markets. There even remains a camp of investors calling for a ‘no landing’ scenario, meaning that we can avoid a recession. This sudden change in tone has helped valuations expand for many companies, in addition to earnings expectations of high single digits for the next year. So, as sentiment is seemingly positive and with last year as a good reminder, are markets at risk of missing something?

There are many sayings in financial markets, but one of the most dangerous is ‘it's different this time’. Unfortunately, we are hearing a lot of that lately, and this remains a risk to markets.

The ‘no-landing’ camp of investors are making the leap in their thinking that both markets and the economy will be able to withstand both one of the most aggressive interest rate tightening environments in history, along with one of the most inverted yield curves we have ever seen. This is dangerous thinking. In almost every case that we have seen both a large move in rates and an inverted yield curve, a recession has occurred, and markets have declined.

One of the problems that led some towards this line of thinking is general complacency. A quick glance at the year-to-date performance for the S&P500 will show high teens returns. With most understanding markets are forward looking, this can be taken as a sign that everything is ok. But it doesn’t take long to pull apart the returns to see that the overall numbers at an index level have been masked by the stunningly positive returns of a few mega-cap names.

Lots has been written on the performance of the Magnificent Seven stocks that have led the advance. There are lots of reasons why these few stocks have had such a strong year, and a good part of it is simply because they were down so much the previous year. But it was also a very good environment for these companies. The AI boom has kickstarted a wave of spending in this area and generated investor excitement of a new theme (reminding many of the dot.com hype). These large companies are also unique. Most have pristine balance sheets, and with no debt and lots of cash, they are benefiting from the rise in interest rates vs other parts of the market.

A reversal in bond yields next year, or even a drop from peak levels, will go a long way to reversing the negative sentiment around the sectors that have lagged the most this year. The divergence in performance between the winning groups (technology-focused) and the losing (REITs, Utilities, Financials) is close to extreme levels. The common factor is whether these groups are being helped or hurt by the increase in interest rates. Having these trends reverse will narrow this gap and sector outperformance could flip.

Having more sectors participate in a move higher can lead to an environment that is ideally situated for active management and security selection. Picking between winners and losers and sorting out overlooked names should add value. At the least, the losers certainly enjoy a valuation safety buffer. This would also be setting up for a change that investors would want to get away from just buying the index. With the huge returns of a very few names, the index is as concentrated as it has ever been before (U.S. market), and investors holding it are not getting the diversification they would normally be expecting as they are exposed to only a handful of these large stocks.

From a factor point of view, it may be time to look at quality. Companies across sectors that have been able to manage through higher costs and rates will be ideally suited to see margins expand if yields fall. It is also not the time to take on huge amounts of risk by buying deep value with a recession on the horizon; the margin of error will narrow, and many will wait for an all-clear to invest in some of the riskier parts of the market.

Putting it all together next year should remain volatile. We expect to see some form of a recession next year in North America. Canada may have a more challenging environment, given its housing market is more sensitive to moves in interest rates, but the US economy is also beginning to show signs of stress. On top of that, a US presidential election that looks very contentious will not help matters. Uncertainty is not the friend of markets. While valuations have rebounded on the back of a more positive outlook there is a risk markets have gotten ahead of themselves and pulled forward too much of the good news. This has left the market in a situation in which good news is priced in, and the only real surprise will be if it fails to materialize; that isn’t

a good setup.

The risk/reward for investors is not great for 2024 at an index level. But it doesn’t mean all is lost. There are lots of outcomes that would lead to lower bond yields next year, and that will be a tailwind for markets. Bond-like equities that have underperformed for the last year should begin to turn up and outperform. Companies that showed leadership in a high-rate environment may lag. This reversal may be difficult to manage around but could also result in many opportunities for those who are nimble enough to take advantage of the swings and willing to do the work to determine which companies have been overlooked.

The 5% Hurdle

Over the past year, we have all had to wrestle with a new, often uncomfortable question – will that new investment do better than cash? Yep, the hurdle for a good idea has gotten a lot higher, given the risk-free rate, which, at about 5%, is pretty attractive. It has been a long time since we have been paid this much to sit on the sidelines, and based on fund flows into cash products, the bleachers are pretty full. The logic of this increasingly popular choice is sound. Let’s say the long-term annualized return for global equities is 9%. Is that extra 4% over cash returns worth the risk? Especially since there is a ton of variance around that 9% with lots of 20%+ years and lots of negative ones, too.

In a perfect world, equities would return what they usually return plus a few points extra given cash, or the risk-free rate, is providing such an attractive return. Let’s call this a mythical world where the equity risk premium remains steady. (Equity Risk Premium is the excess return from equities over the risk-free rate). What a boring world that would be, and clearly, this world is not boring.

So, let’s dive in to see the historical impact of higher rates on historical returns. Seems like a good time to consider the impact of higher cash returns across the portfolio. Here we go:

We looked at returns from the 1950s till today, slicing the world into periods when the risk-free rate was above or below 3%. On a marginally positive note, the average monthly returns for various equity markets were a bit higher when interest rates were elevated. Global equities returned about 1% higher when cash yields were over 3% compared to below 3%. Also worth noting, the average performance improvement in a high cash rate environment is more pronounced for bonds.

Of great importance is what happens next. If rates continue to rise, say as inflation starts to reaccelerate again, well that is not good for equities and worse for bonds. It's interesting that Canada does ok in this scenario; we will return to that shortly. If rates stabilize up here, well, returns are decent, a bit better than bonds. But if we get rates coming down, that is the sweet spot. Historically, it is very good for bonds and equities.

We would point out that the TSX was one of the best equity markets in the 2022 bear and has trailed other markets in 2023. Given our resource and bank exposure, the TSX has a bit of a built-in hedge against inflation and movements in yields. This helps explain the underperformance of the TSX in the 2010s and may be setting the stage for outperformance going forward, if you agree inflation will be a recurring risk in the coming decade.

It is not just rates that matter so much for market returns, it is inflation, too. And while they both do follow each other rather loosely, whichever is higher matters for future bonds vs cash returns. You see, if rates are higher because of economic activity and inflation is below cash rates, it's good news for bonds. Conversely, if inflation is running higher and cash rates are lower, this is bad for bonds. It is worth pointing out that the bond bear market over the past few years really started to get going at the end of 2021, when cash rates were 0.1% and inflation was 7%. They didn’t stand a chance.

But today, inflation is down to 3.2% (U.S. CPI), and cash is up at 5.5% (3-month Treasuries). You may love the 5% or so provided by cash or cash products, but we love bonds more.

Portfolio Positioning

We would characterize our portfolio positioning as moderately defensive. Holding above-average bonds and cash and less equities. However, there is still enough market exposure to enjoy the party in case this Santa Claus rally makes it all the way to the

holidays, or dare we say, into January, which is typically a good month. But defensive enough that should things begin to deteriorate, we are decently positioned and becoming full-on defensive is just a few short trades away.

Among equities, we still favour international equities given the valuation safety buffer and since earnings estimates have already

been revised lower. The allocation does have a developed market Asian tilt, with a positive view of Japan (more on this below). Underweight U.S. given valuations and earnings that we believe remain too optimistic. And finally, Canada market weight. The dividend factor is so beaten up, valuations so appealing that we can handle the economic risk inherent in the TSX. However, we would point out our underweight on banks… for now. More on this topic below as well.

This has our bond allocation boring as well. Focusing on government, investment grade, and now more comfortable with duration.

Recession risk is rather high as we head into 2024, and defense is the more prudent positioning. We, of course, will be closely monitoring our Market Cycle Indicators. They did capture the improving data trends earlier in 2023 but have started to roll over again of late. The recent weakness has largely been for the U.S. economy, while signals elsewhere have remained stable or even shown some little bits of improvement. If the signals deteriorate much further, we will likely be moving to be more defensive.

Sticking with the party terminology, we are at the party, standing near the door, sipping a light beer.

Japan Still Rising

Our positive view towards Japan started in the summer of 2022 with the rationale based on 1) a crazy weak yen, 2) Japan is a safer way to gain exposure to Asian economies that were coming out of lockdowns later than the West, 3) Valuations had the PE ratio near the lows of the past 25 years and the dividend yield near the top. And it has worked out; Japan is up about 23% since then, roughly the same as the S&P 500’s 25% advance. And well above the mere 10% for the TSX.

The yen did strengthen in late 2022, but in 2023, it reversed all the way back to about 110 yen to the Canadian dollar. In other words, it is still really cheap from a currency perspective. If you have come across anyone travelling to Japan, they can attest to their dollars going a long way, especially if they had travelled there a few years prior.

Of course, a cheap currency doesn’t mean it will go up. One factor that does matter is the relative hawkishness/dovishness of the central banks. For the past year, the U.S. Fed and Bank of Canada (BoC) had been increasingly hawkish, while the Bank of Japan (BoJ) was on this trend, too, but much more tepidly. Today, it appears the Bank of Canada and Fed are done hiking. If we had to guess who cuts first, we believe it would be the Bank of Canada (or should be). Meanwhile, in Japan, the more tepid moves from dove to hawk continue, albeit slowly. Put it all together, the direction of the relative hawk/dove tilt between the Fed/BoC vs BoJ should support the yen going forward. Or the historically high-rate differential between Japan and the U.S. or Canada should narrow or at least not widen anymore. The wildcard is if or when the BoJ relaxes yield curve control, this could result in a rapid rise of the yen.

But a weak yen has a silver lining even if it doesn’t strengthen. It is a boon for Japanese equities, notably those that have exposure to exporting. A good portion of the Japanese equity market sales are external, at about 50%. All these business lines, arguably, are more competitive when the yen is weaker. This should remain a boost for earnings. This is one of the reasons recession probabilities across major economies remain the lowest in Japan.

This brings us to valuations. A year ago, the Japanese equity market was trading about 13x earnings; today, it is about 15x. It's a bit more expensive but still on the cheaper side of historical averages. Price to sales at 0.8 remains near trough valuation levels. In total, it is not as compelling a reason to buy, but it is certainly still supportive.

When it comes to valuations, PE ratio in this case, it is important to remember that it is not just the P (Price) that can move; it is also the E (Earnings). Earnings expectations for Japanese equities have fallen decently over the past year. This may not sound like good news, but it means the market has started to price in an economic slowdown. For instance, earnings for 2024 have come down from 106 in January of 2022 to only 80 today. That is a 25% haircut. Conversely, S&P 2024 earnings forecasts have come down a paltry 7% during the same period. In a nutshell, earnings estimates appear more conservative for Japan vs the U.S. Add

to this that revisions have stabilized and turned a bit up of late.

And then there is diversification. Sometimes good, sometimes bad, the TSX and the S&P are rather directionally correlated. I know, then, why isn’t the TSX up 19% this year like the S&P? Well, it's directional but not necessarily the same magnitude. Besides, the TSX did hold up better in 2022. The S&P does offer diversification as the correlation to the TSX is about 0.6, based on 3-month rolling returns back to 1990. Japan’s index on the surface may look roughly the same at 0.5, but this misses a key factor. Nobody cares about higher correlations when things are going up; it is more important to have a lower correlation when things are going down. Based on the same time period, only looking at periods when the TSX is in the red, the S&P 500 correlation remains at about 0.6, but Japan’s is much lower at 0.3.

Japan in a 2024 Portfolio

Suffice it to say that we remain positive regarding our overweight position towards Japanese equities in a multi-asset portfolio as we near 2024. The original investment thesis has an ever-increasing opportunity to come to fruition throughout 2024 as the BOJ continues to feel inflation, currency, and rate differential pressure. The opportunity is there; it has taken a little bit longer than originally anticipated to develop.

Japan has not been an easy place to invest for the past few decades. The challenging corporate environment has resulted in many portfolio managers being significantly underexposed to the second-largest developed economy in the world. However, it feels like the tides may be turning, as we have seen some improving economic conditions, such as wage growth and EPS growth over the past few years. If you believe in the overall thesis for Japan, do not lean on active international managers for a Japan allocation. Many remain underweight Japan’s weight in the passive MSCI EAFE Index. This presents an opportunity for multi-asset portfolio managers to stand out amongst their peers in what is seemingly a contrarian bet with much-improving fundamentals.

There are a few reasons why managers could still be underweight in Japan, including the perception of limited growth opportunities, demographic challenges ahead with an aging population or the expectation for continued currency pressure. While these are certainly risks for the market, we believe the story of improving fundamentals continues, and throughout the coming years, we expect to see a reversal in the above chart. The BOJ has already taken a few steps to loosen yield curve control and bring growth back into the Japanese economy, and with inflation steadily above their 2% target, we may yet see some additional tightening. The process will not be entirely simple, but if we get a US recession where they eventually cut rates, we may get a more successful pathway to outperformance in Japan. All in all, attractive valuations, a depressed currency, conservative estimates, and a low downside correlation to the TSX are enough to outweigh the risks.

Are the banks a buy? Banking on a better opportunity

Once the bastion of safety, Canadian banks were long heralded as the world’s best boring banks. The big six are, for good measure, a staple across most investment portfolios. Love them or hate them, with a 19.4% weight in the TSX, their fortunes, for better or worse, play a large role in the overall performance of the Canadian market. Thanks to a long, steady history of solid profit growth and consistent dividend growth, it’s no wonder they are held in such high esteem.

But something isn’t quite right. The group is on pace to post their second consecutive negative annual return, falling 9.3% in 2022 and currently down –1.8% on a total return basis compared to a 7% gain for the S&P/TSX Composite for 2023. Consecutive down years are a rare occurrence, last happening in 07-08 and 98-99. Both periods saw pretty decent bounce back for the group, which begs the question: should we be buying the banks?

Positioning and valuations

Across our funds, we’ve been significantly underweight Financials, specifically the banks, for some time. This has worked out well. However, a time will come when we will be buyers. Valuations have declined by a decent amount this year. The average P/E across the big size is 9.3x forward earnings estimates. A full point and a half lower than where it stood at the beginning of the year. Looking back over the past twenty years, there have been only a few periods with such enticing entry points. Those were the financial crisis as well as the brief Covid sell-off. Both periods saw lower earnings valuations, so from a multiple standpoint, sentiment could get worse. On a price-to-book basis, with an average of 1.33, the group is nearing all-time lows but still

trades above one times book value. It's enticing, but in our opinion, not enough.

Storm clouds are forming, and with profit expectations across the Big Six shrinking, we remain firmly on the sidelines. Across the Big Six, earnings estimates for 2024 have declined an average of 12% this year. Even with the recovery amongst the banks in November, the earnings expectations have continued to deteriorate. On Bay St., banks have been diligently slashing costs, with an increasingly widespread trend of reducing headcount. Besides recession concerns, the trajectory of Canadian housing remains front and centre.

Mortgage book quality, negative amortizations, and renewal risks are all large and valid concerns. Shares certainly reflect some of the prevailing pessimism, but are likely not enough.

When deciding whether to add materially to the Canadian banks, there are a number of important factors to consider, which we’ve outlined in the table below. Before we get more constructive, we prefer to see more checks and fewer strikes.

In our previous report, "Preparing for the Next Bull," we also delved into the banking sector. Specifically, investors are shifting focus from growth and profitability to prioritizing credit quality, capital, loan losses, and overall financial strength. Lenders face significant challenges during periods of slowing economic growth, declining yields, and an excess of available capital. When capital becomes scarce and in demand, the advantage moves back towards lenders.

While we anticipate that banks will eventually thrive, we currently recommend a cautious approach, recognizing that there is no immediate need to rush given the looming recession risk combined with concerns about the housing market. Despite attractive valuations and yields, we believe that patient investors may find a better opportunity to buy the banks in the future.

2024 – the year to start thinking differently about decumulation

The topic of ‘decumulation’ – the phase when investors draw income from their portfolio to meet their retirement goals – has become a sharper focus this year. Given our focus on outcome-oriented and lifecycle-driven investing, Purpose has written about

it from several unique angles. These articles collectively address today’s challenges of investing for retirement in Canada and emphasize the need for further education and innovative solutions, personalized approaches to retirement income planning and a shift toward holistic wealth planning. Many Canadian retirees live off the returns of their investments in fear of seeing their

portfolio balances decline and running out of money. Financial professionals who play a role in supporting Canadian investors through this phase must focus on providing them with the tools and education necessary to navigate retirement finances effectively while accounting for individual goals and circumstances. With 40% of advisors’ clients in Canada today in the decumulation phase, this is highly relevant to many investment advisors in this country. As we approach the end of the year, we

wanted to weave four of these articles together into a more cohesive narrative.

"How to Solve Canada's Slow-Moving Retirement Crisis”

There is a retirement crisis slowly unfolding in Canada as a large number of baby boomers transition into retirement and life expectancy increases. The multiple intersecting uncertainties investors face in retirement – around market returns, cost inflation, and the unknown length of each individual's lifespan – make financial planning and portfolio construction immensely challenging. At the same time, the steady disappearance of Defined-Benefit pensions adds to the complexity, as these DB plans had muted the impact of these uncertainties for previous generations. Financial products like lifetime annuities and innovative lifetime income funds (such as the Longevity Pension Fund by Purpose) can play a role, yet much more innovation is needed.

Further collaboration must follow between governments, private-sector firms, and non-profit organizations to provide Canadians with the tools and education needed to navigate retirement finances effectively. Governments have a strong incentive to see this happen, as the goal is not just personal financial security but also reducing the burden on public resources.

Full article HERE

“Consider that a 65-year-old woman entering retirement can expect to live on average to age 87. This average hides variability: she still has a 10-per-cent chance of living past 100, a one-per-cent chance of living past 105 and a tiny chance of reaching 110 or even beyond that (the oldest Canadian on record passed away at 117 years and 230 days). This variability makes determining how much to safely spend from her nest egg rather tricky.”

"Beyond the 4% Rule: Improving Your Safe Retirement Withdrawal Strategies"

The conventional wisdom of relying on safe withdrawal rates, such as the 4% rule, for safe retirement income is inadequate. The approach of self-insuring against the small risk of living a very long life is, for many people, suboptimal, while blindly withdrawing from one’s portfolio without consideration of evolving market and personal circumstances lacks plausibility.

A more dynamic and personalized approach to retirement income planning is warranted for almost all investors. Instead of focusing solely on portfolio management, clients should consider options like delaying CPP and OAS payments, purchasing lifetime annuities, or investing in lifetime income funds. By adding an element of longevity risk pooling to a portion of the portfolio, these products better align the assets with the total needs, making it a sort of personal liability-driven investing (LDI). The key is to tailor the portfolio approach to each individual's goals, risk tolerance, and desire for guaranteed income versus flexibility.

“One notable by-product of following this approach is that an investor should expect to leave to their estate an amount approximately equal to the “real” value of the starting retirement account. For some people, this might nicely align with their personal preferences and wishes, while it might be of little value for others and create suboptimal outcomes, effectively obligating them to leave a sizable estate even if that’s not their intent.”

Full article HERE

"Why Separating Planning for Retirement Income and Estate Goals Can Lead to Better

Outcomes"

It is important to clearly articulate retirement income and estate planning goals and the trade-offs between them to achieve better outcomes for retirees. The traditional investment approach utilized during accumulation must be fundamentally rethought as clients enter the decumulation stage. Here, a holistic wealth planning approach is needed that considers clients' goals around spending vs. leaving a meaningful estate for their heirs and frames the client’s complete financial picture. The retirement portfolio can be divided into three functional sleeves:

the first sleeve is for basic income needs (e.g. housing and healthcare) with lower-risk investments a housing and healthcare) with lower-risk investments and steady cashflow; though not addressed in the article, suitable asset classes here would include ultra-short duration bonds, money market instruments, and lifetime income funds (e.g. annuities, longevity risk-pooling mutual funds, etc.).
the second sleeve is for the client’s “wants and wishes” spending (e.g. travel, hobbies, gifts), with more risk-tolerant investments and less cashflow requirements than the basic needs sleeve; suitable asset classes to support this spending could include global equities and corporate bonds with less allocation towards cash and lifetime income funds.
The final sleeve is purposefully designed for the estate, with a longer-term investment horizon allowing investors to take on more risk with little liquidity; additional asset classes to consider as part of this sleeve include long-duration bonds, private assets and alternatives.

The objective is to align investments with the client's desired lifestyle and legacy goals while balancing the trade-offs between those two.

“Every advisor will differ in what investments they use for their basic needs, wants and wishes, and estate sleeves, and how much to allocate towards each investment. What’s critical is that they first identify their clients’ goals across each of these sleeves and use outcome-oriented investments designed to reach each of the specific sleeve’s objectives.”

Full article HERE

Help Wanted: Navigating Decumulation for Plan Members

Decumulation is a critical transition within the second pillar of the Canadian retirement system: workplace savings programs. The challenges of converting lump sum retirement savings into lasting income are probably most acute for this group of middle-income Canadians. As these plans evolve, employers must maintain focus on helping their plan members achieve income security in retirement. With a growing number of Canadians entering retirement, portfolio construction alone cannot address the income planning challenges caused by lifespan uncertainty. It’s important to provide retired workers with complete confidence that their income will endure throughout their lifetime. Various strategies can be embraced by employers to make these savings

programs more effective, including allowing members to stay in the plan after retiring, offering in-plan retirement income product options, providing financial planning consulting, and establishing a variable benefits program. For advisors, it’s essential to factor these workplace plan assets into your clients’ holistic financial picture, even though they fall outside the account they hold at the firm.

“But what do plan members want? Greenwald Research found that workplace retirement plan participants in the United States are looking for more options, specifically those that generate retirement income for increased security: 85% of plan participants wished their employer’s retirement plan offered an option designed to generate a stream of income in retirement. Consequently, the decision to include decumulation options is intensifying through industry associations.”

Full article published in Jul/Aug issue of IFEBP’s Plans & Trusts

Final Note

We’ve explored decumulation this year as a generational societal challenge and as a dimension of employers’ overall pact with their employees as key stakeholders. We’ve argued why applying simplified heuristics is inadequate and then shared a new approach to compartmentalize an investment portfolio into ‘sleeves,’ each in clear pursuit of a specific objective. Everyone involved in wealth management for retirement has an important role to play. Yet investment advisors, as trusted partners to their clients, can make a pivotal difference in whether those clients achieve their desired outcomes – or fail to. In 2024, rise to this challenge and lead as the tide continues shifting towards decumulation thinking.

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Greg Taylor and Derek Benedet Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

Inflation Victory Lap

Mon, 20 Nov 2023 17:18:40 GMT

Inflation Victory Lap

Grab that bottle of Veuve and give your sabrage skills a test; inflation is over, and it's time to party. Well, that is the way the equity markets have rejoiced on a handful of data points supporting the view that inflation risk is quickly fading. Rejoice may be a bit of an understatement; the S&P 500 went from woefully oversold at the end of October to being overbought a mere 2 1/2 weeks later (as measured by S&P 500 relative strength, aka RSI). The old adage is markets take the stairs when going higher and the elevator when lower, denoting the amount of time passing (stairs being slower than an elevator). Well, over the past few months, it has been the opposite after a three-month steady grind lower and a sudden jump higher.

This swing in the RSI measure isn’t unprecedented, but looking back at the past 25 years, it certainly doesn’t happen often. Most past occurrences followed more tumultuous declines, such as the Asian crisis or a few during the multi-year tech bust. But let’s not diminish the good news – Inflation and the response to inflation by central banks (rates/yields) have been the greatest angst for markets during the past couple of years. Cooling inflation fears is a HUGE positive for markets.

Among all the components of the CPI index, some react to changes more quickly than others. The faster moving parts are coming down quickly and are now flat on the year (chart). The slower components are still high but also appear to be starting to roll over.

We are not saying inflation is over, nor that it will follow a nice orderly decline back to that sweet spot of 2%. In fact, we believe it will become more volatile in the years ahead. And while it may get down that low (or even lower), the swings will be higher than in recent history. A lot of long-term factors will keep it higher than in the past decade. Yet, with the news at the moment, we appear to be clearly on one of those downward trends, so let's party.

Cooler inflation data and cooler economic data have helped bond yields come down. Measuring the 10-year Treasury, yields dropped from 5.0% at the S&P 500 low near the end of October to 4.46% at the time of writing. So does a 50bps yield drop equate to a 9% or near 400-point rise in the S&P 500? The lower yield does open the door to some multiple expansion. The market weakness in October was primarily caused by high yields. If 50bps = 9%, well load up. We think yields will continue to grind lower on softer economic data. Unfortunately, that “math” won’t hold. There has been something else afoot in the month of November… stimulus.

In a simpler world, higher overnight Fed funds rates plus gradual selling of bonds at about $50 billion per month from the central bank’s $7 trillion hoard would equate to tightening financial conditions. Or Quantitative Tightening (QT), the opposite of Quantitative Easing (QE). But just like inflation, Q (E or T) doesn’t move in a straight line. The Fed’s balance sheet has continued to grind lower, but the general account and Repo market (Reserve Repurchase Agreements) have not. In June, with the debt ceiling kicked down the road a bit, government bond issuance jumped higher to replenish the general account (the government's

chequing account). This would add to tightening, sucking money out of the financial system. But, the Repo market simultaneously started to move lower. Think of the Repo market as a place where money ended up when there was too much money sloshing about, and it has ballooned since 2021.

Declining Repo balances is money making its way into the financial system (QE). From mid-June till the end of October, this was largely offset by a rising General Account (roughly net neutral). But since the General Account was replenished back to the more historical balance of $700-800 billion and given the Repo market keeps declining, this equated to QE since mid-October and into November.

Final Thoughts

We are not saying the cooling inflation plus softer economic data bringing down bond yields isn’t the main good news story of this recent rally. It likely is, and it is really good news. But stimulus has increased the magnitude of the gains. So what happens next? The Repo market, which before 2021 was near a zero balance, could continue to drain. At $1.26 trillion, it still has a ways to go. If the General Account remains stable, any faster draining of the Repo above $50B per month to offset the Fed’s balance sheet reduction would be stimulative. So this could have further legs, perhaps even leading to that Santa Claus rally many like to talk

about.

Alternatively, if the draining of the Repo slows or if bond yields stop heading lower, this market rally may run out of steam, becoming more of a Turkey rally (American Thanksgiving Turkey, that is). Wouldn’t stand in the way of it, but this is a renter’s rally. Especially given earnings revisions have turned flat to slightly negative and economic data is softening, making the underlying foundation not so solid.

— Craig Basinger is Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

Active & Passive

Mon, 13 Nov 2023 17:53:25 GMT

Active and Passive

This is a reprint of ‘Portfolios with a Purpose,’ a monthly publication spearheaded by Brett Gustafson focused on important portfolio construction topics. Other editions can be found HERE , and we listed the topics with links at the end of

this post.

The debate between passive and active is not something new. There are strong arguments that can be made for both sides, but in our eyes, there does not necessarily have to be a clear winner of this battle. Investors who are fans of passive index following strategies often argue passive has a fee advantage and clear, strong performance. Proponents of active management often cite the mutual social good of price discovery, that certain markets are less efficient, and the importance of risk management controls around concentration.

The debate is often framed in a binary fashion— either active or passive. Yet, from a portfolio-construction perspective, investments, whether active or passive, are building blocks for building a portfolio. How the pieces are selected and fit together, given exposure to different factors at different costs in different markets, is much more important than an academic debate. After all, at the portfolio-construction level, all investment decisions are active, even if you opt to use market capitalization-weighted passive vehicles or more active strategies designed to gain or reduce exposure to certain factors.

Shades of Grey - Terms can be misleading, so before we get into the weeds of the active vs. passive debate, we should clarify a few things. Passive investing has changed a lot since Jack Bogle championed the case for index investing decades ago. Index investing is simply a way to gain exposure to an index. Historically, most indices were aggregates of certain securities trading in a certain market and weighted based on market capitalization. Funds or ETFs that track these indices are some of the largest in Canada and the United States. They feature massive liquidity and usually small fees. Active investing is any deviation from a set benchmark with the aim of a different performance experience. This can be in search of higher returns, less volatility, or even uncorrelated returns.

Given there is no shortage of available strategies, it is better to think of active to passive as a spectrum (Figure 1). A fund or ETF can sit anywhere along this spectrum, depending on the implemented strategy. And it’s worth noting that structure does not imply the strategy any longer. There are some funds that are passive and ETFs that are active. Life used to be simpler in the olden days.

The far-left - The far left of our active/passive spectrum is where you would find pure beta, low-fee index exposure ETFs and funds. The goal is simply to match the market returns of an index for a low fee.

For these, it is crucial to know and understand the underlying index. Are there concentration issues? The NASDAQ QQQ ETF has an 11% weight in Apple and 10% in Microsoft. There’s nothing wrong with that, as long as you’re aware of it when combining it with the rest of your portfolio. Even the broad-based S&P 500 Index can become very top-heavy. The S&P 500 has seen mega-cap names become increasingly weighted in the index. TSX, too, has seen material concentrations at the company level and sector level. Concentration is a risk that is worth considering. It can be an opportunity for active strategies as well if those megacaps

begin to underperform. Remember, there is very little control for the risk in an index.

There is also market efficiency, as some underlying markets are more efficient and some are not. For a passive strategy, consider if it is easy to trade or if there are market inefficiencies. Fixed-income indices are often difficult to fully replicate and inherently provide higher weighting to the most indebted companies. Perhaps that is not the most ideal weighting scheme. Real estate and other private markets are also not well served by passive investments.

The far-right - Often, the most active strategies are simply trying to produce a materially different performance experience. Some are focused on the outperformance of their respective asset class. Others are attempting to produce lower volatility or provide uncorrelated performance for diversification benefits.

Manager selection and strategy are paramount here. Costs tend to be higher, so make sure it is truly a differentiating strategy. Active share can be a useful way to determine how closely a fund mimics its underlying benchmark. Research suggests that the deck is stacked against active managers when it comes to long-term performance. However, active management can still outperform – given the right combination of talent and discipline…a little luck never hurts either.

It’s important to pick your markets. Active managers typically have a better edge in markets that are less efficient or poorly designed in the first place. It’s very difficult to have an edge in large-cap U.S. equities, but emerging markets, preferred shares, and other smaller, less liquid markets are where active managers have a real edge. Some would include the TSX in this bucket of less efficient markets. Due diligence for any investment is important, but even more so for actively managed funds. There is a big divide between the best and worst, whereas there are only small differences when it comes to selecting between passive ETFs.

Everything in between - It’s the middle of the spectrum where the lines begin to blur. It’s where we’d place your smart beta, factor, and quant funds. Their primary aim is to provide alpha at lower prices by being systematic in nature to isolate certain exposures. Whether it's equal-weighted ETFs or single factor-based ETFs to gain exposure to dividends, value, momentum, etc., these investments typically are quant-based and don’t have a team of analysts doing bottom-up analysis.

The actual management may be mechanically passive, but it is certainly an active call, leaving it up to individual investors to decide which risk factors to get exposure to. In essence, these tools now make it easier than ever to unbundle a portfolio and allow investors to actively select which risk factors will be purchased. Systematic strategies can help enhance portfolios by providing a cost-effective option to gain specific exposures, but even if they use passive ETFs, these types of investments begin to lean more active.

Similarly, actively managed mutual funds that have a low active share and low turnover probably lie somewhere in the middle of the spectrum. You might be paying active management fees, but the returns will largely resemble benchmark returns less the fees. As new products continue to evolve, the lines between passive and active will continue to blur. Terms such as enhanced index construction or adding ESG considerations to market indexes are both examples of how product manufacturers can create something new with a bit of a tilt.

The active-passive experience

It is true that for the last decade, passive management has wildly outperformed active management in the largecap U.S. market. But prior to that, the experience was not the same, and moving forward, we do not expect it to be either. The chart below is specific to US Equities in the Large Cap Blend category but has enough funds in the category to make the case for cyclicality.

It is clear that in periods of economic uncertainty, active has the edge. From 2006-2011, active was the clear winner, and more

recently, active has crept towards the upper percentiles as passive returns lower. As described above, there is an opportunity for

active managers to outperform in more challenging markets.

But confirming our belief that passive and active is cyclical is the decade-long run of outperformance throughout the 2010s. It is not a coincidence that this outperformance overlaps with one of the greatest bull runs in US equity history. The 2010s was a decade pushed forward by a low rate, low inflation, and a highly accommodative monetary environment. This allowed growth equities to flourish, which is more represented in U.S. market cap indices. This decade run also produced some of the largest index concentrations we have seen. It also should not go unnoticed that the 2010s saw the creation of a majority of the passive index ETFs that exist today; we saw a massive migration of capital into these newly created products, which also pushed the

performance higher. It was a consistent cycle of new capital, extension of a bull run, accommodative policy, and increasing concentration, resulting in outperformance of growth.

What this shows is that there is a case to be made for both active and passive in a portfolio. Having a mix of both management approaches sets your portfolio up for any unexpected environment. Rather than determining whether to be all active or all passive, higher on the scale of importance in portfolio construction is how the pieces of the portfolio complement each other. To achieve the goals set out for the portfolio, the components must work with each other and against each other to manifest strong portfolio diversification. Actively managing each piece of your portfolio is what is going to achieve success, not whether you chose an active equity mutual fund or a passive equity index ETF.

Final Thoughts

Breaking away from the active vs. passive debate is easy when thinking of asset allocation decisions from a portfolio perspective. In constructing and managing portfolios, you make active decisions, regardless of the solutions or products you choose to include. Whether you are adding U.S. exposure or tilting a portfolio more into growth, those are decisions you must actively make. Even if you use a passive investment, you still actively make that decision at the portfolio level. Below is a checklist of sorts or specific areas to consider during the investment vehicle selection process for potential inclusion in a portfolio from the lens of active vs passive. This is not an exhaustive list:

As you can see, it is not only about active or passive. Ask yourself: what does an investment bring to the existing portfolio? Does it provide added exposure to a factor that you believe will benefit the portfolio given the macro market environment and outlook?

Whether to go active or passive, is much lower on the totem pole decision-making process. We have found complementing low-cost passive with active provides a much more diverse and resilient exposure in various asset classes from bonds to equities. As in many different areas of investing, there is no winner, simply building blocks for a portfolio.

Insights with Purpose

At Purpose, we are attempting to change the status quo within the investment industry. Mainly, the enigmatic standards by which the industry operates. We are an open book when it comes to portfolio design and discussions surrounding our outlook and strategies. We want to make managing portfolios simpler for advisors and act as a sounding board for ideas. We start by running portfolio comparisons between your portfolios and ours. Not to say ours is right and what you are doing is wrong, but to understand the differences and have discussions surrounding the rationales. We aim to keep this discussion going quarterly, this is not a one-and-done service. We want to build our relationships with advisors so that the end client has a satisfactory investment experience.

If you want to know what exposures your portfolio is tilted toward, feel free to reach out to our team . As the great Peter Lynch once said, “Know what you own and why you own it".

— Brett Gustafson is a Portfolio Analyst at Purpose Investments

— Craig Basinger is Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

Year-end Rally?

Mon, 06 Nov 2023 17:29:27 GMT

Year-end Rally?

2022 was certainly a rather painful year for investing. There were more central bank rate hikes than any of us would care to count, yields moved from ultra lows to the highest in a few decades, and markets took it on the chin. Worse yet, everything moved together as both equities and bonds fell. Sadly, that is what happens when rates, or the discount rate, go from near zero to 5%. As

usual, the market went too far, and a bottom was put in about a year ago in October, after which a decent rally ensued.

And that’s the way it's supposed to work, right? If investor memory is limited to the last few years or even the last two decades, any material sell-off is “always” followed by a recovery, which then goes even further to make new highs. That mindset was further cemented in 2020. Sadly, if you have a long memory, you may well realize this is not the norm. We are likely in a repricing

of everything environment. After more than a decade of too much capital floating around, costing too little (aka low yields), and being used for perhaps non-economical endeavours, the reversal is now on. And the reversal will likely be a long process, longer than a few months or a few quarters. Which we believe ends in a recession.

Fortunately, nothing moves in a straight line, and that is certainly the case for markets. The market rally over the past twelve months that peaked at the end of July was very impressive. This was followed by declines from August through October, a seasonally weak period. The main culprit was rising bond yields, not due to inflation concerns like in 2022, but instead due to a strong U.S. economy and the very aggressive issuance of U.S. Treasury bonds into a market that has some historically resilience buyers not as enthusiastic.

The good news is the strong issuance is slowing for now as the general account has been largely replenished after being bled dry during the debt ceiling self-induced stress. And economic growth, even for the mighty U.S. economy, is slowing. This has bond yields coming back down, which could very easily set the stage for a pleasant year-end rally, which may have already gotten started.

Bonds – We don’t believe the market needed to hear the Fed indicate they are likely done. If more people bothered to look at the recent data, some cracks are increasingly showing up in the economy and the trajectory of inflation data, all of which the Fed certainly looks at – they ought to be done and may have already gone too far. That is good news for bonds; the chart below is the 10year yield before and after the Fed stops hiking. The path is predominantly lower; yay, bonds up.

Stocks – We’re not big fans of seasonality, but we certainly are aware of it and the evidence behind it. The fact is, year-end rallies happen more often than not, and those gains can be impactful. Perhaps that has already started as the market, measured by global equities, had fallen 11% from August 1 through the end of October but has not ‘bounced’ 4%. Earnings season is over, company share buy-back blackouts are largely over, sentiment has turned rather negative (AAII is 50% bearish, 24% bullish), markets are oversold (less so after the past week), one could easily argue the table is set for a year-end rally.

The data doesn’t lie, and the above chart is rather compelling for both the S&P and TSX. But we would temper this with the knowledge that averages often hide more than they reveal. Yes, over the past 50-someodd years, the average price gain for the TSX and S&P has been positive and stronger than other periods. However, that range of performance goes from +13% to -10%, and it was positive about 2/3rds of the time, conversely negative the other 1/3. So the chart looks great, but there remain many

outcomes.

Still, seasonality is an incremental positive. We remain in the same camp as before. We believe inflation is cooling and will fade as

a near-term issue (likely to return in future years). The recent move higher in yields was driven in part by a strong U.S. economy, partly thanks to QE being turned back on temporarily back in March and a very healthy or resilient consumer. Getting so tired of the word “resilient.” The higher yields were also a short-term supply/demand issue, which is starting to fade (again, for now). Pile it all up, and yields should cool, and we may have seen peak yields.

