Echelon Wealth Partner Blog

Is it over?

website@sitemodify.com (Website Editor) — Mon, 17 Jun 2024 16:33:00 GMT

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.

This chart breaks focused on a number of early or fast movers vs slower or lagged. Clearly, since the spring of ’23, we have seen the fast-moving components showing some disinflationary pressures. But the lagged movers remained high, owing to their name. Yet of late, those, too, have finally started to turn down a bit.

Where to next?

Back down to 3% or so is likely the easy part; then things get a bit less clear cut. Helping out, there remain a number of factors that should continue to put downward pressure on inflation:

The nature of the price resetting in the lagged movers should continue to put some downward pressure on overall inflation.
Given how much of inflation is services, employment certainly matters. While nonfarm payrolls remain healthy, that is contrary to other metrics. Household survey is less enthusiastic, and temp workers remain on the decline and job openings continue a downward trend. Quitters, too, the quit rate drops should help on wages and the flow through to inflation.
Supply chain bottlenecks are very low again. And China PPI, producer prices, remain negative. Given its global manufacturing market share, lower prices for goods coming out of China is disinflationary.

But don’t get too excited. While we think inflation will likely cool a bit more, there are some counterforces that will probably limit the improvements.

Over the past few months, global trade and manufacturing activity have been turning back up. This could just be an echo coming out of the manufacturing recession of '22/early ’23, or it may have longevity. Regardless, in the near term, rising global economic activity will not help prices to go down.

Price intentions among survey data, which improved a lot last year, have stabilized. Companies will charge as much as they can, and given consumers continued fortitude to suck it up and pay higher prices, well, that keeps prices higher. There is some evidence the consumer is starting to change, but for now, they keep hitting the ask for flights, trips, dinners, etc.

Inflation may fall further, but the gains are likely getting harder to come by.

Final Thoughts

We do believe inflation is likely back to being influenced more by the economy and less by the pandemic-induced gyrating behaviours. If the economy reaccelerates, we could easily see inflation pick up again. And if the recent uptick in economic growth proves fleeting, inflation will likely back down. At the very least, this is an easier world to navigate compared to the previous years.
— 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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Crisis Alpha

website@sitemodify.com (Website Editor) — Mon, 10 Jun 2024 15:34:00 GMT

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.

This Ain't That

website@sitemodify.com (Website Editor) — Mon, 03 Jun 2024 17:56:00 GMT

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.
1. 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.
2. 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.

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.

The Calm Before the Calm

website@sitemodify.com (Website Editor) — Tue, 28 May 2024 13:43:00 GMT

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.

Final Thoughts

Markets are certainly eerily calm across many different geographies and asset classes, like a Muskoka lake early in the morning. Maybe it is the calm before the storm or perhaps just the calm before the summer calm. There are certainly positives from an improving trend in the global economy; earnings continue to come in healthy, and inflation is cooling, albeit in a straight line. If the market can continue to ignore the campaign rhetoric leading to the U.S. election, that would be great and unprecedented. At some point, the banter will start impacting markets, but likely not in a positive way. The consumer is getting tired and weighed down by slowing labour gains and inflation, which continues to eat away at previously accumulated savings.
The only thing we are pretty sure of is that volatility will rise in the second half.
Let’s just hope for a calm summer.

— 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.

More Bad News S'Il Vous Plaît

website@sitemodify.com (Website Editor) — Tue, 21 May 2024 18:06:00 GMT

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 accumulation 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.

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.

Is It Time for Emerging Markets

website@sitemodify.com (Website Editor) — Mon, 13 May 2024 18:06:00 GMT

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 – T he 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.

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.

Lots of Bulls & Bears

website@sitemodify.com (Website Editor) — Mon, 06 May 2024 17:53:00 GMT

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 this 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 bankowned 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.

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.

Earnings Optimism

website@sitemodify.com (Website Editor) — Mon, 29 Apr 2024 16:31:00 GMT

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 3- 4% 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.

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.

Energy Stars Align

website@sitemodify.com (Website Editor) — Mon, 22 Apr 2024 17:11:00 GMT

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 1) step function increase in production, 2) lower volatility from better-realized pricing of WCS, 3) attractive (but not firesale) valuations for steady returns, and 4) 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.

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.

Your Money & Your Heirs: What’s Your Plan for Wealth Longevity?

