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TriDelta Insight Q3 Commentary

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Market Overview

Coming off a difficult June, markets were optimistic heading into the early stages of the third quarter. By mid-August markets in Canada and the U.S. were strongly positive on several good news stories. Recession fears eased on the back of improving economic data and inflation showing early signs of having peaked, and company earnings from the second quarter were not nearly as bad as many expected.  Some believed we had found our bottom in June amid several indications the market had grown too pessimistic.

As quickly as the market had seemingly reached a turning point, markets reversed course. The bounce off the June lows ran out of steam due to persistent inflation and indications the central banks of the world were going to continue aggressively raising interest rates. This was coupled with further escalations in the conflict between Ukraine and Russia, an ensuing energy crisis forcing European countries to begin rationing ahead of what is likely to be a very difficult winter, and a struggling consumer in China.

Central banks raising interest rates is worth further attention as it’s one of the primary drivers impacting markets today. It’s important to note that never in all recorded history have central banks all raised rates at the same time. While all central banks will act independently of each other, the U.S. Fed is ultimately the driver behind a slowing global economy and will not stop until its goal of bringing inflation down shows signs of life.

September, in particular, was a very difficult market for stocks which put the TSX and S&P 500 back down to their June lows. Bloomberg has coined this the “Everything Selloff” which is in direct contrast to the Covid rebound in 2020 termed the “Everything Rally”. With inflation at 7% in Canada, interest rates meaningfully higher, and major stock and bond markets negative, it’s true there have been very few places to hide this year. The question we need to ask ourselves; is it really all bad?

In this quarterly review, we will look at why there is opportunity in the face of extreme negativity and what we are seeing in the market today and moving forward.

Year to Date Market Returns

Global markets are meaningfully lower and while each offer an interesting reference point, a traditional balanced portfolio has fared just as poorly. To the end of September, a passively managed 60% stock, 40% bond portfolio is down 15.1%. This has provided further evidence to the value of active management as our portfolios continue to outperform and protect on the downside.

Finding Optimism in a Bear Market

“In the real word, things generally fluctuate between “pretty good” and “not so hot”. But in the world of investing, perception often swings from “flawless” to “hopeless” – Howard Marks

There is no valuation metric or sentiment score that marks the bottom of a bear market. The end of such a market is always identified in retrospect and the reasons are not always clear. That said, there are indications we can use to help identify long term opportunity despite the near-term uncertainty.

Sentiment (investor attitudes) has reached extreme negativity, which can be a positive indication markets have become oversold. The latest AAII Sentiment Survey showed bears (those seeing stocks lower in six months) topping 60%. This poll has been around since 1987 in which the last time we saw these extreme levels we were nearing the bottom of March 2009 during the Great Financial Crisis.

Readings at these levels tend to imply a strong market advance during the following 12 months.

Valuations offer another point of optimism for investors. While it’s true whether the S&P 500 or TSX is trading at a 15x or 20x price-to-earnings ratio will never, by itself, mark a bottom, as prices fall and valuations improve, the downside risk declines as upside potential rises. For example, we look to include high quality companies whom we have long term confidence in their ability to outperform the market. If we believe the appropriate price for a company is $100/share and it falls to $80/share, it may continue to fall but $80 still represents a better opportunity for a long-term investor. After all, we are not trying to catch a falling knife, we are investing in companies we believe will have a positive impact on client portfolios.

We tend to caution against drawing comparisons to past bear markets because no two are the same. The financial world is in much better shape than 2020 and even 2008/09. It’s easy to forget that during the late 2000’s there was very real concern the entire financial system would collapse. Major institutions either failed outright or required government assistance. Insurance companies were at risk of not being able to pay out policies and houses were being abandoned because speculators couldn’t afford payments on third houses they never should have bought. Today is not without its challenges, but we are increasingly seeing higher wages, companies continue to hire albeit at a slower pace with unemployment still at record lows, and banks and large institutions have had the eyes of regulators on them for over a decade to ensure the stability of the financial system.

No two bear markets are the same and although the future remains uncertain, it is uncertain regardless of whether the market has fallen 20% or has risen 20%. What’s most important is to take emotion out of the decision-making process and maintain a long-term perspective despite short term negativity.

The worst thing you can do in a time like today is turn temporary declines into permanent losses.

Yields on Investments Now Versus One Year Ago

The surge in bond yields and rise in interest rates are giving investors options they haven’t had for some time.

This is not to say that stocks don’t present an attractive long-term opportunity, but that our options for how we construct portfolios and make allocation decisions for individuals has increased. In fact, today is a great time to review why it pays to remain invested in difficult times. The following chart demonstrates what a $100,000 investment in 1990 until the end of September 2022 would look like if: you had remained invested for the whole time, had missed just the best 5 days of the market, and had missed the best 10 days of the market.

Clearly, patience pays off in the long run.

What we are doing and why

Equity

The factors weighing on markets during the first half of the year persisted into the third quarter and are expected to continue for the remainder of 2022. We reiterate from earlier in the year that markets are not likely to sustain a prolonged uptrend until we have greater clarity around the path of interest rates, and we remain highly active in our decisions to take advantage of near-term opportunities.

Moving forward, we foresee equities trading in response to what is happening elsewhere in the markets. Rising bond yields have had the dual effect of making bonds and cash an attractive alternative for income investors seeking stability and decreasing the valuations of public companies.

Here in North America, Canadian markets have continued to outperform much of our global peers. Canada’s reliance on commodities have benefited from a stronger USD and the supply disruptions happening abroad. Historically Canada has been more sensitive to global recession fears rather than inflation which is why the TSX was one of the best markets earlier in the year, before fears started migrating from inflation to recession.

The U.S. have continued to see strong employment numbers and wage gains. The markets have been especially hit hard due to their higher exposure to growth companies in relation to Canada and are expected to remain volatile with a highly polarized midterm election taking place in November.

Abroad, Europe has struggled in response to the conflict and associated sanctions on Russian energy. Europe’s energy infrastructure has failed in entirely foreseeable ways as policymakers have increasingly made short-sighted decisions and failed to adequately diversify their energy needs towards renewables.

In Asia, China has struggled amid slowing growth and a troubled real estate sector. Covid restrictions in the country also remain, with as many as 20 cities facing some form of lockdown in the past three months. This has hurt consumer confidence and economic activity.

Into the last three months of 2022, the TriDelta Funds continue to be highly active to take advantage of attractive opportunities.

  • Bond yields declining in the months ahead should have a positive impact on equities and an indicator we continue to watch closely.
  • We expect Canada to continue to perform well in comparison to markets globally and predict a potential recession in Canada would be mild as the Bank of Canada reaches a peak interest rate before the U.S.
  • Global equities have felt the brunt of poor policy decisions and the ongoing conflict but pose an increasingly attractive long-term opportunity for investors willing to tolerate near term volatility.
  • We have added to the cash positions in the funds as a defensive measure and to take advantage of near-term price swings.
  • Future company earnings releases will be of key concern as the market gets a closer look into how today’s challenges are impacting companies bottom lines.

The TriDelta Pension and Growth Funds have performed well in the quarter and year-to-date relative to the broader markets. For the year ending September 2022, the Pension and Growth funds were down 9.00% and 16.01%, respectively. Presently, the yield on both funds is greater than 5% which marks the highest since the funds inception and poses an attractive opportunity for income investors.

Preferred shares

Preferred shares continue to see much of the volatility being experienced in the stock and bond markets as the yields have not yet increased enough to attract sufficient activity in the space.