Falling yields will help the equity market move higher. Yes, bonds and equities are moving in the same direction, up this time, so I highly doubt anyone will complain. How far it could go is challenging as next year is quickly becoming the problem. 2024 recession risk is high. Corporate margin risk is high. We are renters of a year-end rally.

Who yields first?

Despite recent noteworthy moves in the currency markets, overall volatility measured by the Deutsche Bank FX Volatility Indicator remains rather subdued. Japan has been in the news, with the Yen falling to near a 33year low after the recent Bank of Japan’s policy move. Besides that, the moves in FX land have been more plodding along and less spirited compared to certain periods

over the past few years. Global rates being higher for longer is sure to ramp up some financial drama. Higher rates have this

ability to expose weaker players both at a company as well as at a country level.

This is the primary reason why the Canadian dollar has slid against the U.S. dollar over the past four months. Declining as much as 5.8%. Quite the move in currency land. Surprisingly, the Canadian dollar has shown more resilience against other currencies than it might seem. In the chart below, we plot the loonie’s returns against several other key currencies over the past six months, and it’s actually held up rather well, outperforming the Pound, Euro, Aussie dollar and the Yen. So no, the loonie isn’t in peril, but Canada does face a number of challenges.

Whether it’s credit losses, liquidity crunches, or simply exposing high leverage and weak hands, tighter financial conditions can impact countries just as much as companies. This would explain the swift shift in sentiment for the Canadian dollar in both futures as well as spot markets. The critical question is which central banks will yield first. Both the Fed and BoC have expressed caution, saying it’s too early to wave the victory flag after their battle with inflation. While both have moved in tandem over the past year and a half, Canada was the first to pause and may be the first to cut. The market is making its bets, but such big shifts are inherently unpredictable.

The surprisingly resilient economy south of our border in recent months has helped push the U.S. dollar higher. Mounting recession fears and lower growth expectations across Europe as well as in Canada have pushed these currencies lower. Nonetheless, the market is still pricing in more rate cuts for the Federal Reserve than other major central banks despite the reality of a more resilient U.S. economy. This is highly incongruous. If the Fed is indeed cutting, we believe others, such as the BoC, will be cutting first.

Key drivers of the CAD-USD relationship remain economic factors, commodity prices, market sentiment and monetary policy. These factors manifest in the bond market. In the chart below, we can see that despite oil moving higher since the summer, rate differentials have trended lower, placing the Canadian dollar at the lower end of a year-long range. Previously, this would be an area that might have prompted the consideration of partial hedges. However, we continue to hold a near-term positive view of the USD due to several factors. Rate differentials make the U.S. a relatively attractive destination for investment. This favours the USD. The spread – or gap – between the yield on benchmark Canadian and U.S. debt was 42bps this week, the highest level since the spring. To think that in June, the spread had all but evaporated.

The graph below illustrates the market’s growing dovish expectations of the BoC growing over the past few months. The implied March 2024 central bank rate for the U.S. and Canada was nearly equal in the summer; however, the market is pricing in a 32bps difference within the next four months, suggesting that the BoC will act first.

The Dollar Smile Theory, although somewhat theoretical, remains a core currency concept. The graphic below is a simplified version that outlines three broad scenarios for the dollar and everything else. A stronger dollar occurs when the US is the big relative winner versus everyone else in terms of growth. This is pure American exceptionalism. The other side is when the dollar benefits from a global downturn, sparking safehaven demand for the U.S. currency. Two opposite ends of the spectrum, but both

result in a strong dollar. The dip in the middle is when the dollar is weaker, indicating global economic stability or synchronized

growth. Given these scenarios, our base case remains a looming recession. It could be global but possibly less synchronized. In

either case, we believe the more likely scenarios will result in sustained dollar demand.

Our outlook for the CAD is more cautious, with a downside bias. Although, near-term, we could see a technical bounce from oversold levels, there remain several major factors that present risks. Chief among them is the potential that Canada is likely to experience a deeper economic slowdown. Though fluctuation in commodity prices may have an impact in the near future, we don’t see the recent strength in the energy market to provide enough of an updraft for the loonie to fly. For now, we prefer unhedged U.S. exposure, believing the Bank of Canada will maintain a relatively dovish stance compared to the Federal Reserve, which will weigh on the Canadian dollar.

Market Cycle, Positioning, Probabilities

There is some good news out there, and that good news is things have gotten a little worse. Yes, we are all living and investing in the upside-down (thankfully, no Demogorgon for those Stranger Things fans). It is upside down because signs of weakening economic data is a good thing. It further alleviates inflation concerns, which we believe will continue to fade. The weaker data also helps bring those bond yields back down a bit, and given much of the equity market weakness over the past few months was largely caused by higher yields, weaker data equals good news…..for now.

And the data is getting weaker. Yes, we have all heard how resilient the U.S. economy is, and it did just post a 4.9% annualized rate for Q3. We would also point out that everyone had come around to seeing the U.S. economy really took a step up in the summer, which is embedded in that GDP print. More recently, though, the strength appears to be oscillating back to weakness. The October U.S. labour report was a miss. We are also seeing further weakness in a number of our Market Cycle Indicators.

Three Market Cycle indicators for the broader U.S. economy flipped to bearish. GDP Now from the Atlanta Fed dropped. This GDP measure doesn’t track GDP but instead uses a number of more timely inputs to gauge how the economy is doing, ‘today.’ After all, the official GDP, which was just released in late October, tells you how the economy was doing all the way back in July, August and September. Consumer sentiment also dropped, and unemployment ticked higher. The unemployment one is a big deal; it has risen to 3.9%. This may sound inconsequential, but unemployment is now +0.5% from its cycle low of 3.4% back in

March. A half percent move in unemployment has been a very reliable early indication of a recession.

Add a drop in housing starts that flipped from bullish to bearish, and the drop in all the indicators came from America. Our belief is the economy is slowing, more outside North America, but it's coming back closer to home now, too. The U.S. enjoyed a positive economic growth bounce in the middle of this year, which everyone jokingly attributes to the Barbie movie and Taylor Swift. But now, with the movie fading and Taylor focused on the Chiefs, things are slowing down. Ok, now I’m really kidding. More likely, quantitative easing was turned back on in the spring to help out U.S. banks. This likely injected capital, suppressed yields and led

to this uptick in growth. Whatever the cause you prefer, we believe growth will fade into 2024.

Portfolio Positioning

In terms of portfolio positioning, we did add a bit to bonds when yields spiked higher. So clearly happy to see them coming back down a bit. This change increased our government and duration a little, as we used cash to fund the change. In equities, we

prefer safer vehicles with an affinity toward dividend-yielding shares, which we view as attractive value. We remain overweight international. Within the fixed income space, we prefer the safety of investment grade bonds and government debt, believing the risk/reward trade-off in the high yield space is not yet tilted in the investor's favour. Despite the continued sell-off in emerging market shares, we’ve yet to even dip our toe into this asset class. Within alternatives, we prefer real assets and defensive strategies.

Probabilities

Markets have come down in August, September and October as bond yields have risen (aka bond prices down). Things certainly became oversold on a short-term basis, and we believe the bounce has started. We slightly increased our probability of equity

markets moving higher in the next three months. However, longer-term views have not moved.

The table below is a synopsis of some of our behind-the-scenes debates, analyses, and even arguments. We hope this provides some added insight into our process but also into our conviction on current positioning. This will become a standard component of future updates so we can all monitor changing views, opinions and, of course, positioning. If you would like to compare it with last month's (HERE) – but really, as mentioned, there are just minor changes from that edition.

The Final Word

Markets and the economy are gradually adjusting to higher costs of capital (higher yields/rates) and less abundant capital. The process will take a long time to work its way through, causing both up and down oscillations in the stock and bond markets. This will also likely lead to a recession that may not be as soft as the consensus believes. This does have us still leaning with a moderately defense stance in our multi-asset portfolios. But still with enough exposure to benefit from a potential rally into year-end. If this does transpire, we would anticipate getting a bit more defensive on strength.

Year-end rally or not, hard, soft or no landing, either way, markets are making progress and steadily getting closer to being in a much better place to start the next cycle.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

— Derek Benedet is a Portfolio Manager at Purpose Investments

— Brett Gustafson is an Analyst at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Purpose Investments Inc. is a registered securities entity. Commissions, trailing commissions, management fees and expenses all may be associated with investment funds. Please read the prospectus before investing. If the securities are purchased or sold on stock exchange, you may pay more or receive less than the current net asset value. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated.

Forward Looking Statements

Forward-looking statements are based on current expectations, estimates, forecasts and projections based on beliefs and assumptions made by author. These statements involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed,implied or projected in such forward-looking statements. assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. Neither Purpose Investments nor Echelon Partners warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. These estimates and expectations involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. The particulars contained herein were obtained from sources which we believe are reliable, but are not guaranteed by us and may be incomplete. This is not an official publication or research report of either Echelon Partners or Purpose Investments, and this is not to be used as a solicitation in any jurisdiction. This document is not for public distribution, is for informational purposes only, and is not being delivered to you in the context of an offering of any securities, nor is it a recommendation or solicitation to buy, hold or sell any security.

Earnings Hits and Misses

Mon, 30 Oct 2023 15:18:02 GMT

Earnings Hits and Misses

We are about halfway through the U.S. earnings season, with 245 of the S&P 500 having already reported. Earnings are rather backward-looking, kind of like GDP reports, since the quarter started in July and ended in September. Nonetheless, companies offer a direct look at what is happening on the ground and their expectations for the coming quarters delivered via guidance.

We would include Canadian earnings as well, but only 14% of the TSX has reported. Things move a little slower up here. So, let’s dive into U.S. earnings.

There is some good news: earnings growth has returned. After three quarters of negative or no earnings growth, Q3 2023 earnings appear to be coming in at about +5% compared to the same quarter last year. Based on current bottom-up analyst estimates, earnings growth is expected to continue to improve up to about 10% or so.

Continuing on a positive note, about 80% of companies have so far surprised to the upside. That is in keeping with historical norms. Impressively, this was widespread across all sectors except Energy. Growth, too, was widespread, with all sectors except Energy, Materials and Real Estate showing positive earnings improvement over last year. With commodity prices lower than a year ago, that is what drives the earnings in Energy and Materials, so it is not surprising. And, of course, Real Estate continues to struggle. Margins have also remained resilient. Yes, costs are up, but so is top-line revenue growth for most firms. Overall, it was a decent earnings season so far.

While on aggregate, it does appear that things are holding up or even improving from an earnings perspective. But it is important to remember periods of higher inflation create a great deal of confusion, not just for people making decisions but for businesses and even for economists. Inflation churns up the water, making it hard to see what is happening in the economy.

There is no denying higher inflation helped offset higher input costs to maintain margins and help restore earnings growth. The question is not what happens as prices and producer prices come back down. Without the ability to raise prices, either input costs have to reverse as well, or margins suffer.

So, will input costs come down? Ford appears to have resolved the strike and, as a result, removed profit forecasts. Sure sounds like input costs may keep going up even as inflation comes down. This may put margins at labour-intensive industries at greater risk in the coming quarters.

There is another cost that is starting to bite: interest expense. In 2022, when yields started to rise, there was much talk about how great a job corporate America did on extending the terms of their debt when yields were so low. Absolutely true, and this has helped. But as time goes by, it starts to show up more and more as rising interest expense.

Final Thoughts

We are encouraged so far by this earnings season, but we also are starting to see forward estimates come under a bit of pressure. It is important to focus on the composition of companies, their ability to pass through costs, how labour-intensive their operations are, and what the debt situation looks like.

Estimates for 2024 remain too high in our opinion for the S&P 500, and we believe this adds to risk. Canada and most international markets have already seen a rapid decline in estimates, which does provide a margin of safety. U.S. earnings appear the most at risk, but it really depends on the industry and the company.

Sorry, there is no quick and easy shortcut here, just the conclusion that digging deeper into fundamentals is

becoming increasingly important in this challenging market.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

The Thematic Riddle

Mon, 23 Oct 2023 15:29:25 GMT

The Thematic Riddle

Okay, we will start this week with full acknowledgement that this edition is a bit self-serving; it’s about thematic investing, and yes, we launched a thematic focused strategy last week. But we would like to share ‘Why’ we created this strategy, beyond the obvious fact that we manage money. We believe investors face a number of big hurdles when investing in thematic ETFs, which

we are trying to address.

The essence of thematic-focused investing is, at its core, a really good idea. There is no denying that the world changes over time, and often there are long-term tectonic shifts. In years past, we have all witnessed the rise of smartphones, or the rise of cloud computing, and healthcare spending due to advances in solutions and aging populations. Identifying these trends isn’t that

difficult as they become increasingly evident as society evolves and behaviours change demand patterns.

More recent themes include EGaming, cyber security, AI and the ever-popular rise of electric vehicles (EVs). Securing electronic data in an ever more electronic world remains a top priority for people, companies and governments. Demand to secure data from unsavoury characters is something that will likely continue to grow faster than the overall economy for many years to come. Or EVs, which continue to gain market share among total vehicles sold, is forecast to continue for many years, if not decades.

Naturally, creating an ETF or fund that attempts to capture one of these faster-growing or exciting themes is a good idea. And investors agree if you measure agreement by the inflows into thematic ETFs. The previous chart is the number of shares outstanding in thematic ETFs, which has exploded over the past few years. We use shares outstanding instead of market value as this avoids the impact of changing market prices. Even in the past couple of years, which have been more of a risk-off environment for investor appetites, thematics have increased.

BUT, there are some hurdles investors face with investing in these high growth potential thematic ETFs.

1) Which one(s) to invest in?

To put it plainly, thematic ETFs can offer outsized returns, but they can also offer outsized losses. The variability or disparity of performance is massive. If you are buying a Canadian bank and you pick the wrong one, it’s unfortunate, but the disparity is low, so not too much of an issue. Pick the wrong thematic—yikes. What if you chose the Marijuana theme? Tough times of late. More optimistically, if you picked AI, you won.

The nearby chart is the 50 largest thematic ETFs listed in the U.S., showing the 1-year price change. Yes, you are reading the chart correctly, that is from +47% to -32%. Even those poor-performing themes are still enjoying a long-term growth trend in their industry. But investor appetite is a fickle thing; it can change a lot from one year to the next. Or a theme can experience a headwind of some sort or another, such as changing legislation.

Pick the right one, you win. Pick the wrong one, you lose. Even some of the poorest-performing thematics over the past year are still focused on a theme that has great prospects. Some are down because they simply went up way too far the previous year. Picking who will win in the next year, now that is challenging.

2) The lure of performance chasing

Performance chasing is evident in all kinds of investing; it is very evident in the thematic space. An artificial intelligence (AI) ETF is one of the big green bars on the left of the previous chart. Up about 40% over the past year, with all that gain reached by the end of May this year. In other words, flat over the past five months. At the end of May, there were 9 million shares outstanding for this ETF, today, there are 24 million. In simple terms, most of the money in that ETF came in after its gains.

To further show this performance chasing, we broke down thematic ETF price range into four equal buckets (quartiles). Quartile 1 was the lowest 25% of prices over the past five years. Quartile 2 was the next 25%, still below average but not as cheap. Quartile 3 is above average, and Quartile 4 is the most expensive. We then measured ETF flows during these four price ranges.

Guess what? The VAST majority of inflows from investors occurred during the more expensive price ranges. In fact, during the cheapest quartile, there were outflows. Buy high, sell low has never been a viable long-term strategy.

With the same universe of thematic ETFs, we measured the actual return experienced by investors using money-weighted returns. Comparing this dollar-weighted return to if an investor had simply held the ETF all along. This is more evidence that the average investor has had a tough go with thematic ETFs.

3) No sell discipline

Contributing to the previous evidence of poor timing is an apparent lack of sell discipline. Even thematic ETFs that have seen their share price fall 40, 50 or even 80% over the past few years have seen very few sell. One of the largest thematic ETFs in the U.S. is down 75% since early 2021 and still has about the same number of shares outstanding. Congrats on being a stable investor and sticking with your conviction. Unfortunately, you are now poorer.

The challenge is, if you believe in the long-term theme, why would you sell? Yes, 50% of cars sold in 2035 may very well be EVs, so just stick with the EV thematic ETF and ride out the peaks and troughs. But what if the composition of the ETF doesn’t capture the theme as the companies involved change over time? Most auto manufacturers now sell EVs, clearly not pure plays like in years past when it was just one or two new companies making EVs. One of the biggest EV ETFs was up 62% in 2020, up 28% in 2021 and down 34% in 2022. Yet the theme continues its path.

Unfortunately, you can’t use valuations as a sell signal. Many times, the underlying thematic companies are very expensive to begin with. They can become more expensive and may still be expensive even if they fall by 50%.

A lack of sell discipline and stubborn attachment to thematic ideas has caused many investors to take the full ride, up and down. Sometimes, it’s more down than up.

Final Thoughts

Thematic ETFs can offer a growth boost for portfolios. Plus, given the composition of the TSX and its lack of growth (lots of dividends, not as much growth), many Canadian investor portfolios are light on the growth factor. There are many options available, covering many different themes, from many different ETF providers that could actually experience a positive tailwind for many years. But the data clearly points out that picking a theme or two or five and jumping on board is not the best path.

Thematic ETFs are an exciting part of the market that lack a disciplined investment process. To help solve this problem, we launched our strategy.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

Sometimes Even a Free Lunch Can Taste Bad

Mon, 16 Oct 2023 19:28:59 GMT

Sometimes Even a Free Lunch Can Taste Bad

Harry Markowitz, the father of modern portfolio construction, is often quoted as saying, “Diversification is the only free lunch” in investing. Diversifying across more equity holdings, more bond holdings, more geographies, and more distinct asset classes reduces risk. This is why don’t put all your money just into one stock. If you pick the right stock, it is fantastic, but the downside

of vastly higher probability scenarios is rather dire. So, we diversify across multiple equities, bonds, cash, alternatives, commodities, etc.

Diversification works because different investments have different correlations with one another. Correlation measures how two investments move in coordination with one another. The lower the correlation, the better the potential risk reduction benefits of adding to a portfolio. There is a return assumption component as well, but we will park that for now. Diversification works because different investments are not perfectly correlated.

But even a free lunch of diversification can leave a bad taste in your mouth. There is variability in the process. For your lunch, maybe the vegetables were not so fresh, or the chef was off that day. For diversification, correlations are not constant; they fluctuate. Sometimes correlations are stronger than usual, limiting the risk reduction benefits of diversification. Sometimes lower, really helping.

At the moment, correlations are higher, especially if you focus on the big two asset classes, bonds & equities (bottom portion of nearby chart). This does bring back some memories of the portfolio pain of 2022, which witnessed falling bond prices and falling stock prices. But starting in March of this year, correlations quickly turned negative and, more recently, back to positive. An easier way to glean this relationship is the following chart. It only looks at down days for the TSX and contrasts how bonds performed that day.

There is a very important takeaway from these two charts. Diversification didn’t work well in 2022 and 2H of 2023 (so far). But it worked well in the 1st half of 2023, which raises the big question – Why? 2022 was a unique year during which the overnight bank rate (as measured by the Fed Funds) moved from near zero to 4.5%, which dragged longer yields along as well. Guess what? If you raise the discount rate that much, the price of all assets moves in one direction: down. Correlations also increase, reducing the benefit of diversification.

The first half of 2023 witnessed the expectations of peak rates plateauing or stabilizing for the most part. More importantly, with the economic risks around U.S. regional banks, recession risk moved higher. Bond/equity correlations became negative again, diversification worked, and we all enjoyed a nice free lunch. But now, in the second half of 2023, we have seen some recession risks fade and treasury issuance/demand risks (see last week’s edition). Once again, correlations elevated and diversification benefits dwindled. This is not the same as 2022, when it was an inflation problem. Inflation expectations and breakevens have

remained relatively stable or even improved somewhat.

So, where do correlations go next? Inflation is gradually improving, lowering the risk of any material increases in the overnight bank rates. That is good news and supports lower correlations. If this recession starts to show up more, that too would lower bond yields and likely have bond/equity correlations behaving closer to long-term averages. On the other side, if yields keep rising due to imbalances or the ‘no landing’ scenario for the economy, diversification between equities and bonds will suffer.

Has the job of bonds in the portfolio changed? There is a silver lining with all these higher yields: the future return of bonds is higher. Much higher than it was before, albeit a painful journey to get here. For instance, when the Canadian bond universe was yielding 1-2.5%, most investors owned bonds almost entirely for diversification or portfolio stabilization purposes. And while the losses over the past couple of years have probably cast some doubt on that stabilization role, there is no denying future returns have improved. The best indicator for future returns for bonds is the forward-looking yield.

With bonds perhaps not as strong a diversifier as years past but with better future return prospects, are there other diversifiers? The chart below is rolling 12-month correlations between a few asset classes and Canadian equities. Clearly, international equities have a high correlation. You can see the bond correlation becoming elevated as well.

We also included commodity prices. Now, we could have used just energy, and the results are similar. This might be of interest as there are some who now argue oil or energy is a good diversifier because energy did well in 2022. This is recency bias; don’t fall for it. As is megacap tech.

The one line on the graph that stands out is the U.S. dollar. Yes, for Canadians, USD exposure is a strong diversification tool, given it receives safe haven flows during times of trouble. We’re not saying anyone needs to go out and buy USD; instead, just make sure you have enough USD exposure through other investment vehicles, such as equities or bonds. In a world where it is becoming harder to find diversification, US dollar exposure continues to deliver for Canadian investors.

Final Thoughts

We may not be fans of the US dollar when the next cycle truly gets going. But for now, we embrace it for its diversification benefits. And bonds may have failed to be the stabilizer over the past couple years but now offer a much more attractive potential performance contribution. Additionally, if a recession is coming, as we believe, it may quickly become that stabilizer once again.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

Crowding out risk

Tue, 10 Oct 2023 15:33:44 GMT

Crowding out risk

Now, that was a blockbuster jobs report. The U.S. economy added 336k jobs in September, based on the nonfarm payroll report, which was much stronger than expected. Plus, the last two months were revised higher by 119k. This was a strong labour report (or labor as they like to spell it in America). There were almost 100k jobs in leisure/hospitality and education/health, with +70k,

was also a big contributor. As was government at +73k, bringing total government employees above pre-pandemic levels—we will touch on deficits below. Canada, too, enjoyed strong labour gains at +64k. Jobs for everyone, it seems, are still on.

In response, bond yields have jumped higher yet again. At the time of writing, the U.S. 10-year Treasury is now yielding 4.8%, up a full percentage point since mid-July on what appears to be a relentless climb to who knows where. It is not just America; yields have been climbing in Canada, Europe, and the list goes on. The yield gains are larger in North America, but in the past few weeks, the other major markets are hopping on the trend.

So, you are telling me I can lock in a 10-year annualized return of 4.8% by owning a U.S. Treasury or 4.2% for a Canada Govie? That certainly makes for a more constructive financial plan if my portfolio target is somewhere in the 6-7% range. Of course, it wouldn’t be a straight line, but if more end-point-focused, it certainly has an appeal. As does 5% yields on money market or shorter-term vehicles. Clearly appealing yields, looking at investor behaviour this year as money has piled into money market vehicles. Based on ICI data from the U.S., money market assets have increased from $4.7 to $5.7 trillion so far this

year, following a similar trend in Canada, albeit of a smaller magnitude.

Here lies the problem. The U.S. government is expected to run a $1.5 trillion deficit in 2023, which is forecast to rise to $2.8 trillion over the next decade. During the pandemic, when the deficit was an astonishing $3.1 trillion, it was largely funded by the central bank buying bonds and expanding its balance sheet. One hand helping the other. But that is no longer the case as QE has become QT, meaning the balance sheet is shrinking. International Treasury buying is also declining as other central banks, such as China and Japan, are simply less enthusiastic buyers compared to years past.

And then there are the banks. U.S. banks have been buyers of Treasuries in years past. But with short rates so high and unrealized losses on their existing bond holdings (expect to hear more about that in the upcoming earnings season), let’s just say they, too, are not enthusiastic about buying more Treasuries, especially with such a low carry. So, it's up to the private sector, which so far has been a willing buyer given money flows lured by the higher yields. But if you and I are the new buyers of government debt to fund deficits, that means our capital is not going into corporate investments as much. This is what crowding out of private

investment looks like. And while it is no surprise to anyone, a dollar given to the government does not have the same economic benefit as a dollar given to a corporation.

Taken all together, the money supply has been shrinking, yields have moved higher, and now credit spreads are rising. That means financial conditions are tightening at an increasing pace. Monetary policy is a blunt instrument that works on a delay, it is starting to bite more and more. It is worth pointing out that a sudden move like this in financial conditions is unsettling.

Final Thoughts

The cost of capital is real again, and it is a lot higher than it has been in years. Plus, it is not as plentiful, exacerbated by more private capital going to government spending. This isn’t all doom and gloom. In fact, it is probably healthier. Unfortunately, after so many years of low-cost capital and tons of excess liquidity sloshing about the world, the adjustment is likely a long process. Which will continue to see big market moves, like down in 2022 and up in the 1H of 2023. We remained cautious on the 2H of 2023.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

From Bayes to Bulls: A Probabilistic Look into Market Strategy

Mon, 02 Oct 2023 18:09:53 GMT

From Bayes to Bulls: A Probabilistic Look into Market Strategy

On any given day, markets tend to be pretty random, influenced by the daily news, an economic update or two, or even the weather in NYC (sunny days have a marginally higher return than non-sunny days… you can google or ChatGPT it). A little longer term, let’s say weeks or a month, sentiment, flow dynamics, and pre-existing positioning can have a bigger impact. Let’s call this

intermediate term. Here comes some good news: given the drop in August and September, markets are pretty oversold. Sentiment has turned more bearish, which is bullish.

Given the market has sold off lately primarily due to the sudden rise in bond yields (U.S. 10yr has risen from 4.11 to 4.58 in September), it’s easy to surmise a cooling of yields would help the equity market regain some lost ground. Or maybe earnings season. There’s no denying September is largely a blackout month when companies don’t talk much, and share buybacks are muted due to the upcoming earnings season. That all changes in a couple of weeks.

Of course, the news could get worse, bond yields could rise more, and this would extend the current weakness. In the intermediate term, there is a bit more forecastable than the short-term weather, but there’s still a reasonable amount of randomness. In the long term— we are talking quarters and years here—valuations dominate most expected return models or forecasts. And the valuation metric we are going to bring back into the spotlight this month is an iteration of the Fed model.

While there are a few different versions of the model, the one we are sharing today is the earnings yield (inverse of the PE ratio) for the S&P 500 based on consensus estimated earnings for the next 12 months. This equity earnings yield is compared to the yield-to-worst of the U.S. Aggregate Corporate Bond index. For about the last 20 years, this was the valuation model that favoured equities. Of course, there were brief periods when equities were cheap during that 20year period, such as the depths of the 2008

or 2020 bear markets or deeper corrections along the way. But for the most part, U.S. equity valuations were historically high. However, since the Fed model is comparing equity valuations to bond valuations, it’s a relative thing for these two popular asset

classes. On a relative basis, equities always looked cheap simply because bonds were so expensive (aka very low yield)for such a

long period of time. It was this kind of model that encouraged the phrase TINA – There Is No Alternative.

This month that relative valuation lure has evaporated. Bonds are now a mere 2% overvalued compared to equities. Of note, this is the lowest relative valuation for bonds since 2001. Remember, this isn’t saying either bonds or equities are a screaming buy or cheap; instead, from this valuation metric, they are now pretty close to being fairly ‘relatively’ valued.

This doesn’t mean bonds can’t go down more, or stocks for that matter. Simply, stocks just don’t have that relative valuation argument they have enjoyed for so many years compared to bonds. Or perhaps a more helpful way to phrase it is that after 20 years of being overvalued, bonds are back to being fairly valued.

What’s your style?

No, we’re not talking fashion. Frankly, it’s a combination of amusing and exhausting to keep up with all the “cores” in the streetwear scene. The latest we’ve heard about was GORPcore (GORP – Granola, Oats, Raisins, Peanuts), which explains the plethora of Patagonia and Arc'teryx venturing about downtown Toronto streets with not a mountain in sight. Investment style is much more interesting to us and important. Like fashion, the choice tends to be deeply personal. Value and growth sit on opposite ends of the style spectrum, with each striving for the same end goal. Alpha generation. Astute investors like fashionistas can find ways to deftly navigate between styles with the ultimate pursuit of standing above the crowd.

After getting trounced in the first half of the year, value stocks are beginning at least to hold their own. They aren’t leading the market by any means, but value has been keeping up with growth over the past few months. Below, we’ve plotted the ratio between the Vanguard Value and Growth ETFs. The rates-driven relationship really broke down earlier this year, but the ratio line has broken out of the downtrend that dominated the first half. We’ve yet to see any real outperformance from value, but there is a nice setup forming. Technically, if these can get through the recent highs, it would signal a breakout into what could be a positive trend for value. It’s definitely something we’re keeping an eye on here.

Valuations

From our perspective, the valuation gap between both factors is a key determinant of which one is more attractive. Growth should be more expensive, but it’s the degree of expensiveness that’s important. At present, growth is still trading well above its average premium to value. It is not quite as extreme as it was at the previous market peak. However, the spread is wide enough to believe that there is both less downside risk in value should multiples contract and potentially more upside should multiples normalize. From this perspective, it’s a bit of a win-win scenario. However, earnings also matter. A recession or even a slowing

economy could be good for growth when any growth is scarce or longer duration assets if this also drives yields materially lower. much of the value space is also quite rate-sensitive. Value/dividend stocks have gotten punished, with bond yields moving higher. Falling yields, coupled with earnings uncertainty, could drive demand for safer, mature, stable companies.

Know your product

Quite frankly, it’s complicated when it comes to allocating capital across funds in multi-asset portfolios. One of the key tenets is to know what you own. You have to understand your exposures and delve into the underlying holdings of any fund to get a deep understanding of exactly where the risks and opportunities lie. Factor exposures are no different. An easy way to generate factor tilts within a portfolio is simply to buy funds or ETFs that tilt heavily toward those factors. Any fund company can slap value on a fund, but that doesn’t necessarily mean it is truly a value fund. There is no shortage of products specifically designed to isolate any number of factors, whether they be value, growth, quality, size momentum, etc. Digging into the managers, methodologies, and exposures is really the best way to see if they are a robust offering.

Stylistic Differences

The stylistic differences between value and growth are perhaps the starkest among popular factors. In the analysis below, we compare and contrast baskets of the largest U.S.-based Value and Growth ETFs. Fund manufacturers all have slightly different methodologies to get their desired factor exposure, and there are slight differences between them. There is no right answer, so we’re simply looking at the three largest in each category.

True to their name, value ETFs have lower valuations. But they also have significantly lower average and median market caps, higher dividend yields and significantly lower concentration risk. The average weight of the ten positions for the value basket is just 22.6% versus 49.8% for the growth basket. For reference, the weight of the top ten largest stocks in the S&P 500 is 30.4%. We view this concentration risk as material; even for the overall market at 30%, the concentration risk among the growth ETFs is magnitudes higher.

Besides the stylistic differences, the real distinction lies in the sector exposures. The table above compares the difference in sector weights for our funds under analysis compared to the S&P 500. These Value ETFs tilt heavily toward Financials and Industrials in particular while also overweighting Utilities and Staples. Growth, not surprisingly, is heavily geared towards Technology as well as Discretionary. There are some differences between these products. Health Care, in particular, is a little all over the map. But the general theme that jumps out is that if Tech is going to do better than Financials, then Growth will win every time. When the

Banks are doing better, it’s a sign that Value funds are likely outperforming. Below, we’ve compiled a sector heat map pulling together sentiment, fundamentals and price data across the sectors. While we’re not particularly bullish on the banks given our macro view, it is surprising to see Financials scoring well across the board.

Portfolio Implications

Heading into Q4, we’d prefer not to chase the growth outperformance this year. In terms of any definitive style tilt, the increased diversity, superior relative value and, don’t forget, dividends, have us leaning towards value in our multi-asset portfolios. We still see elevated risk in Technology names. The rates duration stocks argument is going for the kill once again. The year’s been interesting because tech/growth were doing exceptionally well up until a couple of months ago. This period also saw US 10-year yields rise from 3.5% to close to 4% again. Incoherence can cause some beliefs to go extinct. The rates/duration argument was played to death in 2022, but somehow forgotten rather quickly for most of this year. Rates moving in one direction or the other are not the only variable. Rates move for a whole host of reasons: changes in economic growth, sentient shifts, the U.S. being downgraded from AAA, inflation expectations, etc. If rates are rising because growth expectations are rising, this can be good for growth stocks. If they are rising for other reasons, then this is decidedly less good for growth.

Hard, soft or no landing at all

When it comes to investing, it is often best to think like a Bayesian. Bayes’ theorem and other related frameworks are all about thinking in probabilities and updating those probabilities based on new information. Of course, everyone would prefer certainty, like “the market will be higher in 12 months”, but that just isn’t how the world works. The future is uncertain; nobody really knows where we will all be in a year or the path to get there. And, as more information becomes visible along the journey, the scenarios and probabilities of those potential paths change.

One of the greatest benefits of thinking like a Bayesian is how it handles uncertainty as it encourages the adoption of new information. This is often the blind spot for investors. It is very easy, once a view is formed, to become entrenched. Confirmation bias lures all of us to focus on information that supports our view and discard information to the contrary. Obviously, this can be a danger, notably when real change is afoot.

At the onset of 2023, we had a positive view of equities. Valuations had become more appealing after the price declines of 2022, and we believed inflation would grind lower. Given inflation was the biggest angst for markets, this would fuel a reprieve rally. However, we did believe as inflation fell, earnings growth would suffer, and the economy was at risk of recession later in the year. The depth of the recession was very uncertain. A healthy global consumer was a positive, as was China's reopening. The higher cost of capital and a falling wealth effect due to declines in 2022 were the big negatives.

This had us looking for a bear market rally, but with recession risks rising for something in between a hard and soft landing. Bumpy landing may have been the term we used. Reflecting back on notes, analysis at the time and our past reports, our probabilities would have been something like 50% Hard Landing, 35% soft and maybe a mere 15% no landing.

When talking about probabilities, you must also give a timeline. Without a timeline, one could just say there is a 100% chance of a recession….and never be wrong. Since this was a 2023 outlook report ( HERE if you want to reminisce or read supporting evidence for the view), let’s say our timeline was for the calendar year.

Fast forward to the end of September. Inflation has come down. The market did enjoy a relief rally that proved to be larger and longer than expected. More so for the U.S. and international developed markets. Meanwhile, the economy proved more resilient, pushing the recession risk further out.

The probability of a hard landing for the economy in 2023 has clearly diminished. We’re not saying there isn’t weakness; there is in many categories, such as global trade, manufacturing, China risk, etc. However, the consumer has endured thanks to accumulated savings, a decent job market and wage growth, enduring higher credit costs and higher inflation… so far. But as we near 2024, the risks have actually grown. Yields and cost of credit have moved significantly higher, along with higher energy costs. And the accumulated buffers appear to be diminishing at a pretty quick pace.

In totality, this has pushed the economic risk into 2024. But alas, we don’t invest in economies; we invest in markets such as stocks, bonds and commodities. And while these asset prices are certainly tethered to the economic cycle, their gyrations are often influenced by other factors as well, especially in the short term. In the following Market Cycle section, we will incorporate this framework for a number of key markets to further increase the transparency of our thinking and portfolio positioning.

Market Cycle, Positioning, Probabilities (conviction)

Market cycle indicators ticked down a bit this past month but remain in relatively neutral territory. One metric improved on the global economic front, but two switched to bearish for U.S. Housing. The U.S. housing industry has certainly entered a rather challenging period. Home prices remain stable, yet existing home sales have fallen to levels not seen since the depth of the housing crisis. High mortgage rates have removed both buyers and sellers from the market, resulting in activity tilting towards new builds. Those new builds are being discounted, given higher financing costs, so it will be interesting to see when or if this spreads to existing home prices. Mortgage rates over 7% are starting to have a bigger impact.

The forward-looking yield curve, leading indicators, and recession probabilities remain bearish. Yet, current activity is

more resilient. Pretty much the same old story of the past few quarters. Earnings season, which kicks off in a couple of

weeks, will be interesting. Higher interest expenses and cost inflation (wages + other costs) are evident across corporate

income statements. But inflation that remains somewhat elevated still offers some top-line revenue growth to

compensate… for now. Corporate America has proven well adapted to navigating these macro trends, and given the small

number of companies that report early given non-calendar year-ends, things look similar to past seasons so far.

Portfolio Positioning

In terms of portfolio positioning, we’ve made no changes this month. After becoming more positive on preferred shares in August, our portfolio position remains unchanged. We remain slightly defensive in equities, preferring safer vehicles with an affinity toward dividend-yielding shares. We remain overweight international. Within the fixed income space, we prefer the safety of investment grade bonds and government debt, believing the risk/reward trade-off in the high yield space is not yet tilted in the investor's favour. Despite the continued sell-off in emerging market shares, we’ve yet to even dip our toe into this asset class. Within alternatives, we prefer real assets and defensive strategies.

Probabilities

Markets have come down in August & September as bond yields have risen (aka bond prices down). The impact of higher yields has quickly translated into lower valuation multiples among equities, achieved by falling prices. Now, the question is how these higher yields impact other market aspects. Risks are certainly elevated. There is a renewed debt ceiling debate, and the economic data remains too warm for the market’s liking. Yet we could also see yields come back down as they are short-term overextended, which would likely fuel a bounce back in equity markets. Helping the probability of this scenario is seasonal factors. Markets often experience weakness in September and into early October, followed by a season period of strength.

Earnings season may go well, as has been the trend. However, we would note that future earnings growth expectations remain too high in our view, and this is a risk in 2024.

The Final Word

Moderately defensive is how we would characterize our positioning as we enter the final quarter of 2023. There’s enough exposure to benefit from a nice year-end advance, but we are really more positioned to navigate the mild weakness of August/September if it continues.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

— Derek Benedet is a Portfolio Manager at Purpose Investments

— Brett Gustafson is an Analyst at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Greg Taylor and Derek Benedet Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

Markets Yield To Higher Yields

Mon, 25 Sep 2023 17:49:22 GMT

Markets Yield To Higher Yields

Not a very kind September so far: Equity markets are down so far in September, TSX -2%, S&P -4%, NASDAQ -6%, international -2%. And reminiscent of 2022, bonds are down too, Canadian bonds -2.4%, US broad bond universe -1.9%, with US investment grade -2.4% and High Yield -1.9%. Normally, when everything goes down together, portfolios are at least partially supported by a strong US dollar. And make no mistake, the US dollar is stronger by about 2% as measured by the trade-weighted dollar index. Unfortunately, with Canada’s higher inflation print a few days back, our dollar has been rising even faster. Pretty much the only thing up so far in September has been oil.