website@sitemodify.com (Website Editor) — Wed, 17 Apr 2024 16:28:00 GMT

As part of your wealth planning, have you considered your wealth’s longevity? Many of us have heard of the “shirtsleeves curse”: Family wealth is often built up and lost within three generations. You may not be surprised to learn that recipients often make “big” purchases within the first few weeks of receiving their inheritance. This is because many heirs are not focused on the longevity of new-found wealth.
What are high-net-worth families doing to help prevent this loss? There has been an increasing focus on intergenerational wealth planning, with the objective of supporting wealth longevity. This involves getting existing generations to meet about their finances and form shared financial goals and values to help encourage lasting wealth. Here are some steps that can be taken as part of this planning process:
Start with a plan and document it Start by thinking about your vision for your wealth for the generations to come. The plan should set out goals and provisions for how you wish funds to be used, accessed and replenished. For instance, you may wish for family members to invest in themselves to gain the experience needed to create and grow wealth, using funds for higher education or a business start-up or expansion. Others may wish to leave endowments to a charity. Once you determine your goals and provisions, it is important to formally record them as this document will be passed along to future generations.
Communicate your plan Once the plan has been documented, it should be communicated to family members. Often, parents keep their finances and related values to themselves, missing the opportunity to pass along their ideals to children. While specific financial details need not be disclosed, sharing your vision is intended to be a catalyst for meaningful discussions. Some families use this plan to form a family constitution to help future generations carry forward their intentions.
Engage in regular meetings Regular family meetings are intended to help cultivate family values based on your vision for your wealth. If wealth has been carefully built up through the generations, it may involve exploring family history. Or, you may use this time to educate children about finances and managing money or introduce high-level strategies to carry out the intergenerational plan relating to running a family business or a family giving strategy.
Consider protection tools You may determine through family meetings that beneficiaries will need support. Certain tools can support beneficiaries to meet your goals, or protect future wealth in situations in which beneficiaries may not be capable. For example, a trust can put assets under the control of a responsible trustee, with the terms of the trust specifying the conditions, timing and amount of distributions to be made to heirs. Other tools, such as life insurance, can protect and grow assets while also providing access to cash. Setting up a support system of trusted professionals may help to ensure a successful wealth transfer, especially if heirs do not have the skills to manage funds independently.
Monitor the plan’s success By having an ongoing dialogue with family members, you will be able to identify and address any gaps or concerns as they arise. You can also continue to define and refine family roles to ensure that your plan has a greater chance of success.
Here to Provide Support While intergenerational wealth planning may not be for everyone, consider that creating a lasting legacy can be one of the greatest gifts you leave behind. If you need assistance with family discussions or educational tools to support children, please contact your Echelon Advisor.

Estate Planning: Avoid These Estate Administration Errors

website@sitemodify.com (Website Editor) — Wed, 17 Apr 2024 16:28:00 GMT

Have you been appointed as someone’s estate “executor” or “liquidator”?* Or, if you are planning for your own estate, will your executor avoid these errors? Administering an estate can be a time-consuming and complex task, often challenged by what may be an emotionally difficult time. All too often, executors can make mistakes that have the potential to lead to increased tax liabilities, conflict with or between beneficiaries or, worse yet, escalation to potential litigation. Equally concerning, the executor risks personal liability for these mistakes.
Here are five common errors: 1. Overlooking directives in the Will. Estate lawyers say that executors can sometimes ignore parts of the Will, such as forgiving loans that were to be collected, perhaps due to a lack of knowledge or because it is easy or convenient. Others may choose to distribute assets differently than directed within the Will, under the belief that they have a more ‘fair’ idea for this distribution. ¹ However, neither situation is within an executor’s authority, exposing them to potential liability.
2. Failing to communicate. Sometimes executors become so involved in the process that they neglect to communicate. One of the executor’s duties is to respond to reasonable inquiries from beneficiaries. Silence may be misinterpreted as being secretive or suspicious, and this can often prompt estate disputes. Maintaining transparency and ongoing communication can go a long way in helping to prevent conflict.
3. Making distributions too early. If distributions are made too early, such as before taxes or other liabilities are paid, the executor may be held personally responsible. This can often happen when the executor succumbs to pressure from beneficiaries for distributions. However, any outstanding debts of the deceased must be paid before estate assets can be distributed to beneficiaries — and it is the job of the executor to identify these debts. Sometimes the executor overlooks the importance of determining whether there are unknown creditors, which often involves a time-consuming process of creating a public notice. Advertising for creditors before any distributions are made can protect the executor should a creditor make a claim after the estate has been distributed.
4. Trying to keep costs low. Some executors may act too prudently to try and limit estate expenses. However, this may lead to higher eventual costs. For example, if an executor decides to do the tax returns without the help of an accountant, they may miss eligible tax credits or deductions. In the past, advertising for creditors in the newspapers of multiple cities was very costly, so some executors avoided the process, only to be caught by surprise when creditors eventually made claims.
5. Treating estate funds as their own. Given the significance of assets that are often available within an estate, some executors may wrongly use estate funds for their own purposes, such as to make loans to themselves or family members. Others may make more honest mistakes, such as using funds to cover travel costs for family members to attend a funeral. If estate funds are used incorrectly, the executor may be held personally liable. As well, if the executor acts unreasonably or in self-interest, they may not be entitled to charge compensation from the estate. ²
Plan Ahead If you have been appointed to administer an estate, being aware of these potential pitfalls may help as you contemplate the role. Remember also that you can decline the position, but doing so after accepting the role can be difficult and/or costly. As you plan for your own estate, carefully choosing your potential executor is important to prevent these and other mistakes; it may be preferable to seek a professional to act in this role. Click here for a copy of Echelon’s Executor Checklist . If you have any questions, please contact your advisor.
*The names vary by province. For this article, the term “executor” is used to describe the role of the person responsible for carrying out the instructions of the Will. 1. http://estatelawcanada.blogspot.com/2010/07/top-five-mistakes-made-by-executors.html; 2. https://www.canlii.org/en/on/onca/doc/2016/2016onca521/2016onca521.html

Value in the Canadian Dollar

website@sitemodify.com (Website Editor) — Tue, 16 Apr 2024 14:04:00 GMT

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.