Our preference is still towards rate-reset preferred shares but see the market trading in line with broader stock markets into 2023, limiting their ability to act as a diversifier in a portfolio despite the added income.

Limited Recourse Capital Notes (LRCNs)

We have recently shown interest in the market for Limited Recourse Capital Notes (LRCNs) for use in client portfolios. This is a relatively lesser-known investment that shares characteristics of both preferred shares and bonds.

There is now over $18 billion worth of these bank notes in Canada, but only recently have the banks come out with LRCNs paying 7+%. These bonds are technically higher risk given that they are secured by preferred shares in the issuing bank and are typically much longer term than we would include in portfolios.

An example of one of these notes technically is not due until November 2082, but it includes a rate reset feature based on the 5-year Government of Canada bond rate plus 4.10%. This will reset in 5 years, and we believe it is very likely that the note will be redeemed at $100 in 5 years.

We see these bonds as relatively low risk and offering an attractive yield for income seeking investors while also providing daily liquidity and the opportunity to gain in value if/when interest rates come down in the next 5 years.

Bonds

Typically, one would expect with stock markets lower, bonds would at least be holding their own but that has not been the case this year. Instead, bond markets have experienced their own bear market when the Bloomberg Global Aggregate Total Return Index of government and investment-grade corporate bonds fell 20% in August from last year. In fact, bonds are having their worst year since 1949 and instead of acting as a diversifier, bonds have been a driver of lower returns.

  • Central banks, most notably the U.S. Fed and Bank of Canada, have recommitted to raising rates to bring inflation under control and the market is finally starting to take them at their word as economic activity slows and likelihood of a formal recession grows.
  • Inflation is still of key concern, and we don’t believe it’s a matter of if inflation comes down but when. Inflation will recede but likely not quick enough to avoid policy rates in the mid 4 to low 5 percent range into early 2023.
    • Presently, inflation in Canada and the U.S. sits at 7.00% and 8.26%, respectively.
  • We continue to watch the inverted yield curve as an indication the market believes the inflation fight can be won. Our hope would be to see a more sharply inverted yield curve in the near term.
  • Our focus heading into this year towards short term and high-quality investment grade bonds to provide insulation from interest rate increases have helped to insulate portfolios from the losses seen in long-term, low-grade bonds.

We remain selective with bonds we choose to include in client portfolios and have actively sought out attractive opportunities. As prices have fallen, we increasingly see the value in including bonds in client portfolios as a source of income and future return.

A Note on Currency

Fueled by rising global uncertainty, the U.S. dollar (USD) has been a notable outperformer in 2022. This has rewarded Canadian investors with bigger dividends and an offsetting boost for their investments held in U.S. dollars or simply through owning companies which derive profits from the U.S. consumer.

An example of this can be seen in the last three months alone where an investment in U.S. dollar assets have helped returns for Canadian investors.

While large swings in the dollar — in either direction — adds to uncertainty in the market, a strong U.S. Dollar is predicted to help many countries boost growth as their exports become more attractive. It may also be a positive for the U.S. to bring down inflation as cheaper imported goods cause disinflation. U.S. companies may also find it harder to compete with global companies whose prices are in other, cheaper, currencies. This isn’t great for the companies in question but is a positive for bringing down inflation in the near term.

Alternatives

Alternative investments, those not publicly traded, have offered support for portfolios. To the end of September, the TriDelta Alternative Performance Fund is +3.22%.

Our real estate partners have benefited on multiple fronts.

  • Rising interest rates have made home ownership less affordable for many. This has added further demand for rentals which continue to see increases in average rents by 10-20%.
  • Canada is not on pace to achieve affordable housing for Canadians. In Ontario, the CMHC estimates 1 in 3 people will be forced to rent in the next 10 years. An already tight supply for rentals represents a significant opportunity for investors as demand continues to rise across North America.
  • Many of our partners refinanced in 2021 at the low rates previously available. Many are locked into those fixed rates until the mid-2020’s.

Our private credit partners have also seen positives.

  • Rising interest rates have translated into higher returns on the loans they provide to small and medium sized businesses in Canada and the U.S. We have seen yields rise this year as the loans tend to be structured with variable rates and/or short term in nature.
  • As rates have risen it has been difficult for these small and medium sized businesses to receive traditional bank financing due to the strict stress testing enforced by regulators. Our partners are seeing a greater pool of opportunity because of this.
  • Our partner funds use little to no leverage as part of their fund’s strategy. This has put them in a good position to act opportunistically as their indebted peers may be less nimble to take advantage of attractive loans.

Alternatives have proven a valuable source of income and diversification in the face of volatile markets elsewhere. Our clients have benefited from this allocation as we continue to do further due diligence on several funds for inclusion in client portfolios.

In Conclusion

Market behavior this year has thrown a wrench in the traditional 60/40 strategy — the idea that if stocks are down, then bond performance will offset the losses, and vice versa. This traditional 60% stock and 40% bond portfolio is down over 15% to the end of September.

We believe strongly in the value of active management and have seen firsthand our ability to protect portfolios on the downside. Our portfolios have outperformed the traditional 60/40 portfolio and broader markets because of this active management and allocation to Alternative investments which have served investors well as a source of income and diversification in the face of volatility elsewhere.

The final quarter of 2022 is likely to continue to see heightened volatility. Seasonality, midterm elections, inflation, slowing economic growth, negative earnings revisions, and higher interest rates are all factors we will have to face.

Ultimately, we are confident that markets will recover regardless of near-term volatility and what the upcoming interest rate decisions may be. Central banks are not raising rates and reversing stimulus because they don’t like investors or are trying to wreck your home’s value – it is in response to inflation.

When, (not if) inflation comes back down, we think both stocks and bond markets will rally. This, on its own, may very well mark the end of the bear market, even if a recession or earnings recession looms on the horizon. After all, stock market bottoms rarely coincide with the bottom in economic activity as the markets are always forward looking.

As always, we are here to help. If you have any questions, please don’t hesitate to contact your Wealth Advisor.

 

 

TriDelta Insight Q2 Commentary

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Overview

While it’s undoubtedly been a difficult first six months of the year, there are still positives. A strong job market, companies buying back their own stock, signs that pessimism had gone too far, and strong bank balance sheets have helped provide some support. The consumer has also largely continued to spend, helped by rising wages.

On the other hand, investors are particularly focused on rising interest rates and the possibility of a recession. Central Banks globally have continued with their interest rate increases. That shift has pushed bond yields higher and squeezed stocks. Earnings estimates have held up for most individual stocks and sectors, but the concern is that with Central Banks raising rates, it could spur an economic downturn, forcing earnings forecasts to fall and pushing stocks lower.

In this quarterly review, we will look at:

  • Bear Markets
  • Inflation & Central Banks
  • TriDelta’s current view on stocks, alternative investments, bonds, and preferred shares

Year to Date Market Returns

The unavoidable reality of investing is that markets do drop. Bear markets arrive. There is nothing any of us can do to control this so we must focus on what we can control. While we can’t force the economy and stock markets to be any better than they are, we can control how we respond in times like these.

After all, panic is not an investment strategy. To overcome these periods of stress, we build investment portfolios directly tied to your time horizon and specific circumstances which leads to a diversified portfolio of stocks, bonds, preferred shares, and alternative investments. No one likes to see the value of their investments declining but it helps when you have been here before and can look back at history as a guide for what may be to come.

So, what is a bear market? A bear market is typically defined as a period where prices have fallen 20% from a recent peak.