This may bring back some rather painful and still fresh memories from 2022. In case you forgot (and for this, I do apologize for bringing back these 2022 memories), stock and bond prices tended to move together – unfortunately, mostly in the down direction. The full year of 2022 finished with Canadian stocks down 6%, US stocks down 18% and Canadian bonds down 12%. Market performance of the past month or so may feel like the same dance, but there are some key differences.

Perhaps the biggest is which yields are moving. 2022 was especially painful because the risk-free rate or peak in expected Fed Funds Futures rose. In fact, up until recently, the equity market, as measured by the S&P 500, moved in the opposite direction of expected peak Fed Funds expectations. When peak Fed Funds expectations rose, the equity market fell and vice versa. Or, at the very least, the market would only move higher when peak rate expectations were stable. But since the S&P 500 peaked in early August, the weakness has not been associated with higher expectations of the peak Fed Funds rate, which has remained relatively stable at 5.45%.

So then, what explains this recent bout of weakness for the S&P 500? It is rising yields but not at the shortest end (aka the peak Fed Funds rate). It is yields further out on the yield curve. Peak Fed Funds rate expectations have remained stable, but longer yields have moved higher, notably the 2-year or 10-year yields. Simultaneously, over the past month, the consensus forecast for the first rate cut has also been pushed out later, from March to June 2024. The higher-for-longer rates and yields have gained momentum. The 10-year US Treasury yield touched 4.5%, its highest level since 2007. Meanwhile, the less talked about 2-year yields touched 5.1%, its highest level since 2000.

Equity markets clearly do not like this move higher in yields, competing asset class, higher discount rates, and all that sort of stuff – even if it's just a 50-75bps move. So, what is moving yields higher?

There’s no denying the economic data has remained resilient or even better than consensus expectations in North America. Add to this some rekindling of inflation fears as some of the base effects that were helping inflation grind lower start to reverse. Maybe, but the data has been on the better side of consensus for a number of months. We continue to remain in the camp that slowing growth is coming as more of the savings buffer built up over the past few years is ground lower by inflation and higher credit costs. The number of cracks continues to grow, but truthfully, we did think they would have shown up sooner.

There is another factor that likely contributed to the recent up-move in yields, which has not been given much attention lately – good ol’ QT. Quantitative stimulus, or the removal of stimulus, has had a pretty big impact on equity and bond markets over the past decade. Now, the Fed has been slowly shrinking their accumulated balance sheet holdings. But there are other components of stimulus that have been more volatile, sloshing money around in the financial system. And those other categories have seen some big moves in September.

The General Account, akin to the government chequing account, had been filling up after the previous debt ceiling drama. Filling up is removing stimulus from the markets, and it accelerated in the past week. Maybe due to renewed shenanigans around the debt ceiling and with quarterly corporate tax receipts incoming. Nonetheless, this is less stimulus. Much of the general account replenishment had been offset by a reduction in the REPO market holdings [call us if you want more details]. For much of the past few months, this neutralized the impact of the rising General Account, but recently, the increase in the general account has been much, much larger than the reduction in REPO. Net result: less stimulus.

Another factor has been the Bank Term Funding Program and Other Credit Extensions. These were the Fed accounts that regional banks tapped when they were under pressure due to deposit outflows. Remember that scare back in March? This tapping was a stimulus, and it ballooned quickly but recently has started to come down quickly. Hence the removal of stimulus.

Final Thoughts

Don’t worry; the market doesn’t need to match the stimulus line in our chart, as that is a rather large gap. But directionally, there is a connection. With less stimulus ahead, this will remain a headwind for markets, both equities and bonds. For bonds, this may be creating an opportunity, lower price / higher yield. If we are correct that slower growth and recession risk will rise in the coming months, those yields will likely see some downward pressure (prices higher). That may prove good news for equities, too, for a bit. Until the recession fears growth larger and earnings growth becomes something else for us to Ethos about.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

— Special contribution from Michael Allen at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

Dividends On Sale

Mon, 18 Sep 2023 15:19:11 GMT

Dividends On Sale

Investing isn’t easy. The markets rarely behave the way most think they should and seem to often behave to make the most people wrong. The financial media is filled with tales of fat tails – either things that went exceptionally well or extremely poorly. Pulling on those emotional strings to participate or capitulate, even when most investors' experience is squarely in the more boring middle. And when profits are made by putting your hard-earned dollars in harm's way, the government tends to show up to share in the party.

It's no wonder Canadian investors lean pretty heavily on dividends or the dividend factor. They’re historically less volatile, with good returns and some preferential tax treatment for Canadian qualified dividends. And while the previous paragraph may sound a bit down, don’t forget the eighth wonder of the world – compounding. As Albert Einstein famously said, ‘compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.’

Wise words. Steady returns and smaller drawdowns can create a lot of wealth over time.

There is one more reason to explain Canadians' admiration for dividends, an often painful experience when deviating elsewhere in Canada. The chart below is kind of fun, and we do apologize if we missed a company along the way. This is a historical look at all the companies that, at one time or another, had a larger market capitalization than Royal Bank. Not implying Royal is a proxy for dividends, but it's still kind of a fun chart. There are many tough experiences among the names on this list, and you can add other groups, too, like gold, marijuana, etc. These all proved lessons that tended to keep investors focused on dividends.

Of course, the good news is dividends have worked really well over the past 20+ years. Using the DJ Canada Select Dividend index as a proxy, dividends have outperformed the TSX rather handily over the years. And done so with less volatility, a happy combination.

We would never suggest investors ignore the past, but it appears some changes are afoot. Perhaps the biggest being yields. One of the positive impulses for the dividend factor over the past 20+ years has been the long grind lower in bond yields. As yields fell, investors looked elsewhere for a nice income stream, resulting in a steady inflow for dividend payers. It also encouraged more and more companies to adopt an investor-friendly dividend policy.

There’s no denying rising yields over the past two years have changed this tailwind to a headwind. The simple fact is if you can receive a 3.7% yield on a government bond compared to a paltry 1.5% a few years back, the yield on a dividend-paying stock must also move higher. It is not a 1:1 comparison because of different credit risks between governments and corporations, different taxation of income vs. dividends, coupons are guaranteed while dividends are not but often increase with time, etc. Still, higher yielding on competing asset classes is a headwind for dividend-paying companies, just as it was a tailwind when yields were falling.

To complicate things a little more, it isn’t as simple as looking at today’s yields but also where the market thinks yields are going. For instance, the broader TSX and the DJ Canadian Dividend index were roughly neck and neck in 2023 until a couple of months ago. So what happened? Well, the consensus started coming around to stronger overall economic growth and recession talk slowed. This increased the likelihood that yields will remain higher for longer, and guess what that means? The yield on dividend companies must be higher as well. The dividend yield goes up as the price of the stock going down.

Today, about 20% of the TSX constituents carry a yield of over 5%. That is up from 8% two years ago. To put it bluntly, higher bond yields have resulted in price declines for many dividend payers, which has helped lift dividend yields.

So, dividend-paying companies are now paying more to remain competitive with higher bond yields. There is also an added bonus: valuations among dividend payers are historically low. The dividend space in Canada is currently trading at about 10x forward consensus estimates, about two points lower than the long-term average. One could argue that given the current dividend yield and valuations, this part of the market is certainly pricing in higher yields.

Final Thoughts

So what comes next? If a recession or economic slowdown is looming, well, that is good news for dividends vs. the broader market. A recession would likely result in bond yields coming back down, somewhat at least. That would change the recent headwind back to a tailwind. And given the long-term defensiveness of the dividend factor, it’s probably not a bad thing if there is trouble ahead. Of course, yields could remain high or even rise (not our expectations, but possible). While that would be a headwind, the current dividend yields and valuations certainly provide a buffer.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

Forward-looking statements are based on current expectations, estimates, forecasts and projections based on beliefs and assumptions made by author. These statements involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. Neither Purpose Investments nor Echelon Partners warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. These estimates and expectations involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. The particulars contained herein were obtained from sources which we believe are reliable, but are not guaranteed by us and may be incomplete. This is not an official publication or research report of either Echelon Partners or Purpose Investments, and this is not to be used as a solicitation in any jurisdiction. This document is not for public distribution, is for informational purposes only, and is not being delivered to you in the context of an offering of any securities, nor is it a recommendation or solicitation to buy, hold or sell any security.

Little trouble in big China

Mon, 11 Sep 2023 16:42:58 GMT

Little trouble in big China

China’s equity market and economy have been under pressure of late, should we be concerned for the broader global markets and economy? Let’s dive in starting with the China stock market.

There’s no denying the Chinese stock market has had a tough go. Over the past 3-years, the Shanghai Shenzhen CSI 300 index is down about 15%. This compares to a time period when global equities have risen 25%. And if you adjust to common currencies, it gets even a bit worse. China’s equity market has certainly endured some bad news over the past few years. Their housing industry is in a multi-year corrective phase, and covid lockdowns didn’t help either. However, China’s market has something in common with the U.S. – as goes tech, so goes the market.

While Chinese technology companies certainly see bigger swings than the overall market, pretty much all the peaks and troughs line up (1st chart). This means that if you are either bullish or bearish on China’s equity market, it is primarily a call on their technology companies. It is worth pointing out that Chinese tech companies suffered similarly to U.S. tech in 2021 and 2022. But

U.S. tech rebounded HUGE this year while China tech failed. Semiconductor constraints and global investor risk appetites have probably led to much of this divergence. Given we are not bullish even on U.S. tech, it is even harder for us to get excited about China tech, which is more support for our low or near nonexistent exposure to emerging markets.

So what about the economy? That actually matters much more, given the size of said economy and its impact on commodities, global manufacturing, trade, etc. Chinese economic data has been coming in soft, or below consensus expectations, all summer long (1st chart right side), and this continues to feed concerns about the growth path of the world’s 2nd largest economy. Some of this should not be too surprising, given the global manufacturing industry does appear to be contracting to some degree. We can say this is a precursor to a broader economic slowdown, or we could attribute it to changing consumption away from goods back to services as the pandemic behaviours get back to normal. Nonetheless, things are slowing in China. And compounding things is their real estate industry, which continues to languish. Real estate in China is as important as it is in Canada; as a percentage of GDP it’s a heavy weight.

This is where things get a bit more challenging and divergent. You don’t need an economics degree to decipher that consumer-related activity is holding up OK in China; manufacturing is weak, and real estate is even weaker. The consumer has become more important for China’s economy over the past decade as the percentage in the middle-income bracket has risen. Encouraging on the surface, retail spending is up 7.3% so far this year compared to this point last year. That does sound incredibly strong, but this is being compared to covid lockdown periods. So it should be up nicely. Unfortunately, compared to dollar levels before the lockdowns, its pretty flat, which is not good. On a positive sign, Macau gambling revenues are rising, still well below pre-pandemic but certainly closing the gap quickly.

Real estate is not good. And a real estate crisis is a common byproduct of extended periods of economic advancement that lifts much of a population into the middle class or better. It happened in Japan, it happened in S. Korea, and it happened in many of today’s developed economies if you look back far enough. This could be China’s turn. Many signs are there, from loose building standards, excess debt among developers, and leverage among consumers.

It is difficult to say how long this could last, and government stimulus/intervention is certainly evident. Our preferred index to watch is one we created two years ago that tracks the average price return of real estate developers listed in China and Hong Kong. The premise is straight forward: the stocks will turn ahead of any improving sign in the economic data or elsewhere. So far, there’s not much to be optimistic about. And yes, this index has lost over 60% of its value in a couple years.

Real estate in China is important, but not because any of us are looking for a 2nd home. It’s the knock-on effects of real estate and construction on the global economy. When China builds, whether homes or infrastructure, this has helped provide an economic boost that goes well beyond their borders. Looking at commodity prices of key building inputs, the trend has been lower but not aggressively. These too provide a signal for signs of further deterioration or improvement in China’s real estate market.

Overall, it’s not that encouraging. Historically, though, it has been government stimulus or changing of rules that has helped lift the economy out of a funk and, in many cases, helped out the global economy. Just look at the relationship between stimulus in China and the price of base metal commodities (copper, nickel, tin, lead, etc) 12 months in the future. Stimulus would kick start projects, which would lead to planning and then purchasing of materials. And there has been some announced stimulus, but it seems elsewhere in the economy deleveraging is offsetting.

Of course, the stimulus taps could be turned on higher, or real estate could turn. But for now, the momentum is in the direction of slower economic growth. On a positive note, imports of coal and oil continue to be robust. This may be pointing to more decent economic activity, but not the kind that consumes tons of steel, copper and concrete. The TSX and the global economy prefer the latter kind of activity.

Final Thoughts

Valuations in China’s equity market are low, and perhaps this mitigates the risks somewhat, but not enough for us. Currently we remain with a negative view on emerging markets and that certainly includes China. More importantly, it’s the economy. A slowing China, should it continue, will be yet another headwind for the global economy. And while the slowdown could be classified as ‘little’ at the moment, given the size of China’s economy and consumption, a little trouble matters.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

AI to the Rescue (Again)

Tue, 05 Sep 2023 15:41:19 GMT

AI to the Rescue (Again)

August was a difficult month for both stocks and bonds. Rising rates tightened financial conditions and sent both asset classes into the red. At one point, the S&P 500 was down nearly 6% from the July highs. August is just the second down month this year for the S&P 500, and yet again, we have AI to thank for the rescue. In perhaps one of the most anticipated earnings announcements this quarter, Nvidia blew out street expectations. After an initial wobble, the stock went on to make a new all-time high. The monster quarter helped cap off yet another relatively positive earnings season.

Despite the beat, we’ve seen some discouraging market developments. For the first time since the beginning of the summer, sentiment shifted slightly in favour of the bears. We’ve also seen a slight increase in the number of 52-week lows, but nowhere near the degree seen last fall. Towards the end of August, new highs once again began to outpace new lows.

Increasingly, everyone appears to be piling into the same names, once again with the momentum trade becoming increasingly crowded. Hedge fund exposure to tech mega-cap hit a new high in August. Speculators remain net short of S&P 500 futures. The change in position over the past few weeks has been minor, but the current standing remains quite a shift from the extremely

bearish positioning a handful of months ago.

Bond yields in August rose to their highest level since 2007, with US 10s hitting a high of 4.36%. They’ve retreated into month-end, having almost completed the round trip after the anxiety spike into Jackson Hole. Market expectations for yet another rate hike in September for the Fed and BoC rose in August, but with the odds for each around 35%, the market seems more convinced that

central banks will be patient and let the current restrictive policy influence the economy, without tightening too much.

Over the past month, concerns that growth is too hot for the Fed already caused some pre-emptive tightening of financial conditions. This tightening of financial conditions helps explain the recent underperformance of many cyclicals.

Expectations of a pivot next year are higher, with some interesting data from the jobs market coming out recently. While on the surface, jobs data appears solid, it is hollowing out cyclically. Job openings continue to decline, reaching their lowest level since early 2021. JOLTS Job Openings cratered to 8.8MM versus expectations of 9.5MM. Jobs data is inherently a lagging indicator, but

looking at the trend in job openings is useful as it’s an earlier lever a company will pull to when budgets begin to tighten.

The economic surprise indicators are rolling over pretty quickly as expectations for accelerating growth likely got a little optimistic. Levels are important, but it's where the data comes in relative to expectations that are often more significant. This divergence is worth paying attention to. As we head into the seasonally weak September, we have equities once again catching a bid on falling rates, weak JOLTs data, and consumer confidence. Reasonable in the short term, as bad news is still good news.

The Digital Revolution: AI Will Power a Secular Wave of Enhanced Productivity

Artificial Intelligence has reached its "Taylor Swift Era's Tour" moment – equal in popularity but slightly different in impact. While both will undoubtedly provide boons to the economy, I'll attempt to make the case here that one might be slightly more productivity-enhancing, accessible, and enduring than the other (Sorry, Swifties…).

Much like whatever the startup du jour is, AI has been a decades-in-the-making overnight success. Critical researchers in the area of artificial intelligence have been working on this since the 1950s, mostly in the dark, during what insiders have coined the "AI winter." This was a period where general interest had ebbed and flowed around breakthroughs and breakdowns. It's tough to get funding when you can't get people excited.

I'll skip the full history lesson just to say that AI use cases were mostly isolated to a) Private research-focused organizations and b) Government bodies. There were few use cases of widespread commercial adoption and even fewer engineers working on problems in the field. Fast forward to the past decade, and rapid advancements in the underlying transformer infrastructure have spawned Generative AI and its commercialized application: ChatGPT.

ChatGPT changed the game forever. Instead of AI happening behind closed doors, the general public could now physically touch and feel what artificial intelligence could do, all through a simple prompt box and a clean user interface. As OpenAI's ChatGPT shattered every new user record, network effects took hold through "plug-ins" and massive amounts of data input. Increasing the volume of prompts strengthened the large language model, which then improved the output - a virtuous productivity-enhancing cycle. Need to write that anniversary card? ChatGPT. Need a shortcut for writing lines of code? ChatGPT.

Every technological leap forward needs two things: 1) A killer use case and 2) Product-market fit. While VR technology is a cool fad that Meta messed up betting most of the company on, it never had a killer use case. Useful applications, Latency, and general dorkiness while wearing a headset have proved to be insurmountable hurdles. Some thought a form of augmented reality would be relevant to industrial applications like factory engineers, while others thought maybe this would be useful to medical experts in the operating room. Both are niche applications with small audiences, and they couldn't even get that right. AI couldn't be more of the opposite, where use cases have been born from mass digital transformation coalescing wonderfully with productivity-enhancing mass adoption.

Product-market fit is one of those fancy terms that every VC says far too many times, but unfortunately, they're correct. You need the product to come at the right time for the right audience. AI is coming to market in an era where the infrastructure has already been put in place. Cloud players like AWS, GCP, and Azure built the abacus that AI does the math on, and they’re all powered by Nvidia’s platform. Look no further than NVDA’s most recent quarterly data center revenue to see the coming wave.

So now that we know that this is AI's time to shine, we need to go back to a critical component of product market fit. The product. There has to be something to sell. The blog post wars continue to debate whether AI is a feature or a product. It can be "sold" as

a feature in terms of increasing the efficiency of an already existing product line, or it can be sold as a product through a stand alone SKU.

Microsoft skipped the debate and instead just told everyone that it’s a product (called Copilot), and it is going to cost you 30 bucks a seat per month. There are currently 345 million paid seats using Office 365, and just like that, a product TAM of $120B+ in

annualized revenue is born.

Products also need distribution. Right now, software seems like the most viable option for the distribution layer of artificial intelligence. Organizationally, there are already Research & Development as well as Sales & Marketing teams in place that are up for the task.

The easiest way to play this theme in the early days will be the large-cap proprietary data companies like Microsoft, Google, Amazon, ServiceNow, and Adobe. These companies have unique data sources that can unlock specific productivity enhancements. But there are more direct plays in the space as well that focus on powering and protecting data infrastructure

networks through companies like MongoDB, Snowflake, Zscaler, Crowdstrike, and Datadog.

At the end of the day, AI is a tool for productivity enhancement. It will be pervasive across every industry, with the most disruption over the short term to knowledge-based work. While previous revolutions have been industrial, based on physical machine tooling, this era of boosted productivity will be digital. As opensource models become more available to the public, the

impacts of AI will ripple throughout the economy.

While you can't get tickets for the Era's Tour, everyone is welcome to the AI party.

Why moderate overweight international equities

If your recent memory is dominated by the past decade, nobody would blame investors for shying away from international equities and paying homage to the almighty S&P 500. No denying in the 2010s, US equities dominated the equity asset class, and the US dollar also did well. We would point out that equity leadership among international markets does tend to oscillate from one decade to the next. In the 80s, it was international; in the 90s, America, the 00s international again, and the 10s America. Does that mean the 2020s are lining up for international? Perhaps. There are certainly a few factors that favour international equities, in

addition to it simply being its turn to outperform.

Valuations – Valuations are a common reason used to argue for more global diversification. However, it has become even more stretched over the past few years. Today, the price-to-earnings ratio (PE Ratio) of global equities sits at about 14.6, which is neither overly cheap nor expensive. However, Europe, Asia, and the TSX are 2-4 points below this average, while the US market is 3 points above average.

It is fair to point out that the valuations in one market are not always comparable to those in another market. Different composition often leads to sustained differences, like more tech or more value in other markets. But even if you look at regional valuations compared to their multi-decade histories, it paints a similar picture. The US S&P 500 is in the 87th percentile valuation over the past twenty years. 100th percentile would be the most expensive during the analysis period. Meanwhile, the TSX at 13x is in the 15th percentile, Asia at 14.4x is at the 42nd percentile, and Europe at 12.4x is way down in the basement at its 10th percentile.

Valuations provided a good argument for international diversification in the 2015-2020 time period. Today, this argument is a number of earnings multiples stronger.

Correlations -Geographic diversification has always been a core tenant of portfolio construction. Unfortunately, it's been more like geographic 'diworsification' over the past cycle. A simple overweight US equities has been the no-brainer portfolio allocation move, as seen in the chart below (hindsight being 20/20 and all). US mega-cap tech has been the global cycle leader, driving US returns over the past cycle to outperform Canadian and international allocations significantly.

Besides the outright dominance of US markets, the past cycle has been characterized by a sustained period of synchronized global growth, which has caused global correlations to rise, decreasing the benefits of international diversification. Higher correlations reduced the benefits of diversifying, but as the chart below shows, correlations have dropped from historically elevated levels. And if global growth is going to become less synchronized and more variable, the benefits of international diversification should continue to rise.

The risk – One aspect that may be counter to this view is if we are heading into a global recession of some sort. While European valuations are certainly priced for a tougher go, that region is more sensitive to variances in global economic growth, given its trade profile. As is Japan, given a large portion of sales for the Nikkei are export-related. The truth is, the stars never completely line up, and when they do, it is often too late to do anything because the market has already moved.

Taken all together, we feel more comfortable having a moderate overweight in international developed markets. If all goes according to plan, we could increase this weighting should better entry points arise due to slowing economic activity. In the meantime, we think the valuations offer a good safety buffer and believe falling correlations with the TSX provide an added benefit.

Market Cycle

Market cycle indicators were flat the past month and remain close to a more neutral stance. The yield curve became much less inverted mid-month but retraced some of that gain by month-end. US Economic indicators remained stable as manufacturing and housing saw no changes. However, we are seeing encouraging signs in the underlying trends for our signals. Fewer of them are getting worse, which is a positive. Recession probability has decreased, and leading indicators are beginning to improve ever so slightly.

While the overall market cycle is steady, the lone area where we see continued degradation is in the global economy. We’re seeing quite the dichotomy. Oil has moved into the bullish camp along with the broad commodity complex, and we’re seeing some positive trends for copper. However, both the Kospi and emerging markets moved into bear territory. It’s easy to peg the blame on China for the emerging market wobble. The debt risk across Chinese property developers is material and could give way to a wave of defaults. Unfortunately, there is no easy solution for the government. China property developers are too big to fail, yet also too big for an easy fix.

We’re also seeing some overall improvement across our fundamental metrics. Though EPS revisions moved negative, the tail end of earnings season continued to impress, with EPS growth going positive in both Canada and the US. Despite the market weakness in August, the fundamentals have not further deteriorated, and the backdrop on balance is positive.

Portfolio Positioning

In terms of portfolio positioning, we’ve made no changes this month. After becoming more positive on preferred shares last month, our portfolio position remains unchanged. We remain slightly defensive in equities, preferring safer vehicles with an affinity toward dividend yielding shares. We remain overweight international share, as you have seen in the section above. Within

the fixed income space, we prefer the safety of investment grade bonds and government debt, believing the risk/reward trade-off in the high yield space is not yet tilted in the investor's favour. Despite the continued sell-off in emerging market shares, we’ve

yet to even dip our toe into this asset class. Within alternatives, we prefer real assets and defensive strategies.

The Final Word

Can defensives work if yields are going up? Rate-sensitive assets managed to resist the downward force of rising yields earlier in the summer, but north of 4% yields once again exerted too much pressure on stocks. We still believe bond yields are likely lower in the medium term, but the current trend has been resilient.

After a mid-month mini spike, the VIX has tumbled back down to its recent lows, with the summer lull back in full effect. However, September has historically been the most volatile and weakest month, so we’d be surprised if this lasts. As we head into the seasonally weak fall months, we prefer to remain defensively positioned across our portfolios. AI came to the rescue in August and reinvigorated the bulls; however, this song, even if AI-generated, can only keep people on the dance floor for so long.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

— Derek Benedet is a Portfolio Manager at Purpose Investments

— Nicholas Mersch is a Portfolio Manager at Purpose Investments

— Brett Gustafson is an Analyst at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Greg Taylor and Derek Benedet Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

What happens on the other side?

Mon, 28 Aug 2023 14:45:22 GMT

What Happens On The Other Side?

Each year since 1978, the Federal Reserve Bank of Kansas City has sponsored a symposium on an important economic issue facing the U.S. and world economies. This annual pilgrimage to the beautiful mountain resort town of Jackson Hole, attracting bankers, finance ministers, academics, and financial market participants from around the world for its economic symposium, is

highlighted by a keynote speech by the Federal Reserve President. Last year, Jay Powell dropped the mic and surprised markets with his steadfastness to raise rates to fight inflation. This year, it was less of an event, with very little that is new, but we still appreciate the gorgeous CNBC backdrops. It’s becoming clear that the steep hiking path is likely nearing its end, but the big

question is… what happens on the other side?

With the soft landing outcome gaining steam, bankers likely feel some satisfaction and a sense of achievement after reaching the peak after the painstaking path that began last March… it reminds us of the Latin saying, dulcius ex asperis, which means ‘sweeter after difficulties’ (admittedly, we’re not Latin experts, but we came across the saying watching the Sandy B movie, The

Lost City). Both the Fed and Bank of Canada were busy with an accelerated steepening cycle that pushed up borrowing costs, contributed to the bear market last year and tightened financial conditions that have yet to be fully felt in the economy. We don’t know what will happen in the future or if we’re at peak rates right now, but the market seems sure we’re close if not there already. The end may be at hand – but the Fed will remain agnostic and data-dependent.

Long bond yields have steadily pushed higher over the past few months. With U.S. 10yr bond yields solidly back over 4%, expectations of higher for longer rates have resurfaced, which is one of the reasons why stocks have wobbled in August. Higher long bond yields pose a conundrum for valuations across asset classes. What’s interesting is this move in rates has been primarily focused on the long end of the curve. The chart below shows the basis point change across the various bond tenures for the U.S. yield curve. This clearly shows how long bond yields have been rising more than short rates, with 10s hitting their highest level since 2007. Sure, there are some more nuanced drivers of the move; some blame the Bank of Japan or the Fitch downgrade, but the real reason is that recession fears have subsided, inflation is still present, and the economy is doing better than expected. While this sounds good, unfortunately, bear-steepeners like this cause confusing signals and are historically not great for the economy, often preceding recessions.

So, what precisely can we expect on the other side of peak rates? Historically, there’s a pause period, where the economy is doing alright, before lagged effects of the hike worth their way through the economy, leading to a recession. Looking back to the early 90s, this period we’ll call the “flat peak” can last anywhere from 100 to 445 days, averaging 229 days before central banks cut rates when a recession is apparent. We don’t know if we’re at the peak yet or not, but the markets are straightforward with their pricing. Fed funds futures show rates topping out at the November meeting with an implied rate of 5.46%, about 13bps higher than the effective rate today. This is less than a single hike, so the implied probability of hiking is still low. The futures market expects the Fed to start cutting in mid-2024. This timeframe is consistent with the average length of prior peaks in 1995, 2000, 2006, and 2018.

On the other side

Timing the turn is not impossible. Still, looking past the crest, we wanted to examine what areas of the market tend to outperform after central banks stop tightening. We looked at the best and worst sectors going back to 1990 for clues, specifically the 6- and 9-month periods following the Fed's last hike. What became immediately apparent is that every cycle is unique, and there is no clear playbook. No surprise there. But digging into the data did reveal some interesting tendencies.

Some themes from prior cycles are apparent: Health Care, Staples, Financials, and Tech were among the best average performers, outperforming the market across multiple time periods. In terms of a win rate across these four previous peaks, Health Care, Financials, and Teck all did quite well, outperforming the S&P 500 75% of the time. It’s interesting that the average returns for Technology stocks were so strong, considering this period included the washout performance of 2000. It helped that Technology shares were some of the best performing in the post-hike periods of 1995 and 2018. The worst-performing sectors were Energy and Materials, including gold miners, steel makers and specialty chemical companies. Communication Services stocks surprisingly weren’t too great either; however, they were some of the best-performing stocks during the 2006 period. Other cyclicals, such as Consumer Discretionary stocks and Industrials, also lagged.

Markets, on average, were positive over these periods, with only the 2000 period seeing a decline in the overall market once the Fed stopped hiking. Tech was crushed that year, and the defensive nature of Staples and Health Care were huge winners with a relative outperformance of over 20%

Final Thoughts

The long end of the curve is doing some work for central bankers, tightening financial conditions so perhaps they don’t have to. For now, markets aren’t convinced that we’ll see another hike, so perhaps the peak is in. Given that it’s a good time to examine portfolios to ensure they are in line with what could happen in a peak rates scenario. This typically means adding some duration and increasing sector exposure to more rate-sensitive stocks. Given some of the best-performing sectors post-peak have sold off recently, this makes them even more attractive from a relative value standpoint. Within our dividend funds, such as the Purpose Core Equity Income fund, we’re increasingly tilted towards Health Care, Staples, and other rate-sensitive securities that tend

to benefit when we reach the peak and get to the other side.

— Derek Benedet is a Portfolio Manager at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

This document is not for public distribution, is for informational purposes only, and is not being delivered to you in the context of an offering of any securities, nor is it a recommendation or solicitation to buy, hold or sell any security

In Need of Some Bad News

Mon, 21 Aug 2023 15:28:31 GMT

In Need of Some Bad News

Markets have enjoyed a great advance in June and July, thanks to a number of factors. Certainly, some hype around AI helped a few of the mega-caps, but it was much more pervasive. During those two months, the S&P 500, NASDAQ, equal-weighted S&P (adjusts for concentration), TSX and Europe were all up about 10% (common currency USD). Perhaps some of this advance was fuelled by a sudden change in sentiment, but it would appear more driven by some firming in the global economic data.

Of course, the star remains America!! Housing is humming along, enduring higher financing costs. Sure, manufacturing is in the dumps, but nobody seems to care because of the consumer. Resilience would be an understatement. Whether thanks to some dwindling stockpiled pandemic savings, an uptick in wages, or continued ease to find a job, the U.S. consumer remains in spending mode. Anyone who has flown recently would agree the prices are on the high side, yet the volumes going through TSA security checkpoints are now well above pre-pandemic levels. And in the past few months, box office numbers have finally broken above pre-pandemic levels (thanks, Barbie!!). Maybe there is some truth that Swifties and Barbie have pushed off the recession.

There has been an improvement in economic data beyond just the U.S. consumer. European data, which had been deteriorating since the start of 2023, turned more encouraging over the past month or so. Based on the Citigroup Economic Surprise indices, even China has shown some improvement, albeit from depressed levels. Meanwhile, Canada and the U.S. remain in positive surprise territory.

The improving economic data is generally a positive development as this helped alleviate concerns over near-term recession

risk. Adding to this good news, the May and June inflation data, which is released with a one-month lag in June and July, showed

continued cooling. Better economic data cooling inflation are a great combination for markets. This lifted the S&P 500 to 4,600, a

mere 5% below its all-time high set in back in January 2022. Global equity markets also rallied up to within 7% of their all-time

high, set around the same time as the S&P.

Herein lies the rub. The good news of better economic data, which lifted markets for a while, has started to become a negative

due to rising bond yields. It seems some good economic news is great, but too much good news is not. We could bring in the appropriate temperature of porridge, but not this time. 10-year yields in Canada and the U.S. have moved back up to previous

highs set in late 2022.

It is these higher yields that are weighing on equity markets in August. Hence our need for some bad economic news. Compounding the yield situation is the base rates on the inflation side are subsiding. Meaning that we could actually start to see CPI year-over-year measures tick up as the data from a year ago falls off.

With the benefit of hindsight, the market of the past two years has gone through a number of phases. In 2021, quantitative easing, fiscal stimulus was flowing as the economy recovered and bond yields remained low. Put that into the market mixing bowl, and you get price appreciation. Then inflation proved to be less transitory, eliciting a central bank tightening response and a rapid repricing of assets (repricing = lower).

But as the market always does, it went too far. Especially given a recession had not begun. This led to a prolonged bounce back up. Then there was optimism around AI, short covering and improving sentiment – combined with some improving economic data pushing out the recession risk, and markets took another leg higher.

The problem now becomes we have a market that moved higher on a lack of fundamentals. Earnings have held in but certainly not growing or accelerating. Which means the rally was all multiple expansion. And now that the good economic news is leading to higher yields, the market valuation multiple is under pressure to come down. You may notice a near-perfect inverse relationship between 10-year bond yields and the PE of the S&P 500 in the above graph.

Final Thoughts

Good news is good news, but sometimes it isn’t. The biggest risk for the market today is if yields continue to rise, the valuation multiple will likely continue to fall via lower prices. Some softer economic data may cool yields, and provide a bit of a reprieve for the market, but that will bring recession fears back pretty quickly. The silver lining is maybe if you were thinking of adding to bonds but missed the higher yields of late 2022, well, it looks like there is another similar entry point. We would have to see better valuations than these to get us excited about adding to equities.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

Bulls, Bears, and Pumpkin Spice

Mon, 14 Aug 2023 14:37:52 GMT

Bulls, Bears, and Pumpkin Spice

Investor sentiment is a pendulum that swings back and forth between extreme optimism and extreme pessimism and never sits still. Every individual stock has its own little pendulum. At times investors rapaciously bid up shares, believing prices will continue driving prices to irrational levels. In contrast, when the pendulum swings the other way, investors want nothing to do with the stock market. Selling pressure drives prices to irrational levels as well, with the stock languishing and few motivated buyers in sight. Sentiment shifts are subtle at first, but an increase in momentum can quickly escalate. These shifts typically occur at the extremes; the fear of missing out kicks in when the market goes higher and makes investors want to buy. When it moves lower, it

makes you want to sell because you don’t want to lose what you have. Buy high and sell low isn’t how it’s supposed to work, but that’s how our brains and emotions operate. Unfortunately, the market and your brain never scream at you to do the right thing, only the wrong thing. It’s why gauging current market sentiment can help investors understand and hopefully be prepared for those important shifts.

At an aggregate level, market sentiment can be measured in many ways. One of our favourites is the AAII Investor Sentiment Survey. The American Association of Individual Investors has been doing a simple weekly survey since 1987. The long history makes it an ideal data set to understand the relationship between sentiment and stock returns. The most recent reading shows that bullish sentiment is unusually high for the second time in three weeks, while bearish sentiment is below average for the 8th time in 10 weeks. Bullish sentiment has risen extremely fast the past couple of months, as detailed in the chart below, and while

not at historical extremes, the spread between the bulls and bears moved into the ‘sell zone’ a few weeks ago. When the spread is above 20, it means that the bulls are in control and the pendulum has swung nearly to its limits. On the other hand, below -20 is the ‘buy zone’ where bearish sentiment is extreme and future returns are more promising.

So what does this mean for investors? The chart below shows S&P 500 future returns following sentiment extremes. This clearly shows the benefits of buying low, with future 3-month returns at bearish sentiment extremes nearly four times higher compared to future returns when sentiment is extremely bullish. The most recent AAII release on August 10th has the spread falling back under 20, so the bullish sentiment has backed off slightly but has spent the past three weeks in the sell zone.

There are many ways to measure sentiment. One other noteworthy method is gauging how pervasive the positive sentiment is. While also a breadth measure, looking at the percent of members above their 50-day moving averages helps with this. It’s now turning back down after recently reaching the year's highest level. While the S&P 500 is only down 2% from recent highs, 25% of companies within the index have fallen below their 50-day moving averages. This warrants some concern as this type of reversal has a good track record of identifying decent-sized pullbacks.

Beware the pumpkin spice

We’re nearing that time of year. By the end of the month, we’ll be bombarded by pumpkin spice everything. We blame Starbucks and influencers for this trend. Pumpkin spice has been as synonymous with fall as crisp autumn air and changing leaves. Apologies for jumping the gun, but August is almost half over, and September is just around the corner.

Besides stretched investor sentiment, one other potential risk on the horizon for investors is seasonality – whether real or perceived, seasonality and sentiment are inexorably intertwined. Bit of a chicken and egg situation, but market seasonality assumes some sort of repeating sentimental shift in risk aversion, which in turn affects prices. Seasonality in stock returns has been known for decades. As the chart below shows, average monthly stock returns are negative in September and extremely positive around the turn of the year. Going back to 1951, the average return in September in Canada is -1.2%, with just 42% of the months positive. December is the highest, with an average of 1.7% with a win rate of 82%. Now these are averages, so it’s not a guaranteed exploitable trading event, but the numbers are on your side to tread carefully and take some risk off the table. Anyone surprised if the market were to sell off in the next month or so is NOT a student of market history.

We’ve seen some research that attempts to attribute seasonality to Seasonal Affective Disorder (SAD). We’re certainly sad to see summer go, but the sad reality is that in September, trading desks are back at full staff, and real work gets done. More often than not, it seems it’s a time of profit-taking, de-risking, and of course, a pumpkin spice latte.

Final Thoughts

Sentiment is not the be-all and end-all of investing. If only it were that easy. But it is important, especially at extremes. The big question is whether or not we’re in a new bull market or is this just the mother of all bear market rallies. The market loves the soft-landing narrative, and given how well markets have performed the past few months, it's really taken hold. Looking at the global economic data, there is still enough ambiguity to not rule it out. For an investor, if you believe in the soft landing, it makes sense to rush into risk assets now before the data plays out. But this is simply greed taking hold. This still could be a big bear market trap, and given stretched sentiment and heading into the seasonal weak season for markets, we caution investors not to join the herd.

