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TriDelta Insight Q4 Commentary – Putting 2022 In Its Place

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Market Overview

2022 was a rollercoaster year that saw war between Russia and Ukraine, fears of an energy crisis, surging inflation, and central banks raising interest rates at a pace not seen in decades.

While it’s impossible to summarize a year in just a few sentences there are several points from 2022 worthy of note:

  • Stocks had their worst year since 2008. Bonds had their worst year on record.
  • Market movements continued (and will continue) to be driven by the expectations versus realities of interest rate changes.
  • Inflation rates in Canada and U.S. appeared to have peaked and have continued, albeit slowly, to come down.
  • Recession concerns will continue to be top of mind as we wait on whether central banks can avoid inflicting additional hardship.
  • The conflict between Russia and Ukraine, while tragic, has become less of a concern for the market in the latter half of the year.
  • Economic activity has been slowing, and some countries are likely in a recession today, but others remain reasonably healthy.
  • Commodities remained one of the few bright spots for the year, helping the Canadian market outperform many peers.

While some of these worries will continue to drag markets, no one can know for sure how exactly 2023 will look when it’s all said and done. Our views continue to be cautious, but we are increasingly seeing long-term opportunities when looking at all the volatility being experienced globally.

Year to Date Returns

How did you do?

Do-it-yourself investing became a well talked about phenomenon during the early days of COVID lockdowns. Established financial news outlets found themselves reporting on the success of “meme stocks”, NFTs, cryptocurrency, and the larger than life individuals behind these risky endeavors.  Have you ever wondered how these same investors did in a year when not everything went up? We did, and fortunately, we were not alone.

According to data compiled by Vanda Research, the average active amateur investor suffered losses of approximately 30% in 2022. JPMorgan Chase & Co. was even more downbeat about these amateur traders, estimating they saw losses of 38%. (Retail Traders Lose $350 Billion in Brutal Year for Taking Risks – Bloomberg)

Even the traditional balanced portfolio of 60% stocks/40% bonds was down over 15% at its lowest in 2022 and finished the year down over 11%.

While no one likes to see the dollar value of their portfolio decline, we think these figures and the ones in the market returns chart seen above pose an important reminder of what value working with an experienced team can provide.

While each individual portfolio is unique and depends on many different factors, we have been very happy with how our clients have fared in 2022. Our outperformance relative to the broader markets can largely be attributed to:

  • Our continued focus on active risk management,
  • Taking emotion out of the decision-making process,
  • Exposure to energy markets in most portfolios,
  • Developing a well-diversified portfolio that can withstand the ups and downs of the market, and
  • Our inclusion of alternative investments with less correlation to public markets.

Why the next 10 years won’t look like the last 10

The last bull market was 13 years in the making and born out of the Great Financial Crisis of 2008/09. This recession was a difficult time for many reasons outside the scope of this commentary but what is important is what came afterwards:

  • Consumers significantly lowered their debt to disposable income (unless you were Canadian).
  • We saw persistently low inflation and slow economic growth. This allowed central banks more leeway to stimulate the economy and drive asset prices higher.
  • Markets enjoyed strong and steady gains. Companies were able to borrow at next to nothing and investors bet on companies they assumed could grow exponentially in this new normal.

For years investors, economists, and bankers speculated when this bull market would come to an end, but no one foresaw a global pandemic as the underlying reason. A pandemic that drove the excesses of the previous decade to new highs, buckled supply-chains, and finally showed that inflation would not be low forever. We have discussed several times this year that while we believe inflation has likely peaked and will continue to come down from its highs, it is likely to remain well above the central banks 2% target to which they have become accustomed.

What does this mean moving forward?

  • Central banks won’t be able to act as freely. Interest rates will rise and fall but are not likely to reach their previous lows any time soon.
  • Households and companies will need to rethink their spending.
  • The market should still trend higher over the long run, but the highs and lows will be more abrupt.
  • The “winners” of the last decade are not certain to be the winners of the next decade. You can’t drive a car looking in the rear-view mirror. Buying something simply because it is down 30+% does not mean it is a good investment.
    • Technology stocks provide some history. Prior to 2022, tech stocks grew to become 30% of the S&P 500 and every time an industry has been 30% of the S&P 500 it has then underperformed the next 10 years.
    • We analyzed a winner from the early 2000’s tech bubble earlier in the year: TriDelta Financial – Market Commentary for June 2022

Much of this probably seems ominous, but if anything, it has only made us more excited for what’s to come. Will there be difficult years like 2022? Yes. But with each period of volatility there is far more opportunity for the long-term investor than the short-minded trader. We think the value of working with an active manager will be increasingly important moving forward. We are not only investment managers, we help to manage emotions so the households we work with can keep their long-term goals in focus. The risk of a market correction in our mind is not that portfolios have declined but that a client sacrifice achieving their goals in favour of short-term comfort.

The value and importance of financial planning alongside investment management

These days, it can be downright depressing watching the news too closely.  Depending on which news source you watch, it is hard not to get despondent.  Often, the cure for this is to step far back and look at your personal situation, your immediate world, and not get so worried about the global issues that you can’t control.