The S&P 500 officially entered a bear market June 13th and while it may be tough to see any positives when stocks are falling, a look at past bear markets shows there is good news and bad news for investors once the S&P 500 has crossed that largely symbolic threshold.

This year’s declines have marked a quicker-than-average descent into bear territory, at 111 trading days since the S&P 500’s January 3rd record high, according to Dow Jones Market Data. Among the past 10 bear markets, only the 1987, 2009, and 2020 versions took fewer trading days to achieve a 20% drop. The S&P 500’s average bear market peak-to-bottom decline has been almost 36% taking about 52 days to bottom after reaching this 20% threshold. That would put the bottom in roughly late August. The key word is roughly.

No two bear markets are the same and while no one knows when we will reach a bottom, history suggests the long-term returns after reaching a bear market are quite positive. In bear markets since 1950, the index has been higher 75% of the time three months later, by an average of 6.4%. A year after falling into a bear market, the S&P 500 has been positive 75% of the time and climbed 17% on average.

While we don’t know what the next few months hold, we do know that bear markets don’t last forever and often offer the most attractive opportunities for those looking long term.

Inflation & the Central Banks

It remains our view that the inflationary pressures will begin to fade later this year, but we don’t expect it to be smooth. Central banks have continued to raise interest rates globally to fight inflation with Canada’s benchmark rate presently 1.50% and the US Fed at 1.75%. To the end of June headline inflation in Canada stood at a multi-decade high of 7.7% and 8.6% for our neighbors to the South.

The higher cost of borrowing is now starting to slow economic activity, but the subsequent slowing of inflation can take even longer.

One question we receive frequently is how long these interest rate increases will go on for and how high will they get. While it is nearly impossible to predict with perfect accuracy, the below chart shows us that in the past 30 years there has been six tightening cycles and, in each case, rates came right back down within two or three years.

 

Source: Bloomberg

The key takeaway is that over the past 30 years, Canadian rate hikes have not been a one-way street.  There has usually been a corresponding decline to each period of rate hikes and people should not be fearing long term significantly high interest rates. History suggests that we may have a relatively short window of ‘high’ rates.

Central Banks continue to walk a very fine line. Too much too quickly can trigger a recession while too little too slowly can propel inflation out of control leading to even more aggressive action. This is an area we are watching closely and are beginning to see a possible opportunity in bonds, but also believe the stock markets of the world cannot see a bottom until Central Banks begin to ease the reins of the current rate increase cycle we find ourselves in.

What we are doing and why

Equity

The market stress in the second quarter was focused on global Central Banks’ ability to achieve a so-called “soft landing” or raising interest rates just enough to slow inflation without triggering a recession. June was particularly difficult for equities as the markets expectation for a recession has grown and while, in some areas, stocks still do not look cheap, they are becoming increasingly attractive despite the potential for near-term volatility.

The one-year forward price-to-earnings multiple, an estimate to gauge future relative value, for the S&P 500 dropped from 21 times at the start of the year to around 16 times last month. (Since 1990, the median multiple is 15.4 times.) This doesn’t mean equities are cheap, but value has improved.

Despite the uncertainty surroundings businesses, a report from BMO determined earnings expectations have largely held firm, with 2022 profit growth for S&P 500 companies expected at just under 10% compared to 9% at the start of the year.  One of the keys moving forward will be examining the impact Central Bank tightening has on earnings forecasts potentially forcing stocks lower.

Global stocks have fallen for many of the same reasons we are seeing in North America but amplified because of the conflict between Ukraine and Russia. One of the bright spots have been China. In June China posted one of its best months since July 2020 as the government eased COVID lockdowns and eased their extended crackdown on the tech sector.

While we acknowledge it has been a difficult year investing in equities, we remain focused on owning high quality businesses we feel are well positioned to perform regardless of how their stock price does in the near term. During COVID some businesses saw their revenues more than cut in half yet rebounded very quickly. We would argue the businesses we own are even better positioned today to weather the economic storm clouds above.

Into the last half of 2022 TriDelta Funds continue to be highly active to take advantage of attractive opportunities.

  • We echo other market commentators that the market likely will not see a bottom until we have greater clarity on when interest rates will peak.
  • Contrary to the start of the year, commodities struggled in the second quarter and while we still see value in this asset class. we had trimmed some of the top performing energy names in favour of other areas which had been oversold.
  • We have continued to reduce exposure to cyclical stocks and throughout the quarter increased exposure to the US while decreasing exposure to Canada.
  • Defensive companies and those with the ability to pass along rising costs to consumers have provided some support.
  • We have remained flexible with the amount of cash in the Funds to allow us to take advantage of opportunities in the markets. We began the second quarter with 8% cash which increased to 12% in April and is presently at 5%.
  • Our team is closely watching company earnings reports to better gauge company health, inventory and supply chain issues, as well as gain a better picture of the resilience of the economy as a whole.

Bonds

Uncertainty remains around bonds, but if the focus shifts away from interest rate increases towards weakening economic data, we would expect this to provide support for bonds and potentially equities if markets view that the current interest rate hiking cycle is fully priced in.

  • Our view is that bond markets have priced in the current interest rate hiking cycle, even more than what the Central Banks have indicated.
  • Presently, we see government bonds being traded close to fair value while, for corporate bonds, we prefer high quality investment grade bonds. Concerns remain over potential defaults in light of weakening economic data and because of this we have stayed away from low quality investment grade bonds in danger of credit downgrades.
  • We continue to keep a close eye on credit spreads for corporate bonds and see a wider spread from where we are today as a positive indicator to increase portfolio weightings to bonds.
  • High yield bonds have done very poorly as lower grade credit has been heavily hit with higher rates and a slowing economy.
  • We remain focused on short duration bonds to provide insulation from rate hikes as we stay patient for an attractive entry point.

Bond prices have fallen dramatically this year, which means their yields have risen sharply. These higher bond yields are becoming increasingly attractive following the selloff in the first half of the year.

Look no further than Apple as an example on the corporate bond side. It’s one of the most creditworthy U.S. companies — sitting on loads of cash — and its bonds are trading for 70 cents on the dollar, down from around 100 last fall. Yielding around 4%, compared to 2.7% when Apple issued them last August, this is one of the increasingly attractive opportunities in the asset class.

Preferred Shares

Preferred shares have remained volatile since our last quarterly commentary but, on a relative basis, have held up slightly better than broader equity and bond markets.

The asset class has benefited from continued redemptions of existing preferreds. So far in 2022, $6.7 billion have been redeemed which equates to 10% of the entire market. We see this as one of the key factors for why preferred shares have performed well.

  • Rate Resets, which should be more attractive as rates rise, have yet to perform as we would expect.
  • Institutional participation has shown little enthusiasm this year and some investors are opting for conventional asset classes at cheaper levels (bonds and equities). This has created liquidity issues in the market.
  • We continue to hold our allocation steady with a focus on picks we believe may be redeemed in the next six months. Along with the income component, we see this as a significant value add in taking advantage of the market dynamics which are pushing the asset class to shrink.
  • The rate pressure is the greatest challenge for Fixed Rate Preferred Shares.

Alternatives

Alternative investments have been one of the brightest spots for portfolios this year and have helped to reinforce why they are an important component in a diversified portfolio. Our primary focus has remained in Real Estate and Private Credit.