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.

Dividend Depression

website@sitemodify.com (Website Editor) — Mon, 08 Apr 2024 15:03:00 GMT

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.

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.

Why?

website@sitemodify.com (Website Editor) — Mon, 01 Apr 2024 17:04:00 GMT

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 s urrounding 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.

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.

IPOs - Where Art Thou?

website@sitemodify.com (Website Editor) — Mon, 25 Mar 2024 15:24:00 GMT

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 12- months. 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.

— 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.

Inflation – Not going quietly into the night

website@sitemodify.com (Website Editor) — Mon, 18 Mar 2024 15:22:00 GMT

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 bit 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.

Your 101 on How Canadians are Taxed

website@sitemodify.com (Website Editor) — Thu, 07 Mar 2024 18:47:00 GMT

The time to file your 2023 personal income tax return is just around the corner. Need a reminder about how Canadians are taxed… read on.
Individuals who reside in Canada are taxed on the worldwide income they receive in the calendar year. There is a federal layer of tax and a provincial layer of tax. The tax rate you pay depends on the amount of taxable income you received in the calendar year and the tax brackets you fall into. The 2023 Federal tax brackets are shown in the table below (which are indexed each year for inflation). Each province also has its own tax brackets and rates.

As you can see, the rate you pay will be a blended rate depending on your taxable income for the year. You pay Federal tax at 15% on the first $53,359, then the rate increases to 20.50% for income above $53,359, etc. Once your income is over $235,676, then every dollar after that will be at the 33% Federal tax rate. With provincial taxes added on, the top combined income tax rate ranges from 44.50% in Nunavut to 54.80% in Newfoundland and Labrador. Check out these links for the combined Federal and Provincial tax rates for the province in which you reside: E&Y (rates and a personal tax calculator), KPMG (tax rates and brackets), as well as this easy-to-use Tax Calculator . There is an alternative minimum tax (AMT) that could apply if you have certain preference items. A taxpayer pays the higher of AMT and regular income tax. There are changes to the AMT for 2024, outlined in this article Alternative Minimum Tax Changes – What You Need to Know.
Some types of income are more tax efficient than others. If you earn capital gains, only 50% of the gain will be included in your taxable income, while your employment and investment income will be fully taxed. Withdrawals from your RRSP or RRIF are also fully taxable. Dividends receive preferential tax treatment through the use of the dividend gross-up and tax credit. There are two types of dividends: eligible and non-eligible dividends. Non-eligible dividends are taxed at a higher rate than eligible dividends. Usually, dividends you receive in your investment portfolio would be eligible dividends (dividends from publicly traded securities). While preparing your 2023 tax return, review the types of income you earned and evaluate if you should make a change to the types of income you are receiving. However, don’t let the taxation of the income be the only reason for changing an investment. Talk to an Advisor to help match your income to your planning goals.
Certain expenditures are deductible from your income and there are also tax credits available that can reduce your tax liability. The CRA’s website has a page that describes the deductions and tax credits that are available. To be applied to your tax return, the expenses must have been incurred by December 31 of the tax year in question (except for RRSP contributions which can be made 60 days after year end and still reduce the prior year tax liability - so for the 2023 tax year, RRSP contributions can be made up to February 29, 2024). For employees, there are less deductions than for those who are self-employed. The most common deductions are for RRSP contributions, childcare expenses, capital losses and investment related expenses. New for 2023 is the first home savings account (FHSA). The contribution limit for this account is $8,000 and is tax deductible. For more information on how this account works, consult CRA’s First Home Savings Account page. The most common credits are for medical expenses, charitable donations and tuition fees.
Of course, there are also ways to save taxes on income in the long-term by investing in a tax-free savings account (TFSA) or registered education savings plan (RESP), for example. While contributions to these types of plans don’t result in a deduction on your tax return, the income earned in the plans are not taxable while in the plan. For TFSA, there is no tax to you on withdrawal. For RESP, the funds are taxed in the hands of the student. The TFSA contribution limit for 2024 is $7,000. If you have not made a TFSA contribution in the past, the contribution room carries forward. For example, if you were 18 years or older in 2009 and have never contributed to a TFSA, you could contribute $95,000 to a TFSA in 2024. For more information on how TFSAs work, read How to Use a TFSA to Get Better Investing Results and for more information RESPs, check out Getting the Most from Your RESP, SMART TALK… about registered education savings plans (RESPs) and this Start Education Planning Now calculator.
Now is also an opportune time to review your overall financial and estate plan which would include your wills, power of attorney and representation agreements, life insurance needs as well as critical illness and disability insurance.
Contact us to learn more or if you have any questions.

Source: Charts are sourced to https://www.thelinkbetween.ca/

The contents of this publication were researched, written and produced by The Link Between (https://www.thelinkbetween.ca/) and are used by Echelon Wealth Partners Inc. for information purposes only.

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.

Alternative Minimum Tax Changes – What You Need to Know

website@sitemodify.com (Website Editor) — Thu, 07 Mar 2024 18:46:00 GMT

Did you know that Canada’s Federal Budget proposed changes to the Alternative Minimum Tax (AMT) rules with draft legislation that came into effect on January 1, 2024? So, what is AMT and how does it affect your tax planning?
Under the existing AMT rules, the most common situations where AMT could apply is where you have large capital gains and especially if the lifetime capital gains exemption was used on a sale of qualified small business corporation shares or qualified farm and fishing property.