— Derek Benedet is a Portfolio Manager at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

The particulars contained herein were obtained from sources which we believe are reliable, but are not guaranteed by us and may be incomplete. This is not an official publication or research report of either Echelon Partners or Purpose Investments, and this is not to be used as a solicitation in any jurisdiction.

Economists Vs Analysts

Tue, 08 Aug 2023 14:47:02 GMT

Economists vs Analysts

Here we are again — closing out Q2 earnings season for the U.S. and Canadian equity markets. The S&P 500 is now over 84% complete, and keeping with standard practice, has seen positive surprise rates of about 80%. As inflation continues to be a positive for corporate earnings — combined with an economy that keeps on chugging along, it’s a decent earnings season.

Q2 S&P 500 earnings are sitting at about $52, roughly flat with last quarter and up a little from Q2 2022.

On an optimistic note, based on current estimates, earnings are poised to accelerate in the coming quarters. The positive economic growth and weaker USD has resulted in analysts remaining a bit more upbeat. Of course, the big question will be the

economy. There is no denying that the stock market and the economy have a very loose relationship, often moving in opposite directions at times. However, earnings and the economy have a much stronger relationship. So, these estimates really come

down to the direction of the economy.

So, everything is looking good right? Not so fast. These are bottom-up analysis forecasts that are, let’s just say, influenced rather heavily by individual company guidance. Companies are always most often optimistic about the future. Even if the CFO is worried about a slowing economy, do they bake that into their guidance or do they rely more on what is happening today? Since forecasting the economy is not easy or accurate, most extrapolate today into tomorrow. Especially if today is a good

news story.

Here is where things don’t really add up. From the data above, earnings are about to start expanding at about a 10% growth rate compared to last year’s levels. Meanwhile, economist consensus forecasts for the U.S. economy have real growth 1.6% in 2023 and slowing to 0.8% in 2024. That trend is slowing, not accelerating. Now this is real growth, meaning it is adjusted for inflation. And earnings are nominal, so inflation is actually a positive.

But here too, things don’t add up. Inflation, which you would add on top of real economic growth, is forecasted to be 4.1% in 2023 and slowing to 2.5% in 2024. Add these up, economist say nominal GDP growth is 5.7% in 2023 (1.6+4.1) and 3.3% in 2024 (0.8+2.5). That is deceleration, not acceleration.

Now this is pretty loose math. Companies have operational and financial leverage that can magnify changes in economic activity which makes its way to the bottom line. Markets are levered. But with higher interest costs and rising wages, these leverage multipliers are likely diminishing. This is evident in corporate margins which have been steadily falling.

Let’s throw another twist into the economist vs. analyst disagreement. The economy is largely driven by consumer spending, yet the stock market is more tilted to business spending. As a result, corporate earnings are actually more sensitive to manufacturing and other cyclical parts of the economy, regardless of what the consumer is up to. As a result, PMI (Purchasing Managers Index) has a long history leading the trend in corporate earnings growth. In fact, earnings growth trends in six months match pretty well with PMI surveys today (we pushed PMI to the right by six months in this chart). The bad news is PMI keeps going down, meaning bad news for earnings growth.

Final Thoughts

There are other factors that influence S&P 500 corporate earnings such as the global economy or changes in the U.S. dollar, etc. Clearly we are faced with a situation where consensus analysts are optimistic about the future of corporate earnings while the views from economists paint a much more tempered path forward. Who is right and who is wrong? Only time and the path of the economy will tell. But hats off to analysts for being more correct so far in 2023!

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Purpose Investments Inc.

Forward Looking Statements

securities, nor is it a recommendation or solicitation to buy, hold or sell any security

Time Flies

Mon, 31 Jul 2023 15:04:22 GMT

Time Flies

Time often seems to slow down during market sell-offs or corrections, as the volatility creates a more news-filled world. On the flip side, when markets keep going up, time flies. So if you are wondering why this summer seems to have flown by quickly, blame the stock market. The S&P 500 is now up about 20% on the year and within 5% of its all-time high set back in January of 2022.

The TSX, which has enjoyed more modest mid-single-digit returns this year, is about 7% away from its 2022 high. Really, there isn’t much to complain about so far this year. Even if a bit more defense positioned, such as ourselves, returns are pretty good.

Markets this year have wrestled through a number of headwinds. Some U.S. bank turmoil, debt ceiling, continued geopolitical tensions, slowing earnings and a ton of recession warning signals. But some big positives too. Inflation hasn’t gone away, but the trend appears in the right direction. Yes, parts of the economy are slowing, but other parts are proving rather resilient. Add to this,

positioning in options/futures markets, investor sentiment and fund flows were very negative a couple of months back. Part of this recent uptick in markets appears to have been a partial unwinding of some of these bearish bets.

Over the past couple of months, one big positive has been the broadening of the market advance. A couple of months ago, when the S&P 500 was up a more modest +15%, all of this advance was attributed to the big mega-cap technology names. While the market leadership is still tilted and concentration risk remains, we have seen the laggards finally start to participate over the last

bit.

The above chart covering the past five years plots the percentage of S&P 500 constituents trading above their respective 50-day moving average. At the end of May, this was below 30% as the market moved higher on the backs of just a few companies. Now we are knocking on the door of 90% market breadth. This has been helping the equal-weighted index catch up a bit to the more popular market cap-weighted index.

Interestingly, when this measure of market breadth reaches the 90% area, it often stalls. In other words, this rally is getting deeper into overbought territory. But that shouldn’t be a surprise given the Dow rose 13 consecutive days in July, which Brett says ties the previous record set in 1987 over the Dow’s 125+ year history.

If this is just a bear market bounce off of last year’s sell-off, it is one helluva bounce. Certainly noteworthy, the biggest gainers this year from a market perspective are the biggest droppers last year. In order, last year's biggest decliners were crypto, NASDAQ, International Equities, S&P 500, and then the TSX down the least. This year the biggest gainers are crypto, NASDAQ, International Equities, S&P 500, and then the TSX up the least.

Can’t go down forever

Investors have grown to have a love/hate relationship with preferred shares, tilted more towards hate of late. High after-tax adjusted yields are enticing, yet the volatility in the space can prove detrimental. Downside volatility of the preferred share asset class over the past year has been particularly acute. From January 2022 to the beginning of June 2023, the TSX/Preferred Share Index fell over 20% from a total return basis before recovering a few points.

Despite this, a convergence of factors suggests that preferred shares now present an attractive opportunity for investors seeking income and potentially capital appreciation. We look at technical, fundamental, and value drivers, highlighting the potential for increased yields and capital appreciation. Though there remain risks associated with this asset class, current conditions offer a compelling case to add into multi-asset portfolios.

Fundamental Drivers

Despite the recent weakness, several fundamental drivers suggest a positive outlook for preferred shares. Two primary drivers, credit spreads and interest rates, play a crucial role in determining the performance of this asset class. Credit spreads and preferred shares have a strong correlation, yet there is a growing divergence. The current rally in credit spreads contradicts current sentiment, implying a more favourable environment for preferred shares.

Normally higher yields result in higher trading levels in Canadian preferred shares since the index is now predominantly made up of rate-reset preferreds whose coupons float periodically on a fixed reset schedule. Rate reset coupons will be resetting preferred coupons significantly higher at current levels given the large move higher in 5yr bond yields. Currently, the Canadian 5yr bond yield is 3.9%, the highest it’s been since 2007, when the average preferred share coupon will be adjusted significantly higher in the future, considering reset spreads average 2.84%. This equates to an average yield for rate resets of 6.7% over the next few years.

This is an attractive yield on its own, but considering these are dividend payments, the interest-rated adjusted yield of 8.8% is quite attractive on an after-tax basis.

Technical Factors

In June, despite risk assets continuing to shine, preferred share returns were weaker (1.3%) compared with equities and higher beta credit segments. The underperformance can be attributed to various technical factors, including outflows from the asset class and an apparent "buyers strike.”

Fund flows have taken over as the main technical driver of the market, which is magnified given less liquidity. The chart below details the cumulative outstanding shares of the three largest preferred share ETFs in Canada as well as the 30-day change. Thanks to a solid rebound following the pandemic, fund flow peaked in late 2021. Since then, there have been 16 months of outflows out of the past 17 months. This consistent selling pressure in a rather illiquid market was sufficient to overwhelm bids and drag the asset class lower, even suppressing what should be positive fundamental drivers. The good news is that there are some green shoots. Fund flow turned positive last week, and as you can see from the chart, the intensity of the selling pressure has gradually been calming down over the past few months.

Risks to keep an eye on

Investors must be mindful of the risks associated with preferred shares. The asset class is exposed to credit risk and is sensitive to movements in interest rates. A significant decrease in interest rates could negatively impact preferred shares. Additionally, the illiquidity of preferred shares results in increased volatility at times. One other notable concern is that the proposed tax treatment of dividends received by banks and insurance companies may have deterred these potential buyers from entering the preferred share market. Opportunity rarely comes without risk, but at present, we believe we believe there presents a favourable risk/reward ratio.

The current market environment presents an intriguing opportunity to increase exposure to preferred shares in a portfolio. Despite recent weakness, technical and fundamental drivers indicate a potential upswing for the asset class. The rate reset feature, solid credit quality coupled with attractive current and even better future yields offer a compelling proposition. For those seeking income and capital appreciation, the time seems ripe to reevaluate preferred share allocations within their portfolios. Another intriguing aspect is with the market rally broadening; it’s beginning to expand to areas of the market that have

long been neglected.

Market Cycle

Market cycle indicators continued to improve a bit over the past month and are getting close to a more neutral stance (still mildly bearish). The yield curve became a bit less inverted, and housing data improved a bit. Meanwhile, international and fundamental metrics remained stable.

Let’s talk yield curve as measured by the 3m vs 10yr yields. This has one of the best recession indication track records and remains pretty deeply inverted but has become a bit less inverted. The short end, of course, went up once again with the Fed raising overnight bank rates but the longer end picked up a bit more. Could the bond market be coming around to the equity market’s view of ‘no recession’? The old adage is the bond market is much better at sniffing out a recession or no recession, while the stock market keeps the party going longer than it usually should. Right now, there is no denying this stock market is in party mode.

What to do when the most reliable recession indicators continue to flash red danger signals and the more coincidental economic metrics show resilience? That is the question of 2023. The yield curve, Federal Reserve recession probability models, and leading indicators are but a few that are in the red zone. Yet companies are making money, jobs are still decent (albeit less abundant), flights/restaurants are full, and the U.S. market is inching towards its all-time high. What to do, what to do….

The answer is the same as before. Tilt to be mildly more defensive, simply because ignoring all those red flags is not responsible. Mildly defensive enables you to participate in the stock markets party; just think of it as leaning against the wall near the door sipping your Michelob Ultra. You are not the life of the party, but should it end suddenly, you are ready to make a quick exit.

Portfolio Positioning

As you have seen above, we have become more positive towards preferred shares. This is included in our bond allocation bucket, which has increased our bond allocation from neutral to mild overweight. Otherwise, no other changes. Bit defensive on equities, bit heavier bonds & cash. Equity allocations have a more international tilt than neutral, focused on developed markets. Yes, emerging markets are cheap and certainly have some appealing characteristics, but we believe there will be a more timely

entry point. Bond allocations are more focused on quality, albeit a little less now with the preferred share increase. Within alternatives, we focused more on real assets and defense.

The Final Word

Often when a new bull cycle begins, just about everyone doesn’t believe it and remains cautious for quarters and sometimes years. New cycles begin on hope, with the initial rally lacking fundamental improvement, which catches up later. This could be that. But usually, there is a stabilization in the fundamentals, such as earnings or economic indicators. Today these are still gradually deteriorating.

If the new bull cycle has started, time will keep flying by, and it will be Christmas before we know it. That is not our expectation, though, as we believe the divergence between the market and fundamentals will resolve to some sort of corrective action. When? Who knows but certainly more comfortable remaining a bit more defensive, standing near the door.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

— Derek Benedet is a Portfolio Manager at Purpose Investments

— Brett Gustafson is an Analyst at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Greg Taylor and Derek Benedet Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

advice.

Currency Matters

Mon, 24 Jul 2023 15:26:36 GMT

Currency Matters

At the beginning of the year most strategists expected a few things: recession to soon materialize, the Fed to stop hiking, pivot mid-year, and then aggressively cut in the second half leading to U.S. dollar weakness. None of that really materialized, except the U.S. dollar peaking last fall. The U.S. dollar index (DXY) is now down -11.8% from the peak and down -3.6% from the beginning of June. The DXY index also briefly dipped below 100 this week, breaking through support and well below key moving averages.

So, is the dollar depreciating, or just other major currencies appreciating? Most G10 currencies have been rather strong recently. And it’s precisely these currencies that the U.S. dollar gained a lot of ground on when the Fed began aggressively tightening, compared to other banks. With the pause, and perhaps one more hike left, other central banks that started a little later are catching up. Divergences in central bank paths are budding. This is big, as globally not every central bank is moving lockstep with the Fed (BoC may be an exception). The pace of global central bank hiking is beginning to slow as more are beginning to pause as detailed in the chart below. Looking out, we’d expect this trend to continue as the market is expecting the Fed to pivot in the next 12 months. With U.S. rates at or near the peak, this only reinforces the fact that we’ve likely seen the peak dollar for this cycle.

Drivers of U.S. dollar strength historically are relative growth, rate differentials and demand for the dollar as a “safe haven” asset. Rate differentials are narrowing and it’s easy to see just looking at the performance of the S&P 500 or NASDAQ that we’re in a risk-on environment. Market volatility is low, so there is little appeal for “safe haven” protection.

The implications of a longer-term cyclical dollar bear cycle are fairly complex, but the most direct beneficiaries are commodities, notably gold, emerging markets, and risk-on currencies such as the Canadian dollar. One other spin-off effect is the impact on corporate earnings. Many of the largest U.S. companies generate a lot of revenue outside of the United States. A falling dollar tends to boost earning. Historically, the S&P 500 tends to do better when the U.S. dollar index is declining. Looking back to 1980, when the U.S. dollar index was more than 5% below its 52-week moving average, the average look forward quarterly return

annualized is 11.74%, compared to an all-time average of 8.42%. In contrast, when the DXY is more than 5% above its 52-week moving average, forward returns are just 6.39%. It’s a small tailwind, but worth keeping in mind. Interestingly, the U.S. tech sector, which derives a substantial portion of its revenue from outside the U.S., could benefit from this relationship.

Canadian Dollar

Global currency trends are interesting, but what’s most important to Canadians is the loonie. And rightfully so! Risk is back on.

And risk on currencies like the Canadian dollar have been getting bid back up. WTI is in a stubborn range below $80/bbl however

oil prices are no longer falling, and we’re beginning to see some green shoots for the black barrels. With the combination of

renewed risk appetite and at least some consolidation in the commodity complex, this could help entrench a moderately bullish

trend on the Canadian dollar as we head into the second half of the year.

Yield divergence between Canada’s 2-year yield and the U.S. is just 20bps after blowing out to as much as 77bps in March. Yield

differentials have historically been a key driver but the yield driven case in support of the Canadian dollar lost appeal earlier this

year. It has certainly come back with the recent U-turn by the Bank of Canada, which revised a bullish trend for the Loonie. While the market isn’t currently expecting more rate hikes, the BoC has kept the door open. In addition, Canada’s economy is proving more resilient than expected this year. The surprise pickup in housing is a big difference-maker, especially since it’s one of the largest risks for the country and at least it doesn’t appear to be getting worse. In terms of the future path, the implied year-end central bank rate for both Canada and the U.S. remains pretty close. We’ll have to wait and see which central bank blinks first.

Longer term considerations like valuation measures such as Purchasing Power parity show that the Canadian dollar is moderately underpriced relative the U.S. dollar. At a current 7% discount to the greenback, it’s hard to have a firm view one way or the other. For now, shorter-term drivers will remain behind the wheel.

Technically, the Canadian dollar at $0.7567 CAD/USD is right at the top-end of the narrow range between $0.76 and $0.72 that’s been in place since last September. Momentum is not terribly stretched, and the recent trend has been higher. The recent move above prior peaks around $0.75 is encouraging for the current trend to remain. Since March it has consistently been making higher highs and higher lows which is indicative of a sold medium-term bullish trend.

Final Thoughts

It’s worth remembering that the Canadian dollar is also a U.S. dollar proxy globally. Our economies are incredibly intertwined. If you expect a cyclical weakening of the U.S. currency to remain in 2023 that also probably means that the Canadian dollar may be exposed vs. other international currencies (even with possible outperformance) vs. the greenback. With that in mind, we strongly recommend remaining unhedged versus international currencies.

In terms of managing portfolios, currency considerations mainly have to do with whether to hedge or not to hedge. Our preference is to typically leave U.S. dollar exposure unhedged unless the Canadian dollar becomes so undervalued or technically oversold that hedging at lease some U.S. exposure become an easy decision to make. At 76 cents the loonie isn’t extreme enough for us to get excited about in either direction. If it gets to 80, remove any hedges and start doing some cross border shopping. If it gets down to 70 or 71, hedging becomes a much easier decision. Given markets continue to run with risk-on sentiment escalating, we think having some U.S. exposure makes sense, should things reverse. Though peak U.S. dollar may be in the rearview mirror, and global growth expectations have improved any signs of recession. Or growth slowdown can see risk appetite sour quickly. It’s precisely at these times that “safe haven” currencies like the U.S. dollar tend to prove their true value.

— Derek Benedet is a Portfolio Manager at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

advice.

Style Postmortem

Mon, 17 Jul 2023 14:33:27 GMT

Style Postmortem

In 2022, we had a positive opinion and tilted towards the value/dividend factor among equity holdings in our multi-asset model portfolios and, subsequently, a rather negative opinion on the growth factor. That worked out really, really well, adding a good amount of alpha compared to peers. But then, in late 2022 and so far into 2023, the growth factor has returned to dominance. While we have kept up with our peer group thanks to some other contributors such as Japan, an overall overweight in international equity and manager selection within fixed income, our style tilt has been, well, wrong so far in 2023.

A Postmortem is what it sounds like, except there is no dead body, and instead, it is your portfolio on the slab. It is an exploratory process to dive deep into previous portfolio decisions, now with the benefit of hindsight into what happened in the markets and the performance of the portfolio. In this case, what drove our value/dividend tilt in 2022 proved correct. And why didn’t we

pivot back to more growth so far in 2023? The objective is to learn from both past mistakes and correct decisions to aid in future decision-making.

We hope you find this insightful, not just for your portfolio process, but for diving into any past decisions, whether they be investing, personal or business.

“We do not learn from experience….we learn from reflecting on experience.” – John Dewey.

Why we were negative on the growth factor in 2022

Tilting away from growth and more towards value/dividends worked out smashingly in 2022. Almost all the stars were aligned in favour of value over growth at the start of that year. Measuring various equity style indices, growth really outperformed value in the 2010s, and this accelerated in 2020/21 with the pandemic induces spending patterns. At the start of 2022, growth indices experienced about double the performance of comparable value indices during the past three years. So let’s say the performance was certainly stretched.

Valuations

This was confirmed in valuations. To say the valuations of growth indices were stretched at the beginning of 2022 would be an understatement. The average PE ratio across the S&P 500 Growth, Russell Growth and Bloomberg Global Growth sat at 33x. The average index percentile ranking based on their historical valuations was 95th – really close to the top. This was similar across other metrics, including price-to-book and price-to-sales.

Value factor index valuations were not cheap based on their respective histories, as the markets, in general, were more expensive. But they were nowhere near as stretched as you can see in the chart below.

Earnings Growth

There is a long historical relationship between earnings growth and relative style performance. Generally, when earnings growth is strong, value outperforms growth. Few intuitive factors behind this; earnings growth is more abundant when the economy is doing well. And the value factor has a greater representation in many economically sensitive sectors. Meanwhile, when earnings growth is scarce, growth tends to do better. This is also a scarcity issue because when growth is hard to find, those companies that can still grow often fetch a premium.

So at the beginning of 2022, what did earnings look like? Earnings growth looked pretty good. For the S&P 500, estimates sat at $209 for 2021, growing to $223 in 2022 and $241 in 2023. Solid high single-digit growth. This favoured value over growth.

Yields

When yields rise, as measured by the 10-year U.S. Treasury yield, value tends to outperform growth, and vice versa. This is driven by a couple of factors. Higher yields are more common when economic growth is accelerating, which makes earnings growth more abundant to favour value. Plus, growth companies tend to be viewed as longer duration based on future cash flows that are often much further in the future compared to value companies. Lower yields make the present value of those more distant cash flows worth more, favouring growth.

So at the beginning of 2022, yields had started to come off the troughs caused by the pandemic and subsequent monetary stimulus. But the path was clearly higher in 2022, which favoured value.

Putting this all together, performance, relative valuations, earnings growth and the trajectory of yields all favoured value over growth as 2022 got going. A value tilt was clearly an easy decision and the right decision.

But then something changed in 2023

Value’s outperformance in 2022 has certainly reversed in 2023 so far. So how did the above metrics stack up on January 1st of this year? Perhaps the strong run by value was due for a reversal, simply given the magnitude of the move. But other factors also lined up better for growth or at least much less of a headwind.

Valuations

Based on the S&P 500 style indices, the valuation spread between value and growth, which was at historic extremes at the beginning of 2022, had narrowed considerably. In January 2022, growth traded with a 10point premium to value. A year later, in

January of ’23, this had narrowed to less than a 2-point premium. Growth has traded on occasion with a lower valuation than

Value but very rarely. So safe to say a mere 2point premium for growth was check mark favouring growth over value [see previous

chart on style valuations above].

Earnings Growth

Earnings growth, which was abundant in 2022, gradually declined. Recall there was high single-digit earnings growth in January

2022, 7% earnings growth forecast for the coming year compared to the previous. As estimates declined during the year, earnings

growth expectations did as well, down to 2% earning growth in January 2023. Once again, this lower earnings growth environment favoured growth over value.

Yields

It doesn’t seem to be the absolute level of yields that matters; it is the change in yields that seems to correlate most with relative

equity-style performance. 2022 saw yields rise materially, from 1.5% to 3.9%. This was good for value. So far in 2023, yields have

moved around a bit but have been largely stable, sitting at 3.8% today. This may not favour growth, but it clearly isn’t the headwind compared to 2022.

At the onset of 2023, it may not have been a slam dunk that growth would outperform value, but it was a materially better environment for growth compared to the previous year.

Final Thoughts

Whoops, we should have clearly pivoted back to Growth from Value at the beginning of 2023, hindsight being 20/20 and all. Maybe it was the overconfidence that was fed by being so well positioned in 2022 had us believe there was more room to run for value. Regardless, the setup in early 2023 clearly favoured growth or at least a more neutral style stance.

This, of course, raises the more important question, what about the 2nd half of 2023 and beyond? In the table below, we have summarized our signals/methodologies for style tilts, including the readings in January 2022, 2023 and in July 2023.

We would not chase this growth performance run as too many of the signals are now favouring value once again. The lesson of this postmortem is to really develop and trust your process and don’t be afraid to pivot. If you sit on a great trade for too long, it can become less of a good trade.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

Jobs

Mon, 10 Jul 2023 15:39:51 GMT

Jobs

Well, it looks like AI (artificial intelligence) has not replaced everyone’s job just yet. Last week saw a surprisingly strong ADP employment report of 497k – double what economists were expecting. Then, on Friday the U.S. Department of Labor reported non-farm payrolls of 209k, a bit below forecasts. Canada joined in too – with 60k new jobs in June, pretty much all over the place.

Let’s see if we can break it down.

ADP or Automatic Data Processing, is a payroll processing firm, that many may have seen on their pay stubs over the years. This is a firm that handles payroll processing, mainly in the U.S. but also with some operations in Europe and Canada. People receive actual pay stubs by some 365,000 companies that use ADP’s services. This is big-data kind of stuff, and sounds like a pretty good

measure of employment. A few cautionary notes – June is often a more active month for hiring and while ADP data is seasonally adjusted, the June data could be slightly inflated. Also, ADP tends to be rather volatile from one month to the next. Nonetheless, the recent report clearly provides evidence of a healthy labour market.

The non-farm payroll data (NFP), often viewed as the more official measure, is a survey of a number of larger U.S. companies’ monthly hiring/firing activity. This one was a bit softer showing 209k new jobs, of which, 60k were government jobs, while previous months’ readings were revised lower. NFP may be more stable but it is also revised a lot. While this one was a bit softer – there is still evidence of a labour market that is enjoying a good amount of strength.

Let’s not ignore Canada, which had a very strong report. But the Canadian data is borderline manic, so in this report, we will be focusing on the U.S. There’s no denying that if labour markets remain strong, a recession is unlikely.

Employment is a lagging indicator

When corporate margins start to come under pressure, companies react. Maybe the corporate retreat is on a tighter budget, hence travel may be reduced, or other discretionary spending is curtailed. One of the last levers to be pulled is laying off employees. Nobody ever wants to do it, it’s often expensive, and when business returns, it is expensive and/or hard to find good people. This makes layoffs one of the most lagged employment indicators, which have started to rise nonetheless. There have been 417k announced layoffs from January through May of this year. This has already surpassed the 361k total for all of 2022.

Other parts of the employment picture start to show signs of stress before the big headline numbers. Initial jobless claims is a weekly data series in the U.S. that often is one of the earlier movers when trends in employment are near. This has risen a bit over the past couple of months – but not to a material level.

Since laying people off is often the last resort for a company, there are other signs on the hiring side. The number of job openings has been steadily falling. Naturally, one of the earlier employment levers a company will pull is to stop or slow hiring. There is additional anecdotal evidence that the quality of the job postings has fallen. This is being picked up in quit rates as well. If it starts getting harder to find a new job, people become less willing to quit their current post.

Perhaps one of the best leading indicators for turning points in the U.S. labour market is temporary workers. Again, its pretty intuitive, a company will layoff contract workers or not renew contracts before they start letting go permanent employees. Don’t take our word for it, just look at the data. We added an arrow for points when temporary workers experienced a trend reversal, red for a new down trend and green for an uptrend. Clearly this precedes turning points in total employment, sometimes by a few months, and sometimes by a couple of years. Also, note that temporary jobs peaked in Q1 of 2022 and have been falling ever since.

Final Thoughts

The labour market is relatively healthy on the surface which has certainly helped alleviate or push out recession risks for the moment. This is clearly good news. This has also lifted yields higher and raised the market’s view on how many more rate hikes we could see this year. But don’t forget, labour is lagging. And many of the underlying data measures that have historically been more timely, are showing softness. This may not be the best time to quit that full-time gig and become a contract worker.

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. forinformation purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

advice.

Everything Has Gone K-Shaped

Tue, 04 Jul 2023 15:01:28 GMT

Everything Has Gone K-Shaped

Economic parlance often tries to use a single letter to capture what is happening. For example, a V-shaped recovery in the economy or market represents a sudden drop followed by a sudden rise; L-shaped is a sudden drop followed by a muted recovery. 'K' is used to denote a divergent two-pronged recovery – the portion of the letter going up to the right representing

the positive and the downward to the right portion of the letter representing things that are not going well. At the moment, it

appears both the economy and markets are K shaped.

Take the economy; some aspects are going really well. Spending on services remains robust, thanks to pent-up demand and still resilient labour markets. Meanwhile, manufacturing and other cyclical components continue to show weakness. Or the equity markets. The technology-heavy NASDAQ is up 30%, as is Japan. Meanwhile, the Dow Jone Industrial Average is up a paltry 2%, as is the TSX. Divergent, just like the letter 'K.'

Economic resilience or just delayed?

The study and analysis of the economy is really the study of human behaviour and decision-making. During the pandemic, we all changed our behaviours just a little bit, and this aggregated in such a way to really change the economy. Buying stuff, watching too much Netflix, and staying home more often pushed supply chains beyond capacity and wrecked other business models (all the cupcake shops are long gone from the downtown path). Then behaviours started to change back, some faster than others.

We shouldn't be too surprised to see economic activity in manufacturing slowing while service-related activity remains robust. This is very evident in Purchasing Managers' Survey data (PMIs). Looking across most major economies, service activity remains in expansion mode (above 50) while manufacturing activity has been in contraction mode (below 50) over the past year.

The glass-half-full lens for this data is that overspending on goods during the pandemic and subsequent catching up within supply chains resulted in bringing demand forward into 2020-2021. Normalizing our spending on goods is simply manifesting in less manufacturing activity. This is also evident in other metrics. Trucking demand is way down, given cardboard box shipments are running almost 10% below year-ago levels. Think of those little boxes on your porch. Meanwhile, our desire to travel, eat, and do stuff has services activity rather robust.

The glass-half-empty lens would highlight the fact that changes in manufacturing activity often precede economic activity in the service sectors of the economy. Implying that service activity is at risk of following the trend in manufacturing, providing yet another sign of future slowing in economic activity. Add this to the inverted yield curve, recession probability models and leading indicators.

This divergence of economic activity can also be seen from one economy to the next. China and Germany, which have relatively larger portions of their economy driven by manufacturing, have seen a downturn in data. Meanwhile, economies such as the U.S., which are more service-oriented, have remained more resilient.

What comes next?

Not surprisingly, there are two potential paths (there are probably more than two, but let's simplify). The normalization of goods spending could work itself out and stabilize, with service activity keeping the global economy growing at a reasonable pace. Or all those rate hikes that hit manufacturing/good spending quicker could finally start to weigh on services activity. Bringing on slower economic growth or even recession. We remain in the latter camp but must acknowledge the resilience of the economy or at least that we have once again been a tad early.

Looking at consensus economic forecasts for global economic growth, there is no denying that 2023 is shaping up better than the collective wisdom predicted. Six months ago, forecasts for developed economic growth were barely above zero, and now it has risen to almost 1%. Still a sizeable deceleration from 2022, but at least it isn't negative.

The good news kind of ends there, as forecasts for 2024 have continued to be revised lower for both developed and emerging (developing) economies. Taken at face value, global economic growth still appears set to slow to near stall speed….just later than many had previously expected.

Release Valve and Pressure Cracks

After two months of flirting with the 4,200 level, it was clear this was a major resistance level for the S&P 500. Once released, this pressure point opened the floodgates in June. Aggressive repositioning and short covering from extremely depressed levels on the futures market led to one of the largest weeks of money entering the market over the past five years. Total mutual fund and ETF weekly inflows nearly reached $28 billion mid-month. Lots of fresh new money-long positions have been established as FOMO kicked into high gears. The futures market has also seen a sudden move off some of the most bearish positioning we've seen in the E-mini futures over the past twenty years.

Sentiment has shifted; AAII Bull-Bear reading is now over +20. Not extreme, but any time you have this much of a gap between the bulls and bears, it typically follows some strong returns in the market and is a sign that it is becoming increasingly tilted towards excessive greed. As a contrarian, it's time to take some notice whenever sentiment shifts by such a degree and be ready for a reversal. At this point, it just doesn't seem worth it to jump into the momentum trade from a risk/reward standpoint. Historic flows coupled with stretched sentiment are both signs of pressure cracks building in the market. In addition, the VIX, maybe the

most well-known measure of market sentiment. At 14, it's a sign that complacency is abundant in the market.

Predicting isn't easy

It's always hard to make the right call when it comes to forecasting where markets will be in the future. Predictions are difficult, and we'd argue that they are a futile task for several reasons.

Markets are complex: Financial markets attempt to tie in the complexities of the economy, business valuation, geopolitical events and sentiment every second of the day.
Uncertainty: Nobody knows what's going to happen in the future. Unforeseen developments can play a major role in market movements. You also have Black Swan events, which are rare and unpredictable events that can disrupt the functions of the market.
Behavioural: Despite the rise of AI and algos, markets are still largely driven by human factors. With it, they reflect a range of human emotions and all of our wonderful biases.
Information Asymmetry: The speed and amount of new information that gets disseminated every single day makes it very difficult for strategists to gain any sort of information advantage.

We've been in the recession camp since the beginning of the year. We were not alone. In hindsight, most other strategists had the same idea. The consensus forecasted year-end level for the S&P 500 on January 20th stood at just 4,050. It's since risen to 4,091. Since 1999 there have been very few periods where the market trades through the average year-end forecast for the S&P 500. The fact that the S&P is now nearly 10% over the forecasted level speaks volumes about how fast the recent advance has happened and how widely out of sync the market appears to be with the macro and fundamentals. Besides the stimulus-fuelled advance

following the pandemic, the spread has never been larger.

Higher for longer driving divergences

There were multiple themes that took hold during the first half of the year. The return of tech dominance fueled by the AI boom was front and centre, driving the NASDAQ 100 to its best first half on record. What started as the snapback rally off the lows last year, with the biggest losers becoming the biggest winners, gained momentum as everything AI took hold of the market. Rising rates be damned.

Mega-cap tech companies have broken free of the rising rate handcuffs that restrained the sector in 2022. Unfortunately, not every sector was given the AI key. Central banks have resumed hiking, and there the market is currently expecting more to come. The higher for longer premise has taken a toll on many sectors, in particular Real Estate, Utilities and Telcos. Structural headwinds within parts of the real estate complex, particularly the office sector, remain firmly in place. Infrastructure, especially renewable energy companies, has also faced persistent pressure over the past few quarters. The dislocation across sectors is most evident

when comparing cyclical sectors versus defensive sectors. We see the reoccurring K-shape in the graph below, which shows just how disjointed market the market has become. Amidst a murky evolving macro backdrop, spreads between the best and worst-performing sectors over the last three months reached nearly 30% a few weeks ago.

Earnings – Not all negative but certainly paying up for them

Part of this divergence is fundamentally driven. Headline expected EPS for the S&P 500 for 2023 and 2024 has moved slightly higher. In addition, the 3-month change, which was consistently negative for most of last year, is now positive. Though earning expectations have only risen a paltry 1.4%, the rate of change has drastically improved. With recession forecasts being pushed back and/or tempered towards a soft landing, Tech EPS are up a meaningful 12% from their 2023 lows. Likewise, other cyclical sectors have also seen a recent rebound. Defensives, on the other hand, are lagging. With the beginning of the Q2 earnings season set to kick off in a couple of weeks, we'll get a better picture of the winners and losers. Perhaps there is still a lot of wishful thinking in these estimates, especially with the vigorous growth penciled in a few quarters from now. Earning expectations are still high and not consistent with any type of recession scenario. The market appears to be fully expecting a soft landing followed by a strong recovery. While possible, we still don't see this as a probable scenario given the lagged effects of monetary policy that is set to continue to tighten.

Earnings estimates for the Technology sector have improved, but the market still might have gotten ahead of itself. In the chart below, we have the PE ratio for the S&P 500 Technology index as well as the S&P 500 and the ratio between the two. Valuations for the Technology sector are now 1.4 times higher than the index, which is historically quite stretched. While not quite at 2000 levels where the ratio rose to over two times, investors are clearly paying a high price to gain exposure to AI or the relative safety of fortress-like balance sheets for many of the big tech companies.

Market Cycle

Directionally 2023 is playing out as expected – it is the magnitudes that are really surprising. Inflation, which remains, is gradually fading as a dominant fear in the marketplace. With peak central bank rates nearby and economic activity remaining surprisingly resilient, the market has continued to rally off the October lows. The S&P has regained 66% of its 2022 losses, the TSX 40%, but those losses were much less. International markets have regained 60% of their previous pain, with some markets reaching all-time highs.

One could conclude the next bull cycle has started, and nobody got the memo. Given the biggest bouncers were the biggest decliners in 2022, we believe this is a bear market bounce, albeit a big one. With credit conditions continuing to tighten, more forward-looking economic indicators rather bearish, and earnings starting to contract, we remain cautious. The drop in 2022 was a valuation decline. After this bounce, we believe a fundamental decline looms.

As a result, we remain moderately tilted towards defense. This translates into a moderate underweight in equities, marginal overweight in bonds and holding elevated cash. Among equities, we have a tilt towards international, market weight in Canada and underweight in the U.S. (unfortunate of late). This is partly valuation driven and some initial positioning for the next cycle, which we believe international will outperform. Bond allocations are lighter on credit, and duration is normal after years of low duration. Our base case is some sort of recession, and duration will once again be a portfolio's friend.

Market cycle indicators have improved a bit but remain below average, warranting our moderate portfolio tilt towards defense. We will remain keenly focused on signs of improvement/deterioration in the manufacturing measures and fundamentals as we enter the Q2 earnings season.

Portfolio Positioning

No changes to our portfolio positioning this past month. We remain with a moderate underweight in equities and a moderate

overweight in cash and bonds. Full underweight in emerging markets and moderate overweight in international has worked well of late. The moderate underweight in U.S. equities, not so much.

We continue to find decent value in the more conservative parts of the bond market, given the rise in yields. Again, our fear of duration has fallen as a potential recession is our base case. And among alternatives, we continue to lean on volatility or defense strategies with real assets.

The Final Word

With K-like divergence among different equity markets, within markets depending on cyclicality and defensiveness, among types of economic activity, between different economies and between the market vs forecasts, there is no shortage of mixed signals. This is often a characteristic that becomes prevalent near key turning points. The turning point could be the start of a new bull, but we remain in the camp that it is a potential turn towards an economic or earnings recession.

We continue to lean towards defense but still have enough market exposure in case our conservative mindset proves misplaced.

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Greg Taylor and Derek Benedet Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

advice.

Does the Market Need to Drink to Have a Good Time?

Mon, 26 Jun 2023 15:27:45 GMT

Does the Market Need to Drink to Have a Good Time?

If the punch bowl is stimulus, it is safe to say over the past number of years, the market has become rather hooked on this sweat-intoxicating elixir. QE, rate changes, and twists all had pretty big impacts on stock prices, both up and down. And this relationship arguably became even stronger following the pandemic, given the sheer amount of stimulus. From the go-go highs of 2021 on the back of an overflowing punch bowl to the pain in 2022 as the quantity of punch was slowly drawn down. But over the past month, the S&P broke to the upside as the aggregate amount of stimulus stabilized… or did it?