On Real Estate,

  • High quality apartment buildings continue to see strong demand. The lack of supply in Canada and abroad remains which has made this an increasingly attractive space for investors.
  • Broadly speaking, rents are rising everywhere in North America as people are priced out of homes and increases in interest rates have made mortgages out of reach.
  • Despite rising interest rates impacting individual homeowners, large real estate managers continue to be well positioned for the inflationary environment we find ourselves in.

On Private Credit,

  • Private Credit returns remained favourable and, in many cases, have offered protection from rising interest rates. Loans in this space tend to be shorter term, and in some cases floating rate, which helped returns.
  • The borrowers engaged with these lenders often work closely with each other, which provides these managers unique insight into giving strategic business advice to assist companies in a variety of market environments. To date, we have not seen any notable increase in defaults.
  • Rising interest rates can make it more difficult for small and medium sized businesses to borrow from the large banks which have helped to increase the pool of potential borrower’s credit managers have access to.

TriDelta Recognized as Top Wealth Manager


We were pleased to be selected as one of the Top 10 Wealth Managers in Toronto for 2022 by AdvisoryHQ. AdvisoryHQ has a strict selection process that is designed to identify the best financial advisory firms in multiple cities across Canada.

 

In conclusion

Since WWII there have been 12 different bear markets, all with specific reasons or fears around what was happening at the time. While no two bear markets are the same, the biggest mistake people have made time and time again is letting emotion take control over logic and reasoning.

Panic is not an investment strategy, and you would not drive your car looking out the rearview mirror. Our focus remains on looking forward and building portfolios suitable for each individual and family we work with. Managing risk in good times and bad is one of greatest value adds we can provide but almost more important is helping keep emotion at bay and focusing on the things we can control. No one can say what tomorrow will look like, but we do know the current bear market, like all others, will come to an end.

History has shown repeatedly that in the long run there will be more good days than bad and, in our experience, the best days in the market often come right after the worst.

Source: S&P 500 Index, Bloomberg.

As always, we are here to help. If you have any questions, please don’t hesitate to contact your Wealth Advisor.

TriDelta Insight Q1 – Managing through change

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Overview

The world is a difficult place to navigate in the best of times, and Q1 2022 was certainly not the best of times.

In this quarterly review, we will look at:

  • Interest Rates and Inflation
  • TriDelta’s current view on stocks, alternative investments, bonds and preferred shares
  • Some personal finance highlights from the recent Federal Budget – including Flow Through Shares

Q1 proved a difficult three months for many stock, bond, and preferred share markets globally but did also give rise to some positives and opportunities. While March was largely a positive month and provided a recovery from the first two months of the year, the U.S. had its first negative quarter in two years while Canada remained positive. Canada’s outperformance can be attributed to our greater concentration in Energy and Materials sectors which outperformed the broader markets. Notably, the US indices have less concentration in these sectors while our lower concentration in higher growth tech sectors provided further protection from the market turbulence.

Source: Bloomberg.

Q1 Market Returns

Interest rates and Inflation

The economy is at a delicate moment in which high inflation could become entrenched. That has created a new urgency to raise interest rates, itself a source of risk for markets and the economy. Central Banks around the world have signaled more aggressive steps to fight inflation and here in North America we are no different as both the Bank of Canada and U.S. Fed raised rates in March with further expectations to do so throughout the year. There has also been a focus on reducing the size of balance sheets in recent months with the U.S. Fed stating they intend to cut their bond holdings by about $95 billion a month – nearly double the pace implemented five years ago when they last shrank their balance sheet. Financial markets now expect much steeper hikes than previously in the year. Higher rates from these Central Banks will heighten borrowing costs for mortgages, auto loans, credit cards and corporate loans. In doing so, they hope to cool economic growth and rising wages enough to rein in high inflation, which has caused hardships for millions of households and poses a severe political threat to those in power.

We are still positioned for higher inflation and higher interest rates but are open to buying into sectors that may be oversold. We continue to place a premium on active management in the face of immense uncertainty and volatility. The two TriDelta equity funds have performed well in comparison to global equity markets, with what we view as much less risk. The TriDelta Pension Fund was up 0.86% on the quarter, while the TriDelta Growth Fund returned -0.44% for Q1. This outperformed our benchmarks (which include Canada, the U.S., International and Emerging Markets) by 2 to 3 percentage points on the quarter. Outside of Canada, major equity markets globally fell as much as 5% to 15% in some cases.

TriDelta equity view – what we are doing and why

Three risks dominated headlines this quarter: the Omicron wave, the spike in inflation/Fed rate hike fears, and the war in Ukraine. Due to these concerns equity markets had a difficult quarter with high growth companies and those exposed to the Ukraine conflict suffering the most. The focus has continued to be on quality as investors have prioritized profitability, stability and realized growth. Coupled with a strong balance sheet there are companies which are still well positioned despite the risks moving forward.

The move in commodities has also been notable over the past three months. Energy, in particular, had a great move to the upside, justifying the gains in the equities and helping the TSX manage this tough quarter. Prices have been driven higher because of the lack of capital provided to this sector over the past few years and the sanctioning of one of the largest commodity-producing countries.

Into the remainder of 2022 TriDelta Funds continue to be nimble and active to take advantage of attractive opportunities.

  • We continue to view this as a rangebound market and are focused on adding equities when oversold and trimming when overbought.
  • In the funds, we are becoming more concerned about the cyclical sectors and have been trimming some cyclical exposure and adding to underperforming sectors like technology, consumer discretionary and financials.
  • The world seems to be coming to the realization that the transition to clean energy will not happen over night and we will need a period of transition. Energy has been the leader, but we should also see strength across the materials sector going forward.
  • There has been a common theme among many multi-national companies who have stressed the need to reorganize their supply chain to help insulate themselves from the issues currently being experienced. This will have a significant impact on these businesses and has been dubbed “de-globalization” by many influential investors and business leaders.

 

 

TriDelta Alternative View – what we are doing and why

The Alternative asset class provided greater insulation relative to being invested in a typical stock and bond portfolio.

On Real Estate,

  • Real Estate continues to perform well and include critical inflation protection and steady yields.
  • Many of the partners we work with were able to pass along the added costs of inflation to tenants in 2021 with some increasing rents 10-20% in some areas.
    • Property types with short lease durations can reset lease rates more frequently and are in a more advantageous position to grow cash flow. Concurrently, lease structures offer inflation protection with built-in rate increases tied to inflation.
  • North America continues to be a top performer while Europe and Asia have struggled.
  • Moving forward North American Residential and Industrial Facilities are poised for further growth while high quality Office Space may be well positioned to attract tenants. We also share the view that the fragmented Self-Storage market offers an attractive opportunity.

On Private Credit,

  • Private Credit returns remained favourable and, in many cases, offer protection from rising interest rates. Loans from these managers tend to be shorter term which offers them the ability to provide new financing terms to reflect the increase in interest rates.
  • These managers continue to see increased deal flow and expect further opportunities as traditional bank lenders restrict capital to small and mid-size businesses. Moving forward, we see this as an ample opportunity.
  • Borrowers continue to look to the private markets due to its relatively greater speed and certainty of execution, after many were burned by public markets and banks pulling back capital during more uncertain times. Equally, borrowers value the adaptability and partnership of private lenders.

Yields on Private Credit and Real Estate remain much more favourable than investing in traditional bonds.