We find that financial planning becomes even more important in times like today as it allows you to focus on your world much more than the big, bad world.  Just like stepping away from the online news, to focus on your smaller world, a financial plan review allows you to get a better handle on how you are doing, and any adjustments you can make in your world to better align with your goals.

By looking at your taxes, debt, income, estate planning and insurance, it allows us to put your investments in context with your overall picture, goals and plans.  This can help us to manage not just the ups and downs of the investment market, but the risk required to meet your overall goals.

What we are doing and why

A couple of weeks back, Ted Rechtshaffen, President & CEO of TriDelta Financial wrote a featured article in the Financial Post discussing his thoughts for what’s to come in 2023.  It provides an overview of the world as we currently see it, and we think may come about in the year ahead. In case you didn’t see it, we are providing a link here.

23 investing and personal finance thoughts for what’s to come in ’23 | Financial Post

Stocks/Equities

Worries remain that central banks will raise interest rates too high, and a severe recession will follow. On the other side, worries are central banks will not do enough or governments will introduce stimulus too soon which will prolong the issues and do little to bring down inflation. Both scenarios will have material impacts to investment portfolios but there’s a case to be made that a recession could be the optimal outcome in terms of facilitating a sustainable path towards long-term growth.

Historically speaking, a central bank induced recession is easier to rebound from than a structural failing like what we saw in 2008/09. If a short and mild recession gets the economy back on its low-inflation track, that could be preferable to a world in which high inflation persists for years.

We have mentioned all year that markets are not likely to sustain a prolonged uptrend until we have greater clarity around the path of interest rates. Heading into 2023, the path of markets hinges, as always, on economic growth, corporate profitability, and — most importantly — whether inflation abates, and we can stop raising interest rates.

As we have already written, the last 10 years are very unlikely to simply be repeated when markets finally recover.

  • The last cycle centered around growth-oriented stocks (i.e., tech) while the next cycle is likely to be focused on high-quality companies with stable and growing cash flows, often paying a dividend and trading at a much more reasonable level than some of their high-growth peers.
  • With inflation being more elevated, the winners and losers in this environment will depend on those that can better contain costs.
  • We continue to expect Canada to perform well in comparison to global peers. Canada was a relative stand out in 2022 with economic growth likely finishing in the 2.5%-3% range.
  • We are not simply looking for companies trading at discounts relative to their pre-2022 highs. Some companies are justifiably down. Companies with poor debt management, inexperienced management teams, and slim cash flows should likely be avoided.
  • Both TriDelta equity funds continue to use cash tactically to take advantage of significant price swings as we expect to remain cautious in the first months of 2023.
  • Areas we like moving forward include:
    • Healthcare – the population isn’t getting any younger. Healthcare is the third-best performing industry of all time, and it has just come off a three-year period of underperformance.
    • Energy – despite the recent volatility there remain a lot of strong fundamental reasons to be confident in energy. There are also a lot of uses of oil and gas for which there is no substitute such as plastics, vitamins, fertilizer, drug ingredients, flavors, and fragrances.
    • Globally (outside of North America), markets have seen meaningful selloffs and are often trading at much better valuations than their U.S. peers, creating an attractive entry.
    • Emerging markets pose an attractive entry point at current levels. A potentially weakening US dollar, new optimism around a Chinese reopening, and valuations at extreme lows all bode well for these companies in the near term.

The TriDelta Pension and Growth Funds performed exceptionally well in 2022. The Pension and Growth funds were -1.09% and -6.96%, respectively. Following a strong 2021 where the Pension and Growth funds returned +16.4% and +28.5%, 2022’s performance is evidence to the risk management strategies we employ within the funds and why capital preservation is always an important consideration.

Bonds

As mentioned earlier, bonds had their worst year on record and because of this decline have become a much more attractive space for both income and capital gains. That said, not all bonds are equal and active management will be key to ensuring we take advantage of this asset class in 2023.

Some important aspects to note include:

  • There is a broadening belief there will only be one or two more interest rate increases occurring in the first half of 2023 and then subsequent declines in rates as early as the latter half of the year.
  • Central banks have been adamant that they disagree with this assessment and do not forecast cutting rates in the second half of the year.
  • Key to the future of interest rates will include inflation continuing to fall and a weakening labour market in North America.
  • As we saw with the United Kingdom in 2022, government decisions to use fiscal spending to spur growth would likely force central banks to raise interest rates higher than expected.
  • Globally, we expect currency changes to be volatile. Much of this change will be influenced by government decisions in the face of declining economic growth. Fundamentally we see the Canadian dollar as lower than what it should be.
  • Limited Recourse Capital Notes (LRCNs) have been an important addition to our inclusion in bond portfolios. With yields currently averaging around 7.5% on new issuances, we foresee further issuance into 2023 at potentially even greater yields.

Preferred Shares

Preferred shares ended a difficult 2022 down 20% on the year. Pressure from Limited Recourse Capital Notes and tax loss selling into year-end were significant detractors to close the year. Preferred shares continue to be a space we monitor closely as income yields have continued to rise, yielding 6.3% on average, and investors have benefited owning preferred shares that have been redeemed in 2022 with 15% of the Canadian market being redeemed by issuers.