The above chart measures stimulus based on three inputs – the Fed balance sheet, the Repo market, and General Account (we will discuss the dashed line later). The size of the Fed’s balance sheet essentially measures quantitative easing or tightening as this results in changes in holdings for the Fed. If they buy bonds (QE), then it rises, and if they sell bonds (QT), holdings decrease. Remember, if the Fed buys a bond, what does the seller do with the money? If they go out and reinvest in other bonds or anything, that is a stimulus into the financial system. However, if they park it in the Repo market (depositing back at the Fed), well, the money has just gone in a circle. That is why the size of the Repo market is subtracted from the total stimulus.

This brings us to the General Account. The U.S. government’s chequebook is what they use to fund government spending. If this account increases, the government is holding onto money, and if it is reduced, they are spending. As a result, the size of the General Account is subtracted as well. With the previous debt ceiling issue, the General Account had been almost bled dry since new issuances were not approved. Now with the debt ceiling raised, the coffers are being replenished with increased Treasury issuance. This would result in falling stimulus – depending on where the money comes from.

If the Repo market is the source of funds to buy the new Treasuries being issued, there is no change to stimulus as this money was parked at the Fed anyhow, outside the financial system. If the money comes from elsewhere, it will be a reduction of aggregate stimulus, which is not good for markets, ignoring everything else. The partial good news so far is it appears the Repo market has been the source of most funds being absorbed by the General Account replenishment.

The chart below is scale normalized for the General Account and Repo market. As one fills up, the other is emptying. We would also point out that since the start of 2023, these two accounts have largely been offsetting one another. That is good news and also helps explain why the U.S. market has remained so resilient.

But, back to the first chart and the dashed line. When the regional banks started to come under pressure due to fleeing customer deposits, a couple of banks failed, and the Fed stepped in with a loan program. Banks could pledge bond holdings as collateral (valued at cost, not market), thus stop-gapping any liquidity concerns or need to realize losses due to customer pulling their deposits. We are not going further down this rabbit hole into the working of the U.S. financial system, as we would never finish our report on time. The key is this loan program could be viewed as a stimulus, but it is murky, given where the money goes. If it was the stimulus from the market’s perspective, it certainly helps explain this pop in equity prices beyond just AI hype.

Can the market dance sober?

If the trend in the punch bowl is in the direction of less punch, can the markets still go higher? Absolutely. But looking back over the past years of this quantitative monetarily influenced market, you can draw your own conclusion. The chart below is the Big 3 central bank balance sheets vs global equities. The circles are periods where it would appear the relationship has broken down. Red circles are periods when the stimulus was increasing, and markets still went down. Green circles are flat or less stimulus with an improving market.

The circles actually line up with strong exogenous events impacting the market. For instance, in 2011, we were going through a European debt crisis while the U.S. debt was being downgraded. In 2015 it was a sudden slowdown in economic growth coming out of China. The good news is that green circle in 2019 was the first real run where the market appeared to be lifted by improving global economic activity. Skinny 2020 red circle was the mother of all shocks – Covid. And now we have 2023, the market is moving higher with stimulus flat to down.

Hard to support the recent bounce on an improving economy. Perhaps it is just the bounce from the big fall of 2022. Risky if this bounce is not supported by economic or stimulus.

Final Thoughts

Over the past month, the U.S. equity market has done well, as has Japan. After that, just about everyone is down. Maybe we can attribute the narrow lift to AI or a bit of residual stimulus coming off bank lending programs. But any w ay you cut it, the stimulus is being drawn down, which is a headwind for equity prices. Especially given a global economy that isn’t falling but certainly is not accelerating. Sober dancing rarely lasts long.

Craig Basinger is the Chief Market Strategist at Purpose Investments

Derek Benedet is a Portfolio Manager at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

Forward-looking statements are based on current expectations, estimates, forecasts and projections based on beliefs and ssumptions made by author. These statements involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. Neither Purpose Investments nor Echelon Partners warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. These estimates and expectations involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional

advice.

Dividend Divergence

Mon, 19 Jun 2023 14:28:53 GMT

Dividend Divergence

The headlines are currently dominated by stories or ‘financial explanations’ as to the jump in U.S. equities, enjoying one of the best weeks in months. AI, Fed pausing rate hikes, some decent economic data, and improving breadth are the most prevalent. Digging a bit deeper, it’s the abrupt change in sentiment (40% bearish a couple of weeks ago, now 23%), gamma trade, money market inflows became outflows last week, or while the refilling of the general account is sapping liquidity, the repo market is more than giving it back. And now we have the S&P 500 rallying to lift its relative strength (momentum indicator) into nosebleed territory.

We could devote a note to any one of these attention-grabbing topics and, of course, are totally open to discussing their influence… just give us a ring. But this week, we are diving into the dividend space, as there appear to be some very interesting changes afoot that really don’t seem to get any headline attention but likely have bigger potential portfolio implications. Especially given the healthy dividend exposure in most Canadian investors’ portfolios.

Investors often gravitate towards dividend-paying companies (or the dividend factor, if you prefer) for a number of reasons. Historically, this space has enjoyed lower volatility or beta than the general market. Plus, decent returns as well. Then there is the tax benefit of Canadian dividends; let’s call that the cherry on top of the dividend sundae. These are great long-term reasons to keep loving dividends, and the factor analysis below continues to support those characteristics.

However, the dynamics in the dividend space appear to have changed. We would contest that dividend-paying companies have enjoyed a positive performance influence from the 1980s till the end of the 2010s in the form of generally falling yields. Lower yields in the bond market simply make dividends-paying companies more attractive since everything is relative. When bond yields are 3%, a dividend-paying company with a yield of 6% may seem worth the added market risk. And if that bond yield moves to 2%, that makes the dividend-paying company still worth it at 5%, so the price goes up.

It was this long-term trend in falling bond yields that lifted all boats in the dividend space, from telcos to banks, to utilities to pipes to others. We believe it also contributed to the clustering of returns in the dividend space. In other words, the difference between one dividend strategy and the next was, on average, pretty narrow. You just needed to be in the space, and it didn’t matter how you did it, from buy-and-hold dividend stocks to passive strategies to rules-based or even actively managed solutions.

But now, with bond yields rising over the past couple of years, we have seen an increased divergence among dividend strategies. Essentially, the factors that have been driving performance in the dividend space have changed, which is good news. If changes in bond yields were still the dominant driver, well dividend companies would likely be lower in price given current yields. However, now other factors are having a bigger influence. These factors still include interest rate sensitivity but economic cyclicality, quality defensiveness appears to have an increased influence on performance. This can be seen in the divergence of performance

among popular dividend ETFs and Funds.

If quality becomes the dominant factor, strategies that have more weight to this factor will perform best. If cyclicality is strongest, other strategies will do best. This creates a challenging environment as strategy selection, or the composition of a small basket of dividend payers, has likely become more important. It also supports taking a bit more of an active approach in the space. Rotating exposure may add value if a factor runs for an extended period and becomes expensive.

Cyclical yield is a bigger driver than interest rate sensitivity

One lens that we have used for over a decade to help manage dividend strategies is Cyclical Yield and Interest Rate Sensitivity. Essentially, cyclical yield names tend to be more sensitive to gyrations in economic activity and less to changes in bond yields. In an environment with rising or higher bond yields, cyclical yield tends to win. If yields are falling, the opposite. As you can see in the chart below, interest rate sensitives dominated in the 2010s (falling aqua line), and so far in the 2020s, it's been cyclical yield winning (rising aqua line).

The question today is whether the cyclical yield names have run too far or if interest rates sensitives offer value given the current yield environment. So far in 2023, we have been cooling our enthusiasm for cyclical yield and currently have a more balanced view between the two factors. If you’re wondering what a cyclical yield company vs an interest rate sensitive is, we have the following spectrum at the industry level.

Digging into the dividend factor

With the explosive rebound of growth stocks this year, dividend stocks have certainly lagged. Using Bloomberg’s library of thematic factors, we delved deeper into the dividend factor to help explain some of this relative underperformance. Sector exposure has a lot to do with it. The chart below outlines the year-to-date sector performance as well as the sector weights of the top two quintiles of the divided factor for U.S. stocks. From a yield perspective, this is roughly any stock that yields more than 2%.

The top sectors are Financials, Utilities, Real Estate, and Consumer Staples, all of which have significantly lagged behind the top performing sectors (Tech, Discretionary, and Communication Services).

Digging more into the factors, the table below outlines the average quintile across a number of factors for dividend stocks. What’s clear is that higher dividend stocks are, on average, higher value, lower growth, and lower volatility. No real surprise here, but it’s interesting to see the math reinforce commonly held assumptions about dividend stocks. Size doesn’t jump out as a major factor across the dividend universe. However, when you look a little deeper and realize that out of the top nine largest stocks in the U.S., not one yields more than 0.8%, and the average yield is a paltry 0.24%. Collectively these nine stocks account for 28% weight of the S&P 500. There are lots of dividend stocks in the large-cap space, but when it comes down to the mega-caps (>$500 billion in market cap), dividends are clearly not prevalent.

Growth is by far the best-performing factor this year, but looking back over the past three years, value and dividends remain the best-performing factors, even with the recent troubles. The chart plots the long-only performance of the top quintile for each factor. What’s also promising is the recent reversal and uptick in value and higher dividend stocks. It’s surprising to see how little ground growth has made up after last year's collapse considering many of the top growth stocks that come to mind are at or back near their all-time highs. It’s really hard to get fully behind a factor driving performance when it’s literally just a handful of companies driving performance.

Final Thoughts

The dividend space in Canada is certainly a very mixed bag. Banks are under pressure as growth slows, real estate pricing is in either a big recession or ‘work from home forever,’ energy company share prices are high while valuations are crazy low, utilities with renewable exposure are down (those with none are up), and insurance companies are trucking along. Clearly not moving as one.

For the second half of 2023 and beyond, the question is which factors will be most influential, either positively or negatively. Will a potential recession become a headwind for cyclical yield names and instead reward those more defensive? Could yields come back down, lifting those more interest rate sensitive? The factors that drive performance seem to be changing more often these days. Set-it-and-forget-it used to work for dividends, but now it’s just for indoor grilling.

It's Priced In

Mon, 12 Jun 2023 14:13:55 GMT

It's Priced In

Have you ever heard the words “it's priced in,” referring to the market or an investment pricing in some sort of potential negative event? The TSX is trading at 13x earnings estimates, historically low for this index, clearly pricing in some uncertainty or potential recession ahead. The S&P is trading at 19.7, which is historically high, implying the U.S. may not be pricing in much chance of a slowdown. Truth be told, in our years of investing, it's never completely priced in. Even the low-valuation markets will likely feel some pain if a recession does come. But likely less pain compared to those markets that are not pricing in any potential bad news.

Let us instead look at valuations as a safety buffer, never pricing in all the bad news but a portion or degree, depending on which investment or market you may be looking at. Using 20 years of valuation ranges, we broke down some major equity markets to contrast current and recent valuations. For instance, at the start of 2022, global equities were very close to record-high valuations. Then by the end of the year or the start of 2023, valuations were well below average. A bear market can do that. And now valuations are back up in the most expensive quartile. Breaking it down a bit more, based on the past 20 years, the U.S., Japan, and NASDAQ are the markets priced to near perfection. While Canada, Europe and China are in the dumps, possibly pricing in a potential recession or at least partially priced in.

Of course, then the question is how to look at valuations. One could argue the last 20 years is not the greatest sample period. However, another factor is the 'earnings’ part of valuations. Earnings have contracted a bit over the past few months, but how far will earnings fall if a recession is coming? If they fall a lot, perhaps some of those markets that appear to be pricing in a decent amount of recession risk are not as cheap as they look.

The chart below has a lot going on. The data table at the top of the chart shows how far each sector’s earnings have already contracted so far in 2023 and the average earnings contraction during past recessions and economic slowdowns. These include the 2001, 2008 and 2020 recessions, plus the economic slowdowns in 1998, 2015 and 2018. The bars below show the price-to-earnings today, the median over the past 30 years and what today’s PE ratio would be if earnings contracted by the average of past recessions/slowdowns.

For example, the energy sector is trading very cheap, and if earnings, which are already down 29%, fell by 68%, this would still have valuations roughly in line with historical norms. In other words, the energy sector appears to be pricing in a good amount of recession risk. The same can be said for Health Care, which actually tends to hold up well during periods of economic weakness. Materials, Financials, and Telcos are not pricing in as much risk but still a decent amount. On the other end of the spectrum, Information Technology, Industrials, and Consumer Discretionary sectors do not appear to be pricing in much risk.

We did the same thing for the TSX. Not surprisingly, TSX often sees bigger contractions in earnings during periods of economic weakness. The good news is that valuations are low, and if we have an average earnings recession, current valuations are just about in line with historical norms, as do financials and energy. We would caution against making conclusions on some sectors given the narrowness of companies or other ‘TSX’-centric nuances.

Credit Markets

For the most part, credit markets are signalling some degree of caution, but despite recession fears, spreads have not widened dramatically. In fact, they have fallen a decent amount over the past couple of weeks and remain well below the recent highs seen last September. With high yield spreads currently at +433bps, they are a little elevated, but not much. The credit market is discounting relatively benign economic conditions going forward. Within the high-yield space, lower-quality, CCC-rated corporate bond spreads are perhaps telling a slightly different story. The bifurcation of the high-yield bond market remains elevated. More creditworthy companies are still able to borrow at more reasonable spreads; however, the gap between BB and CCC-rated spreads is considerably wider compared to other periods corresponding with similar spreads in the high-yield market. The lowest-rated junk bonds are showing meaningful credit risk in the U.S.

Spreads between BB and CCC corporate bonds are in a bit of a twilight zone right now. Historically this zone is where spreads spend some time digesting forthcoming credit conditions before jumping higher during a liquidity/credit crunch. We’ve yet to see any real spike.

Some investors may hold off getting excited about high yield, perhaps waiting for spreads to blow out between 600 and 800 basis points based on where they topped out prior to previous recessions or economic slowdowns. The space is somewhat enticing with a yield-to-maturity in the large U.S. junk bond ETFs north of 8%. For now, we’re comfortably less exposed to the space. We believe we’ll get a better opportunity when spreads take heed from the early warning call from the lower-quality borrowers.

Commercial Real Estate

Concerns over the office real estate sector following the pandemic have increased over the past few months, in part due to the mini banking crisis among U.S. regional banks. Whether it's rising rates, sky-high vacancy rates thanks to a painfully slow return to office or concerns over leverage, there is no shortage of bad news or bear case arguments. No doubt, there are a lot of troubled office buildings, as well as other troubled properties such as malls etc. The risks inherent in the space are high, but the prices of many of these REITs are also incredibly low. Canadian Office REITs are down 55% from their pre-pandemic high. The total return

index is down to levels last seen in early 2016. The spread between Office REITs and other types widened considerably this year as seen in the chart below. There’s also a large disconnect between the public and private markets. At some point – and to be clear, we don’t know if we’re there yet – office REITs will be a buy simply because they have overly discounted a worst-case scenario.

Determining when enough of the bad news is already priced into the market is a challenging but potentially lucrative task. It involves a lot of subjective judgement simply because if there was enough hard data to reinforce the view, the market would have already reacted to it. Some of the factors to assist in trying to address this are market sentiment, lack of a market reaction on bad news as well as digging into the fundamentals and factoring in worst-case scenarios.

Final Thoughts

This is an interesting time for investing. Parts of the market are rich with euphoria and are paying no mind to valuations. Other parts are clearly pricing in a lot of bad news. ‘It is fully priced in’ never really comes to pass because we never know what ‘it’ is or its depth and duration. The good today is whatever ‘it’ is; parts of the market have priced in a decent portion. And that provides a bit of a safety buffer. The same cannot be said about other parts of the market.

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

advice.

Two Tales of the Same Market

Mon, 05 Jun 2023 15:39:10 GMT

Two Tales of the Same Market

Global equities, as measured by the Bloomberg World Equity Index, are up 9% so far in 2023. So, is it safe to give the all-clear with a soft landing and markets go higher? The market advance certainly supports the bulls, as does continued strong employment and recovery signs in housing. On the other side are the bears, highlighting the narrow breadth and weakness in many forward-looking economic signs pointing to recession risk. This is normal. Often during economic turning points, the cross currents in data reach very high levels. Confounding this is lingering inflation, which boosts topline sales growth and can mask the signs of deteriorating business activity.

In fact, it is also common to see material equity market advances in and around economic turning points. The following chart montage measures the S&P 500 one year before and after recession onset. The percentage is measured from the pre-recession high. It is rather common to see decent market advances before a recession hits and sometimes even rallies after it starts, before things typically get worse. Of course, knowing when a recession has started is also something that only becomes clear many months or quarters after the face. Kind of hard to tell in real-time.

Now if you believe the current environment is some sort of cross between 1973 (inflation+nifty 50) and 2000 (tech bubble), those years should be focused on a little more. We would point out that a +10% rally for the S&P 500 in the second quarter of 2001 was led by a +38% advance in the Information Technology sector. That did not end well. Sound potentially familiar? The S&P 500 Information Technology sector is up +35% year-to-date in 2023, with the S&P +10%.

The crux of this is not to get too excited or complacent just because we have enjoyed a good rise in stock prices so far in 2023. But the real question remains – is there a recession coming soon?

Recession/No Recession Cross-currents

As our readers hopefully know, we are in the higher recession probability camp. Hence our moderate underweight in equities with moderate overweights in bonds and cash [see portfolio positioning below]. We are back to a neutral duration on bonds and less credit. Not super defensive, but it's certainly tilted that way. Our multi-asset balanced model is +3.7% year-to-date and is defensive with some up-market capture. Ideally, we plan to become even more defensive as/if recession evidence builds. Which, of course, raises the most important question – what if we are wrong?

With names such as 'pre-mortem' or 'bull vs bear case,' the objective is clear – actively engage and try to see the other side's opinion. With our defensive tilt, we believe a recession is a higher probability than no recession. Here is an attempt to convey both sides:

Recession Risk

Rate hikes – the track record of central banks managing a soft landing is poor. Given the number of hikes globally, even less likely. It takes 9+ months for rate hikes to fully impact the economy, which means pain is mostly on the horizon. Plus QT.

Leading indicators – or manufacturing surveys, or recession probability models, or the yield curve inversion all point to a likely recession in the near term.

Buffers depleting – Savings during the pandemic are dwindling fast, given inflation and higher interest costs. Even with a decent labour market, this could start to change the behaviours of consumers.

Labour – IT IS A LAGGING INDICATORS, don't take solace in the fact that it is holding in. Temp employment is falling, often a leading indicator of total payrolls.

Commodities – Dr. Copper and its other commodity friends are certainly signalling weaker demand ahead. Even with the tight supply of many commodities, prices have been declining.

Inflation migration – Inflation was very positive for corporate earnings, boosting the top line while companies managed to slow cost inflation. Costs appear to be catching up now, and this is hitting margins.

Earnings – Starting to see negative earnings growth; if the economy slows and/or costs keep rising, this will get worse. Wages are up, interest expense is up, and the cost to do anything is up.

Valuations – Global equities are trading 15.6x, roughly in line with longer-term averages. This means valuations are not pricing in much bad news or even higher yields available in cash/bonds.

No Recession anytime soon

Just normalizing, not recession – Manufacturing ran beyond full speed to catch up with shortages/bottlenecks from the pandemic. Coming off this high was always going to 'look' like a recession.

Labour – Strong employment gains continue and remain broad-based. Hard to see an imminent recession.

Consumer strength – credit card spending remains strong, delinquencies low. The U.S. and European consumers have very strong balance sheets, sturdy enough to weather higher inflation and rates.

Housing – Rising rates in 2022 caused a slowdown in housing, but since rates have generally stabilized, a rebound of activity is on. The U.S. economy rarely moves in the opposite direction to housing.

Hard vs Soft data – Much of the weak economic data is survey or other 'soft' data. The hard data remains much more upbeat. Better to believe in what people do (hard data) than what they say (soft data).

Valuations – The TSX is 12.8x, Europe around the same, which means it's the U.S. at 18.5x, which is making things look expensive. But the S&P is skewed by a few names, and so is its valuation. 26% of the index is trading below 12.5x, up a lot from only 18% a year and a half ago.

China & Europe – China reopening and Europe avoiding an energy crisis have really set the stage for better growth on the global front.

Bearishness – Investors are bearish, portfolio managers are bearish, and speculators are bearish. The market often proves the maximum number of people wrong.

Hopefully, this highlights some of the cross-currents the market and investors are currently battling. It is no 'slam dunk' in either direction. That being said, we believe the left column carries more weight or a higher probability. Also worth considering is not just which side has the greater likelihood of being correct but the magnitude of the impact. If the bulls are right, given S&P 4,200 and TSX 20k, the upside may be limited. If the bears are right, but clearly early, the downside impact may be larger.

For now, we will keep our foot off the gas and hover over the brake.

Market Message

Since the beginning of the year, we've increasingly become incrementally more defensive in our positioning. Perhaps our framework is wrong. After all, the S&P 500 is up 10% so far this year and is up 17% off of the lows from last October. International markets have performed even better, with the MSCI EAFE Index up over 25% off the lows last year. Thankfully we have been overweight international. Canada has lagged, but this, too, corresponds with the theme that last year's worst markets are this year's best-performing. Tech certainly fits into this theme, with the NASDAQ up a stunning 25% YTD. It's worth noting that the

NASDAQ is still 18% below its all-time high, and the S&P 500 is 12% below its high-water mark.

Is this a bear market rally or the beginning of a new bull? Unfortunately, it's impossible to give a concrete answer without the benefit of a rearview mirror. The broad market narrative is signalling this could be the beginning of the next bull, with the S&P above all major moving averages. We don't believe it's a coincidence that the rally has stagnated right at the 50% retracement from last year's fall. We saw similar bounces to exactly the 50% retracement level in both 2001 and 2008.

The four horsemen (actually six)

This is one of the thinnest rallies that we've really ever seen. In the late 1990's tech bull, the "four horsemen of the apocalypse" were repurposed as the four horsemen of the Internet – EMC, Cisco, Oracle and Sun Microsystems. At times during that bull, these names represented most of the market's advance. They were changing the world and how we communicate. Not owning them meant you lagged the market cap-weighted index. Sadly, Oracle is the only one of the four to ever exceed its 2000 peak, a feat achieved fourteen years later in 2014. Once again, we have a market that is ridiculously narrow. The S&P 500 is up 10% this year, with six companies representing almost all of the gains!! Are these the six horsemen of AI….

Digging further into market breadth, or lack thereof, we will highlight the performance difference between the S&P 500 Equal Weight vs Market Cap. Last year's outperformance for equal weight has been erased, with the market cap index now just narrowly

outperforming since the beginning of 2022. So far this year, equal weight is losing by the widest margin for a calendar year since Bloomberg's data began in 1990. Returns being driven by the largest companies in an index aren't unusual, but this does look extreme. Markets are not suggesting broad strength, it's idiosyncratic, and this is why we don't believe it's really giving us an all-clear signal despite briefly breaking out of the 4,200 range.

We believe it's time to fight the momentum trade. Even the world's largest momentum ETF seems to be late to the party once again. Its semi-annual rebalance will see its tech weight move up from just 3.2% to 20.6%. Energy and Health Care allocations will be slashed, and the Fund will once again be tilted heavily toward tech and other growth sectors. The very exposures that drove tremendous underperformance to the S&P 500 last year. Ignoring the confines of the calendar, we wanted to see just how unprecedented the past five months have been in terms of the historical five-month performance difference between the Technology sector and the equal weight index. The 33.8% difference is massive and historically rare over any 5-month period going back to 1990. The only two similar periods were a brief stint in 2020 and in the late 90s. In both periods, we believe it's noteworthy that the relative performance then dropped in subsequent months.

With the debt ceiling nearly behind us, investors can turn their attention more fully to central banks and the potential for further hikes. AI's prominence in corporate updates has helped defy the gravity of rising rates which typically have an outsized impact on the tech sector and other rate sensitives. This relationship is currently broken, but we would expect that the AI boom is merely a mirage, like a bountiful oasis in the desert. We are not doubting the potential of AI, but we are doubting the near-term impact. It evokes a sense of hope and promise but conceals the underlying challenges facing not only the sector by the market as a

whole.

Other concerning relationships

Key sectors such as discretionary stocks, transports, and banks have continued to struggle. These economically sensitive stocks are finding few buyers even at current depressed levels. The relationship between discretionary stocks and consumer staples is a useful indicator to read into risk sentiment within the market. In the chart below is the ratio of the equal-weighted sectors against each other to remove the outsized impact of Tesla and Amazon. Though Discretionary stocks have rebounded somewhat relative to Staples, most of this happened in January and has been all but absent the past few months.

Dow Theory is a classical technical tenant, and it suggests that the movements of the stock market can be analyzed by examining the interaction between the Dow Jones Industrial Average and the Dow Jones Transportation Average. According to the theory, confirmation of a bullish trend occurs when both the DJIA and DJTA move in the same direction. Both were strongly in line in 2022 but had been diverging of late, with Transports recently making new lows for the year.

Looking ahead, we should assume there will be volatility and twists and turns in the months ahead. For now, given the underlying market signals and lack of breadth, we suggest continued defensive positioning in equity markets. The market will start to fully discount potential earnings recession and further economic weakness. We remain underweight sectors that are more cyclically sensitive and would suggest fading the tech advance.

Tech innovations such as the PC, internet and wireless proliferation have changed all our lives over the past few decades. But history shows that markets can get ahead of themselves, and it takes time to see who ultimately wins. This year's tech blowout is not without precedent; however, these periods of outperformance have historically been followed by relative underperformance. The lack of broad participation shows that investor sentiment and confidence are concentrated in only a select few stocks, making the market more susceptible to volatility and potential downside risks.

Market Cycle

Market cycle indicators remained stable from last month with no changes. Off the bottoms, thanks to some improving economic data in housing. Manufacturing remains weak while global and fundamentals are mixed. Welcome to continued cross currents in the data, again a regular occurrence around potential turning points.

Portfolio Positioning

No changes to our portfolio positioning this past month. We remain with a moderate underweight in equities and a moderate overweight in cash and bonds. Full underweight in emerging markets and moderate overweight in international has worked well of late. The moderate underweight in U.S. equities, not so much.

The Final Word

We don't know if there will be a recession or how the market may react one way or the other. But we do know there is more evidence of slowing than accelerating. Today, this does not appear to be reflected in equity prices and probably not in bond prices either, given credit spreads. The data will likely remain mixed, offering support to make either a bullish or bearish argument. Given the impact of either scenario and the probabilities in our analysis, we remain defensively tilted.

"It's tough to make predictions, especially about the future" – Yogi Berra

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. forinformation purposes only.

This report is authored by Craig Basinger, Greg Taylor and Derek Benedet Purpose Investments Inc.

Disclaimers

Echelon Wealth Partners Inc.

construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.

Forward Looking Statements

3rd time's a charm?

Tue, 30 May 2023 14:38:21 GMT

3rd time's a charm?

For the 3rd time in as many years gold is brushing up against the 2,000/oz zone, which of course raises the question whether this resistance level will hold once again or will the yellow metal finally break out. As any investor that has invested in gold or gold miners for more than a few months, it can be one of the more frustrating and sometimes mystifying holdings. The rally in 2020

was pretty logical, given the uncertainty of covid and the amount of central bank balance sheet expansion. But the languishing price in 2021 and drop in the first half of 2022 was at odds given rising inflation. More recently, bank stress has seen gold rise again to 2,000 before giving a little back in recent weeks.

Even today, many historical drivers of gold prices are at odds. The rise in nominal and real bond yields certainly augers for a lower price of bullion. As does limited equity market volatility. Yet the persistent higher inflation is supportive of a higher price as is the U.S dollar. Nobody said investing would be easy.

Perhaps one of the biggest swing factors that tends to drive gold price is ETF flows, aka retail. As you can see in the chart, gold often moves in tandem with gold ETF flows. Both up and down over the years. Yet the recent advance has been during a period of ETF outflows. Counter the ETF outflows has been central bank buying, which set an all-time record in 2022 and continues into 2023. Perhaps the Western imposed sanctions has encouraged many central banks to increase their reserve diversification away from Treasuries on the margin. Whatever the motivation, this has helped counter the ETF flows.

Gold Technical Take

From a technical perspective, gold is at an interesting crossroad. Over the past three years, it’s gone from a new all time in 2020 to a prolonged consolidation period. It’s now attempted on two occasions to break through and solidly hold onto a 2000 handle. The first attempt early last year, saw it later retrench to nearly $1600/oz largely due to a strong dollar and central banks hiking rates at an accelerated pace. Following the breakout from that downtrend last November, gold has rallied alongside risk assets to attempt a second thrust to new highs. Aided by a mini bank crisis, gold held above $2000/oz for a number of days but has pulled back rather suddenly thanks in part to dollar strength, and rising rates. The pullback has brought it back to the lower bounds of the current trend channel.

With the price sitting on a key support level as well as staying within the current trend channel we see a favourable setup for a potential upside rotation back towards recent highs. For now, gold remains in a mid-long term upside trend with an upward

bias.

As the bulls and bears battle it out around key support, it appears the gold market is mired with indecision. The RSI oscillator has pulled back below 50, but is showing a mild bullish divergence which is a good sign for the further rally. In addition, there is an impending bull cross on the MACD indicator. This indicates an oversold market with tiring sellers. Upside moves could find some resistance around the psychologically important 2000 level as well as the 50 day moving average at $1993. For those underweight, this is looking like a good time to begin to a build position from a risk/reward perspective.

What’s next?

Investing isn’t about trying to explain the past, its about the future. Do you think central banks will continue buying? We do. What about yields, both nominal and real? Well, gold has weathered yields moving higher in good fashion. They could still move higher but most of this move is probably done. And as the Fed likely stops raising rates soon, that should turn a headwind into no-wind. Inflation may continue to come down this year, as is our expectation, but will likely remain higher than past years. This should continue to be a positive for gold.

Then there is the dollar. We are not in the de-dollarization camp and the U.S. dollar could see an uptick if a recession develops. Near term that may be a headwind but if the dollar is moving higher on recession, market volatility may provide an offsetting tailwind. Sorry, too much talk of wind, starting to sound like some sort of swirling vortex. Nonetheless, longer term we are anticipating to be dollar bears, which is gold positive.

Final Thoughts

Gold remains a stone throw from a key resistance level despite cooling inflation and higher yields. If a recession is on the horizon, we believe yields could tick lower and market volatility rise. Both potential positives that could help gold finally break through this ceiling. And if retail start buying, which there has been some signs of late, this 3rd visit to resistance maybe the breakthrough gold investors have been long waiting for.

New Paragraph

Buy the Dip or Sell the Tip?

Wed, 24 May 2023 17:30:44 GMT

Buy the Dip or Sell the Tip?

Looks like we are closer to a deal. Markets are pleased that a debt ceiling appears to be within reach, avoiding all the potentially bad stuff that this politically motivated crisis could have unleashed. Certainly, good news, and this has lifted equities higher – dare we say, without jinxing it, the S&P is peaking above the upper range of the past six months.

So, all smooth sailing from here? We continue to view this as an extended relief rally but certainly acknowledge the resilience of this advance. From the bottom at the end of Q3 ’22, global equities are up +17%, US +16%, EAFE +29%, with Canada lagging at +12%. If you ranked this positive performance, it would be an exact mirror of the poor performance during the sell-off in ’22. Canada fell the least during weakness and is bouncing back the least. Nasdaq fell the most and is bouncing back the most.

Over much of the past decade, the strategy of buy the dip has become the mantra of many. This was obviously not the ideal strategy for the first nine months of 2022 until the October low. Since then, it has been working once again as the market softened in late December to bounce higher, then weakened in March to bounce higher. To be fair, selling the tip has worked, too, from the mini peaks in November, February and perhaps now…

We lean more towards selling the tip – perhaps trimming the tip is more accurate. And we have got valuations on the side. The move higher in the S&P on the back of pretty muted earnings has pushed the forward price-to-earnings ratio up to 18.5. By comparison, it was down to 15 last Fall. This puts S&P 500 valuations well into the most expensive quartile grouping based on data back to the 1950s. And on average, this bucket is followed by pretty muted market returns for the index.

Price to earnings is a very useful valuation metric but life and investing is never that simple. Here are a few other aspects to consider, most of which support our trimming of the tip mindset.

Yields – There is a relationship between equity market valuations and yields available in the bond market. Bonds are a competing asset class, and, everything else being equal, higher yields attract capital. To counter this, equity markets tend to offer lower valuations. Since lower valuations are associated with higher average forward returns, this balances with the higher yield/returns in the bond market.

When yields were below 2%, that was more supportive of higher equity market valuations. Today, with 10-year Treasury yields at 3.7%, we would say this is less supportive of higher equity market valuations. Cash, too, if you can pick up 4-5% with no risk, the expected return in the equity market has to be higher to compensate. Not sure 18.5x for the S&P fits into that framework.

Earnings growth - Price to earnings is a snapshot of valuations, and both the P and E can change. On occasion, when earnings are depressed and/or earnings are expected to grow rapidly, this supports higher valuations. Often the term used is the market will grow into its current valuation. Consensus estimates have the S&P 500 earning about $210 in 2023, which would be a record high. So clearly, earnings are not depressed.

So will earning growth be robust? We are not optimistic. Margins had remained high for many quarters but are now starting to come under pressure. Sales growth is slowing as the economy slows and inflation cools. Meanwhile, costs are still rising from wages to the impact of higher rates. Even if you don’t believe a recession is coming, you probably agree that the economy is set to slow.

Earnings quality - $1 does not equal $1 when it comes to earnings. $1 of earnings from a cyclical company, such as an energy producer or $1 from a levered financial, is not as valuable from the market’s perspective as $1 from a more stable source. Consumer Discretionary earnings are worth less than more stable Consumer Staples. This helps explain the persistent valuation gap between markets such as the TSX and S&P.

On a relative basis, the TSX has a higher weighting in many sectors that simply carry less value per dollar of earnings. And today, a larger portion than average is coming from these same sectors. To show the higher variability of fundamentals, the chart below is the R squared of a number of metrics. If these grew steadily over time, the R squared would be 1, so the further the reading from 1, the more volatile.

Final Thoughts

Even with lower qua lity of earnings for the TSX and international markets, the valuation gap more than makes up for it compared to the U.S. market. We continue to believe on a relative basis, and we are more comfortable with Canadian dividend-tilted equities or deeper value among international equities such as Europe and Japan.

On a shorter-term basis, maybe we will buy the dip when it comes, but for now, we would rather sell the tip.

Good News, Good News, and More Good News

Mon, 15 May 2023 15:54:09 GMT

Good News, Good News, and More Good News

Over the past few weeks, we would say the news has been tilted solidly towards the ‘good’ side. The world’s largest central bank (Fed) effectively announced the cessation of rate hikes, ending a fourteen-month journey that raised overnight rates from 0.25% to 5.25%. Yay!!!

Q1 earnings season is wrapping up, and it finished stronger than it began. With over 90% of companies having reported, 77% surprised to the upside, with an average magnitude of 6.5%. We have not seen that large of a surprise in a couple of years. Of course, you could be bearish and point out that Q1 earnings had been almost $60, and forecasts fell over the past few months to just over $50. So the surprises were against some rather low forecasts. Nonetheless, the earnings season finished well. Yay!!!

Inflation has improved. The US reported April CPI data that continued to show signs of improvement. It was the first year-over-year print below 5% in the past two years, at 4.9%. Yay!!! Labour remains resilient in both Canada and the US. Of course, this is a double-edged sword as too much good news would be inflationary, but a strong report for both Canada and the US, including solid gains in higher-paying jobs, is good news for the economy. At least showing recession risk as not being imminent. Yay!!!

Sure, there is some not-so-good news as well. Consumer confidence moved lower, the debt ceiling remains top of mind, and the US regional bank stresses remain. But taken as a whole, the news of the past couple of weeks has been good. One would expect this preponderance of good news to lift the market higher, but that hasn’t happened. The daily gyrations have been up and down, but overall, markets are down slightly in May so far. The S&P and TSX are both off a minor 1%.

When good news fails to lift markets higher, Mr. Market is saying something and we should all listen. In the near term, the path of least resistance may be to the downside.

Debt Ceiling

We have a history of rarely weighing in on politics for a few reasons. One, we believe the economy is usually a bigger deal than any change in policy. Of course, there are exceptions to this, but it is a good general rule. Secondly, good luck trying to guess the likely path of policy decisions, as what should be done for the markets/economy is often confounded by ideological views. Thirdly, even if you ‘guess’ right as to what the policy, announcement or outcome may be, how the market reacts is equally challenging and often surprising.

Take the debt ceiling debate. We feel confident it will be raised, but how we get there is a guess. Maybe it will be resolved quickly without any disruption. That is our base case, remembering back to the last time this became a tenacious topic over a decade ago. The government started to shut down, which impacted people who voted, resulting in a drop in support for the party viewed as the blocker. Neither party likes to lose votes.

A debt ceiling resolution would certainly be good news, and perhaps markets would react positively. BUT, that may be short-lived. The markets for much of the past few years have been very sensitive to the amount of stimulus. During periods of more stimulus, equity markets have advanced, and during periods of dwindling stimulus, markets have fallen. The above chart highlights this relationship. While not a perfect fit, directionally, it is very strong.

Stimulus is a combination of measurements that really center around the Federal Reserve’s balance sheet. Most are aware of the expansion of Fed assets as a quantitative stimulus tool at their disposal. The stimulus we track includes this and also incorporates the Repo market and General Account. The Repo market is a kind of parking spot for excess liquidity for banks and other institutions. Effectively it is money being diverted out of the economy/markets and being re-deposited with central banks. So the size of the Repo market is subtracted from the total stimulus.

The interesting component of the debt ceiling is the General Account. Think of this as the government’s chequing account. If they write cheques to consumers or businesses or for projects, this is stimulus back into the economy, and the account goes down. That is why the account is subtracted from the stimulus. So if the account gets smaller, that is stimulus. And it sure has gotten smaller.

With the debt ceiling looming, the General Account has been bled almost dry. So what will happen when the debt ceiling is raised? Well, the government will likely replenish this account by issuing Treasuries. As investors buy those Treasuries, money/liquidity/stimulus will be removed from the markets. So that aqua line in the first chart will likely move lower. And what about the other assets on the Fed’s balance sheet? Well, the Fed has continued to reduce their asset holdings, combining for potentially an even bigger drop in the total stimulus.