What is AMT?

The AMT was introduced in 1986 as a parallel tax to the regular tax system and applies to individuals, but not to corporations. In general, individuals are required to pay the higher of AMT or regular tax. To calculate the difference, first regular tax is calculated (at progressive tax rates). The next step is to calculate taxable income for AMT which is determined by adding back certain “preference” items into your regular taxable income. There is an exemption amount that is deducted from the AMT taxable income of $40,000* and any excess income is taxed at a flat tax rate of 15%* and certain non-refundable tax credits are allowed to reduce the amount of tax owing. So if your taxable AMT income is under $40,000, AMT will not apply and just the regular tax will be payable. Any additional tax paid under the AMT can be carried forward as a credit to offset regular tax for seven years. (AMT does not apply in the year of death of a taxpayer.)

What are the changes?

The 2023 Federal Budget has proposed changes to broaden the tax base subject to AMT, increasing the tax rate but also increasing the exemption amount. The following table highlights some of the proposed changes, but please reach out to us if you require more details.

What do you need to do?

These proposed changes could result in AMT applying if your taxable income (calculated for AMT purposes) is in excess of $173,000. In addition to being aware of the implications of AMT when there are large capital gains in a year (as well as planning for it), starting in 2024 you will also need to consider the implications of significant interest deductions (for example, if using a leveraging strategy) or large donations (especially gifts of capital property as these donations not only have the 50% limitation on the donation tax credit, but also 100% or 30% of the gain, depending on the type of property, could be included in taxable income for AMT).
If you think AMT may apply to you, contact us to discuss planning options.
*$40,000 is the exemption amount as of the date of this article and the rate of tax is 15%.

Source: Charts are sourced to https://www.thelinkbetween.ca/

The contents of this publication were researched, written and produced by The Link Between (https://www.thelinkbetween.ca/) and are used by Echelon Wealth Partners Inc. for information purposes only.

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.

A Bubbly World

website@sitemodify.com (Website Editor) — Mon, 04 Mar 2024 16:43:00 GMT

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: Investor s 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: 1. Early bubble identification 2. Prudent exposure – sizing 3. 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.

Cash vs GICs vs Bonds

website@sitemodify.com (Website Editor) — Mon, 26 Feb 2024 16:46:00 GMT

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.

Nobody Controls Risk in an Index

website@sitemodify.com (Website Editor) — Tue, 20 Feb 2024 20:51:00 GMT

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.

Fall in Love with these Income Splitting Tips for you and your Spouse

website@sitemodify.com (Website Editor) — Wed, 14 Feb 2024 18:15:00 GMT

Want to make the most of your savings in retirement with your married or common-law spouse? The trick here is not knowing to save, but knowing how to save. Which accounts make sense?
(Keep in mind, we're just going to cover the basics here…but if you need help, your advisor is just a call away.)

Spousal RRSPs

RRSPs are a popular retirement savings vehicle for many Canadians. Can you contribute to your spouse’s account? Sort of – but not exactly.
You can’t contribute to a spouse’s individual RRSP. That’s a no-no, leading to potential attribution penalties coming by way of a CRA audit.
But here’s the trick: you can contribute to a Spousal RRSP. And there might be a very good reason to do that.
Don’t think that 50 percent pension splitting is enough to fully split retirement income for you and your spouse? Is your employment and future retirement income expected to be significantly higher than your spouse’s? Or vice-versa? That’s when contributions to a Spousal RRSP could be a good idea.

Zakk and Ella show how income splitting with Spousal RRSPs works

Let’s imagine a nice, happy 30-ish couple, Zakk and Ella. They’re both gainfully employed and doing well for themselves, though their incomes are a little mismatched. After stints tending bar and running a coffee shop, Zakk finally followed his calling two years ago and became an art teacher at Ridgemont High.
He earns $60,000. Meanwhile, Ella has been working continuously for 10 years as a software developer with a growing tech company. After raises most years, she now earns $90,000.
Ella is the higher earner. After paying off debt and expenses, she contributes $12,000 to a Spousal RRSP for her husband, Zakk.
Ella deducts the RRSP contribution from her income and that $12,000 contribution reduces her personal annual RRSP contribution limit. That would help her get a tax refund, or at least lower the taxes that she pays that year.
In this case, because Zakk is the lower-income spouse, he is the person authorized to withdraw the funds from the RRSP. However, there is a little bit of a complication…
If you want to take out that money to use it, here comes the tax man! How do you deal with that?

