Foresight - Spring 2023

We recently attended the Vancouver 2023 CFA Financial Forecast dinner featuring as the keynote speaker Mark Carney (the former governor of the Bank of England and the Bank of Canada). It was very interesting to hear his views on the global economy, interest rates, inflation and the various recession themes being forecast. Although he does agree that we may be nearing the top of the rate hike cycle in Canada and the United States, he does not see these central bankers cutting rates in 2023. He expects inflation in Canada and the US will continue to fall throughout 2023; however inflation rates will not get to the central bankers’ target rate of 2% in 2023. With employment remaining relatively strong throughout North America, there is a low probability of a severe recession in 2023. In this environment, we believe equity and fixed income markets will continue to seesaw through, at least, the first half of 2023 as households, businesses and governments continue adjusting to this higher interest rate environment.

Undoubtedly, higher interest rates will have an impact on the borrowing decisions of households and businesses as they assess the viability of servicing debt at these higher costs. This leads to the dampening effect on demand for goods and services that the central bankers are aspiring to with their recent rate hike programs. This economic slowdown is being engineered to deal with a supply side that can’t keep up with demand due to supply chain issues coming out of the global economic shutdown of 2020. However, China recently has reopened their economy, which should have a significant positive impact on the supply of goods for the global economy. We expect that the global economy will respond to the supply side shortage through investment in new production facilities, and likely closer to, or within, domestic markets. Further, there will be productivity gains from investment in new automation to help alleviate the pressures of a declining workforce demographic. While the baby boom generation is working longer, as they retire out of the workforce, there just aren’t enough individuals entering the workforce to replace them. The historical solution to this has been immigration; which is controversial today in many societies. This investment cycle will help fuel the next round of economic growth, resulting in increased employment for individuals and earnings for the corporate sector. Our expectation is that the North American jobs market will continue to remain relatively strong throughout 2023.

Households that are gainfully employed will continue to pay their mortgages, credit cards, car loans etc; thus keeping the economy running and mitigating significant loan loss pressures for the banking sector. While the current higher interest rate environment negatively impacts borrowers, especially those with floating rate loans, it is a welcome change for the bond investor. Over the last ten years we have maintained a very short-duration bond portfolio as we just weren’t getting paid enough to hold long-term bonds and risk the negative pricing impact of increased interest rates. We recently took advantage of the increase in interest rates and have extended the duration on approximately 20% of the bond portfolio. We have added the BMO Long Provincial Bond Index ETF (current average yield to maturity 4.3%) and the iShares 20+ Year Treasury Bond ETF (current average yield to maturity 4.1%). If we see another leg up in interest rates, we will extend another tranche of the bond portfolio. The recent increase in bond yields will have a meaningful positive impact on our portfolios’ long term returns.

 A Global Approach….

At Trivest, we take a global approach to investing in equity markets as part of our diversification strategy. Volatility in these international investment returns can be exacerbated, or  mitigated, by currency fluctuations. When investors buy an investment in a country, or ‘union of countries’ (as in Europe), they also implicitly are buying the underlying currency. At the end of an investing year, the investor’s return is equal to that foreign market’s return, plus-or-minus the exchange conversion back into the investor’s home currency. Therefore, for a  Canadian investor, an appreciation of the loonie is “bad”, ie lowers the international return. As you can see below, in any given year, the cross-currency exchange movements between two countries can be significant.

The following chart shows the last five years of exchange fluctuations:

					Historical Annual Change in Canadian Exchange Rates From Canadian dollar to:
	2022	2021	2020	2019	2018
US $	-6.39%	+0.43%	+2.01%	+5.04%	-7.81%
Euro	-0.46%	+8.46%	-6.56%	+7.06%	-3.25%
Japanese Yen	7.21%	+12.17%	-3.16%	+3.76%	-9.99%

 (“+“ means a rise of the Canadian $)

We continue to augment your foreign content with a list of international ETFs that are “hedged” to remove the currency impact of international investing, and they span geographic regions and industrial sectors. You may see them on your NBIN statement by their ticker symbols, including XHC,  XCD, XGI, XQQ, VUS, XEH, XIN, CJP, XSP, XSU and VEF.

The shaded returns across the diagonal in the chart below show the calendar 2022 domestic equity price returns (ie excluding dividends) in the major economies. All of the other entries include the currency impact on these returns to show the effective returns for Canadian investors who are branching out internationally from their own domestic market. Global markets performed exceedingly well across the board, with double digit returns in Canada, U.S, Europe and Japan. The left hand column shows the 2022 currency-adjusted returns for a Canadian investor branching out across the globe.

Quarterly data that we track show that, over the past 16 years, the U.S./Canadian foreign exchange movements contributed approx. 10% of the overall return.   

				Annual Equity Index Price Returns that include Foreign Exchange Changes – Calendar 2022
Country/     Equity Index	Canadian Investor	American Investor	European Investor	Japanese Investor
Canada /TSX 60	-6.24%	-12.63%	-6.70%	0.97%
U.S./S&P 500	-11.28%	-18.11%	-12.09%	-4.28%
Europe/Euro 350	-8.12%	-14.26%	-8.58%	-1.21%
Japan/Japan 150	-10.14%	-15.57%	-10.28%	-3.42%

The following chart shows on the right the last five years of simple price returns for a Canadian investing around the world. It also shows, on the far left column, the 18 year annual compound returns (2005-22). The difference between that and the Domestic International returns column to its immediate right, highlights the 18 year geometric currency impact on Canadians investing internationally. You can see that these 18 years of currency volatility have added to the Canadian investor returns abroad.