This is a simplified lens into central bank balance sheets regarding the ebb and flow of stimulus. And we have omitted the stimulus provided to banks via Primary Credit Loans and the Bank Term Funding Program. Both of which exploded in size as US regional banks rushed to replace fleeing deposits. Technically this is a stimulus not captured in our framework. But that is because we do not believe banks using these programs are rushing out to inject that money into the economy via loans or investments. Most banks are becoming increasingly tight on lending, given the uncertainty of their deposit base.

Final Thoughts

A resolution to the debt ceiling will be good news since no resolution is really bad news. But it may not prove to be a lasting panacea for the markets as it could trigger less stimulus in the weeks or months afterwards. So once again, even this good news may do little to lift markets higher.

Leaning Back a Bit

Mon, 08 May 2023 16:24:20 GMT

Leaning Back a Bit

Good news – the world’s largest central bank hit the pause button on rate hikes last week. After embarking on a rate hiking cycle in March of 2022, it would appear the Fed is done for now after hiking from 0.25 to 5.25%. Yay!! And what did the market do? Not much of a celebration, they have trended downward. Maybe after the recent rally, all the good news was priced in, or more likely, the re-flare up in U.S. regional bank woes, softening economic data and deteriorating earnings were the culprit. Any way you slice it, markets have soured a bit, even with a strong bounce following Friday’s labour report.

Last week we also moved our mild underweight in equities to a more moderate underweight. As our readers have likely picked up, we did not believe the recent strength in equities was sustainable given the softening fundamental underpinnings. And we believe a break lower is more likely than a sustained move higher in equity markets. This time we reduced Canadian equity exposure while increasing cash. Combined with our trimming of International Equity in early March (Worth a Read or Two), we have moved from a mild to moderate underweight in equities.

Probabilities & Return Expectations

The future path of markets is always uncertain. The good news is the very long-term trend creates value for your hard-earned savings, creating more savings through the 8th wonder of the world, compounding. But there are times to lean into it (the

market) and times to lean a bit back. How and when to lean, that’s the tricky part.

Today, you can earn 4-5% on your cash with no risk, often referred to as the risk-free rate. You can earn about the same in higher quality bonds that carry duration. Don’t just focus on the comparable yields here; the duration of bonds plays an important

role in the portfolio. Should a recession develop in the coming months or quarters, duration will provide a better ballast/stabilizer for your portfolio than simply sitting in cash. Hence our lowered equity weight is spread across both bonds and cash. Bonds just in case the next ‘R’ is approaching, cash to be more opportunistic.

For equities which have a long-term average return of, say, 8-9%, the question is, with a risk-free rate of 4-5%, is the risk worth it? Now ‘averages’ are what people with a little math skill use to mislead. Equities have an average return in the high single digits, but at times this can be well over 10 or 20% and at times well below 0 or -10%. On average, we are taller than our parents, but that doesn’t mean many are not shorter.

So what is the probability that the next 12-month equity market returns will be above or below its average? With the risk-free rate so high, shouldn’t we demand a higher-than-average return from equities of, say, 10-12%? The U.S. market (S&P 500) may be hard-pressed to deliver simply because valuations are not cheap. At over 18x, multiple expansions may be hard to come by. So solid earnings growth would have to deliver, but with the economy slowing and margins coming under pressure, the odds are not in favour.

International and Canadian equities certainly have a more compelling valuation starting point between 13-14x. That is a better safety buffer and is one of the reasons that even after our international trim, we are still a little overweight international equities. While Canadian equities are just a minor underweight which leaves the U.S. a more material underweight.

The fact is our earnings growth models are not encouraging. Interest costs are starting to weigh on companies’ income statements. Wages certainly are rising, as are other input costs. And while sales growth has been strong over the past couple of years, lifted in part by inflation, costs appear to be rising faster of late. The last two quarters for the S&P 500 have seen sales growth combined with negative earnings growth… that is the literal definition of margin compression. In simple terms, earnings growth is challenged.

Final Thoughts

Now we are not overtly bearish on the equity markets. The fact is earnings revisions have turned positive in the past few weeks, which is encouraging. And the labour report on Friday clearly points to an economy that is not on the brink of anything, not to mention the billions of cash that is sitting on the sidelines.

Nonetheless, given the risk/reward trade-offs, the yield on competing asset classes and with both the S&P 500 & TSX bumping up against the top end of their recent trading ranges, leaning a bit more to bonds/cash appears prudent.

Hold the Line

Tue, 02 May 2023 16:18:22 GMT

Hold The Line

The S&P 500 is up about +8% so far this year, the TSX +7%, Europe is up well over 10%, and Asia is doing pretty well, too. Even bonds are up. This bear market rally (assuming we are still in a bear market) is being fuelled by a healthy dose of good news. The rate of inflation is coming down; in fact, durable goods prices in the U.S. have fallen 2% over the past six months. That doesn't seem to get much attention in the headlines. Nondurables, excluding food, are down over 2%, while services are higher by a bit over 2%. Nobody is saying it's over, but it certainly is getting better. Add to this the flare-up appears to be calming among the few U.S. banks that really proved to have poor business models for today's environment.

Is everything hunky dory, or is the market whistling past the graveyard? According to my new best friend, ChatGPT, the phrase means to proceed while ignoring an upcoming hazard, hoping for a good outcome. That kinda sums up today's market. Earnings continue to be revised lower, and while the current earnings season has its fair share of positive beats, there is something else afoot. Sales growth is still decent, helped by our old friend inflation, but earnings growth has turned negative.

What does that mean? Well, the costs are now rising faster than revenue as companies are unable to offset cost inflation as well, plus the rising cost of credit (aka higher interest rates) may be starting to show on the bottom line. Don't take our word for it. The chart below shows the total interest expense per quarter for all S&P 500 index members, which is rising; and on the right, how often companies mentioned 'cost inflation' during conference calls and other communications.

Margin compression has already started. The S&P enjoyed peak operating margins of a little over 16%, which have returned to more normal 13.5% levels over the past year. As cooling inflation removes the previously enjoyed sales growth lift, we believe cost inflation won't fall as quickly. Combine this with a slowing economy, and things could accelerate. BUT, this is down the road a ways.

For now, the market is stuck in a range, albeit bumping up against the top end of that range of late. 3,800-4,200 for the S&P (currently 4,160) and 19-21k for the TSX (currently 20,630). Maybe there is a bit more of a lift on earnings still holding in or the Fed announcing a rate hike pause. Unfortunately, this rally is built on a very soft foundation. Falling margins and falling earnings are not ingredients for a durable market advance.

For the foundation under this recent rally to improve, you have to believe the economy is going to stabilize and then maybe improve. Q1 economic data was largely better than expected, so there is obviously a chance. However, the preponderance of indicators and data point to a more troubled scenario. Yield curve inversion, recession probability models, leading indicators… the list goes on. And let's not forget companies are cutting costs now, with one company's cost being another company's revenue. There is a delayed wealth effect due to the drop in markets last year and a delayed economic impact of higher rates/yields.

The good news is that even though signs are rising that the economy is cooling, it does not look like it is falling over a cliff anytime soon. Three months, six months, or a year from now, is when things may look very different economically. And while we are enjoying this recent market rally, you never know when the market will begin to fret over the economy. When it does, it likely won't be gradual.

We continue to remain defensive, slightly underweight in equities and slightly overweight in bonds/cash.

Tech Is Not Defensive

There are periods throughout market history where investing can seem like a simple game. That is precisely what we saw from 2019-2021. A decade of low inflation and interest rates capped off by an impulse of stimulus created one of the most unique market environments we have ever seen. The mantra "Buy the Dip" was not born in 2020, but it certainly became a common motto for a whole new investing demographic. And who is kidding whom? Over those three years, we saw the S&P 500 double, rising by +100%, making the investment process look easy to anyone. The growth in the S&P 500 was largely driven by the Technology sector, rising +191% during the same period. So, while the S&P 500 was posting a measly double, the Tech sector nearly tripled. These massive returns coincided with a global pandemic and the very temporary -33% market pullback. Impressive.

This extreme performance of the Tech sector has brought forward a new mindset, one that states Technology stocks are defensive, with some solid supporting arguments. Dominant market share, very healthy balance sheets, and sitting on lots of cash to deploy additional buybacks help make that argument. And don't forget recency bias, our tendency to overweight recent history compared to more distant memories. Tech did really well in the 2020' flash bear' thanks to holding lots of cash in a frightful time. The subsequent fall in yields certainly provided multiple expansions. And our changed behaviours had us ordering new tech gadgets to help outfit the home office or keep us entertained.

Conclusion – that was a unique situation that made tech appear defensive. But it isn't. Ad spending, consumer gadgets, and business spending dominate tech sales. And these are all very cyclical.

We are not anti-technology. We realize the world has changed and become more tech-driven, but that does not always translate to the markets. In our view, the economic fundamentals drive the market. We have already laid out the work that the next decade will not be like the last. That could potentially mean higher than 2% inflation, higher yields and more volatile economic growth. Technology investments are still very cyclical; as the economy goes, so do they (with the exception of 2020) – not to mention the ever-present risk of disruption. Should any new technologies usurp the current tech giants, markets will have to adjust meaningfully, and given the current top-heavy nature of the sector, the results will not be welcome to investors.

How we view defensive stocks

When we think of defensive stocks, we think of a few key attributes. At the top of the list is earnings stability in various stock markets or economy states. We'd place what did the best in the last bear market somewhere near the bottom. In terms of earnings variability, Consumer Staples and Health Care stand out very well. Looking back to 1990, these two sectors have by far the lowest volatility surrounding earnings. At the top of the list, it's no surprise to see Energy, but interestingly, Technology, the previous bear market darling, is also up there.

Earnings in the Tech sector are heavily affected by mega-cap names. These companies have also disproportionately driven earnings and recent gains for the entire market. This past week, we got a glimpse. With the sector up 18% year to date, they must continue to deliver strong earnings to justify current valuations. So do recent outperformance and strong gains over the Covid correction mean Tech stocks are defensive? We do not see them that way. Yes, they have some defensive characteristics, especially when it comes to balance sheet strength, but they are not immune to cyclical slowdowns.

Evidence of their fallibility is the vast amount of layoffs announced over the past six months. Last year's tech-wide reckoning in the job market continues, albeit at a slowing pace. According to LayoffsTracker, since January 2022, over 50,000 tech workers have lost their jobs. The reason behind the layoffs typically blames the macroeconomic environment and a need to find efficiencies to maintain profitability. And perhaps some overly aggressive hiring during the recovery from the pandemic. Increased layoffs have helped mitigate earnings damage so far, but margins in the sector remain high and are still at risk of at least normalizing to pre-pandemic levels. The chart below shows how much margin pressure the sector has already experienced. So far this earnings season, earnings have narrowly exceeded previously lowered expectations. However, compared to all other sectors excluding Real Estate, the Tech sector has the lowest earnings surprise and has seen growth fall by over 10%. The profitability outlook remains uncertain, and we believe there is risk in the massive premiums attributed to the sector relative to its history.

Stability is the key

Over the past six months, only Staples and Utilities have seen a rise in forward earnings estimates. All other sectors have seen a reduction. On the low end, not surprisingly, are your classically cyclical sectors like Energy and Materials, and the Tech sector sits somewhere in the middle with a definite tilt towards the cyclical. Tech earnings will likely prove to be not as defensive as many hoped or as they did in the 2020 pandemic bear. Certain segments of the tech industry are more stable, but some, like semiconductors and hardware, can be extremely cyclical.

If you were to match all the stock sectors to their corresponding items on the menu at Starbucks, Tech is definitely the Cappuccino. Popular but with lots of froth. The chart below outlines where sector valuations stand compared to their long terms history. Only Tech and Consumer Discretionary (Amazon is the largest company in this sector) remain significantly overvalued. Low valuations do not mean stocks are immune to downside risk, but they certainly help reduce it.

Conclusion

Recent outperformance in the face of a looming recession does not equal a flock to safety. We remain focused on earnings stability as a crucial characteristic that defines winning stocks during recessions. A company with steady and reliable growth is preferable to one that has more erratic growth. These companies also possess some degree of pricing power which continues to be a beneficial attribute during periods of elevated inflation.

Tech stocks cannot be the bellwether of bullish market sentiment as well as a defensive stalwart. Though companies within the sector provide exposure to prevailing and emerging trends such as AI, the sector is also exposed to massive sentiment swings. Traditionally, defensive sectors may not offer the same growth potential, but they do have less downside potential. Given the current macroeconomic climate, we recommend tilting portfolios to traditional defensive sectors.

Market Cycle

While we continue to lean defensive, we are not outright bearish. We believe some sort of recession is coming, and the market will likely react negatively, but the timing is very difficult to ascertain – not just the recession but also the timing of the market reaction. So, for now, we are holding the line with a mild underweight in equities and a mild overweight in cash/bonds. Enough market exposure to enjoy this current rally but with one foot in defence to hopefully pivot should things begin to deteriorate

or rise high enough for us to believe the risk/return favours are becoming more defensive. For now, the economic has improved a bit and so have our Market Cycle indicators. Little improvement in the U.S. data, namely consumer sentiment, plus a bit of improvement in housing helped; as did Emerging market performance as a bellwether of the global economy. This is good

news, reducing the risk of a sudden imminent recession.

Portfolio Positioning

No change to our portfolio positioning during the past month. Still mild underweight equities, mild

overweight bonds/cash. The equity breakdown has us neutral in Canada, given better valuations and value tilt

of our home market. Mild underweight in the U.S. as we believe the growth factor and a decade of relative

outperformance are both negatives going forward. Prefer international developed markets, both Europe and

Asia.

For bond allocations, we are leaning on quality and have a neutral duration view after many years of carrying a lower exposure. Duration is bad when inflation is the biggest issue; it is a positive when a recession is the risk.

Alternatives we have a slight underweight simply because we can now find defense and yield in more traditional asset classes – less need to be fancy. Within alternatives, we continue to lean on defensive or volatility management strategies and real assets.

The Final Word

After going overweight during the summer rally in '22, we went back to market weight equity at the end of last summer. This was then ratcheted down to a mild underweight in early March. Clearly, so far in 2023, everyone should have piled back into the NASDAQ but we are not convinced. Yes, inflation is better, the Fed may pause, and the economic data has not imploded, but earnings are starting to feel the pinch. This pinch may become more pronounced at the same time the economy weakens, which is not a healthy combination.

We continue to remain defensive, slightly underweight in equities, and slightly overweight in bonds/cash. If the market rallies much more, we may consider trimming market exposure even more. This is the strategy for a rangebound market that has a greater probability of breaking to the downside than the upside.

Bigger is Not Always Better

Thu, 27 Apr 2023 15:11:06 GMT

Bigger is Not Always Better

For broad U.S. market exposure, bigger isn't always better. In a multi-asset portfolio, we've long argued the case that being active can provide long-term added value. But being active doesn't necessarily mean solely relying on active managers. Making an active call on allocations, even on a rather generic cheap market beta, can make a difference. ETFs are popular choices, and plain

vanilla market cap ETFs give great exposure to the overall market. But many of the most popular go-to ETFs are simply passive vehicles that mirror market cap indices.

Since mid-2020, we've recommended equal weight exposure versus traditional market cap exposure as a sleeve in multi-asset portfolios. Our rationale was that within the broad U.S. market were hidden risks that we wanted to avoid. Equal

weight basically levels the playing field in today's market. Attempting to maximize returns through diversifying over the long term. Typically, it costs a little more due to more active rebalancing. With ETFs, understanding your

exposures is an indispensable first step because it's in these differences that the alpha can be generated.

Know What You Own

A fund's expense ratio or AUM gathers a lot of interest, but truly digging into a fund's exposure makes a difference. At first glance, you wouldn't think there is much of a difference between the S&P 500 and the S&P 500 Equal Weight. Index

construction matters, and looking under the hood reveals several key differences between the two. Some fundamental differences between the two are outlined in the chart below. What stands out is a definitive tilt towards value as well as more

exposure to dividends for equal weight. Both of these factors tend to outperform during prolonged periods of market stress.

From a sector perspective, this chart outlines the difference in sector weights of equal weight compared to the

cap-weighted index. By far, the largest difference is the weighting in technology. The cap weight is 25.5%, while it's

just 13.3% in the equal weight index, a 12.2% difference. Equal weight is much more balanced with more exposure

to industrials, real estate, utilities, and materials.

Concentration Risks

Though down from its peak in 2021, there remains a considerable amount of concentration risk in the S&P 500.

After the difficult 2022 for many companies in the tech space, the top 5 companies still account for nearly 20% of

the index. Broaden this to the top ten names, and you're up to 27% of the index in just ten companies. Down

from its peak but still well north of where it was in the dot com bubble at around 18%. Concentration risk always

comes down, and it's really never been higher. Words like concentration, top-heavy, and unbalanced have been

talked about a lot over the past few years. It isn't inherently wrong, but it's truly about a lack of diversification.

Concentration risk can be really bad or really good, rarely in between.

The entire market is now virtually made up of just a small number of stocks. Without just 18 companies, the S&P

500's gains in the first quarter would have been negative. We question the sustainability of this when some of the

biggest tech names have to punch well above their weight to drive market cap outperformance to this degree. The

chart below contrasts the contribution of Q1 returns from some of the largest index members in comparison to

their index weight. Q1 has been an aberration from recent trends, and we do not see it as simply the resumption of

previous bull market winners.

Recent Performance – Markets back to their old ways

Equal weight began its outperformance following covid and has been a decided winner over the past three years,

rising +18.6% compounded annually vs +15.2% for the S&P 500. Markets don't move in a straight line, and neither has the relative outperformance of equal weight. The past quarter has seen a sudden reversal, with the capweighted index striking an impressive

comeback. Below, the chart outlines both the relative outperformance over the past three years as well as the sudden bout of underperformance last quarter.

So far this year, markets have returned to their old ways. Rising rates are less of a worry, and a large injection of

stimulus has also propelled big tech stocks higher. From an attribution standpoint, lack of tech exposure is by far

the largest driver of recent underperformance. On top of that, security selection within the Banks has also

negatively impacted equal weight. Year to date, the increased exposure to regional banks rather than being heavily

tilted to the large money centers has lost nearly 80bps versus cap-weighted. Performance depends on your

timeframe. Equal-weight outperformed in the last 3yrs, while market-cap weighted did better over 5yrs. Long-term

data going back to 1990 shows a virtual tie between the two, but coming off of the 2000 tech bubble, the equal

weight index has compounded annual returns of +8.6% versus +6.7% for cap-weighted.

Final Thoughts

Leadership in the stock market tends to change from one bull market to another because different sectors and

industries experience varying degrees of growth and decline. The chart below gives a few excellent examples of

how often the previous leaders become laggards in the next bull. During the dot-com boom of the late 1990s,

technology stocks were in high demand, while during the 2000s, bull energy and materials tended to outperform.

Investors need to be vigilant and adaptable to capitalize on changing market trends and leadership. If you believe

things are going to change, market cap isn't really where you want to be, as it's just overweighting previous

leaders. A return to more value-oriented exposure and away from mega-cap tech stocks will also benefit equal

weight.

Despite the recent rebound in technology shares, we stand behind our call to limit exposure to the sector. We're

entering a global economic slowdown, and there is still plenty of remaining froth in tech stocks. We're likely in a

higher for longer rate environment, and growth stocks were massive beneficiaries in the low-rate world. The lowrate

world was extremely beneficial for growth investors, and momentum, in particular, was a dominant factor for long periods

over the past decade. In contrast, value was decidedly out of favour.

The current market environment emphasizes the importance of active decision-making in investment allocations.

Equal weight investing provides a potential solution for investors seeking to diversify and avoid concentration

risk in market cap indices. It's essential for investors to understand their exposures and actively manage their

portfolios, even when it comes to something as seemingly straightforward as their exposure to U.S. equities.

It Is 2023, Not 2008

Fri, 17 Mar 2023 17:09:00 GMT

It’s fair to say that investors remember the last bear market the best; the one before that is a hazy memory, and if they have been investing long enough, the one before that is almost forgotten . This is part of recency bias. If we skip over the pandemic bear burp, the 2008 global financial crisis was the last bear market. So, it’s not surprising that when a couple of regional banks fail and a large global European bank appears on the ropes, the memories of 2008 are still vivid. ‘Sell first and ask questions later’ has pushed U.S. regional banks down 25% in the past week and a half, and the big banks down 15%. All bank shares have been under pressure, with the Canadian bank index off 8%. Broader markets are down a bit, but this so far appears isolated.

So are Silicon Valley Bank (SVB) and Signature Bank the Bear Stearns and Countrywide of this bear? Those latter two were early to collapse before the crisis really got going in the Fall of 2008. The short answer is ‘No.’ 2008 was caused by bad assets and CDOs, and upon realizing the value was not there, banks and other companies failed. That was a solvency issue. Today, the failure of SVB and Signature appears more of a liquidity issue caused by bad business models in a changed environment, not an asset issue. But we also remember similar statements were prevalent back in 2008. So that might not be totally reassuring.

SVB’s demise appears to be more of an asset/liability mismatch that deteriorated as deposits were suddenly pulled. On the positive, the asset side is not overly complex leveraged assets such as CDOs in 2008. Perhaps the real takeaway may be that an extended period of an artificially low cost of capital and too much abundant capital led to an explosion of venture capital growth businesses (small & med sized tech firms and CEOs in their 20s with business plans written on napkins). Now that capital has a real cost (yields up and less abundant access to capital), many of those ventures are proving to be a tad overly optimistic or require continued free and plentiful capital to continue, which no longer exists. So, should we be surprised a bank that primarily focuses on this niche of the technology industry has failed? Or, in Signature’s case, a bank sensitive to the gyrations in the digital asset space? Greater variability in both inflation and economic growth does not encourage higher earnings multiple for equities. Depending on a market's current valuation, this may prove to be a headwind.

Higher rates = higher cost of capital. That is the tide going out, and now poor business models and capital allocations are being punished. It is the circle of life (or the circle of capital). This has highlighted that a diversified deposit base has become extremely important for banks and other lenders. Especially given movements among deposits. The bigger the bank, the more diverse the deposits (usually).

What happens next?

Will there be other shoes to drop or other vulnerable business models exposed? No doubt. The era of easy money has ended, and many companies need to pivot. This will continue to be a challenging period. For the banks, a period of ‘no news’ would certainly be positive and could easily lead to a relief rally. But make no mistake, the stresses of so many rate hikes and higher yields over the past year continue to work their way through the economy and financial system. And while the sudden drop in yields over the past week is welcome, potentially alleviating some stresses, it may be causing stresses elsewhere. At the end of February, the net speculative positioning in the combined options & futures market for bonds was VERY short – making this sudden drop in yields (rise in prices) very painful. Some investment models are clearly feeling this pain now.

Sticking with the short term, it is worth pointing out that the market appears poised for a bounce. Relative Strength got down to a buy signal on Monday (near 30). Market breadth for the S&P 500, measured by the percentage of companies above their 50-day moving average, is bullish (meaning oversold).

The AAII investor survey, out on Thursday the 16, has 48.4% bearish and only 19.2% bullish (net -29.2%). That is bearish, which often coincides with short-term troughs. The put/call ratio pushed over 1 on March 10, another buy signal. Put all this together, and a rally could be afoot. But just as we penned in on February 6 ( Rent This Rally, Don’t Buy It ), we would be ‘renters of this rally, not buyers.’

2023

This banking flare-up has not changed our view for 2023, and in fact, it is supporting evidence. Last year inflation was the largest angst for markets, which we believe peaked in the fall. While inflation won’t follow a straight line lower, as evidenced by a small uptick lately, we believe the general path will be down. As inflation fear fades, markets rally. That is what we saw to start the year. But this inflation fear will gradually be replaced by economic/recession fear as the year progresses.

The economic data at the moment is very mixed. We have an inverted yield curve, leading economic indicators that are negative, Fed recession models that are flashing a warning sign, and a drop in asset prices that often precedes a recession.

Meanwhile, on the other side of the economic ledger, we have a consumer in decent shape and a healthy labour market. But these are not leading, more coincidental or even lagging. So if you look out the side window of the bus, everything looks hunky dory…just don’t look out front.

Even if these bank issues fade, there will be an implication for quarters and years ahead. With what has happened, credit just got a lot harder to come by. Banks will continue to become more restrictive and conservative. That is deflationary and will continue to bite into economic growth.

Finally, what do you think it looks like as a recession approaches? Over-levered or vulnerable business models are exposed first. Well, check that box over the past week. And if you had previously given the probability of a recession 50%, which way have those odds moved in March? (hint: higher).

Final Thoughts

Nobody knows if a recession is a certainty in 2023 or even 2024. For us, best to prepare for it and be pleasantly surprised if a recession is avoided. Much better than denying the recession risk with rose-coloured glasses and being surprised if one develops. After reducing international equity and adding to bonds at the beginning of March (Worth a Read or Two), our balanced model is underweight equity and overweight bonds/cash. Plus, we are carrying a nice duration of just over 5 for our bonds. We prefer leaning into defense – bonds, dividend-focused equities and defensive alternatives.

Trade this market turmoil or potential price overreactions if you like, but best to remain a short-term renter.

— Craig Basinger is Chief Market Strategist at Purpose Investments

S ource: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Greg Taylor and Derek Benedet Purpose Investments Inc.

Disclaimers
Echelon Wealth Partners Inc.
The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Echelon Wealth Partners Inc. or its affiliates. Assumptions, opinions and estimates constitute the author's judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.

Purpose Investments Inc.
Purpose Investments Inc. is a registered securities entity. Commissions, trailing commissions, management fees and expenses all may be associated with investment funds. Please read the prospectus before investing. If the securities are purchased or sold on a stock exchange, you may pay more or receive less than the current net asset value. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated.

Forward Looking Statements
Forward-looking statements are based on current expectations, estimates, forecasts and projections based on beliefs and assumptions made by author. These statements involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. Neither Purpose Investments nor Echelon Partners warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. These estimates and expectations involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Unless required by applicable law, it is not undertaken, and specifically disclaimed, that there is any intention or obligation to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice.

Do You Have These Seven Habits of Highly Effective Investors?

Tue, 14 Mar 2023 17:49:00 GMT

Over thirty years ago, the book “The 7 Habits of Highly Effective People” quickly became a bestseller by offering a common-sense approach to improving life outcomes through personal change. Investing may be seen in a similar light — establishing certain habits can help to make better investors.
Here are seven practices that can serve investors well:
1. Recognize that time is one of your greatest assets. The odds of investing success fall in your favour when you combine a long time horizon with the power of compounding investments. Even average returns, compounded over a long time period, can lead to superior overall results. Consider that a one-time, lump-sum investment of $55,000 will yield around $209,000 in 25 years at a compounded annual rate of return of 5.5 percent. However, in 55 years, it will yield over $1 million. ¹
2. Accept that markets are inherently volatile. Volatility is what allows equities to be one of the greatest generators of returns of any asset class over the longer term. In periods of volatility, remember that it is a permanent fixture in equity markets. Over time, equity markets will have incredible up periods, such as the one we experienced in 2021, but also many difficult down times.
3. Maintain patience, through good times and bad. Participation, by having the patience to see through the inevitable ups and downs, can make a significant difference in investing. Successful investing often involves the patience to overcome many short-term setbacks in order to enjoy longer-term compounding and progress.
4. Don’t abandon risk controls. When equity markets are rising, it can be easy to get caught up in the excitement. When markets are falling, it may be difficult to believe that the down times will eventually end. Of course, emotions are not usually an investor’s best ally. Some of the most successful investors are able to put emotions aside when they make portfolio decisions, and this often involves following various guidelines that have been established to control risk — for example, strategic diversification, rebalancing to a certain asset mix, limiting the size of any holding and maintaining quality criteria for holdings. These can help to guard against being caught in the prevailing momentum by identifying potential risks that may not always be overly apparent.
5. Stop listening to the noise. Everyone has an opinion on investing and the markets. In good times, everyone can sound like an expert and we may fear missing out. In difficult times, the media headlines can magnify economic misery and instill fear. At the end of the day, thoughtful analysis should drive decision-making — not any peripheral noise.
6. Save more. Saving is one of the cornerstones of building wealth. You can build wealth without a high income, but you have no chance without a high savings rate. Saving is one aspect that an investor can control — unlike the many others which we cannot, such as stock market performance, interest rates or the timing of recessions.
7. Continue to have confidence in the value of support. We are here to provide support at every stage of the investment journey to help you achieve your goals, and this can extend beyond investment advice. This may include helping to instill discipline, through saving or investing, or to enhance total wealth management, through retirement-planning, tax-planning or estate-planning support. Studies continue to show that advised clients have greater assets — more than 3.9 times the assets than non-advised investors after 15 years — and greater discipline through volatile times. ²
1. Assuming no taxes or fees; 2. IFIC

Disclaimers Forward-looking statements are based on current expectations, estimates, forecasts and projections based on beliefs and assumptions made by author. These statements involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Echelon Wealth Partners Inc. or its affiliates. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. These estimates and expectations involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Echelon Wealth Partners Inc. is a member of the Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection Fund.

How Much Do You Need to Retire?

Tue, 14 Mar 2023 17:49:00 GMT

Worried about retirement? Specifically about the cost of retirement and whether you will have enough money? If so, you’re not alone. According to recent surveys, over 60 percent of Canadians are concerned about being able to live comfortably in retirement. ¹
Worrying Too Much?
Some studies have shown that perhaps we worry too much about our funds in retirement. One expert estimated that a couple could live on around $44,000 per year. ² Government safety nets could supplement this amount if personal assets were exhausted. Many of us would dispute this assessment, as most would like retirement to go beyond subsistence!
If you are fortunate enough to have a defined benefit pension plan at work, you will have at least some idea of your retirement income. However, the world continues to change and defined benefit pension plans have become increasingly rare.
Registered Retirement Savings Plans (RRSPs) are the other major component of retirement savings for many Canadians. They are often converted to a Registered Retirement Income Fund (RRIF) to provide taxable income. How much can a RRIF provide? For those who are regimented in contributing, the RRIF may play a substantial role.
Need More Income?
The RRIF is flexible in the amount of income you can draw, so some may withdraw more than the minimum when needed. The Tax-Free Savings Account (TFSA) has also become a significant investment vehicle that can help to fund retirement. And in many cases, people do not stop working at age 65. While they may leave lifelong jobs, they may end up doing something else that is productive (and perhaps even profitable!).
For those concerned about longevity risk, the Canada Pension Plan (CPP) has the potential for greater payouts if payments are deferred to the age of 70. The current maximum annual benefit is $15,678 ³ for an individual who starts payments at age 65, but this rises by 42 percent at age 70. Yet, fewer than one percent of retirees delay CPP until age 70, despite studies that show it to be one of the more financially prudent decisions should you live beyond the average life expectancy of 82 years old.
How Much Can the RRIF Provide?
We Are Here to Assist. One of our roles is to help clients prepare for a comfortable retirement. We can assist with worksheets and tools to project your requirements as you plan for the future. Continue to look forward with confidence!

1. https://benefitscanada.com/pensions/retirement/new-surveys-highlight-discrepancies-in-retirement-readiness/; 2. https://www.thestar.com/business/personal_finance/opinion/2020/02/10/a-fulfilling-retirement-may-be-cheaper-than-you-think-heres-why.html; 3. Based on maximum monthly payment amount at the start of 2023 of $1,306.57. https://www.canada.ca/en/services/benefits/publicpensions/cpp/payment-amounts.html
Disclaimers Forward-looking statements are based on current expectations, estimates, forecasts and projections based on beliefs and assumptions made by author. These statements involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Echelon Wealth Partners Inc. or its affiliates. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. These estimates and expectations involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Echelon Wealth Partners Inc. is a member of the Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection Fund.

Worth a Read or Two

Mon, 06 Mar 2023 17:37:00 GMT

Markets and the economy never travel in a straight line, and the last few months have had more than their normal share of zigs and zags. In October, after rising steadily all year from less than 1%, the market started pricing in a stable peak Fed Funds rate of about 5%, expected to be reached sometime in 2023. Parts of inflation had started rolling over a few months prior, and the data was accumulating that inflation was starting to ease. Markets reacted positively, bond yields came back down, and equities moved higher. This move accelerated in January, largely due to more cooling inflation evidence and a bit of a junk rally ( Rent This Rally, Don't Buy It ). But markets nor the data move in a straight line.

More recently, we have seen a tick higher in inflationary data and an improvement in the economic data, two things the markets don't like. This has woken up that stable peak Fed Funds rate pushing it up 50bps to 5.5%, with the 10-year U.S. Treasury yields back over 4% and the S&P back below 4,000 (chart). Clearly, the decline of inflation is not going to be a straight or smooth line.

Taking a step back, which often helps to gain perspective for both the economy and markets, the inflation trend is to the downside. The 3-month change in CPI is trending lower, wage growth has come off a bit, and inflation expectations have come down both in the short and longer term. Supply chain pressures are largely gone, based on CitiGroup's aggregate measure. There are always some data points that counter the trend – the NFIB survey of small businesses indicated a small rise in pricing plans and ISM service pricing too. Inflation moved higher in Europe, and the U.S. PCE Deflator was higher than expected (happy to explain what a deflator is, just ring or email us). But at the moment, the majority of the data is pointing to less inflation going forward.

And let's not forget what causes inflation: too much money chasing too few goods/services/assets. Well, the supply of goods logistic issues are resolved, and the amount of money is shrinking. M2, a measure of the U.S. money supply, peaked in March 2022 and has gradually declined. A peak in M2 growth has preceded all past peaks in CPI; sometimes, it takes a few months and sometimes more than a few.

Our view remains – markets can move higher on signs of softening inflation and clearly can move lower on signs of more inflation. Looking through the zigs and zags, we see the inflation data trend to the downside, just not in a straight, smooth line. BUT, the good news will be short-lived as the signs of a slowing economy grow louder and garner more attention. We remain renters of any rally and like bonds a little more with every tick higher in yield.

Market Cycle

Our Market Cycle indicators continue to hover just above the zone that has a good reliability of signaling a pending recession. But things are actually a bit better than they appear on the surface. On the signal side, we have seen a few improvements in the fundamental data, meaning earnings revisions/growth. Offsetting this was a few signals turning negative for the global economy. The U.S. economy improved, notably on the housing side.

Housing data in the U.S. is very important. Just about every recession in the U.S. can be traced back to changes in activity in housing and/or manufacturing. These are the more cyclical components of the U.S. economy which is, on a relative basis, more insulated from global factors. Housing activity had been softening for many months as the impact of higher mortgage rates took its toll. Similar to trends here in Canada. The question is whether the recent improvement in U.S. data is a turning point or just a temporary counter-trend move. We don't believe it will last, as the housing part of the economy will still be absorbing the past rate hikes for many months. And this recent move in yields has mortgage rates moving up again.

There is more good news, though. The trend for most signals is improving. With 34 signals improving and only 8 deteriorating, we expect to see more green signals in the coming weeks. Nothing moves in a straight line, and with economic data getting a bit better, the Market Cycle is picking this up.

Cooling on International and Warming to Bonds

International equities are an area of the multi-asset universe that we have chosen to be much more overweight than your average Canadian balanced portfolio. So far, so good over the last five months, international markets have been on a tear of outperformance. A long-term cycle analysis drove the thesis for being overweight international equities. Looking back throughout decades of data, market dominance shifts between the U.S. and International markets. The 80s was International., the US crushed it in the 90s, the 00s saw outperformance from International, and we all know what dominated in the 10s, US mega caps. Markets like to move in cycles, and leadership changes each cycle. We believe international equities will likely be strong for the foreseeable future, but from a near-term tactical mindset, it might not be that simple.

The fact is, we remain in the camp that the move higher in equities over the last five months is a bear market rally, and the economic outlook remains challenging. Inflation remains high, especially for our counterparts across the ocean. Year-over-year core Eurozone inflation remains high at 5.6%, which moved higher as of March 2, and the UK Core CPI is at a similar level. The ECB has signaled that the interest rate hiking cycle is far from over. The widely forecasted earnings growth deceleration is coming, shown by tepid guidance from a majority of companies in the US and international markets. The economy is starting to slow, but there will always be some form of lingering tailwinds that keeps the bulls alive and well.

A surefire sign that things may have moved too quickly has been the rapid move in G10 currencies against the US dollar. This move has contributed towards the international returns for us North Americans. Albeit, for the majority of the below currencies, the starting point is from extremely depressed levels, especially the British Pound and the Euro. So, it is no surprise that these kinds of returns in a relatively risk-on environment were found internationally. Still, many of these currencies remain undervalued from a long-term perspective, another reason why our overweight in international will persist. The rapid movement of these currencies simply allows for a short-term tactical shift towards other multi-asset allocations.

This is a good thing, in not so many words. Over the past few months, the overweight in international has been the right call. It is important to reiterate that looking ahead through the next cycle, our thesis remains for a period of desynchronized global growth, which should enhance the prospects of geographic diversification. Persistent inflation should alleviate, which could lead to large differences in country performance. Our long-term view has not changed; we just like to take profits.

With earnings estimates falling, multiple expansions were doing the heavy lifting for equities this year. For example, blended forward valuations for the S&P 500 rose from a low of 15.2x in October to a high of 18.7 in early February. International stocks are still cheap relative to the S&P 500 but have also seen a similar degree of multiple expansion. The earnings yield is simply the reciprocal of the PE Ratio and is useful in comparing the relative valuations between stock and bond markets. The chart below shows that equities are now the least attractive relative to 10-year Treasuries since 2010. The spread is not historically high going back decades but is at a level that begs some attention. The disparity is even more apparent on the short end of the curve, with the S&P earnings yield nearly equal to the U.S. 2-year bond yields. Falling risk premia indicates an overbought equity market relative to bonds. The historical risk premium in equities relative to treasuries exists for a reason: a necessary payment for the risk of volatility and drawdown.

For investors, it's important not to get caught up in bond market recency bias. The experience in 2022 for the fixed-income market was terrible, and we're not going to sugarcoat that. Unprecedented is just a way to sugarcoat a poor investment decision. We're not going to deny that pace and magnitude of rate hikes were a surprise last year. However, we won't abandon a key tenant of portfolio diversification because of a bad year. Over the past year, the FTSE TMX Universe is down -7%, compared to just -1.1% for the S&P/TSX Composite – not the type of defence we anticipated in a drawdown environment, but also not the type of performance we expect looking forward. The future path of bond yields is uncertain, and there will always be a degree of rate risk in the bond market, but investors need to remind themselves why they want bond exposure in the first place…and that is diversification, plain and simple.

