Portfolio Update

Capital markets declined in September as investor sentiment regarding the global economy turned negative. Nevertheless, markets are up year-to-date, with the S&P 500 returning 12.8% (total return in C$), while the S&P/TSX rose 3.4%, MSCI Europe 8.4%, MSCI ACWI 9.8% and MSCI Emerging Markets 1.6%.

As we detail in our October Economic and Capital Markets Outlook, the global economy is on track for a healthy expansion in 2023. However, we acknowledge that the risk of a more pronounced slowdown in 2024 is on the rise due to the delayed impact of tighter monetary policies. The outlook varies by region, with some economies demonstrating resilience to headwinds, while others are struggling due to a variety of internal and external factors. We are maintaining our overweight allocation to equities over fixed income as we believe equities present more attractive risk/reward prospects over the medium to long-term.

Valuation Considerations

Equity markets have delivered very strong returns over the previous twelve months, while bonds have performed rather poorly. Indeed, the one-year total return of Canadian and U.S. 10-year government bonds was -3.8% and -3.0% respectively, as yields reached 4.06% and 4.59% at the end of September – their highest levels in almost 15 years. At this juncture, it is prudent to ask ourselves whether stocks have become overvalued as an asset class and if a greater allocation to bonds in our balanced portfolios is warranted.

We do not believe that stocks are expensive across the board. While developed market equity indices have increased notably since last year, this was primarily driven by heightened optimism surrounding a handful of technology companies that make up the largest weights in the index. Accordingly, the valuations of these indices have also expanded; the forward price-to-earnings ratio of the S&P 500 was 17.5x at the end of September, up from 15.1x a year prior. Meanwhile, valuations on the S&P 500 equal-weighted index, which is rebalanced quarterly to assign the same weight to each company in the index, remained more stable and currently sits at 13.9x. While our equity portfolios have delivered strong absolute and relative returns over the previous twelve months, they remain attractive from a valuation perspective. In fact, our global equity portfolio, which trades at 9.9 times forward earnings, is in line with the least expensive stock quintile in the S&P 500 (as measured by its forward price-to-earnings ratio) yet exhibits higher forecasted earnings growth. Furthermore, our equity portfolios deliver an attractive dividend yield of 3.8% as well as provide an opportunity for capital appreciation.

At this juncture, we remain optimistic about the medium to long-term return opportunities in our equity portfolios and do not believe bond prices are attractive enough to warrant a fundamental shift in the asset allocation of our balanced portfolios. Said differently, there are greater opportunities in the equity market from a risk/return standpoint. Nevertheless, we remain active in the management of our fixed income portfolios. We are gradually extending the duration by acquiring high-quality medium-term government bonds and we continue to view long-term bonds as unattractive. With the inversion of the yield curve, longer-dated instruments not only carry additional interest rate risk, but also offer less yield. As highlighted in our recent note, A strategy that pays off: maximizing returns through a risk/reward approach, our approach is to evaluate the individual merits of each investment. Using this method, we achieved strong outperformance in the fixed income market relative to the benchmark.

Important Developments in our Invest in Canada Campaign

Since the beginning of 2022, Letko Brosseau has been vocal in expressing our concerns regarding the dramatic decline in investment in Canadian public companies by our domestic pension funds. In 1990, Canada’s pension plans allocated around 23% of their total assets to Canadian publicly traded equities, and by 2022, this figure had dropped to around 4%[1]. This decades-long divestment from Canadian public equities has given rise to a much greater portion of Canadians’ savings and productive capital invested outside of the country, including in illiquid and opaque private assets. This development is not healthy for our country’s economic well-being, and we believe the first step to remedying this issue is awareness. As such, we formally launched our Invest in Canada campaign in the first quarter of 2022 which has garnered the attention of leaders in both the public and private sectors. On September 21^st, 2023, Letko Brosseau’s founders Peter Letko and Daniel Brosseau were invited to the House of Commons’ Standing Committee on Finance in Ottawa where they discussed the importance of investing in Canada and proposed a method to encourage pensions to invest capital domestically. We invite you to watch their speech by visiting the following link and to read the FAQ page we prepared that exposes the problem and possible solutions in more detail.

Conclusion

As we navigate through short-term economic challenges, our focus remains on creating value over the medium to long-term. As active discretionary managers, we are not required to mimic the index. Indeed, we always seek to construct well-diversified portfolios of attractive companies in the broader economy, trading at or below our assessment of their true value. We are confident our equity and fixed-income portfolios will continue to contribute to the preservation and growth of your capital. Moreover, we promise to keep you abreast of further developments in our Invest in Canada campaign. Canada is rich in opportunities, with favorable demographics, a tolerant, well-educated and diverse population, and an expanding economy with moderate debt levels. It also hosts abundant natural resources, modern infrastructure, and world-renowned educational institutions. We passionately believe the country is a great place to invest; our balanced portfolio has always had significant exposure to Canadian publicly traded equities, which currently account for 20.1%. In our view, it is time that the country’s pension plans recognize the value of investing domestically and the important role Canadians’ savings play in forging the country’s future.

[1] Pension Investment Association of Canada (PIAC) https://piacweb.org/