Canadian Investor International Returns 2005-2022

	Cdn   19 yr cpd	Dom Int’l 19 yr cpd	2022	2021	2020	2019	2018
TSX 60	6.75%	6.75%	-6.24%	28.05%	5.56%	18.11%	-10.50%
S&P 500	9.66%	8.01%	-11.28%	28.29%	16.43%	24.08%	2.28%
Euro 350	5.35%	5.23%	-8.12%	18.27%	4.23%	15.99%	-9.65%
Japan	4.10%	3.76%	-10.14%	3.86%	13.52%	12.62%	-5.4%

Investors have an affinity towards high returns. It makes them feel better, and fortifies their feeling of financial comfort. Investment management isn’t just about generating returns.... it is about generating returns relative to risk. Risk-and-return operate asymmetrically...meaning that achieving higher returns probably means that one has taken on more risk, but conversely, taking on more risk does not guarantee higher returns. One of the sub-characteristics of a portfolio is its volatility: how much does it fluctuate in value – in the short run, but more importantly, in the long run. One of the markers for this is the statistical measure called standard deviation. In the following chart, we have calculated the 18 year standard deviations from the historical return data in the Annual Equity Index Returns chart. The numbers on the right represent the standard deviation for each of the geographic domestic markets. The numbers on the left represent the standard deviation for a Canadian investing in those markets, factoring in the currency aspect. 

Standard deviation	Canadian investor	Domestic Int’l
TSX 60	15.83%	15.83%
S&P 500	13.50%	17.21%
Euro 350	15.34%	18.13%
Japan 150	13.84%	21.14%

Here, we see that the 18 year currency fluctuations acted to reduce the volatility for a Canadian international investor. This analysis can be fine-tuned by creating a mock portfolio where a Canadian investor invests across all of these geographic markets (simulating what we actually do). This mock portfolio would contribute a 18 year annual compound equity price return of 7.19% to a balanced global portfolio, with a standard deviation of 12.69%. The dividend yield adds approx. 2%. Always beware of “lies, damned-lies and statistics”! These analyses are only based upon the 18 years that we have been tracking this data. Prudent investing always needs a long term perspective.

Twelve month sectoral results for 2022

The chart below shows our annual report on how the industrial sectors performed in Canada, the U.S. and globally for 2022 (Annual historical comparatives on sector data can be found on our website). These are price returns, which means they include the price appreciation (or decline) year-over-year, but exclude dividend income (approx. 2%). The Canadian results are reported in our domestic currency. The U.S. S&P returns are reflected in USD rather than our currency, so that the foreign exchange movement does not contaminate a comparison. Global returns of course reflect a myriad of the world’s currencies, which here are consolidated in USD; thus, there is some foreign exchange element to that data. The top line “WHOLE INDEX” return data in the chart below result from applying sector weightings to the sector returns. These weightings are different in the three regions. The 2021 comparative WHOLE INDEX returns appear in (brackets) below.

All three markets posted large negative WHOLE INDEX returns. All of this 2022 data follows from the two previous years which were both very robust: Global returns were 13% and 19% and US returns were 16% and 27%, while Canada lagged at 2% and 21%.

In the Table, only 5 out of the 30 sector data points had positive returns, and three of those were energy around the globe. All Canadian sectors followed the global negative returns, except Canadian consumer staples which actually had a healthy positive return. Four Canadian sectors notably underperformed the global  results: utilities, energy, health and tech. Those last two are fairly thin sectors in the Canadian economy. The remaining Canadian sectors, for the most part, did much better (meaning lower negatives!) than around the globe.

In the global markets, three of the ten sector returns were (significantly) lower than the Whole Index. We monitor these sectoral movements and re-balance at various points in the year to realize the appreciation in those leading sectors, and seek buying opportunities in the lagging ones. Investors need to understand that investing isn't just “buying the market”; rather, it includes selective sector picking.

For the year 2022 (2021) SECTOR	Annualized Price Returns for S&P Global 1200 Index Sectors (in US dollars)	Annualized Price Returns for US S&P 500 Index Sectors (in US dollars)	Annualized Price  Returns for Cdn. Composite Index Sectors (in Canadian dollars)
WHOLE INDEX	-18.7% (19.3%)	-19.7% (26.9%)	-9.0% (21.7%)
Energy	40.9%	59.5%	24.8%
Materials	-12.2%	-13.7%	-0.1%
Industrials	-13.5%	-6.7%	0.2%
Consumer Discretionary	-32.9%	-37.8%	-8.1%
Consumer Staples	-7.7%	-2.5%	8.0%
Health Care	-6.0%	-3.9%	-62.8%
Financials	-11.1%	-12.5%	-13.1%
Information Technology	-30.3%	-29.3%	-53.1%
Telecommunications	-35.2%	-41.1%	-7.1%
Utilities	-7.1%	-1.1%	-13.9%