Source: BofA Securities, Bloomberg, Clarkson, Cliffwater, Drewry Maritime Consultants, Federal Reserve, FTSE, MSCI, NCREIF, FactSet, Wells Fargo, J.P. Morgan Asset Management. *Commercial real estate (CRE) yields are as of September 30, 2021. CRE – mezzanine yield is derived from a J.P. Morgan survey and U.S. Treasuries of a similar duration. CRE – senior yield is sourced from the Gilberto-Levy Performance Aggregate Index (unlevered); U.S. high yield: Bloomberg US Aggregate Credit – Corporate – High Yield; U.S. infrastructure debt: iBoxx USD Infrastructure Index capturing USD infrastructure debt bond issuance over USD 500 million; U.S. 10-year: Bloomberg U.S. 10-year Treasury yield; U.S. investment grade: Bloomberg U.S. Corporate Investment Grade.

TriDelta bond view – what we are doing and why

While we remain at historically low interest rates and ultimately view increased interest rates as necessary, the Central Banks walk a thin line with very little room for error. Here at TriDelta we share several views moving forward:

  • Central Bank logic is twofold – (1) to rein in inflation (which is evidently no longer transitory) and (2) to raise rates surrounding a strong economy.
    • Many perceive them to be too late on this front; we agree in terms of the underlying economic conditions, but not on inflation as, unlike other periods of outsized inflation, the drivers are largely structural, such as the inefficient deployment of physical capital and labour forces due to the COVID mitigation measure, the shifting landscape (including work from home), economic warfare, and ESG shifts are raising costs.
  • Lowering the demand for money through raising the price of money does not address these long-term supply issues. This is occurring while the underlying economy, particularly in the U.S., is already slowing.
    • Consumer demand has softened into 2022; corporate spending was already reduced; mortgage rates are up 1.75% year to date in the U.S.
    • Coupled with fiscal support being withdrawn this year poses a significant risk to the economy.
  • While it is possible to have a recession without monetary tightening, the opposite does not hold true; monetary tightening always happens with a recession.

In recent updates we have continued to share our preference towards using a tactical approach to bonds and owning short term bonds for their greater protection in a rising interest rate environment. As you can see in the chart below this has proven the correct approach.

Source: Purpose Investments

We continue to view bonds as an important component of a diversified portfolio and advocate for a focus on being selective and tactical in our approach.

On Bonds,

  • Central Bank intentions are clear, but they will not likely be able to raise rates as much as intended before underwhelming economic performance and falling markets derail their efforts.
  • We believe we are at or near the highs in government bond yields.
  • As opposed to 2021, the 1-5 year bonds represent the best value in our opinion as the yield curve has become exceedingly flat.
  • The outlook for riskier bonds is uncertain. Spreads have widened in the high grade and high yield spaces and are likely to continue to do so as corporate bond supply is continuing to be issued while the extent of an economic slowdown has not been fully recognized.

TriDelta preferred share view – what we are doing and why

Preferred shares have had a volatile start to the year, with many cross currents in play. Down roughly in line with bonds, Rate-Resets have outperformed Straight preferred shares by about 3%. This is a continuation of 2021 when Rate-Resets outperformed by a large margin. Many institutional preferred share investors have shifted out of the space and back into traditional yield markets or into equity opportunities.

In our 2021 Q4 update we referenced one of the challenges in the preferred share market being that the market is shrinking as banks and some oil and gas names redeem issues in favour of cheaper financing via specialized bonds. Perhaps shockingly, the first three months of 2022 saw several new issues into this challenging market at yield “concessions”, rendering existing preferred shares relatively expensive.

Moving forward there are important trends we continue to watch closely.

On Preferred Shares,

  • Higher rates should be a positive for Rate Resets and Floaters.
    • Wider credit spreads are not, and resets will likely take their cue from corporate bonds.
  • The shrinkage of the market is still a tailwind, and the recent selloff represents an opportunity.
  • We continue to hold our allocation steady and pick away on further weakness while being comfortable with near term volatility.
  • The rate pressure is the greatest challenge for Fixed Rate Preferred Shares but most of the backup should be behind the market.

Some personal finance highlights from the recent Federal Budget

  • Very few negatives.
  • No change to capital gains taxes.
  • Flow Through Shares were largely left alone. These continue to be a great tax savings opportunity for those with taxable income of $275,000+ or those with a Corporation where you are drawing out $400,000+. Be sure to talk to your Wealth Advisor if you are in that category.
  • There may be some changes to Alternative Minimum Tax in the Fall. It will be focused on those with taxable incomes over $400,000, who are currently paying less than 15% of Federal taxes.
  • New Tax Free First Home Savings Account in 2023. This is meant to provide savings room for up to $8,000 a year and up to $40,000 in total, that can be used for a first-time home purchase. While this isn’t a negative at all (other than the tracking and implementation of another tax- sheltered account), it will likely have very little impact for younger people in saving and putting in down payments on a first home.
  • There are all sorts of other details in the Budget, but these are the ones that would likely affect some of our clients.

In conclusion

The World is particularly complicated at the moment. In times like these, our general tilt is towards companies making solid profits, with reasonably low debt ratios, especially those with hard assets like real estate and commodities. Rate reset preferred shares and shorter term bonds, along with some higher yielding alternative investments, should work well in an increasing rate environment.

As always, we are here to help. If you have any questions, please don’t hesitate to contact your Wealth Advisor.

TriDelta Q4 Review – Back to ‘normal’

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Overview

At the end of December 2018, markets had just completed one of the worst quarters in several years.  The general view was very weak.

Today, many investors are much more positive after very strong returns in 2019.

Where that leaves us today is much more in the middle in terms of our outlook for 2020.

On the positive side, interest rates remain very low and the general trend is for them to remain at these levels for a while.  In addition, global growth is showing some signs of improvement after real slowdowns in 2019.

On the negative side, U.S. markets are now at the high end of their valuations, and there isn’t a lot of room to go higher unless corporate earnings pick up strongly.  Of interest, most other equity markets, including Canada, have much more reasonable valuations at the moment.

In Canadian Dollars – Total Stock Market Returns in 2019:

*TSX (Canada) 22.9%
*S&P500 (U.S.) 25.7%
*European Stocks 18.6%
*Nikkei (Japan) 16.3%
*Emerging Markets 13.2%
*Hang Seng (Hong Kong) 8.4%

Other key 2019 Returns included:

* FTSE Canada Universe Bond Index 6.9%
*BMO CM50 Preferred Shares 2.1%

What do we see for 2020 and why

We do not believe that a bear market is imminent.

Last quarter we said that historically, bear markets occur when at least two of the following four circumstances are found:

  1. Economic Recession – Two consecutive quarters of negative growth.
  2. Commodity Spike – A movement in oil prices of over 100% over an 18 month period.
  3. Aggressive Fed Tightening – Unexpected and/or significant increases in the Fed funds rate.
  4. Extreme Valuations – When S&P500 trailing 12 months price/earnings levels were approximately two standard deviations higher than the long term average.

As of the moment, we are seeing reasonable growth with expected real GDP growth of 1.8% in the U.S. and 1.6% in Canada, so no economic recession, although certainly not stunning growth either.

There was no major commodity spike in oil prices, even with the recent Iran conflict.

No meaningful increases in interest rates are envisioned.  We expect rates to remain flat or to be slightly down in 2020.

The only bear market risk at the moment is high stock market valuations, but even the overvaluation is not significantly large.  Focusing on the S&P500 in the U.S., the measure is a trailing 12 months Price/Earnings ratio two standard deviations higher than the long term average.  While not trailing, on a forward P/E basis, the S&P500 is at 18.5 vs. a 25 year average of 16.3.  This is 0.7 standard deviations higher than average. 