How withdrawals from Spousal RRSPs get taxed

Zakk wants to make a withdrawal from the Spousal RRSP. Let’s say that his withdrawal is equal to or less than contributions Ella made in the year of withdrawal or two preceding calendar years.
In that case, the CRA will tax the withdrawal amount back to the contributor, Ella. But Zakk won’t get taxed, even though (as the lower-income spouse) he is the official holder of the Spousal RRSP (probably the lower-income spouse).
Let’s take a different case: Zakk wants to make a withdrawal from the Spousal RRSP, but Ella hasn’t made a contribution that year or in the preceding two years. In that case, he’ll be taxed on that income.
There are exceptions where the spousal attribution rule wouldn’t apply, such as if Ella died the year the funds were being withdrawn. It also wouldn’t apply if Zakk and Ella became non-residents. There are a few other technical exceptions, so if you're using this strategy, best to chat with your advisor.
Now, Spousal RRSPs aren’t the be-all, end-all of income splitting strategies. There is also…

Pension Income Splitting

You can transfer up to 50 percent of eligible pension income to your spouse. However, there’s a catch.
Eligible pension income is different when you’re under 65 than when you’re over 65. Here’s how:
Before 65, pension income splitting is limited to:

Lifetime annuity payments from a registered pension plan (eg. monthly payments from a private pension)
Certain death benefits

65 and over, pension income splitting includes:
The same stuff as above, plus payments from:

RRIF
Deferred Profit Sharing Program (DPSP)

For most Canadians, this up-to 50 percent splitting is usually enough to split couples’ retirement incomes to maximum efficiency. But maybe one spouse’s income is so high that there is still a gap? Well, there are other strategies…

Splitting your CPP

Splitting your CPP is not terribly common (we’ll explain why, below) but here’s an example of how it could work.
Let’s go back to the case of Zakk and Ella (many years later). When Ella took time off to raise their children (and even after she went back to work part-time), Zakk became the higher income earner. Now that he is retired, he is entitled to about $12,000 a year from CPP. Ella didn’t contribute as much and now is expecting only $6,000 a year from CPP. By sharing CPP credits, Zakk and Ella could lower their total tax bill.
We’re including this just to be comprehensive… but just to be clear, while it might work for Zakk and Ella, for many Canadians, this might not be worth the trouble. Your maximum CPP payment might only be around $1,100 a month, each. The tax savings on that income could be meagre. But hey, if you’re on a limited income in retirement, every dollar counts.

Tax-Free Savings Account (TFSA)

While this is not specifically an account that couples could use directly for income splitting, the TFSA can be part of anyone’s comprehensive retirement income strategy. And certainly, in cases where there is a big disparity of incomes, it may be better to draw income from this in retirement, instead of paying tax on drawn income from other types of accounts.
You can gift money to your spouse or common-law partner , who would then put it into their TFSA account. (You can’t ordinarily directly contribute the money into their account – but if it’s coming from a joint bank account, it won’t matter).
There are no tax consequences to withdrawing that money… so, make sure it’s at least considered for your overall long-term strategy. Reposted with permission from CI Direct Investing.

Source: Charts are sourced to https://www.thelinkbetween.ca/
The contents of this publication were researched, written and produced by The Link Between (https://www.thelinkbetween.ca/) and are used by Echelon Wealth Partners Inc. for information purposes only.
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.

American Exceptionalism

website@sitemodify.com (Website Editor) — Mon, 12 Feb 2024 16:35:00 GMT

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.

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.

Love and Money

website@sitemodify.com (Website Editor) — Thu, 08 Feb 2024 14:45:00 GMT

Ah love… it’s a beautiful thing, but sometimes finances and money worries can get in the way. In fact, 84% of respondents in a Money Magazine survey said that money was the source of marital tensions with disagreements about financial priorities topping the list of problems (1). So, how should one manage money and love?
Here are a few insights to help you keep those love lights burning and your pocketbooks full without the added strain.

Communicate

The world of finances can be complex – TFSAs, RRSPs, RESPs, registered vs. non-registered – it’s a lot and it’s easy to get lost in those day-to-day decisions that shape your financial future. In most households, it’s common for there to be one person who is "in charge" or more involved in the family finances. And that is just fine, but too often this leads to a lack of communication, which is never a good thing. The outcome is that only the one person can answer critical questions like “what comes in every month vs. what needs to come out to support the lifestyle”, “which account types allow for a beneficiary”, “what are the tax consequences of withdrawals from different accounts” or “what happens if I pass away without a will”? Life is busy, but it’s important to set some time aside for an annual review with your partner to discuss the important financial matters that will set you up for success in the future!

Plan

Money matters can get intricate, so do yourself a solid and get expert advice. Consider working with a financial planner, one that will provide some clarity for your financial future. The earlier you and your partner are able to identify key financial priorities, the better! It really just depends on your needs and stage of life – are you preparing for your retirement, to purchase your first home, pay down debts, invest, send your kids to school? It’s a lot to consider, but a good start is to for you and your partner to each list your financial goals (separately), then work with a planning professional to identify the key goals to action now versus which can be deferred to another time.

Manage Risk

Much like a home, a financial plan requires a foundation – this is where risk management comes into play. You need to understand your financial risks and where your vulnerabilities lie. Imagine spending hours putting a solid plan into place, starting on your financial path, only to discover that you or your partner have a critical illness to confront or worse. It’s simply unimaginable, but you DO have to imagine it and then actively prepare for this situation with a contingency plan. There are a number of excellent financial vehicles to protect you from such unexpected risk!