Bond market volatility picking up – so long, Fed pivot

Rates and equity volatility have been on a round trip so far this year, with the narrative changing from soft landing to higher for longer. Bond and equity markets rallied on expectations of a Fed pivot this year, but those vanquished in February. The chart below shows the expected Fed funds rate differences from June '23 to Jan '24. The 72bps difference reached in Jan represented maximum pivot or a high degree of conviction that rates would max out in the summer, followed by multiple cuts. That's been eliminated from the market's view in a matter of weeks, with a slim chance of a pivot this year.

Peak rates went from around 5% last October to a new high of 5.4% based on the current market-implied overnight rates. Also interesting is that the timing of the terminal rate continues to be pushed out. For most of last year, peak rates were expected to be from March to May. Then in the fall, it was pushed out to June. And just this month, the terminal rate has been pushed out to September. The trend is clear, but for some reason, it's not obvious to the equity markets. We increasingly prefer the relative safety of fixed income because of the implications.

Portfolio Thoughts

The renewed volatility in the rates market and still subdued volatility in the equity market has created a divergence between stocks and bonds that concerns us . So far, we've seen only a modest decline in stocks. Just like Nick Nurse, coach of the Toronto Raptors, we have a defence-first mentality. This can be done on the equity side through sector allocation, factor tilts or certain alternative strategies. At the portfolio level, the most important decision is the stock/bond mix. We're currently slightly overweight fixed income and are very near tilting further in this direction. For months now, we've pegged around 4% on the U.S. 10-year as a level where we're comfortable adding to fixed income and even duration.

The current duration for the FTSE TMX Universe is 7.35 years. This is the lowest it has been in six years, and with U.S. 10-yr yields now over 4%, some duration here is again looking attractive. The break-even ratio, also known as the Sherman Ratio (yield/duration), is a measure of interest rate risk, representing yield per unit of duration. The current ratio for the Canadian Aggregate Bond Universe is 0.57, implying that yields would have to rise 57bps from here for the decline in bond prices to offset the yield over the next year. Compare this with a low of 0.13 in 2021 or 0.21 at the beginning of 2022, and the risk/reward trade-off is very different. While interest rate risk is still present, the risk/reward ratio is as high as it's been in nearly 15 years.

Investing is a constant exercise in risk-taking. With thoughtful consideration, we believe the scale is modestly stacked against equities in favour of bonds in the near term. Especially if the economy really starts to slow down. Looking at valuations relative to history and our near-term outlook, we believe now is a good time to tilt further towards defence. From an asset allocation perspective, risk is paramount and given our healthy respect for the unknown, this is why we invest in bonds in the first place.

Bonds, GICs, or HISA?

One of the most recurring questions from investors over the past few months has been on the fixed-income side of their portfolios. Many are licking the wounds of a bond bear market that saw Canadian bonds (based on a broad-based ETF) drop by -2.8% in 2021, -11.7% in 2022, and currently sitting flat in 2023. Limited joy from the part of the portfolio that is supposed to be the stabilizer. This has been fostering a mindset that maybe bonds are broken.

Meanwhile, with yields up across all maturities, including cash products, not surprising there has been a rush into other solutions. High-interest savings accounts (HISAs) enjoy a current yield of just under 5%, while with GICs, you can lock in 4.8% for a year or 4% for five years. And your principal won't go down should yields continue to rise. Clearly, there is a lot of money in motion around these three options at the moment.

Bonds, GICs or HISA – which is the right choice? Each has a unique return profile that depends on what happens next. So, sadly, there is no clear answer unless you know the future path of inflation, short- and long-term rates, the pace of economic growth, plus much more.

So what could be next:

More Inflation Scenario – Inflation has cooled over the past few months, thanks to supply chains getting sorted and some cooling in the economy. But let's say it re-accelerates either due to the service component of inflation continuing to ascend, or the global economy speeds up. There are some signs of improving growth out there, including in China. If this were to occur, central banks would likely continue to raise short-term rates, and longer yields would also move higher.

HISA wins - As short rates move higher, the interest paid will rise. No erosion of principal. A close second would be really short bonds/money market instruments.

GICs draw - Pays a locked-in rate, which becomes below future market rates, so the term is a factor. Since NAV is fixed, it doesn't move, but the price would fall if it were marketed to the market.

Bonds lose - As with 2022, as yields move up the value of bonds moves lower, a function of the duration.

Goldilocks scenario – Inflation gradually comes back down thanks to supply catching up, and the economy slows but remains decent. This is that magical soft landing that is so often hoped for or attempted. It's certainly possible. The global consumer is in good shape, employment is strong, there are pent-up demand/savings, and some signs of growth are out there, along with some signs of slowing. As the impact of past rate hikes is fully felt, the economy adjusted to a slower pace of growth.

Central bankers arrest their hiking ways, and longer yields remain stable or come down a little. This could result in a three-way tie. HISA tie.

HISA tie - Short-term rates remain high, which means your HISA keeps paying around current yields

GICs tie - The interest rate is locked in here, so really about the same

Bonds tie - Bonds likely get some capital appreciation as the economy slows a bit and longer inflation expectations trend lower. Add the coupon, and you are probably looking at a similar outcome as above.

Slowing growth or Recession – Inflation has peaked and is on its way back down, thanks to supply chain improvements and slowing economic growth. The magnitude and speed of rate hikes around the world in 2022 will have a bigger economic impact in 2023, causing economic growth to slow substantially or even trigger a recession. Hitting the air brakes does not result in soft landings.

As the economic slowdown's magnitude and timing become clearer, central bankers may even start to cut rates. And bond yields will fall.

HISAs lose - Not in a big way, but as short rates come back down, so will the interest on HISAs.

GICs draw - Locking in the rate at a higher level pays off here.

Bonds win - Bonds have a decent yield at the moment, and under this scenario, capital appreciation would be a sizeable lift depending on the duration. But this would be lessened based on how much credit exposure is in the bond holdings.

Of course, there are other scenarios out there or other combinations of events. Stagflation could be one, in which case cash likely wins, but it depends. We could see inflation pick up and an economic slowdown not materialize till later, 2024 perhaps. The economy is a mystery. It often doesn't change despite big macro factors….then it suddenly moves quickly.

Two other factors worth considering:

Optionality – Maybe equity markets drop substantially, or yields jump higher. Ensuring you have enough liquidity to make changes to take advantage of any potential material mispricing is important on your portfolio's cash/bond side. HISAs or cash take top honours here, with bonds in second. GICs in a distant last depending on how many years are left in the term as the money is locked in or would suffer a penalty to redeem early. Don't underprice optionality – it has value that could be more than a few basis points of yield.

Big picture - Part of a portfolio – It is important not to suffer tunnel vision on one or two line items in a portfolio. It is the aggregate portfolio structure that matters. For instance, you may be inclined to shed all duration (go super short term) for your bonds and add more credit. That would have helped a lot in 2022. But if a recession is coming, all of a sudden that credit exposure isn't so great, and you will want duration. A recession will also weigh heavily on the equity side of your portfolio. Again, it is important to think of the big picture of the entire portfolio.

There is no perfect answer for the path ahead, primarily because of the uncertainty. The good news is just about every option available now carries a decent yield, a far cry from years past. We like optionality for our portfolio management work, so we lean towards good old fashion bonds and liquid cash vehicles.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

— Brett Gustafson is a Portfolio Analyst at Purpose Investments

— Derek Benedet is a Portfolio Manager at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Greg Taylor and Derek Benedet Purpose Investments Inc.

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Tightrope

Wed, 22 Feb 2023 18:53:00 GMT

Sometimes good economic news is bad (when inflation is the most significant risk), and sometimes bad is bad (when a recession is the risk). Today, this market appears to be walking on a tightrope where either good or bad economic news could elicit a bad market reaction. If the economy is doing well, this is reigniting inflation fears. If the economy shows signs of slowing, the inflation fear decreases, but recession or slowing growth fears rise. Lean too far in either direction, and the markets could tumble off the wire. Especially given valuations have quickly jumped higher given the strong price gains to start 2023 while earnings growth forecasts have continued to moderate.

The strong market advance so far this year appears to be largely driven by improving news on the inflation front. That has helped the S&P and TSX rise in the 6-7% range. But so far in February, this advance appears to have stalled, and the likely reason is the economic data has been surprisingly strong. While this may reduce recession fears, it appears to be reigniting inflation fears. U.S. 10-year yields, which fell from 3.8% to 3.4% during January as equity markets rose, have risen in February back up to 3.8%. Canadian yields have followed a similar pattern.

The trends in the data are well captured by the CitiGroup economic and inflation surprise indices. The inflation index is monthly, so the last reading is from the end of January. With both U.S. Consumer Prices and Producer Prices coming in a bit hotter than expected, this will likely turn up a bit. Meanwhile, the economic surprise index has been suddenly rising. These are surprise indices, meaning it measures how the economic data come in relative to consensus economist forecasts. It appears the forecasts for inflation coming down may have gotten ahead of themselves, as did the forecasts for a slowing economy.

The path lower for inflation in 2023 was never going to be a straight, smooth line. Just as it moved higher in the second half of 2021 and 2022 was not a straight line up. And we may be in a reversal period at the moment. The duration is hard to say, but given the gradual loss of momentum in many of the more cyclical parts of the North American economy (housing, manufacturing), we continue to believe inflation fears will fade this year and gradually be replaced by recession or pace of economic growth fears.

It isn't the most original analysis on our part, but there is no denying the U.S. Conference Board's leading, coincident and lagging indicators are all following a familiar pattern. The leading index is comprised of 10 pieces of economic or market data that have a history of turning ahead of the overall economy. Jobless claims, manufacturing new orders, building permits, and credit are a few of them. As is the stock market. The coincident index includes employment, business sales, personal income and industrial production. Lagging includes duration of unemployment, inventory/sales ratio, prime rate and services CPI, to name a few. Please note that services CPI is literally in the lagging economic indicators index. Inflation is very lagging.

Leading indicators were trending down in 2022. Maybe this is skewed because economic activity was so elevated in 2021 as the North American economy opened up more, and we were still catching up on supply shortages. So part of this downward move could be just 'normalizing.' Or the economy is about to slow down. Likely a combination of both, the world has never been simple or binary. Interesting that the coincident indicators tend to cross over to negative territory at the same time a recession starts. We should add that the onset of a recession (grey shaded bars) is not known in real-time; this crucial turning point is determined many months after the fact by the National Bureau of Economic Research.

Moving to more of our in-house analysis, we have been using our Market Cycle framework for many years. This was developed to provide insight into the risk of an economic cycle coming to an end. Instead of just U.S. economic data, as is used in the Conference Board leading indicators, we incorporate many other data points – economic, yields, central banks, global economic activity, commodities, fundamentals, etc. All told, it tells a similar story. In our publication two weeks ago, we included the Market Cycle bullish indicators and all the specific inputs ( Rent This Rally, Don't Buy It ).

Below we share these indicators and framework looking back about half a century. Nothing is ever perfect, and how the economy works changes over time. But it provides insight into the economic cycle's health beyond just U.S. data. With the signals hovering in that danger zone, things are rather precarious.

Add to this a market that really isn't down all that much anymore…was it even a bear market? The S&P 500 is down 12.6% since the beginning of 2022, but take out those mega-cap tech giants, and it's down a mere 5%. Slicing and dicing an index like this isn't fair, but if a bear market largely punishes a few trillion-dollar mega-cap tech giants, that is not that painful. FYI – the TSX is down a mere 7% from its high, and Europe is down 2% from its all-time high.

Portfolio Considerations

Thematic The market, outside a handful of giant tech companies, is not really down that much after this rally of the past few weeks. Goodbye, valuation safety buffer. Meanwhile, inflation remains a risk, and so does an economic slowdown/recession. Given our Market Cycle and the Conference Board indices, we believe inflation fears will diminish as recession fears grow, even if inflation fear may be experiencing a little tick higher of late. This has lifted bond yields higher, 10-year at 3.85% in the U.S. and 3.30% in Canada, yet our fear of duration is incrementally lower. Dialling back market risk in return for duration risk seems reasonable.

On the left, you have inflation; on the right, recession. And given market levels, this tightrope is more than a few feet off the ground.

— Craig Basinger is Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Thematic ETFs Are Missing Something

Mon, 13 Feb 2023 16:37:00 GMT

Perusing a 100+-page report from a leading thematic fund management company discussing their thoughts on the big ideas for 2023, and the future looks really exciting. AI, molecular diagnostics, orbital aerospace…society is doing things that are truly remarkable. Industries will change and be disrupted—all very cool.

I suppose that is part of the appeal of thematic-focused funds and ETFs. If we can get in on a long-term secular change or trend in society, that can be very profitable tailwind. The iPhone launched in June of 2007 when Apple was trading at $4.36 per share; today it’s over $150.
Thematic ETFs are not just technology focused—really they are attempting to capture any long-term trend or change in society. Rising food consumption has led to agriculture thematic ETFs; there are clean energy, water, infrastructure, millennial-spending pattern ETFs…the list goes on. And who knows, maybe artificial intelligence is the next smartphone. I did ask ChatGBT this question, the response was rather positive on the theme. Then again, when asking AI about the future of AI, what else would you expect.

The asset flows and popularity of thematic ETFs have exploded over the past few years. Of the 315 thematic ETFs currently trading in the U.S., only 67 were in existence five years ago. Measured another way, the chart below shows the total shares outstanding across all thematic ETFs over time. Since as investors buy an ETF, it increases the number of shares outstanding, this is a good measure of rising demand.

Us humans love a good story and story-selling is very powerful. Thematic ETFs clearly lend themselves to a great story. There are more computer hacks today than any time in history and society continues to put more information in the digital world. Invest in cyber security, no brainer. The latest League of Legends championship (that is a video game) had 18,000 people in live attendance to watch the gamers battle, which is about the capacity of Scotia Arena. DRX won. E-gaming is a rising thematic trend. The International Energy Agency predicts 58% of vehicle sales in 2040 will be electronic vehicles (EVs). The long secular trend away from internal-combustion-engine vehicles to EVs is clear: why not use an EV ETF to gain some exposure to this trend?

Please don’t take the above statements as a recommendation—just trying to demonstrate how compelling the story-selling can be even with a couple sentences. They are exciting, even fun to talk about. Certainly more exciting than a North American dividend ETF that focuses on free cash flow, dividend health, and growth. Yawn.

But there appears to be a problem.

Investors are clearly aware that an investment strategy focused on a narrow theme is not diversified and will likely be much more volatile than the overall market. That is part of the appeal, if you believe the thematic trend will persist then hopefully more of that heightened volatility will be the good kind (aka up). The good news is that has been the case.

We took the current 50 largest thematic ETFs and did a bunch of analysis. We know, some survivor bias here, and there is a high degree of time sensitivity to this. Still, there are some really important lessons that shine through:

Volatility – As promised, thematic ETFs certainly move a lot. Initially we looked at the past three years, but that analysis started in the middle of the pandemic bear of 2020. So we expanded to four years to provide a better look. The chart below is an index created by using the average performance across the biggest thematic ETFs that have been around since 2019.

It's clearly volatile in both directions, but this masks over the individual ETF performance. During these periods, the best was up +178% (29% annualized) and the worse was down -86% (-38% annualized). FYI the big winner was a clean tech ETF, and the big loser was marijuana. With this kind of divergence in performance, picking the right thematic ETF is REALLY IMPORTANT.

Rampant performance chasing – Unfortunately, a simple look at performance overlooks the biggest hurdle investors face when investing in thematic ETFs. With ETFs, it is very easy to measure investor flows. When did the majority of investors buy, at what price, what has been the average investor experience? It is sobering.

Of the biggest 50 thematic ETFs that have been around for four years (29), the median annualized price performance is about 10%. However, if you measure the internal rate of return based on when investors piled into each ETF the experience has been much, much worse. The median dollar weighted return is closer to 1%.

The reason behind this very wide performance spread can easily be seen when looking at the price most of the ETF buying occurred at. The right chart is the percentage of flows broken down by the individual ETFs price range over the four year period. With 50% of flows (dollars) coming in then the price is highest, not surprising the investor experience has not been ideal.

Full disclosure, this is somewhat caused by a ton of money coming into thematic ETFs late in 2021 during the speculative and highly elevated market environment. Subsequently, the price of most thematic ETFs have suffered in 2022. Still, performance chasing is very rampant in this space.

Thematic ETFs are missing something – There is nothing structurally wrong with thematic ETFs. The ETF manufacturer puts together a strategy that attempts to capture exposure to a long-term secular trend or potential trend. Sometimes these are active, sometimes they track a thematic index. There is clear demand for these types of strategies, and in our society, if there is demand supply will follow.

Even the worse-performing thematic ETF in our analysis achieved its objective. It remains a basket of companies most exposed to marijuana. Unfortunately, this space went from euphoric optimism to pessimism. The industry has grown, production has grown, (legal) weed usage has grown. The secular trend was actually spot on, yet the investment experience was poor over the past four years.

It would appear the missing ingredient for successful thematic investing is a sell discipline . Even if the secular long-term trend of a thematic is evident, the companies associated with the trend can oscillate around this trend from euphoria to despair. The trend may last for years or decades, but at some points the companies can be extremely highly valued to periods of much lower valuations.

We would agree that EV adoption will continue to rise and has continued to rise over the past few years. During this period, the DRIV ETF enjoyed +62% in 2020, +28% in 2021, and -34% in 2022. Clearly the market prices of companies levered to this trend enjoyed good times and bad times, even as adoption has continued relatively unabated.

Portfolio Considerations

Thematic ETFs have the ability to add exposure to a long-term secular trend for a portfolio. Even some excitement. But be careful of your entry point. Even if the world is going to change, trees don’t grow to the sky. And if euphoric excitement is already evident, you may be late to the party. More importantly, even if you still believe in the long-term trend, you need a sell discipline. This can be rules based, risk based, size based—take your pick. Even if the thematic trend is a long-term secular change and you believe deeply in the theme, thematic ETFs should not be used with a ‘buy-and-hold-forever’ mentality.

— Craig Basinger is Chief Market Strategist at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Rent this rally, don’t buy it

Tue, 07 Feb 2023 14:53:00 GMT

2023 has started off with a bang – a good bang, that is. After a tough 2022, which saw most asset classes, including stocks and bonds, moving lower, 2023 has started off on the right foot, with stocks jumping higher and bonds moving up too. This is the sweet spot. Inflation has started to cool, emboldening some central banks to arrest their interest rate hiking ways that dominated 2022. The Bank of Canada hiked in January and announced a pause. The omni-important Fed may be nearing this point as well. Currently, the market is pricing in one or two more 25bps hikes for the Fed.

Meanwhile, Q4 earnings are coming in reasonably well despite cooling predictions. The widely forecast deceleration of earnings growth remains elusive, but it is coming. Inflation is positive for corporate sales, which is starting to slow but remains positive. And while the economy is beginning to slow, it remains decent with lingering tailwinds. China reopening is helping, as is Europe's management of their tight energy situation during the winter months. Put it together, the narrative around a soft landing has gained some traction.
From our 2023 Outlook – so far, this year is going according to expectations:

2023 should start off decently as inflation comes down a bit more, partially alleviating the market's biggest fear. Plus, a little January effect could certainly help. However, less inflation will start to accelerate slowing corporate earnings. And the wealth effect of falling equity/bond markets over the past year plus delayed economic impact of rate hikes and higher yields will cause economic growth to fall significantly. This could trigger the final leg down of the bear and create the better buying opportunity, hopefully sometime in the first half of 2023, as the market begins to look through the trough and rally back to be positive on the year.

Enjoy this sweet spot, as it is unlikely to last. Take a step back from the month-to-month gyrations; inflation got out of control in 2022, which elicited a very aggressive response from central banks. The speed of rate hikes and the magnitude were breathtaking. This solution to inflation, hiking rates, works because it slows economic activity with a delayed impact. We are now seeing inflation begin to soften, and the slowing economic growth should become increasingly evident next. While a soft landing is not impossible, given global economic growth is coming down from a 5.8% pace in 2021 to 3% in 2022 to ?% in 2023 combined with this magnitude of rate hikes, it may be a long shot. This may harken to bullseyeing womp rats in a T-16.

But don't mistake our tone for bearishness. We remain constructive for 2023, as it should be a better year than 2022. But don't get too excited about the markets' strong upward move out of the gates, either. This 'inflation relief rally' may have more to go, but January is often an odd month due to tax losses, rebalancing, and the often renewed optimism a new year brings for investors. The road ahead still has many challenging twists and turns likely in store. And given the size of the bounce, a twist to the downside keeps becoming more likely. Rent this rally, don't buy it.

Market Cycle

Over the past few months, we have commented that our Market Cycle indicators were hovering just above the danger zone and fully expected this metric to drop as fundamentals such as earnings and valuations weaken. That has started to come to fruition. Compared with last month, one signal from both the U.S. economy and the global economy turned bearish. But the drop really came from 'Fundamentals,' which dropped from 8 bullish of a possible 12 to only 4 bullish. A rise in equity prices pushed some valuations from bullish to bearish. Meanwhile, earnings growth is slowing quickly in both Canada and the U.S. International fundamentals are still looking decent thanks to Europe managing the winter and China reopening.

Earnings – Unfounded Worries

So far, the fear of this earnings season has been misguided, and the current earnings season has not been as bad as feared. Markets have rallied in part because of this. We're still seeing a solid number of companies reporting positive earnings surprises, yet we'd point out the decreasing magnitude compared with the past couple of years. To date, 251 S&P 500 companies have reported 4Q results. Reported sales growth has been 5.1%, and earnings are down by -3.6% -- surprising consensus estimates by +1.0% and +1.3%, respectively. The average stock price rose +0.78% post-results.

Inflation helps with the top line, and companies have thus far managed to control expenses. Consumer Discretionary has been a recent outperformer with an average 12.2% earnings beat and an impressive average 2.2% move in the average stock price. Utilities have lagged on averaging missing expectations and dropping over -2% post-results.

Nearly 30% of reported companies are reporting revenue declines, and 35% have a decline in earnings. Those looking for a broad fundamental confirmation to drive the next leg higher for markets might have to look elsewhere. We continue to have concerns over the coming quarters for a continued deterioration in company fundaments. On the plus side, this earnings season has failed to give markets an excuse to resume their sell-off, with companies, on average, managing to beat already lowered expectations moderately. The chart below shows that the current expected earnings drawdown from the recent peak is around 6%. Not even remotely consistent with a recession scenario.

Looking ahead, analysts expect earnings declines for the first half of 2023 but earnings growth for the second half of 2023. For Q1 2023 and Q2 2023, analysts are projecting earnings declines of -5% and -4 %, respectively. In the back half of the year, projections are far more optimistic, with Q3 and Q4 projected earnings growth of 3.93% and 8.2%, respectively.

Recessions are rarely reflected in forward estimates

The forward price-to-earnings ratio for the S&P 500 stands at 18.6. It's one of the most common valuation metrics to gauge how cheap or expensive the stock market is. It's based on a consensus of forecasts from sell-side analysts for the coming 12 months. One of the big issues anytime you use consensus earnings forecasts is that they usually overstate expected earnings heading into a recession. Forward earnings estimates do decline (-5% from peak currently) but underestimate the inevitable surprises that overwhelmingly tend to be negative. If as reported earnings for this year decline just 20% from 2022 levels (an average recession), then the PE ratio would be 22, and hardly a bargain.

The chart below plots actual earnings per share (EPS) compared with the EPS estimates from 12 months prior. During recessions, reported earnings come in around 20%-30% below the estimates from 12 months prior. Presently, current earnings are still 10% above what was expected at the beginning of 2022, but the trend is falling. Keep in mind a year ago, nobody was expecting a Fed Funds Rate of 4.75% either, and those increased borrowing costs will continue to crimp demand when the full effect of the hikes fully reveal themselves in the economy and consumer spending patterns.

While it's our base case that there will be an economic slowdown and possibly even a recession later this year, the consensus has yet to fully price this change in the macro environment into their forecasts. As noted earlier, estimates have fallen just 6% from their peak.

Where to from here?

Below is a matrix showing projected S&P 500 levels given a number of economic scenarios for earnings growth and what the market will pay for a $1 of earnings. From a very shallow recession with a 5% drop from current trailing earnings to an average recession with a decline of -20%. We've also included a 'goldilocks scenario' with earnings growing 5% from here. On the left-hand side are various PE multiples and, within the matrix, the corresponding S&P levels with the resulting percentage change from where we are now. It is a sobering exercise to go through it and realize that a mild recession and multiples dropping down a few points to 16x earnings would bring the S&P 500 down to the 3,200 level. A sizeable drop, given the rally up to recent levels.

Overall, the current and expected earnings drawdown for the S&P 500 is not consistent with any type of real recession scenario. Should a recession come, we would expect earnings to decline far more than the current estimates as they seem too optimistic in the 2H and underestimate two large negative forces facing corporate America. Continued rising costs (albeit at a slower rate) and deteriorating demand as higher borrowing costs crimp consumer spending.

An expected after-effect of bear markets is a serious shift in investor psychology. Given the rampant low-quality rebound year to date, it would appear that the psychology of markets has NOT changed. The beginning of 2023 has so far felt very similar to 2021, just without the GameStop mania. Investors are still in that permanent QE mindset, despite a completely different state of affairs. There is and always will be a consequence to valuations; they currently appear overly confident. Central banks will not likely be able to flip a switch and stimulate the economy with reckless abandon as they did in 2020. Our base case is that a recession remains on the horizon, and current market conditions are not reflective of the 'old normal.' Instead, the 'new normal' mentality from the preceding decade has taken hold once again.

Japan trip #2

After becoming positive on Japan last summer, it's time for another visit as much has changed. Japanese Yield Curve Control continues to be a hot topic throughout the global markets. A few weeks ago, another opportunity arose for the BOJ to abandon yield curve control and attempt to reign in their 40+ year high inflation. However, the final decision was made to remain steadfast with the program. We also hold strong in our beliefs that this decision was made from a short-term viewpoint and the economic situation will encourage their hand into repairing the currency and reigning in their multi-decade high inflation.

There is good and bad news if the BOJ does decide to abandon yield curve control. The good news is that our unhedged exposure to the yen should spike much higher, posting much stronger returns for us Canadians. The bad news is, abandoning their loose monetary policy could prove challenging for the Japanese stock market in what would be seen as a significant move towards fiscal tightening.

We saw the first sign of it back in December when the BOJ adjusted the policy slightly, allowing their 10-year bond yields to have a wider band of +/- 50 bps instead of 25. We watched the Japanese market fall while the yen showed some strength. We expect a similar event if the BOJ decides to abandon the policy altogether; however, it will likely be more impactful. In our view, the positive move in the yen for us as Canadians will outweigh the drop in the Japanese market resulting in a net positive return for multi-asset portfolios.

Over the last several months, the recovery of the Japanese yen has started to form. Back in July, when we initiated a position in Japan, you could get 35% more yen per loonie compared with a couple of years prior to that. With the strength in the yen over the last few months you can get about 21% more yen per loonie. That move came from the expectation that the BOJ would have to step in an attempt to reverse the weakness. As we saw the first sign of this in December, one has to believe they cannot continue to buy bonds at this pace, inflating their balance sheet and crushing their currency.

As Japan holds loose and the rest of the world holds tight, global spreads against Japan have remained elevated. In our eyes, it does not matter who blinks first. Whether the world becomes a little more dovish due to a recession or Japan is more hawkish to catch up to the globe, the unhedged currency exposure to Japan will continue to prove rewarding.

The easing of lockdowns in Asian economies is another reason to be bullish in Japan. Emerging markets remain expensive and historically have underperformed during a recession. That brings cause for concern for portfolios that are perhaps loading up in China or other emerging economies. That leaves investors with a decision to replicate a "U.S. pandemic recovery" type of event in Asia. How does one do so without too much exposure to those underdeveloped economies? Our answer remains to be overweight Japan, the second largest developed economy in the world. A line from our past market ethos sums up the situation perfectly:

As a developed economy, Japan would benefit from the reopening economic boost of the region while being less at risk from the emerging market headwinds.

The makeup of their current corporate landscape is another reason to feel comfortable with Japan. Earnings remain strong, which has valuations well below the average of the last ten years. The lower currency has proved well for Japanese exports as their goods have been less expensive compared with goods priced in stronger currencies. Yields remain strong as companies in Japan continue to increase cash flow back to investors through dividends and share buybacks. From a market perspective, Japan is poised for strong growth barring any additional major economic setbacks.

The simple thesis moving forward comes down to inflation being elevated (from their standards), and the BOJ will likely have to step in and be more aggressive than they have been. When that happens remains the question. The current term for Haruhiko Kuroda, the governor of the BOJ, will be up at the beginning of April. Perhaps the new governor will bring in a shift in policy that will prove to be more hawkish, resulting in a reduction in inflation and strength to the yen.

Over the last couple of months, we have really started to see some of the benefits that bring our thesis to life. As the yen strengthened, the local currency index is up +5.0% while the Nikkei in Canadian dollars is up approximately +15.0%. The story has been playing out well to start, but there are always risks to any investment decision in a portfolio. A prolonged recession, a mistake by the BOJ, or another spike in lockdowns are a few that could impact Japan. However, we continue to believe that the rewards outweigh the risks in this investment decision. Being international investors purchasing a currency at levels not seen since the early 2000s provides a substantial buffer against the risk.

Getting Real with Inflation

For years in almost every investor's financial plan, inflation wasn't given much thought and had been assumed to be around 2% – just a simple input into the plan for the journey ahead. Well, the past couple of years may challenge that benign assumption of 2%. We are in the camp that inflation will trend lower this year as changed pandemic behaviours normalize, supply issues resolve, and maybe even peace. But looking further downfield, we believe inflation will be more volatile and the average likely higher than in decades past.

Inflation had remained low for decades thanks to a number of long-term trends – demographic, technological advancements, globalization of trade, peace and, in the most recent decade, a degree of deleveraging. Some of these trends appear to have either changed or softened. The demographic transition to more savers is starting to give way to more decummulators. Globalization is now facing onshoring. The world is less peaceful. Energy transition is also inflationary. And the disinflationary blanket that sat atop the global economy in the 2010s is clearly gone. Maybe a 2% inflation assumption is a tad optimistic.

If inflation is going to be higher in the years ahead, this has portfolio construction implications [see 'Thoughts on the next cycle' in our recent report, [Preparing for the next bull]. A higher allocation to investments that can keep up with inflation would help alleviate this new planning risk. Equities do well in keeping up with inflation, primarily because earnings are nominal and enjoy a lift from inflation. Some markets more than others. Even better, real assets.

The term real assets has a rather wide interpretation in the investment world. Commodities, real estate, real return bonds, infrastructure, and the list goes on. Among the many sub-categories of real assets, commodities and, to a lesser degree, real estate, have very strong long-term historical relationships with inflation. Thus, allocations that include real assets, potentially with a commodity/real estate tilt, can help protect a portfolio and financial plan against inflation.

As recent evidence, global markets declined in 2022 largely due to high inflation, while real assets held up very well, somewhat offsetting the higher inflation period.

Commodity Supply and Demand – One could argue there has been an underinvestment in supply capacity for many commodities that have been exacerbated by the conflict in Ukraine. This has also encouraged greater diversity in supply sources. Meanwhile, on the demand side, energy transition is changing which commodities are seeing greater changes in consumption, creating a healthy supply-demand situation.

However, with the FOMC raising the cost of capital over the past year from 0.25% - 4.75%, there is a rising risk of recession and/or slowing economic growth. This is a headwind for commodity prices on the demand side but worth noting that some economies around the world have already slowed and are now improving. China, for instance, which has suffered a multi-year contraction in housing and a zero covid policy, is now seeing growth rebound as both these headwinds dissipate. And when it comes to commodities, China and other emerging economies matter much more than whether or not the U.S. economy contracts.

Agricultural commodities have seen significant strength this year, particularly grains, due to the high demand and supply shortage due to the disruption in Ukrainian exports. Russia's invasion of Ukraine has been a key driver for commodity prices this year. Prices for many major crops are projected to decline in the near term as global production responds to the high prices of recent years. Nonetheless, after these initial price declines, long-term growth in global demand for agricultural products and continued biofuel demand hold prices for many crops above pre-2007 levels.

Infrastructure/Real Estate – Real estate valuations and cash flows held steady last year despite the market turmoil. The infrastructure market is expected to slow down with the higher interest rate environment pushing the forecast towards the downside in the short run. However, the consensus of consumer sentiment, in the long run, shows that people are majorly optimistic in the long run and, in turn, reflects the ongoing attractiveness of global real assets as a theme. Inflation is at its peak, and central banks are still hiking rates, but at a slower pace – the largest headwind for those affected is now subsiding.

Precious Metals – Gold prices were hindered in 2022 by aggressive central banks hiking interest rates to combat the elevated levels of inflation and also dominated by the strong dollar. As we adventure further into the year, expectations for inflation may have peaked; however, we must keep in mind that the only projection is modestly higher equilibrium inflation rates over the next decade. With this supporting the theme of underinvestment in real assets and higher strength in the asset class moving forward, there are clear signs that the strength of gold is not its price rising in the short term but the long-term stability of the asset that provides great value when added into a portfolio.

Investment Implications:

Adding real assets into an investment portfolio can help protect the portfolio and a financial plan from inflation risk, helping retain its value over time. Based on our current portfolio construction tilts, real assets have been an overweight for some time and will likely remain so. And while there are many strategies within the real asset spectrum, we believe those that focus on commodity and real estate exposure provide the biggest bang for the buck in terms of portfolio inflation protection.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

— Brett Gustafson is a Portfolio Analyst at Purpose Investments

— Derek Benedet is a Portfolio Manager at Purpose Investments

— Gloria Huynh is an Investment Analyst at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Beep Beep

Mon, 23 Jan 2023 19:30:00 GMT

In our minds, one of the most iconic Looney Tunes’ misadventures was the relationship between the Road Runner and Wile E. Coyote. The way the Road Runner always gets the better of the hapless coyote with his classic “Beep Beep” just as Wile E. happens to run off an unforeseen cliff into a deep gorge. Of course, with the delayed suspension midair before gravity suddenly decides to take over. Markets, like Wile E., can be so singularly focused on one thing (inflation) that they can for better or worse be oblivious to approaching danger (recession).

Markets are forward looking; they bottom well before the negative impacts of a recession ripple through the economy. At this point, the hope has been that cooling inflation is all that’s needed for markets to catch a bid. However, with all the focus on inflation (i.e., the Road Runner), markets may be overlooking the real risk of an economic slowdown. We touched on this in our recent Market Outlook.
A synopsis of our outlook thoughts heading into 2023:

2023 should start off decently as inflation comes down a bit more, partially alleviating the markets biggest fear. Plus, a little January effect could certainly help. However, less inflation will start to accelerate slowing corporate earnings. And the wealth effect of falling equity/bond markets over the past year plus delayed economic impact of rate hikes and higher yields will cause economic growth to fall significantly. This could trigger the final leg down of the bear and create the better buying opportunity, hopefully sometime in the first half of 2023, as the market begins to look through the trough and rally back to be positive on the year.

We’re not at that trough yet—we’re not even at the cliff’s edge to see how deep the trough is—but it is approaching. You wouldn’t know it by how markets have continued to run, in part thanks to the January effect, an observed seasonal increase in stock prices during the month that’s particularly apparent following an aggressive tax-loss selling period.
There was no shortage of losses to investors to sell last year, especially in some of the more hard-hit segments of the market. It’s not surprising that some of those hardest-hit segments have been the biggest winners so far this year. Cyclicals have been big winners, and from a factor perspective, the three best-performing Bloomberg Factors based on a Q-Spread (long first quantile, short last quantile) are 3M Volatility, Leverage, and Short Interest. Value, Dividends, Size, and Profitability have all lagged.

On the whole, market performance so far this year has been better than we expected. The S&P/TSX Composite is up 5.3%, the S&P 500 is up 2.3%, and the NASDAQ is up 4.9%. International shares, which we’ve been recommending as an overweight since last summer, have had a great run. Europe is up 8.5% YTD, and the Euro Stoxx 50 index is up 24% since the end of the third quarter. China moving past the zero Covid policy has disproportionately helped European shares, as the region is more closely tied to China and global growth compared with the U.S.

We continue to like Europe, but at this point we’d caution adding given the recent outperformance as seen in the chart below. Some markets like the U.K. have also recently hit new all-time highs! It would appear with the abundance of China optimism floating around that markets have gotten ahead of themselves.

Technicals

The S&P 500 now finds itself at a critical juncture. It’s now up against the key downward-sloping trendline as well as the 200-day moving average, which have both proven to be stiff resistance levels. For more tactical and technically oriented managers, it’s at a logical place to begin considering de-risking.

Momentum indicators, such the Relative Strength Indicator (RSI), are also not breaking out, indicating momentum may not be strong enough to break above overhead resistance. At present, the market has not shown any clear technical signs of breaking out of the bear market trend. There are some positives worth mentioning. Breadth is decent, the equal weight index is showing more relative strength, and the market is continuing to make fewer 52-week lows on the last couple of pullbacks.

Value and Dividends remain attractively priced, and we like their defensive characteristics, but our third major portfolio tilt should be put on the back burner at present and await a better opportunity. With markets taking a victory lap over the perceived victory over inflation, the mood in corner offices remains foreboding with caution in the air and job cut announcements beginning to pick up. The word “recession” will be a hot topic as earnings season heats up, and while equity valuations remain depressed, the recent move higher in stock prices warrants a degree of caution.

Bad news may be bad news again

Inflation was clearly the biggest problem for markets last year: the uncertainty about how high it could go, how long it might last, and what the central banks would do to fight it. This uncertainty has been improving of late. Inflation has started to come back down, and investors have a reasonable idea of how far central bankers will go as some have started slowing the pace of hikes.

Helping fuel the view that inflation is coming back down isn’t just in the monthly CPI and related inflation data releases, it has also been in the data showing the economy slowing. For months now, weak economic data was welcomed by the markets, which feared inflation uncertainty over economic recession uncertainty. This was the bad-news-is-good-news environment.

But that may be starting to change back to a more normal “bad-news-is-bad-news” again. Inflation is still likely the biggest issue but we have seen a number of trading days that experienced soft economic data coinciding with weak markets—clear evidence the transition may have started.