It is definitely something to be aware of, but not enough, especially in light of the other three criteria to put us in real concern of a bear market.

In addition, other global markets are valued more cheaply than the U.S.

This chart from J.P. Morgan highlights 25 years of the Forward P/E ratio of the S&P 500.

Interest rates fairly flat with slight downward pressure

On the interest rate side of things, the Central Banks in Canada and the U.S. are both signaling little movement for the time being, although the U.S. could lower rates again before Canada does. 

Strengthening of Canadian dollar vs. the U.S.

Our current view is that the CDN$ will strengthen further against the US$ this year.  The main reasons being that the U.S. Fed has lowered rates and may lower further, while Canada has not lowered rates and is less likely to lower them in 2020 vs. the U.S.  As a result, on the short end of the yield curve, Canada is now paying more than the U.S., and that is where much of the international money flow invests in (short term bonds).  The other driver is that there is more relative growth momentum in Canada than the U.S.  What we mean is that in 2018 U.S. growth was about 0.9% higher than Canada.  In 2019, it was only 0.7% higher.  This year, the U.S. GDP growth is forecast to be only 0.2% higher than Canada, despite a much higher Federal government deficit and more accommodative central bank.  We believe that this shift in growth momentum will be positive for the CDN$ vs U.S.$.

Trade Wars

It looks like we are finally seeing some warming on the trade wars.  As expected, the Trump White House is looking for some trade wins heading into the election.  With the imminent passing of the USMCA (what we will still call NAFTA), and the first phase of a China and U.S. agreement, there are signs of some confidence that may support global growth.

Corporate Earnings

Corporate earnings are expected to grow year over year by 16% according to Bloomberg, but the sentiment is for earnings growth to be lower than that.  This tells us two things.  The first is that strong earnings growth is not likely going to help ‘fix’ the high valuations in the U.S. market.  The second is that with reasonably modest earnings expectations, it is a little easier for companies to meet and exceed expectations.  Overall, we see corporate earnings numbers growing but not driving the markets higher.

Oil Prices

According to the U.S. Energy Information Administration, global demand for oil continues to increase.  In fact, the global demand chart below is remarkably steady for a commodity with a price that can be so volatile.  This is important to remember, because with all of the focus on alternative energy it can be easy to believe that Oil consumption is in decline.

Price expectations for oil are pretty flat, in the $55 to $60 per barrel range for West Texas Intermediate, although the general trend over the past 5 years has been higher.

For energy stocks, which have struggled for several years, this stability, and even the belief of stability, can lead to some modest gains for a depressed sector.

How does this impact your portfolio?

Based on this, we are starting to trim our U.S. stock weighting, and returning some of that back to Canada.  We will maintain our Global Stock weightings.  In addition, we see modest returns for bonds in 2020 and would look to be a little higher weighted in fixed rate preferred shares (with 5%+ dividend yields) as well as rate reset preferred shares, which should benefit from flattish interest rates.

Alternative investments remain an important part for our client portfolios and may be even more important given the more modest expectations from stocks.

On a sector basis, we will likely be lightening up on U.S. Health Care and looking for strong Canadian dividend growers.

Our fearless predictions for 2020:

Before we do our 2020 predictions, it is worth reviewing our 2019 predictions, which came in quite accurate overall:

  1. Better than average stock market returns in most major markets including Canada and the U.S.
  2. Interest rates being mostly flat with maybe one ¼% increase in both Canada and the U.S with a real possibility of an interest rate decline in Canada before the year is out.
  3. The Canadian dollar being fairly flat, but being tied more to oil than we have seen in the recent past.
  4. Oil rising but only slowly, and not a significant recovery.
  5. Preferred Shares having a strong year, bouncing back from their late year steep declines.
  6. Marijuana stocks will see a general decline overall as high valuations and uncertain revenues work their way through, but with increasing gaps between the winners and losers. In fact, we expect to see several bankruptcies in 2019 among the weak players in the market, and at least one major blow up of a more established firm (we just don’t know which one).
  7. Cryptocurrencies – need we even comment?

For 2020, our predictions are:

  1. Average stock market returns in most major markets including Canada and the U.S. – likely in the 5% to 10% return range but with more typical volatility.
  2. Canada will outperform the U.S. market for the first time since 2016.
  3. Interest rates will remain mostly flat to small decreases in both Canada and the U.S.
  4. The Canadian dollar will see reasonable gains vs. the U.S. dollar.
  5. Oil prices will mostly trade within a range of $60 +/- $5..
  6. Preferred Shares will have a stronger year as more investors look for bond alternatives.

Based on these short term beliefs, we have a little higher than average  cash weightings in our stock funds, and will lower our weight on U.S. stocks, increasing the weighting in Canada.  We will also more actively use options to protect against downside risk.

In the Growth fund, which is more active in terms of adjusting industries, we will be adding to Canadian Financials and Utilities and reducing U.S. Health Care.

How Did TriDelta do in 2019?

Our 2019 returns were as follows:

TriDelta Pension Pool (Stocks) 17.3%
TriDelta Growth Pool (Stocks) 20.3%
TriDelta’s Selection of Alternative Income Funds +5.5% to +10.5%

TriDelta Private Funds

In mid-January the Private Fund 1 will do another cash distribution.  Over 9% of the remaining value of the TriDelta Private Fund 1 (Fixed Income Fund) will be distributed out as cash.  We expect to pay further distributions on the fund next quarter as more of the underlying investments mature or are sold.  On the TriDelta Private Fund 2 (High Income Balanced Fund), we didn’t pay a distribution this quarter, after distributing over 30% in the previous two quarters.   

Nine Quick Hits of news and items of interest

  1. The TriDelta Alternative Performance Fund is launching later this month. It will provide a diversified mix of our top growth Alternative Investments in one fund that can be held in any account.  To learn more, please contact your Wealth Advisor.
  2. A reminder that now is a great time to top up TFSA’s. There is another $6,000 per person in contribution room for 2020.  If you have never contributed to a TFSA, the lifetime limit is now likely $69,500 for you.  If you have the funds, January is also a good time to do 2020 contributions to RRSPs, RESPs and RDSPs, as appropriate, as it will help you to tax shelter for a full year.
  3. If you like to save money on gas, a great website to look at is gasbuddy.com. The website shows gas prices at individual stations in your area, and includes prices for standard and high octane as well.
  4. Since the S&P 500 market peak in October 2007, the Technology index is up 348.1%. During the same period the Energy index is up just 6.5%.
  5. S. Household Debt Service Ratio is lower today at 9.7% that at any time in the past 30 years. In Canada it is at 13.3% and higher than it has been for many years.
  6. According to the U.S. Census Bureau, average income for those whose highest education was a High School graduate or less was $38,900, Bachelor’s Degree was $71,200 and Advanced Degree was $99,900.
  7. According to the U.S. Bureau of Economic Analysis, the US Trade Deficit stands at 2.3% of GDP. Despite all of the Buy American initiatives and Trade discussions, this level has been quite constant since 2013.  The Trade Deficit peaked around 2006 at 6%.
  8. While it has come down meaningfully from the peak in mid-2019, there is still over US$11 trillion of debt globally that ‘pays out’ a negative yield, meaning the investor is paying the bond holder for the right to own the bond.
  9. The current interest yield on the full Canadian Bond Index today is just 2.15%.

Summary

We expect a slightly lower than average year in stock markets overall, but do not believe that we are heading into a bear market, at least through the U.S. election.