Save

It goes without saying that you can accumulate wealth with systematic savings. That being said, it’s not always that simple. Take the time to educate yourself on how to save, where to save and when to save. Here are a few quick tips:
1. Identify your time horizon - when do you plan to use these funds?
2. Pay yourself first – don’t count on haphazard deposits to save; instead, put a systematic savings regime in place to get you to your goal! 3. Taxes – definitely something to keep in mind. What type of account best suits your savings goal?
4. Grants, bonds, and special benefits – there are many plans that can help you optimize your financial goals. For example, if you’re saving for your children's education, it's a good idea to invest in an RESP which provides "free" money in the form of contribution-matching up to a certain limit. Another example is if you’re buying a new home while looking to save for retirement; investing in an RRSP will allow you to access $35,000 via a first time homebuyer’s loan program. You have options!
Love and money – we need them both, but sometimes it’s difficult to keep them apart. We hope we’ve provided you with some useful tips here to avoid the strains of love and money – now go and give your loved one a hug!

References 1. CNN. Money? Sex? What couples are fighting about. CNN Money. n.d.

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.

Conflicting Forces

website@sitemodify.com (Website Editor) — Mon, 05 Feb 2024 16:27:00 GMT

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 Coca-Cola.
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.

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.

Do Valuations Matter?

website@sitemodify.com (Website Editor) — Tue, 30 Jan 2024 18:48:00 GMT

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 long-standing 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.

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.

Your 101 on How Canadians Are Taxed

website@sitemodify.com (Website Editor) — Tue, 30 Jan 2024 17:27:00 GMT

The time to file your 2023 personal income tax return is just around the corner. Need a reminder about how Canadians are taxed? Read on... Individuals who reside in Canada are taxed on the worldwide income they receive in the calendar year. There is a federal layer of tax and a provincial layer of tax. The tax rate you pay depends on the amount of taxable income you received in the calendar year and the tax brackets you fall into. The 2023 Federal tax brackets are shown in the table below (which are indexed each year for inflation). Each province also has its own tax brackets and rates.

As you can see, the rate you pay will be a blended rate depending on your taxable income for the year. You pay Federal tax at 15% on the first $53,359, then the rate increases to 20.50% for income above $53,359, etc. Once your income is over $235,676, then every dollar after that will be at the 33% Federal tax rate. With provincial taxes added on, the top combined income tax rate ranges from 44.50% in Nunavut to 54.80% in Newfoundland and Labrador. Check out these links for the combined Federal and Provincial tax rates for the province in which you reside: E&Y (rates and a personal tax calculator) and KPMG (tax rates and brackets). There is an alternative minimum tax (AMT) that could apply if you have certain preference items. A taxpayer pays the higher of AMT and regular income tax. There are changes to the AMT for 2024, outlined in this article Alternative Minimum Tax Changes – What You Need to Know .
Some types of income are more tax efficient than others. If you earn capital gains, only 50% of the gain will be included in your taxable income, while your employment and investment income will be fully taxed. Withdrawals from your RRSP or RRIF are also fully taxable. Dividends receive preferential tax treatment through the use of the dividend gross-up and tax credit. There are two types of dividends: eligible and non-eligible dividends. Non-eligible dividends are taxed at a higher rate than eligible dividends. Usually, dividends you receive in your investment portfolio would be eligible dividends (dividends from publicly traded securities). While preparing your 2023 tax return, review the types of income you earned and evaluate if you should make a change to the types of income you are receiving. However, don’t let the taxation of the income be the only reason for changing an investment. Talk to an Advisor to help match your income to your planning goals.
Certain expenditures are deductible from your income and there are also tax credits available that can reduce your tax liability. The CRA’s website has a page that describes the deductions and tax credits that are available. To be applied to your tax return, the expenses must have been incurred by December 31 of the tax year in question (except for RRSP contributions which can be made 60 days after year end and still reduce the prior year tax liability - so for the 2023 tax year, RRSP contributions can be made up to February 29, 2024). For employees, there are less deductions than for those who are self-employed. The most common deductions are for RRSP contributions, childcare expenses, capital losses and investment related expenses. New for 2023 is the first home savings account (FHSA). The contribution limit for this account is $8,000 and is tax deductible. For more information on how this account works, consult CRA’s First Home Savings Account page . The most common credits are for medical expenses, charitable donations and tuition fees. Of course, there are also ways to save taxes on income in the long-term by investing in a tax-free savings account (TFSA) or registered education savings plan (RESP), for example. While contributions to these types of plans don’t result in a deduction on your tax return, the income earned in the plans are not taxable while in the plan. For TFSA, there is no tax to you on withdrawal. For RESP, the funds are taxed in the hands of the student. The TFSA contribution limit for 2024 is $7,000. If you have not made a TFSA contribution in the past, the contribution room carries forward. For example, if you were 18 years or older in 2009 and have never contributed to a TFSA, you could contribute $95,000 to a TFSA in 2024. For more information on how TFSAs work, read How to Use a TFSA to Get Better Investing Results and for more information RESPs, check out Getting the Most from Your RESP , SMART TALK… about registered education savings plans (RESPs) and this Start Education Planning Now calculator .
Now is also an opportune time to review your overall financial and estate plan which would include your wills, power of attorney and representation agreements, life insurance needs as well as critical illness and disability insurance.
Contact us to learn more or if you have any questions.

Source: Charts are sourced to https://www.thelinkbetween.ca/

The contents of this publication were researched, written and produced by The Link Between (https://www.thelinkbetween.ca/) and are used by Echelon Wealth Partners Inc. for information purposes only.