We have already seen this transition at the company level. Analyzing corporate earnings conference calls, we have seen a significant drop in management commenting on “inflation.” Meanwhile mentions of “recession” have been on the rise. [Q1 2023 is adjusted as the earnings season is only partially complete.]

Portfolio Considerations

Markets are taking a victory lap over the perceived victory over inflation, China’s re-opening, and Europe is apparently avoiding the energy crisis. But we are not convinced these things lasts. The mood in corner offices remains foreboding with caution in the air and job cut announcements beginning to pick up. The word ‘recession’ will be a hot topic as earnings season heats up and while equity valuations remain depressed, the recent move higher in stock prices warrants a degree of caution. “Beep Beep” doesn’t just mean that the goal is close at hand—it’s warning of more pain, whether it’s falling off a cliff or the dreaded ACME anvil.

— Derek Benedet is a Portfolio Manager at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

Hockey & Dividends

Mon, 16 Jan 2023 17:13:00 GMT

Canadians love hockey, and why not? On a per capita basis, we are really good, producing some of the greatest players of all time. Another thing Canadians love is dividends or, more aptly, dividend-paying companies. So are we also really good at producing some of the greatest dividend-paying companies? That might be a stretch. Investors love dividends for all the reasons you can read in the generic marketing material for the space – less volatility provides income to the investor that is taxed less than other sources, etc.
There are a couple of other reasons Canadians love dividends. Our banks didn't have major issues in the 2008 global financial crisis, which certainly helped, given their large representation in the dividend universe. And who's kidding who? Do many Canadian investors have fond memories of buying Canadian growth stocks? That is almost like a field of broken dreams.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used herein under a non- exclusive license by Echelon Wealth Partners Inc. (“Echelon”) for information purposes only. The statements and statistics contained herein are based on material believed to be reliable but there is no guarantee they are accurate or complete. Particular investments or trading strategies should be evaluated relative to each individual's objectives in consultation with their Echelon representative.

But investors should acknowledge that dividend investing, or the dividend factor, has enjoyed a steady lift over the past few decades from falling bond yields. A few years ago, it was pretty straightforward; bonds paid very little, and dividend-focused equities paid more. Sure there was more volatility than bonds, but it was less than the overall equity market, and the distribution enjoyed an after-tax advantage. The term 'bond proxy' even came up, referring to utilities, consumer staples, real estate or other dividend-heavy sectors that tended to move in tandem with the bond market.

Given bond yields are now higher and potentially more variable going forward compared to years past, is this an issue for dividend investors? You can now receive a much healthier distribution from bonds and even from cash. If you ignore the drop and pop in yields right around the pandemic onset, the 10-year yield really started rising on its own accord around mid-2021. Coincidentally, the TSX has outperformed the equivalent dividend-focused index since then. We believe dividend-focused allocations should remain a core for Canadians' portfolios, but the dynamics have changed.

Dividends in 2023 and the next cycle

Starting points matter from both a price and valuation perspective. And dividend-paying stocks are cheap. The charts below are for the U.S. and Canada, contrasting dividend index valuations against their own history and the broader market. Valuations are low for a reason because yields have risen, and there is a higher degree of uncertainty about a potential recession. However, these low valuations provide a safety buffer in the cohort of equities that are historically lower beta. If this bear is not over and we have a potential recession ahead, dividend companies, in general, should provide a better margin of safety.

But even now, it is not the same as before. We took the largest dividend-focused ETFs available in Canada and measured the dispersion of performance over time (chart). The dispersion or variability of performance was low and stable for much of the 2010s. This was simply because falling yields lifted all dividend-paying companies. Not exactly to the same degree, but it was likely the dominant force. However, more recently, there has been an increased dispersion of performance as the finer intricacies of each mandate's holdings have become more impactful.

This divergence is being driven by different factors impacting dividend-paying companies differently. Which then depends on the difference in weights of those companies among the dividend products. It just got a bit more complicated. Here are some of the considerations that appear to be starting to drive performance more so than before:

Debt – Little thought was given to the balance sheet in the last cycle, which is now of greater importance. This includes not just the company's debt but its maturity, types of coupons, etc. Recently companies with more variable debt have been under pressure, given the prevailing rates.
Yield sensitivity – it may be declining in importance, but it still matters. Some dividend companies tend to be more or less sensitive to changes in yields than others. Historically we have broken the universe down between interest rate sensitives to cyclical yield.
Economic sensitivity – This is not just how sensitive a company's operations are to the economy but which economy. Of late North American sensitive companies have lagged behind those more sensitive to the global economy as China re-opens.
Pricing power – Yes, inflation is starting to fade but cost inflation is still strong. How much ability does the company have to pass on higher costs to customers?

This is an abbreviated, simplified list, as it really comes down to direct company analysis. And what value or price is that company being valued? Which does raise a problem depending on the dividend strategy. Many products (ETFs and Funds) and dividend portfolios using direct equity investments tend to be very static. This worked when the companies were all being lifted by falling yields. However, if fundamental factors are becoming more important to the performance of dividend-paying companies, such a static approach may prove challenged.

Portfolio Considerations

We are positive for a continued healthy inclusion of dividend-focused companies in most Canadian's portfolios, whether held directly or from an ETF/Fund. That being said, investors should start to consider allocating more towards actively managed dividend strategies compared to more static or rules-based approaches. The drivers of performance are likely going to change over time, which we have already started to see:

1H 2022: as yields rose, the most interest rate sensitive dividend companies suffered the most (aka bond proxies), and the more cyclical yield names did better.

2H 2022: More recently, the bond proxies have been recovering as fear moves from inflation to potential economic weakness or recession. And the more economically cyclical dividend payers are split – those that are sensitive to the North American economy have lagged, and those more sensitive to the global economy and China re-opening have led.

2023: we continue to believe leaning into defensives is best as the magnitude of the economic slowdown becomes more clear. Would note that real estate is now pricing in a very draconian future, which is likely overdone. And the banks, which benefit from higher yields, are carrying historically low valuations. Perhaps due to a potential real estate speed bump ahead for their operations. Still, the world is changing from one in which the borrowers had all the power to one where lenders are in control.

In short, this is no longer the old dividend universe where you could cobble together a dozen dividend-paying names, buy them and forget it. It now has many moving parts that beget a more active and forward-thinking approach.

— Craig Basinger is a Portfolio Manager at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

A Job-Filled Recession?

Mon, 09 Jan 2023 19:08:00 GMT

Our team absorbs a lot of different economic/market views and opinions from a lot of different sources. We also do a ton of our own analysis. To put it bluntly, 2023 is lining up to be one confusing year. Inflation, the path of central banks, the economy and, of course, how the bond and equity markets react all have very divergent views. For a more fulsome synopsis of our views, we would encourage a look at our 2023 outlook (Bear Market End Game). Because today we are going to narrow our focus on how so many can be calling for a recession all the while companies keep hiring.

The jobs reports of last year and the final December reading that came out on Friday, respect. The U.S. economy added 223k jobs, unemployment dropped to a multi-decade low of 3.5% (lowest since 'the 60s), and even the participation rate ticked up a little. That is 4.5 million jobs added during 2022. For comparison, the average from 2010-2019 was around 2.2 million jobs. Of course, the economies of the world are still recouping jobs in a number of categories as we all move back to 'normal.' The first two charts below show total U.S. employment with a 'really simple' dashed line that one could argue would hold if the pandemic hadn't happened. The biggest gap is in Leisure & Hospitality and Education & Health, which are still missing jobs. The final chart is Canadian employment, which appears to have recovered better, back to trend.

This is all throwing in a bit of a curveball. Because the economy is still recouping jobs from the pandemic in certain categories, labour is likely going to be a super-lagging indicator of the economy this cycle. If you exclude the most pandemic-impacted industries from the employment data, it paints a much different picture. Job gains have been decelerating very quickly as 2022 progressed.

Let's take employment data with a grain of salt in 2023, then. Or at least don't suffer from lazy headline reading and dig a little deeper. We may need a little more salt in the opposite direction when looking at manufacturing. Currently, the five Market Cycle indicators we monitor for the health of manufacturing are all negative. These include purchasing managers, manufacturing & new order surveys, energy demand, trucking demand and rail volumes.

Purchasing managers surveys (PMI) are a diffusion index where, not surprisingly, purchasing managers are asked if they expect to be busier or less busy next month. A score of over 50 means over half said they would be busier, and a score under 50 more said less busy. Among the 16 biggest economies in the world, ALL 16 WERE ABOVE 50 IN JUNE . That is party time on the assembly line. A mere six months later, only 4 are above 50, and those 4 are smaller in the developing economy subset. The U.S., China, Japan, Europe, and Canada are all below 50 now. We could do a chart, but it's just a bunch of lines going down and to the right.

So why the grain of salt, you may ask. Well, if you recall, we had a bunch of bottlenecks, shortages, yadda yadda yadda in the past couple of years. No doubt manufacturing activity was ramped up to catch up with demand. So, is the clear slowing of global manufacturing activity a precursor of a recession or simply coming down from temporary high activity levels that were playing catchup. Chances are, it is somewhere in between. On a sobering note for the U.S., New Orders have fallen so far that it would be very strange if a recession was not nearby.

Still, the warnings are growing louder. Interest rate hikes started 10-12 months ago, depending on which country you look at. Some estimates have rate hikes taking nine months to broadly impact the economy, which means the pain is just starting. And don't forget, markets are down, and inflation sapped buying power, making us all poorer/less rich. That wealth effect also has an economic lag, which is probably coming.

The NY Fed and Cleveland Fed's recession probability models have certainly rung the alarm bell. In the past few months, they have spiked from 'all clear' to 'oh oh.' Those annotation labels are ours, not the bank's.

Leading indicators as well are troubling. In the chart below, we included the lagging economic indicator index, which continues to show positive growth. If you look at past recessions, the pattern is pretty clear. The leading indicators drop first, and the lagging often doesn't drop until the recession has started.

To be clear, there is no recession today. U.S. GDP is positive and could even surprise when we see the print for Q4. We nitpick the jobs data, but a job is a job, another consumer who will likely be a more robust spender. Perhaps this helps soften the slowdown. Perhaps China's removal of covid restrictions helps global growth. Would a Fed pause create a market with more certainty, encouraging housing activity and business spending? And many of these warning signs could prove to be early.

There are strong points on both sides, and this can also be seen in the divergence in economic forecasts. The chart below is based on economists' forecasts for U.S. economic growth. The green and red bars are the high and low estimates, with the line as the median. The bars are the difference between the high and low, which becomes pretty wide in mid-2023. For instance, in Q2, the high forecast is 1.7% growth, with the low at -3.7%.

Portfolio Considerations

We continue to believe a slowdown will materialize in 2023, which very well could manifest itself into a recession. We are leaning more towards the recession camp. The signs are clearly there. This has us tilted more towards defence and holding extra cash. The follow on question becomes, at what point will the equity and bond markets begin looking through the recession out the other side. We believe that point will come sometime this year, but it is not today. You can't look across the valley until you get closer to the edge.

— Craig Basinger is a Portfolio Manager at Purpose Investments

Source: Charts are sourced to Bloomberg L.P. and Purpose Investments Inc.

The contents of this publication were researched, written and produced by Purpose Investments Inc. and are used by Echelon Wealth Partners Inc. for information purposes only.

This report is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.

2023 Outlook

Thu, 05 Jan 2023 18:45:00 GMT

The current bear market began roughly the same time the ball in Time Square dropped to usher in 2022, which means with the more recent ball drop this bear celebrated its one-year anniversary. There is no blueprint for bear markets. Sometimes they are short (2020), sometime long (2000-03). The magnitude of the price changes can vary and have certainly had a varied impact across different equity markets this go around. Global equities dropped by -18% in 2022 (in USD), same as the S&P 500 while the tech heavy NASDAQ dropped -33%. But Europe was down only -9%, Japan down -7% and Canada at -6% was one of the better performing markets. Sometimes bear markets are accompanied by a global recession, sometimes not.
Despite the variations and with inflation as the likely initial trigger of this bear making it rather unique, it is roughly following a normal bear market progression.

Speculative end game for the bull: The market become highly speculative in a number of areas, with lots of talk ‘it is different this time’. Maybe this time it was more ‘you are just too old to understand __________’. The blank could be crypto, Gamestop/Meme stocks, disruptive technologies, take your pick.
Speculative areas get hit: This started in late 2021 as many of the areas in the markets that enjoyed outsized returns over the previous years, popped.
Bear begins: As 2022 started, the price declines spread from the speculative pockets to the rest of the market. We can blame inflation, central banks, yields or the war. Nonetheless, prices of things in bear markets come down. That is what we experienced in 2022, not a straight line of course as the path had many twists and turns.
Earnings: Up until recently corporate earnings held up really well, in part thanks to the ‘getting back to normal’ behaviours and inflation (remember earnings are nominal so inflation often helps earnings). But as 2023, earnings growth is slowing, revisions are negative. Earnings contraction is normal in bears and this phase may be starting to get going.
Recession: The economy often seems like it doesn’t react much, and then it moves quickly. Global economic activity has been slowing, and some countries are likely in a recession today, but others remain decently healthy. What lies ahead is something between a slow down, a shallow recession or a recession. With strong arguments and data supporting all three.
Capitulation: Many have opined that an investor capitulation remains a missing ingredient to mark the potential end of the bear. This could be in store for 2023, or maybe it doesn’t happen this go around.

There is likely more to go in this bear market process which could even manifest as the market’s biggest fear migrates from inflation to recession. There is good news too. Equity valuations have come considerably and, in many pockets, may already be pricing in a recession. This provides a buffer in case there is more bad news ahead. And bond valuations, aka yields, are now attractive. There is also the forward-looking aspect of the equity markets. Often bottoming quarters ahead of the economic trough and even bottoming before the earnings trough.
This is a synopsis of our outlook thoughts heading into 2023 as we don’t get paid to sit on the fence: 2023 should start off decently as inflation comes down a bit more partially alleviating the markets biggest fear. Plus a little January effect could certainly help. However, less inflation will start to accelerate slowing corporate earnings. And the wealth effect of falling equity/bond markets over the past year plus delayed economic impact of rate hikes / higher yields will cause economic growth to fall significantly. This could trigger the final leg down of the bear and create the better buying opportunity, hopefully sometime in the 1st half, as the market begins to look through the trough and rally back to be positive on the year.
Of course the only recurring theme with investing more persistent than cycles, is markets surprise us all in the end. Below we have provided a recap of 2022 plus a few potential surprises ahead.
Market Recap – 2022 the great reset 2023 Market Surprises

Inflation cooling carries a grey cloud
Recession: none, soft or hard

2023 Portfolio Construction Portfolio thoughts heading into 2023

Value & Dividends
Simplified yield
International diversification back in vogue

Final note

2022 – The Great Reset

How do we even attempt to unpack what happened in 2022, on the surface very little sounds good. Russia invaded Ukraine, a travesty, that also caused increased global political polarization, an energy crisis and higher food prices. Global inflation got out of control, not from the war but more from the knock-on effects of the pandemic altered behaviours. Plus the impact of global monetary/fiscal stimulus that was left on too long. Inflation triggered an abrupt reversal in stimulus from accommodation to restriction as just about all central banks tightened financial conditions, some materially.
The global economy downshifted substantially, from a 5.8% growth pace in 2021 (that is really high) to a more subdued 3.0% in 2022 (current estimates given the final quarterly data is still pending). 3.0% isn’t bad but the size of the drop from the previous year certainly made it more noticeable. With inflation and a still expanding economy, bond yields marched higher in 2022, creating a tough year for bonds. Equities were also hit, but not evenly. European markets were weighed down by what is likely a recession in the region, Asian markets by China’s zero covid policy plus a real estate popping. The U.S. market was a tail of two markets as growth stocks were crushed and value stocks held in much better (S&P 500 Growth -29%, S&P 500 Value 5% YTD). The TSX was a star, if a star can be one that is simply down much less. The Canadian market benefited from being very valued tilted and not much exposure to the growth tech space. And of course having companies involved in energy & food was a plus given supply disruptions caused by the war in Ukraine.

Simply put, 2022 was not a kind year for investors. Just look at the traditional 60/40 portfolio, let’s say 20% TSX, 20% US, 20% international and 40% Canadian bonds. Thanks to a falling Canadian dollar which helped buffer the drop in non-Canadian investments, this portfolio would be down about 10% on the year. Worse yet, the bonds, which typically play the role of portfolio stabilizer were responsible for almost half the decline.

The silver lining is 2022 appears to have reset markets. Now we are not saying the reset is over, or the bottom of the bear is in, or even that bond yields are done going up, but things are much more balanced now. Bonds actually carry an attractive yield now after not doing so for many years. And equities, while not cheap and perhaps earnings estimates will continue to fall, are not expensive. Note the red bars in the return decompositions for the S&P 500 and TSX in the YTD (year-to-date) column. The valuation multiples have contracted substantially.
The valuations for bonds and equities went from expensive at the start of the year to cheap or at least fairly valued by the end. Mainly because we moved from a world with excess liquidity that was very cheap to a world with less liquidity and the cost of capital matters again. A painful journey, no doubt, but one that begins to plant the seeds of the next cycle.

2023 Market Surprises

Last year was one of surprises, most of which were not market friendly. Now comes the hard part, what could the surprises of 2023 hold for investors? And what does it all mean for portfolio construction. Below we highlight a number of important themes for 2023 and our take on them from an investor perspective. But if history is any guide, there will be surprises…..
Inflation cooling carries a grey cloud Last year, the biggest issue for markets quickly became inflation, in case you missed the evening news that kept the price of bananas front and center. CPI, the most common measure, reached high single digits in many countries including the U.S. and Canada, highest levels in decades. Pandemic changed behaviours, supply issues, too much money, the list of causes is widely known and talked about. And while we believe inflation will remain a more recurring market topic in the years ahead, in 2023 its path should continue to be in the cooling direction. The pandemic influenced behaviours are getting much closer to normal, the money is being sucked out of the system and the economy is slowing.
Inflation is unlikely to get back to pre-pandemic stable levels, that was the last cycle. But it should continue to grind down from currently levels during 2023 and as it does the market will pay less and less attention [ok, the market doesn’t pay attention but the reaction to the data should become more muted]. This should slow and then stop the continuous rate hikes that we all weathered in 2022.
This is good news and if the inflation data continues to cool, markets can rally around this. Talk of a Fed pivot or arresting rate hikes would be a big positive. But, cooling inflation plus slowing economic activity are a bad combination for corporate earnings. The market is already starting to price in a little bit of slowing earnings growth based on consensus estimates, so this isn’t a surprise. The question will be the degree or magnitude.

The shaded bars have not yet been reported and are based on consensus forecasts. Margins are at historical highs with costs rising, so unlikely to see margins improve. The U.S. dollar has been strong, another headwind for earnings. Add slowing inflation and slowing economic growth, forecasts are still way too high.
Oh, and one more thing. A good portion of earnings growth in the past decade came from share buybacks, much of which was debt financed. The old strategy of issuing debt (remember when yields were really low) and using proceeds to buy back shares, this activity manufactured earnings growth. Now with less liquidity in the bond market and the cost of debt materially higher, this strategy is caput. And general financing costs are now higher, another drag.
The potential earnings recession will disproportionately impact some and not others. Companies able to pass on higher prices will be at an advantage. As will those with less cost pressures. Interest costs and the balance sheet is quickly becoming a performance determinant again. Yes, financial analysis may be back in vouge.
Recession: none, soft or hard There is no denying economic activity is slowing but so far the market has not cared much as it has taken a backseat to inflation angst. Slowing economic activity has also been masked by decent labour markets as service jobs are still being replenished from the pandemic induced capacity reductions. This is still one weird economy being influenced by the reverberations from the pandemic. 2023 economic forecasts for the U.S. have evaporated to nearly zero, same with Canada. The Eurozone and UK have seen their prospects for 2023 turn negative.

It has been our experience when the consensus economists change forecasts to this degree, they are trying to catch up with reality. In other words, those lowered estimates are probably still too optimistic. This raises the question: Recession, shallow recession or no recession at all? Here are our thoughts, some are positive and some negative:
+ Healthy Consumer - Much is talked about the health of the consumer. Not so much the Canadian one but the U.S. and European consumer has less debt and has saved over the pandemic years. Labour markets remain very healthy and wage growth is positive. + It was always going to look like a recession – The pandemic induced behaviours brought forward a lot of spending on durable goods at the expense of services. This helped super charge the global economy, since buying an iPad has a bigger economic impact than buying a pint of beer. As we ‘society’ came off this ‘goods’ buying high, and re-allocated to services, it was bound to manifest in a slowdown. + Desynchronized economic activity – In 2008 and 2020, all economies went over the cliff at the same time. One was credit driven the other a pandemic. Today, economic growth is much more desynchronized. China slowed a lot in 2022 and may now be starting to improve as covid policy is changed plus some encouraging real estate signs. Europe is likely in a recession now given inflation and energy hit. Canada may be in one in 2023 with our overly sensitive economy to housing. Perhaps the US slows afterwards. But others may be on the mend by then. This desynchronized activity is good as it lessens the blow to markets. + Xi pivot – There is much talk of a potential Fed pivot in 2023, which we really don’t see occurring unless something goes terribly wrong in the economy or markets. Fed pause is likely the best scenario. China on the other hand has been experiencing a continued economic slowdown due to a real estate crisis (of sorts) and the zero covid policy. On a positive it appears the zero covid policy is being steadily dismantled. The path is still unknown but economically speaking this is good news. And there are some signs the real estate pain may be starting to ease. - Rate hikes / yields – It always seems the economy is really slow to react….and then it suddenly does react. Higher interest rates impact consumers, business spending and the cost of capital. While it is debatable how long the lag is between changes in rates and when it is felt in the economy, but if its 9-months then only 1 of the 7 Fed rate hikes has been felt so far. Oh, and that one was the small 25bps variety. The economy is about to really start to feel the rest. - Wealth effect – The global bear market in equities and bonds has reduced total wealth by $139 trillion. That is $25 trillion from equities and $114 trillion from the global bond market. These global market capitalization measures are in US dollars, so let’s adjust for the rising USD and the damage is more reasonable at about $65 trillion (rough calculations now, fortunately when talking trillions it doesn’t have to be exact). But, global inflation last year based on the World Economy Weighted inflation index was 9.7%. Which means the world’s wealth, ignoring the market price performance, became almost 10% less valuable. Add that back in and we are about back to the $139 trillion in reduced real wealth. This drop will begin to weigh on the economic decisions of consumers and businesses.

Add it all up and the only thing clear is it is not clear. This is also captured in our Market Cycle framework which continues to sit just above the danger zone that typically is associated with a recession. We believe there is a more material economic slowdown ahead in 2023 which the market may begin to pay more attention.

2023 Portfolio Construction

We have no abrupt changes to our portfolio allocations to start the year. Our optimism on improved pricing in many areas of the market is tempered by the near term path ahead. This has us hugging the neutral line in many categories such as equity and bond allocations. Little extra cash poised to be deployed should more weakness develop. And a mild underweight in alternatives given how far along this bear market has become and the ability to now find defense in traditional bonds.
With a value and small tilt among equities, we remain more sanguine for the U.S. market, neutral on Canada and bit of an overweight international. China’s pivot is positive for emerging markets but given tightening financial conditions we are not.
Our bond weighting is neutral and we have increased duration during the year to a more neutral stance. For a balanced profile this is about 4.5 to 5. Yields may rise further but at current levels the risk/return is more balanced considering there may be a recession of sorts on the horizon. There is no denying that valuations are much more attractive as we head into 2023. Perhaps equity earnings are not as solid as we would like but many markets appear to be pricing a decent amount of bad news ahead. And bonds too offer some of the better yields of the past two decades. Valuations, for either bonds or equities, are in a much better place than at the start last year.

Portfolio thoughts heading into 2023

There may be some added optimism if you look at fund & ETF flows during 2022, especially near the end. Not too surprising bond outflows were pretty sizeable and persistent as yields moved higher (prices lower). Interesting that anecdotal information seems to indicate institutions are now more active in increasing their traditional bond allocations. Equity flows are even more interesting and capture investor behaviour. During the early part of this bear market, the ‘buy the dippers’ were active (positive blue bars in early ’22). As the bear dragged on, this behaviour ended as optimism this was just a short period of market weakness faded. But investor held on and remained invested. Until late 2022 when we have started to see increased outflows and increased inflows to cash.

If this trend continues or accelerates, it may just be the start of the capitulation event this bear market has been missing. Or it was just some more aggressive tax loss selling. Either way, the flows into cash and lack of investor appetite is encouraging that the end of the bear may be getting closer.
Below we have highlighted a few ideas for portfolio allocations:
Value & Dividends The growth factor has so far taken the brunt of this bear market, just look at the relative performance of the S&P 500 Growth Index (-29%) and S&P 500 Value Index (-5%) in 2022. This has help alleviate the valuation premium of growth that had reached nosebleed levels in 2021. And there are some factors that support the growth factor heading into 2023. A mere 2 point valuation premium is appealing. Inflation is set to cool in the coming months which is a positive for growth given its longer duration characteristics. And overall earnings growth is slowing, another positive for growth.

This may set the stage for a relief rally in the growth factor over value. However, as 2023 grinds on and a newcycle begins, we believe Value will be the winning factor. For one leadership change is afoot and while the new leaders remain unknown, we have a good deal of confidence it won’t be the previous leaders which are more dominant in the growth factor. In fact, the last leaders still represent a high weighting in the indices which may become a headwind for some cap weighted indices.
We also expect nominal economic growth (GDP + inflation) to be higher in the coming cycle compared to the last. This should favour the value factor over growth. And yields to remain at higher levels this cycle with greater variability, also favouring value.
While the U.S. equity market has a well defined value and growth factor, it is a bit more complex in other markets. The TSX is a value market in general, notably with the dividend subset factor. International markets, given current valuations, would also mostly be viewed as heavy in the value factor. This is further supporting rationale for our current underweight U.S. (a growth heavy index), market weight in Canada and overweight in international equities.

Simplified yield

This bear market may not be over yet, and yields could tick higher, equities lower, earnings could fall, and maybe even a recession. But already, there has been a massive reset of valuations and expectations. The speculative fever that was evident late in the last cycle is clearly gone, just ask any venture capitalist trying to raise money. Today, you can buy the TSX with a dividend yield of 3.3% and trading at a valuation of 12x. The Canadian bond universe now yields 4.2%, while the corporate subset yields 5.4%. The majority of bonds now trade below par, and cash has a decent return.
We are not contending that any of these measures are cheap; that will depend on their valuation or yield a few years down the road. But we can say after the painful reset in 2022, when everything simply fell in value, the market is much more balanced or fair today. This should better balance out returns in the next cycle. There is no denying returns in the last bull came mainly from the equity side of the portfolio. The following chart is the return attribution for a 60/40 portfolio from the end of 2009 to the end of 2021 (before this bear). With total performance a little over 8% annualized, almost all the performance came from equities.
As we near the start of the next bull, it would appear that yield is now plentiful. Available in equities, bonds and cash. Given the biggest contributor to bond returns are the yield at the time of purchase, these higher bond yields should better balance the performance contribution for portfolios. This bond & equity bear of 2022 may have actually reset returns in favour of the old boring 60/40. It’s been a painful journey to get here, but it’s a much more balanced investment landscape.

Simplify your income – In the last cycle, with yields so low and generally trending lower during the cycle, the stretch to find yield really had to get creative to meet investor demand. Very successful strategies were created to find yield in faraway locations, create yield with more exotic trading strategies, or gain access to yielding assets previously unavailable. Many proved very successful and certainly helped fill a demand caused by this low-yield environment.
Today with yield now being abundant, does your portfolio need to be as creative? Many of the strategies developed and used today carry other risks, perhaps geographic or execution or some nuanced risk that few investors are aware. They may still have a place in a portfolio, but with plain vanilla yield now readily available, simplifying a portfolio’s yield component may prove prudent.

International Diversification Back In Vogue

It isn’t this simple, but it just might be. In the ‘80s, the U.S. sucked, as did the U.S. dollar (USD); meanwhile, international markets rocked. In the ‘90s, the U.S. rocked, as did the USD, while all other markets trailed. In the aughts, the U.S. lagged, plus a weak USD, while TSX and emerging markets (E.M.) crushed it. In the most recent bull, the ‘10s, the U.S. was the star again, plus a strong USD, while others lagged. If this simple long- term pattern follows, the ‘20s should be international/E.M. with weak U.S. and USD.

Geographic diversification has always been a core tenant of portfolio construction. Unfortunately, it’s been more like geographic ‘diworsification’ over the past cycle. A simple overweight U.S. equities has been the no-brainer portfolio allocation move, as seen in the chart. U.S. mega-cap tech has been the global cycle leader driving U.S. returns over the past cycle to outperform Canadian and international allocations significantly.
Besides the outright dominance of U.S. markets, the past cycle has been characterized by a sustained period of synchronized global growth, which has caused global correlations to rise, decreasing the benefits of international diversification. Higher correlations reduced the benefits of diversifying, but as the chart below shows, correlations have dropped from historically elevated levels. Correlations always get lower during bear markets, but it’s worth noting that international markets are still far less correlated to the TSX than the S&P 500. And if global growth is going to become less synchronized and more variable, the benefits of international diversification should continue to rise.

No single country can outperform all of the time. The global economy continues to evolve, and while we cannot predict the outcome of wars or policy decisions of foreign governments, we can quantify relative value. Global markets are considerably undervalued relative to U.S. equities across multiple measures. Given the depressed valuations, the likelihood of some degree of ‘catch-up’ during the next bull should suggest that international exposure can help investors experience a quicker recovery compared with less diversified portfolios.

Looking ahead through the next cycle, we expect to see a period of desynchronized global growth, which should only enhance the benefits of geographic diversification. Persistent pockets of inflation will likely decrease the degree of coordinated accommodative monetary policy around the globe leading to potentially large differences in country performance.

Final note

We are constructive on portfolio returns in 2023. Yes, this bear may have more to grind asset prices lower but we do believe we are closer to the end (bottom) than the start. At some point this will usher in a new market cycle that will look and behave differently than the last bull cycle. The timing on when this will commence will only be known after the fact. But it is worth looking at portfolios and positioning, if it is still built for the last cycle, there may be some preparation to consider.
We published a lengthy report in December entitled ‘Preparing for the next bull’ to help investors and advisors to think about the next cycle. The report is long but so are bull markets, and positioning will count. Expect more instalments in this theme and of course if you would like to discuss in more detail, we are here to help.

Copyright remains with Advisor Marketing for these articles, but it is not necessary to acknowledge copyright when using these articles. The content is your use only, to support and promote your individual practice. No exclusivity is granted with regards to these articles or their use.

— Craig Basinger is the Chief Market Strategist at Purpose Investments — Brett Gustafson is a Portfolio Analyst at Purpose Investments — Derek Benedet is a Portfolio Manager at Purpose Investments
Disclaimers
Echelon Wealth Partners Inc.
The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Echelon Wealth Partners Inc. or its affiliates. Assumptions, opinions and estimates constitute the author's judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them.
Forward Looking Statements
Forward-looking statements are based on current expectations, estimates, forecasts and projections based on beliefs and assumptions made by author. These statements involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. Neither Purpose Investments nor Echelon Partners warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. These estimates and expectations involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may differ materially from what is expressed, implied or projected in such forward-looking statements. Echelon Wealth Partners Inc. is a member of the Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection Fund.

2022 RRSP Season

Wed, 04 Jan 2023 15:26:00 GMT

The deadline to make an RRSP contribution for the tax year of 2022 is March 1, 2023. Please see below for some insight on RRSPs that should help you become more informed and help you formulate your RRSP contribution strategy for this year and going forward:

Tax Deduction: RRSP contributions are tax deductible, meaning for every dollar you contribute to your RRSP, your taxable income is reduced by one dollar. This will in turn reduce the amount of tax you owe, while at the same time helping you prepare for retirement. With a higher marginal tax rate, an individual benefits from a higher savings rate based on the amount of tax they would pay on that extra dollar of income.

Annual Contribution Limit: Your annual RRSP contribution limit is the lower amount of 18% of your earned income from the previous year (2022) or $29,210. This amount increases each year, and you can continue to make RRSP contributions until December 31 ^st of the calendar year you turn 71.

Unused Contributions: Should you not contribute up to your RRSP contribution limit, the difference can be carried forward and added to your contribution room for the following year. An increase in salary over the years will also translate to a higher marginal tax rate, and higher cash flows to be able to take advantage of this additional space when your marginal tax rate and savings opportunities are higher.

Spousal RRSP: This account enables the higher income earning spouse to make an RRSP contribution to the lower income earning spouse. This allows the higher earning spouse to benefit from the tax deduction of the contribution, while the lower income earning spouse will benefit from withdrawing the funds at a lower marginal tax rate in retirement. This is a good example of income splitting.

Withdrawals: By the end of the calendar year of which you turn 72, your RRSP accounts will automatically be transitioned into RRIF accounts (“Registered Retirement Income Funds”), and you will have minimum amounts required to be withdrawn annually. The minimum amount you are required to withdraw is a function of your age and the balance of your RRIFs at the end of the previous year. As long as the funds are not in a locked-in plan, you can withdraw them at any time. In most situations, a withdrawal prior to converting your RRSPs to RRIFs, will result in a withholding tax on your withdrawal, and the amount will be added to your taxable income for the year in which it is withdrawn. This strategy can be advantageous during a low-income period, perhaps in between retirement and prior to when you begin receiving your pension, where you would be able to withdraw a portion of your RRSP account and pay tax at a lower marginal tax rate. Please see below for two programs that allow an individual to withdraw from their RRSP account without it being included in your taxable income:

Lifelong Learning Plan: Allows you to withdraw up to $10,000 in a calendar year from your RRSPs to finance full-time training or education for you or your spouse. The maximum lifetime withdrawal amount is $20,000 over a period of no more than four years. This program cannot be used to finance your children’s education.

Home Buyers Plan: Allows you, as a first-time home buyer, to withdraw up to $35,000 from your RRSPs to purchase a qualified home with the intention of making it your primary residence. *Note that the Tax-Free First Home Savings Account (FHSA) is expected to launch sometime in 2023.

Consider speaking to your financial advisor and/or accountant to help establish your RRSP contribution strategy. Also consider talking to your financial advisor about a wealth analysis, a free resource offered to all Echelon clients, to help ascertain and realize your financial goals.

Are You Using Your RRSP to Its Fullest Potential?

Tue, 03 Jan 2023 20:57:00 GMT

Registered Retirement Savings Plan (RRSP) season is here once again. Are you using the opportunities presented by the RRSP to their best benefit? Beyond fully contributing to the RRSP to maximize the tax-savings opportunity today and the potential for tax-deferred growth in the future, here are five other considerations:

Consider the timing of deductions and contributions. With any RRSP contribution, you’re entitled to a tax deduction for the amount contributed so long as it is within the contribution limit. Keep in mind that you don’t have to claim the tax deduction in the year that the RRSP contribution is made. You can carry it forward if you expect income to be higher in future years such that you may be put in a higher tax bracket, potentially generating greater tax savings for a future year. By making contributions at the beginning of the tax year or throughout the year instead of waiting until March 1st for a deduction for the previous year, you may benefit from the longer time period for tax-deferred growth.
Don’t overlook the benefits of a spousal RRSP — If you have a spouse (common-law partner) in a lower-tax bracket, contributing to a spousal RRSP can help build your spouse’s retirement nest egg and lower the amount of tax you pay collectively. When you contribute on behalf of your spouse, you will receive the tax deduction. If you are in a higher tax bracket, the tax benefit will be greater than if your spouse contributed to his/her own RRSP. There may also be a tax break, down the road, when your spouse withdraws funds and you remain in a higher tax bracket than your spouse. While there may be noteworthy income-splitting benefits to a spousal RRSP, keep in mind that the RRSP is intended to be a long-term retirement savings vehicle. As such, a withdrawal within three years of a contribution to a spousal RRSP may be included in your taxable income rather than your spouse’s. If you are working past age 71 and have a younger spouse, you can no longer hold your own RRSP after the year you turn 71 but you can still make a contribution to a spousal RRSP as long as your spouse is age 71 or less at year end and you have RRSP contribution room. This may be a good way to get a deduction and shift income to a spouse.
Consolidate multiple RRSP accounts. For many individuals, having multiple RRSP accounts isn’t uncommon. Scattered accounts can accumulate over time: you may have had an employer-sponsored account or opened a self-directed RRSP during different points of your life. However, there may be benefit in consolidation. One reason is to avoid having orphan accounts, such as a lost employer-sponsored account that is forgotten after a move of residence. Multiple accounts can also result in unnecessary complications such as failing to maintain a productive asset mix. Consolidation has the potential to improve performance, simplify administration and potentially reduce fees.
Don’t make unnecessary RRSP withdrawals. Consider the implications of making taxable withdrawals from the RRSP to pay down short-term debt. You may be paying more tax on the RRSP withdrawal than you’ll save in interest costs. In addition, once you make a withdrawal from the RRSP, you won’t be able to get back the valuable contribution room. There may be better options, such as withdrawing from a Tax-Free Savings Account (TFSA) — as contribution room resets itself in the following calendar year.
As you approach retirement, consider drawing down the RRSP and funding a TFSA. If you are approaching retirement, there may be benefit in gradually drawing down RRSP funds. This may be useful if an individual is currently in a lower tax bracket than they expect to be in future years. Other individuals may seek to limit future sources of taxable income in order to minimize the possible clawback of income-tested government programs such as Old Age Security. One strategy may be to use these RRSP withdrawals to fund TFSA contributions, assuming available contribution room. With the growth of investments in the TFSA, there may be greater flexibility in the future to receive TFSA withdrawals tax free as needed; by contrast, the RRSP would generally be converted to a Registered Retirement Income Fund (RRIF), which requires minimum annual amounts to be withdrawn and included in taxable income. At death, funds remaining in a TFSA can pass tax free to heirs, as opposed to residual RRSP or RRIF funds that are subject to tax, potentially at high marginal tax rates.

Reminder: The RRSP contribution deadline is March 1, 2023, for the 2022 tax year. Contributions are limited to 18 percent of the previous year’s earned income, to a maximum of $29,210 (for the 2022 tax year). Don’t overlook the opportunity for tax-deferred growth!