This type of market can bring a relative premium to investments that pay decent dividends and other income returns, especially given the overall low return on cash and GICs.

Volatility is expected to be higher in 2020, and the reasons for volatility can crop up from anywhere, as we have seen with the Iranian conflict already this month.

Our goal for our clients is to build peace of mind through financial planning and developing portfolios that have much less volatility than stock indexes with a focus on income.  While stock markets are historically down three out of every ten years, we aim to have client portfolios that are rarely negative.  This is part of the reason for our Alternative Income weighting in portfolios.

At TriDelta we will continue to be nimble while focused on a long-term plan, a steady and diversified asset mix that is built appropriately for the goals of each client, and an eye on tax minimization.

Here is to a good investment year in 2020 for everyone.

 

TriDelta Investment Management Committee

Cameron Winser
CFA

Senior VP, Equities

Paul Simon
CFA, FRM

VP and Head of Fixed Income

Lorne Zeiler
CFA®, iMBA

Senior VP, Wealth Advisor and
Portfolio Manager

TriDelta Q3 Report – Are the markets in better shape than you thought?

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Overview

It is amazing how the day to day can seem very volatile, but when you step back far enough, returns have been fairly steady.  Q3 was one of those quarters.  July was good, August was bad, and September was good.  When you add it all up, the quarter was not great, but decent.

The TSX was up 2.5%, the S&P500 in Canadian dollars was up 1.5% and the MSCI world index was up 2.1%.  This was a rare quarter where Canada outperformed on the strength of Utilities, Consumer Staples and Financials.

The TriDelta Pension fund had a strong quarter, up 4.5%, while the Growth fund was still solid with a 2.3% gain.

The Canadian Bond Index was up 1.2% while preferred shares were up 0.5% on the strength of a rebound in September (after more weakness in July and August).

Despite these numbers, the recession chatter is as strong as ever.

Should we be worried?

How is TriDelta responding?

Where do we see things today and what are we doing about it?

We do not believe that a bear market is imminent.

Historically, bear markets occur when at least two of the following four circumstances are found:

  1. Economic Recession – Two consecutive quarters of negative growth.
  2. Commodity Spike – A movement in oil prices of over 100% over an 18 month period.
  3. Aggressive Fed Tightening – Unexpected and/or significant increases in the Fed funds rate.
  4. Extreme Valuations – When S&P500 trailing 12 months price/earnings levels were approximately two standard deviations higher than the long term average.

Today, we see none of the four circumstances in place.

Current growth rates in the U.S. are 2.0%, while Canada is at 1.6%.  These are not booming growth rates, but solidly better than a recession.

Oil prices did see a big drop from October 2018 to December 2018 and rebound, but it was well under 100%.  2019 has actually had more stable oil prices than we have seen in general.  As you can see below, there has been small positive trend for the past 3.5 years.

We are actually seeing Fed loosening of policy as the Fed Funds rate has been lowered twice this year.  As per the chart below, after four years of slowly raising rates, the tide has turned the other direction in 2019.

Valuations on the S&P500 are currently just slightly above their 25 year average based on a forward price/earnings basis, and in a reasonable space on a 12 month trailing basis.

When we take these factors along with our belief that Donald Trump will ease up on China trade demands and tariffs if stock markets are falling, we do not believe in an imminent bear market.

Despite this relative optimism, we do recognize some real risks that include:

  • Slowing growth
  • Few obvious catalysts for near-term market growth
  • Fear that the Fed won’t lower rates as fast as the market expects
  • Brexit dangers
  • Trump….just saying
  • Middle east hotspots in Syria, Iraq, Turkey.

When we net things out our view is slightly positive.  We did have a fairly defensive stance in the third quarter with both higher cash (10%) and a market hedge position in our funds (4%).  We are now slowly lowering our cash weighting, but will likely keep the small hedge in place for now.

Stocks

We are spending a little cash by adding to Emerging Market exposure.  We simply believe that Emerging Markets are undervalued and will benefit more than the rest of the world if the U.S. and China trade improves.  Year to date, Emerging Markets are up only 2.0% while the S&P500 in CDN dollars is up 18.8%, and we believe that gap should narrow.

We are also moving a little more towards Financials and Consumer Staples and a little away from Consumer Discretionary.

Interest Rates

U.S. – The Federal Reserve looks likely to lower rates another quarter percent in late October.  There may be a tougher case to be made for another cut in December as there are currently some Fed Governors clearly against further cuts.  Having said that, the market is still expecting further cuts after October.

Canada – The Bank of Canada is really standing alone as the only major economy that is not planning to lower interest rates any time soon.  Their view is that growth is reasonable and employment is strong while their biggest concern is consumer indebtedness.

Preferred Shares

We see more value in Preferred Shares than many Bonds at this point, in particular perpetual or straight preferred shares that have dividend yields in the 5% to 5.5% range.  While rate reset Preferred Shares provide the most value, and did see a big improvement in September, we still see more volatility on this side of the market.

Alternative Investments

We will soon be sharing information on a new offering from TriDelta that will represent some of our best thinking on the income focused Alternative Investment space along with better liquidity, better pricing, and full flexibility to be held in registered and non-registered accounts.  Stay tuned.

Canadian Dollar

We believe that there could be some strength in the Canadian dollar over the next year as U.S. interest rates fall below Canadian levels.  The very different view on interest rates between the two countries should provide a solid support for the Canadian dollar.  In fact, we have now put in place a 25% hedge on US$ in our funds when we often have no hedge in place.

TriDelta Private Funds

We paid another distribution in the first week of October.  Over 17% of the remaining value of the TriDelta Private Fund 2 (High Income Balanced Fund) was distributed out as cash.  Over 4% of the remaining value of the TriDelta Private Fund 1 (Fixed Income Fund) was distributed out as cash.  We expect to pay further distributions next quarter as more of the underlying investments mature or are sold.     

TriDelta Ranked one of the Top 10 Wealth Management Firms in Toronto by AdvisoryHQ

Here is what California-based Advisory HQ had to say about our firm:

“TriDelta’s holistic financial services approach ensures clients get personalized help from experts in a variety of financial specialty sectors. This provides additional value and ensures a client’s financial strategy is fully integrated.

With a deep bench of professionals, a wealth of financial education resources, and a talented team, TriDelta Financial earns 5-stars as one of the best financial advisors in Toronto….”

Summary

As we head into the final quarter of the year, 2019 continues to feel like a recovery year from the weaknesses of the second half of 2018.  Despite the fear that seems ever present, we do not see a particularly weak investing environment.  In the short term, anything can happen, but our slightly cautious approach should weather such storms and allow us to take advantage of opportunities.

At TriDelta we will continue to focus on being nimble in the short term, being a leader in the Alternative Income space, and helping clients plan for the long term.

Here is to a beautiful fall for everyone.

TriDelta Investment Management Committee

Cameron Winser

VP, Equities

Ted Rechtshaffen

President and CEO

Paul Simon

VP and Head of Fixed Income

Lorne Zeiler

VP, Portfolio Manager and
Wealth Advisor

TriDelta Q2 Report – The Fed to the Rescue

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The second quarter of 2019 has felt a little like Canada’s Wonderland. You climb the roller coaster, then you experience big ‘wind in your hair’ descent, then another climb. At TriDelta, we definitely work to smooth out your portfolio returns much more than the typical stock market, but I am sure that most of you still felt a bit of the roller coaster as you reviewed portfolios online or through monthly statements.