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.

The ABCs of Spousal RRSPs

website@sitemodify.com (Website Editor) — Tue, 30 Jan 2024 17:22:00 GMT

A spousal* RRSP is exactly what it appears to be , quite simply a Registered Retirement Savings Plan (RRSP) for a spouse; a plan that cannot only help set aside funds for you and your spouses’ retirement, but can save you some tax dollars in the process. The idea is that one person, typically the higher earner, contributes money to the spousal plan on behalf of their spouse. The primary benefit is that a contribution can be made each year and the receiving spouse will see a tax- free return until those assets are withdrawn. A spousal RRSP is typically utilized when one spouse has significantly more money in their RRSP than the other. By splitting the invested amount between an RRSP and a spousal RRSP, both of you can enjoy retirement dollars and pay less tax overall by withdrawing the funds when you are both in a lower tax bracket.
Let’s see how this works – Assume you earn $100,000 and your spouse earns $50,000. With RRSP contribution limits of 18%, you can deposit $18,000 and your spouse can deposit $9,000 to your respective RRSPs. However, if using a spousal account, you can deposit, let’s say, $13,000 to your own account and $5,000 to the spousal account. Your total contribution is still $18,000, but divided over two accounts, allowing you to split the income with your spouse. Your spouse can still deposit their original $9,000 into their account. The scenario becomes quite different without a spousal RRSP: let’s imagine that you have $1 million upon retirement and your spouse has $400,000 at this same time. A standard 5% withdrawal rate would result in taxable income of $50,000 for you and $20,000 for your spouse, with your $50,000 annual withdrawal taxed at a higher rate. If a spousal RRSP had been set up, both accounts could have accumulated $700,000 each (same total amount) and taken out an annual income of $35,000 per spouse, resulting in tax at a lower rate. A spousal RRSP can also be used to save on taxes if one member of the couple is over 71 years of age but the other is not. When a spousal RRSP is opened, contributions can be made on behalf of the spouse who is not over 71 - and claim the income deduction on that deposit. In addition, spousal RRSP payments can still be made in the year of death.
It is worth noting that contributions to a spousal RRSP must remain in the fund for three calendar years from the year they are contributed or else the withdrawal amount will be added to your net income for that year and taxes will have to be paid at your tax rate.
*spouse includes a common-law partner The contents of this publication were researched, written and produced by The Link Between ( https://www.thelinkbetween.ca/ ) and are used by Echelon Wealth Partners Inc. for information purposes only

How Much Do You Need to Retire?

website@sitemodify.com (Website Editor) — Tue, 30 Jan 2024 17:15:00 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. The table shows the payments that would be received based on the current minimum withdrawal requirements for a plan value of $300,000 at age 70. Assuming a five percent annual return on investments, changes in the RRIF value are also shown. For those worried about outliving assets, the numbers may provide some comfort. At age 90, 60 percent of the original asset value is still available, and this doesn’t consider other sources of retirement income that may be available.

How Much Can the RRIF Provide?
Example: Payments Received Based on Minimum Withdrawal Requirements for Plan Value of $300,000 at Age 70 Assumes Five Percent Compounded Annual Return

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 Plan 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 $16,375.203 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. 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. Start calculating your retirement potential today: My RazorPlan

1. https://benefitscanada.com/pensions/retirement/new-surveys-highlight-discrepancies-in-retirement-readiness/

2. https://www.thestar.com/business/personal-finance/do-you-want-a-budget-middle-class-or-deluxe-retirement-i-ve-calculated-exactly-what/article_7f9c740e-3828-5d13-a907-b2202c55b6ff.html ; 3. Based on maximum monthly payment amount at the start of 2024 of $1,364.60 Canada Pension Plan - How much could you receive - Canada.ca

Moody Market

website@sitemodify.com (Website Editor) — Mon, 22 Jan 2024 15:39:00 GMT

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.

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.

Are You Using Your RRSP to Its Fullest Potential?

website@sitemodify.com (Website Editor) — Tue, 16 Jan 2024 15:40:00 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 February 29th 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 February 29th, 2024, for the 2023 tax year. Contributions are limited to 18 percent of the previous year’s earned income, to a maximum of $30,780 (for the 2023 tax year). Don’t overlook the opportunity for tax-deferred growth!

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.

What is an RRSP and How Does it Work?