While the overall returns for equity markets were positive in the second quarter, volatility returned in May. After the stock market continued its strong year-to-date returns in April with the S&P500 (US) rising by 3.9%, the S&P/TSX Composite (Canada) increasing by 3% and Euro Stoxx 50 (Europe) up 4.9%, May saw the reversal of fortunes with the S&P500 declining 6.6%, TSX dropping 3.3% and Europe down 6.7%. June returns were positive again at +5% for the S&P500 (although only 1.8% in Canadian dollars due to a 3% increase in CAD during the month), +0.5% for the TSX and +3.7% for Europe.

Bonds performed well with the FTSE TSX Bond Universe index rising by 2.55%. during the quarter with much lower volatility than the stock market (bonds have sold off a bit so far in July). Preferred shares continued to struggle, with the BMO 50 Preferred Share index declining by 2.4% in the quarter, but have performed well recently with a 0.5% rise in June and so far +1.5% in July. Preferred shares continue to offer high tax-efficient dividend yields, especially relative to other income investments. If bonds prices stabilize, preferred shares could also enjoy some capital gain. For more information on the Preferred Shares market, the reason for its decline, and the opportunity for positive future returns, please click here.

While declines can be stressful, even during periods of overall rising equity markets, it is worth remembering that equity markets have typically provided higher returns than most other asset classes, particularly bonds, but with much higher volatility. Even though equity markets (as represented by the S&P500 in the US) have generated positive calendar year returns roughly 70% of the time, in a typical calendar year, equity markets experience declines of 5% or more 3 times and one decline of 10% or more.

TriDelta clients on average were up between 0.25% and 1.5% during the quarter with the biggest difference being the percentage exposure to Preferred Shares. Our basket of alternative investments continued to perform in line with expectations, with private debt funds up approx. 2%, mortgage investment funds up 1%-2% and real estate up 2.5%, outperforming stocks.

So the key question for most investors is why the strength in April and June vs. declines in May? And more importantly, are we in for weak equity markets like we experienced in Q4 2018 when the S&P500 fell 20% from its peak before recovering? Or can we expect strong market conditions, like Q1 2019 when nearly all major markets were up at least 10%?

Earnings, valuations, cash flows and growth rates should ultimately dictate long-term returns for investors. In fact, most classic equity and market valuation models are based on trying to forecast future earnings and cash flows from an investment based on growth rates, but also bond yields. Sometimes, short-term declines are the result of seasonal factors, or major headlines, such as the continued trade discussions between US and China and in May the threat of US tariffs on Mexico. Often though there may be no clear reason for short-term declines. But in recent years, accommodative monetary policy has definitely been a factor in the strength of (and sometimes weakness in) the equity markets.

Why Central Banks Matter?

Central Banks main goal is to use monetary policy (primarily by setting government interest rates, but also by buying and selling government or related bonds in the market) to keep inflation at stable, predictable levels (price stability). The US central bank, the Federal Reserve, actually has two mandates of price stability and full employment.

Since 2008, central banks lowered interest rates to unprecedented levels and even engaged in quantitative easing, buying long dated bonds, to lower longer-term interest rates. The actions of central banks influence money supply, bond yields and even overall economic growth as more flexible monetary conditions can help protect companies and investors. Companies with higher levels of debt can more easily pay and finance credit. Lower borrowing costs can increase profits for corporations and can be used for dividend increases or share buybacks. Lower rates also encourage individuals and endowments to invest in riskier assets when holding cash that offers only meager returns. Higher dividend paying equities appear more attractive in a low yield environment as they offer higher yields than bonds with the potential for upside (they also have the potential for downside if prices drop). Higher valuations seem more reasonable in an environment of low rates, so stock prices go up and investors seeking higher returns bid up growth stocks.

The Q4 2018 sell-off was impacted by fears of slowing growth, a breakdown in US-China trade discussions, but also due to more hawkish central banks. In fact, when the US Federal Reserve (the ‘Fed’) raised rates in December, then commented that it expected future interest rate increases AND expected further reductions in its bond holdings, this threw fire on an already nervous equity market, accelerating declines in stocks, before recovery began just after Christmas.

Presently, US President Trump is demanding that the Federal Reserve reduce rates, Wall Street is anticipating a rate cut later this month AND at least two more rate cuts within twelve months. If this were to occur, the Bank of Canada, which has been neutral, would have to lower rates as well or see the Canadian dollar rise significantly due to the higher yield of Canadian bonds vs. US bonds. The problem is that while yes the world’s growth rate is slowing and lowering rates would help spur growth, most US economists do not see the need for rate cuts. They still anticipate GDP growth of over 2% in both 2019 and 2020, slower, but still a good growth rate for an advanced economy ten years into a recovery. They expect the unemployment rate, already near historical lows, to decline even further, and for inflation to be slightly above 2% (the Fed’s target rate), so these economists do not see a need for near-term rate cuts. (Source: Blomberg Economics, July 8, 2019). Most members of the Federal Reserve are economists. So who will win? Wall Street and the President or the more conservative economists? Much like the Kawhi Leonard watch to determine which basketball team he signed with, the Fed’s decision will also be followed and analyzed throughout the summer.

US Federal Reserve Interest Rate Expectations

The green line reflects the projected Federal Funds Rate (interest rates) per members of the Federal Reserve at July 12, 2019. The yellow line reflected those projections at December 31, 2018. For example, at the end of 2018, the Fed expected rates to stay at approximately 2.4% in one year’s time and now expect rates to be closer to 1.5% over that period.

At TriDelta, we think the result is likely to be somewhere in the middle. We will get at least one rate cut in 2019, but possibly later than July and we may see only 1-2 additional cuts within the next 12 months. If this is the case, Wall Street is likely to be disappointed and we could be in for a few months of volatility.

As a result, we have focused equally on capital preservation as well as growth. The stocks currently in the equity portfolios have higher yields than the overall market, as well as lower volatility (Beta) and cheaper valuations (as measured by Price / Earnings ratios). We also presently hold higher levels of cash in our equity funds. Our bond portfolios hold shorter terms to maturity than the Canadian bond universe and has improved its credit quality. We also continue to believe that investing a portion of clients’ portfolios in income-focused alternative investments should provide less volatility and a higher level of income than a typical stock and bond only balanced portfolio.

We will continue to monitor market conditions, particularly leading indicators, developments in trade discussions and their impact on the world economy, as well as technical factors that may give indications of potential market movements and which sectors to favour.

Update on Private Investments

At the end of Q2, both TriDelta Fixed Income and High Income Balanced Funds made additional distributions based on investments being sold or maturing. Distributions for the Fixed Income Fund were roughly 0.5% and just over 13% for the High Income Balanced Fund. Additional distributions are expected near the end of Q3 as certain bonds mature and others are sold.

Summary:

We continue to search for value in under covered areas of the market, such as a promissory note issued by a leader in the litigation finance field that pays our clients a 10% yield, as well as stocks, preferred shares and bonds trading below historical averages or offering higher levels of growth than are priced in by the market. We are also focused on capital preservation, income and reducing overall risk through prudent management and diversification.

We hope that you have a chance to enjoy the sunshine and good weather that we are presently experiencing. Summers in Canada are too short, so they must be savoured.

 

TriDelta Investment Management Committee

Cameron Winser

VP, Equities

Ted Rechtshaffen

President and CEO

Anton Tucker

Exec VP and Portfolio Manager

Lorne Zeiler

VP, Portfolio Manager and
Wealth Advisor

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