website@sitemodify.com (Website Editor) — Tue, 16 Jan 2024 15:30:00 GMT

Maybe you can’t drive stick shift. Maybe you don’t know the name of your local representative. Or maybe you’re still unclear on what, exactly, gluten actually is. We all have holes in our knowledge that we’re embarrassed to admit. If you still aren’t sure what an RRSP is, or how it actually works — don’t worry. Using an RRSP doesn’t have to be complicated or intimidating. In fact, once you break it down, they’re pretty straightforward. Even better? Learn how RRSPs work, open one, start contributing, and your future self will benefit. So grab a coffee refill and carve out ten minutes. Here’s what you need to know about RRSPs.
What is an RRSP? RRSP stands for Registered Retirement Savings Plan. An RRSP is an investment account you contribute to each year in order to build up long term savings, most often for retirement (as the name suggests).
How an RRSP works The most important way an RRSP differs from a regular (non-registered) account or a TFSA (Tax-Free Savings Account) is how it’s taxed. Your RRSP contributions are tax deductible. So, when you contribute to an RRSP, you pay less in income taxes than you would otherwise. And while the money is in the account, it grows tax free. Later, when you withdraw that money again — typically in retirement — you pay taxes on it as though it’s income.
Lifecycle of an RRSP Step 1: Earning money Chances are, you’re already completing this step. If you work for someone else, your employment income tax is taken off your paycheque automatically. If you work for yourself, you’ll pay those taxes either annually, or on a quarterly basis, depending on how much money you make.
Step 2: Opening an RRSP Once you open an RRSP, you’ll be ready to contribute assets. Think of your RRSP as a box you can put cash and different types of investments into. These can include publicly traded stocks, bonds, ETFs, mutual funds, or GICS — just about any financial product that holds value.
Because you’re almost certainly saving for the long-term, (retirement being the end-game), it’s wise to take advantage of the opportunity to grow the value of your account by investing the money in the account. Working with an advisor helps you choose appropriate investments and products that meet your unique needs.
Step 3: Contributing money Each year, you can contribute 18% of your previous year’s earned income, or the year’s maximum contribution rate, to your RRSP — whichever is less. For the 2023 tax year, the RRSP contribution limit is $30,780. Also, if you didn’t max out your contribution room in previous years, that amount carries forward to the present. To maximize your savings, consider setting up automatic contributions so the money is automatically taken out of your chequing account on a recurring basis.
Step 4: Using your RRSP money You have the option to withdraw money from your RRSP before you retire. Generally, we strongly advise against making early RRSP withdrawals because you’ll be hit with a tax liability — unless you plan to take advantage of the Home Buyer’s Plan or Lifelong Learner Plan. Even then, there may be better ways to get funding.
Step 5: Converting your RRSP to a RRIF Once you retire, the money in your RRSP becomes retirement income. To make these withdrawals, you’ll need to convert your account into a RRIF (Registered Retirement Income Fund). You have to do this by the end of the year that you turn 71, but you have the option to do so sooner. Any money you take out at this stage will be taxed as income when you withdraw it.
One Extra Step: Managing your estate When you pass away, your spouse can inherit your RRSP on a tax-deferred basis. If you don’t have a spouse, any beneficiaries you name receive it as cash but the value of the RRSP is subject to tax in your final tax return. If you haven’t named beneficiaries, it gets rolled into your estate and would be subject to probate fees so its important to name a beneficiary.
RRSP tax benefits You’ll see the benefits of contributing to your RRSP in the form of tax savings. When people talk about RRSP contributions being “tax-deferred,” they mean that you save on taxes now, and pay them later.
You can expect to save 30 to 40 cents on the dollar in tax when you make contributions to your RRSP. This RRSP tax savings calculator can help you determine the tax savings of an RRSP contribution — the exact amount depends on your marginal tax rate which is determined by income level and differs by province. When you withdraw that money in the future, you’ll pay taxes on it equivalent to your tax bracket at that time. Generally, you can expect your income in retirement to be lower, so you’ll pay less taxes.
RRSP vs. TFSA: Which is right for you? RRSPs and TFSAs (Tax-Free Savings Accounts) are both excellent options for long-term investing, and both offer tax advantages. Like the name suggests, the RRSP is typically going to be the best option if you’re investing specifically for retirement. That’s especially true if you’re in your peak earning years. With a TFSA, you don’t benefit from any income tax savings upfront, but when it comes time to withdraw the money from your account, you won’t pay any taxes, even on interest and investment growth. If you think your income will be higher in retirement than it is now, or if you want to ensure that the money’s available for any purpose, not locked away until retirement, then a TFSA might be your best bet. Check out our detailed comparison of TFSA vs. RRSP.
Spousal RRSPs If you’re married, you can set up a joint RRSP for you and your spouse. This can come with several benefits. If one of you earns more than the other, they can make a larger contribution and benefit from the tax break — while you’re both able to withdraw the money later. In that case, if the spouse with the lower income withdraws the money, it will be taxed at their tax rate. This maximizes savings for both spouses. However, there are some requirements you have to meet — such as making sure the spouse with the higher income doesn’t make a contribution the year before the withdrawal. The ABCs of Spousal RRSPs will help explain how you and your partner can make the most of a spousal RRSP.
The 2024 RRSP contribution deadline You have 60 days after the end of the year to make your RRSP contribution for the previous year. The deadline to contribute to your RRSP for the 2023 tax year is February 29, 2024.

The contents of this publication were researched, written and produced by The Link Between (https://www.thelinkbetween.ca/) and are used by Echelon Wealth Partners Inc. for information purposes only.

Maybe It Was Transitory After All

website@sitemodify.com (Website Editor) — Tue, 16 Jan 2024 15:00:00 GMT

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.

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

website@sitemodify.com (Website Editor) — Mon, 08 Jan 2024 16:21:00 GMT

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 differen t 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.

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 Year in Review

website@sitemodify.com (Website Editor) — Tue, 02 Jan 2024 19:43:00 GMT

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 xUS 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 targe 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 megacap 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 is authored by Craig Basinger, Chief Market Strategist, Purpose Investments Inc.