Alternatives

2022 was a year where alternatives demonstrated a lot of value in client portfolios. Private credit and real estate returns remained broadly strong and have been one of the lone positives in portfolios. We continue to have regular conversations with our managers and have continued to add new funds to our offering.

  • Private debt stands as a beneficiary of rising interest rates as they are able to pass along these rates to borrowers and expand their pool of opportunity as more companies are no longer able to seek traditional bank financing.
    • Rates on these loans are up 4% in most cases and referrals continue to come from the banks themselves.
  • Private real estate has performed much differently than their publicly traded peers. While the impact of rising interest rates is being felt across the space, not all types and geographies of real estate are the same.
    • Many of our managers operate in niche markets which has provided insulation from these changing rates while rent increases have continued to climb as the long-term case for rentals persists.

In Conclusion

In five years’ time we see it as a very real possibility we will look at 2022 as a year people look back on as having been a great opportunity for investors. Stocks in 2022 had their worst year since 2008 while bonds had their worst year ever recorded. We know first-hand that there is no one on our team who would say they wouldn’t go back in time and put everything they could in the market in late 2008 but we also know hindsight is 20/20. We still think there will be ups and downs in 2023 and beyond but having a long-term focus will be what ultimately protects your portfolio and helps you succeed.

If you would like to discuss your financial plan or investment portfolio, please give us a call or send a note.

 

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 3rd Q 2012 Market Outlook

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What Happened in the Quarter

The third quarter can be summarized by two major government announcements:

  1. The European Central Bank announced the Outright Monetary Transactions programme aimed at providing significant monetary support to ensure that the “Euro Will Not Fail”. The new bond-buying plan is aimed at easing the eurozone’s debt crisis. The ECB aims to cut the borrowing costs of debt-burdened eurozone members by buying their bonds.
  2. Later in September, the US Federal Reserve Bank headed by Ben Bernanke announced Quantitative Easing 3. This included a commitment to buy $40 billion in mortgage backed securities each month from Fannie Mae and Freddie Mac (the US version of the Canadian Mortgage and Housing Corporation – CMHC). This is in addition to the $2 trillion in Treasury bonds that it bought in QE1 an QE2.

Both of these actions and the expectations of these actions drove markets higher during the quarter. Among the biggest beneficiaries were precious metals, energy, and other commodities – sectors of the market that lagged for much of the year.

The Toronto market was up 6% on the quarter after having fallen over 6% in the previous quarter.

The bond universe market was up 1.2% on the quarter.

How did you do?

At TriDelta Investment Counsel we have two main types of clients. The first group seeks conservative growth and income and are invested in our ‘Pension’ model. The second group is looking for growth, which is delivered via our ‘Core’ model.

Pension Clients:

This group is typically in retirement or close to it and looking for less volatility, higher income and steadier 5% to 10% gain, especially while interest rates and GIC rates are so low.

Most pension clients grew by 1.5% this quarter (after fees).

Our Pension model (based on 60% stocks and 40% bonds) returned 5.5% year to date (after fees). So far on the year we are very pleased to see that our Pension portfolios are delivering the type of returns that they were designed to deliver.

While the performance this quarter was not as strong as the super charged stock markets, it is important to remember why. Our approach is based on finding a mix of bonds, preferred shares and dividend paying stocks that will provide a steady level of income. The capital gains growth from the portfolio will usually come from companies that are rarely flashy in the short term (like the precious metals index) but act more like the tortoise than the hare. Companies like Trans Canada Pipelines, Philip Morris, and Colgate Palmolive.

These are the type of companies that will not jump meaningfully upon hearing about the latest round of quantitative easing.

Dividend Changes in Q3 – Pension

One area of Pension focus for us is to hold companies with stable and growing dividends. In terms of dividend changes this quarter we saw 7 dividend increases and no decreases:

  • Microsoft boost its quarterly dividend by 15%
  • Phillip Morris boost its quarterly dividend by 10.4%
  • Norfolk Southern boost its quarterly dividend by 6.4%
  • BCE boost its quarterly dividend by 4.6%
  • CIBC boost its quarterly dividend by 4.4%
  • Emera boost its quarterly dividend by 3.7%
  • Verizon boost its quarterly dividend by 3.0%

 

Core Performance Clients:

This group of clients is looking for greater growth, less concerned about income, and want to beat the market over time. Ideally for peace of mind, these portfolios will still have less volatility than the market overall. We call this group Core Performance portfolios.

Most Core Performance clients grew by 2% this quarter (after fees).

Our Core Performance model (based on 60% stocks and 40% bonds) returned 9.7% year to date (after fees), with a healthy part of the gains coming in the first quarter.

The numbers are quite positive although we saw a little portfolio drag of higher cash balances in the Q3 performance in our Core Performance portfolios. We look forward to adding some more momentum to the portfolio over the next few months as opportunities present themselves.

Some of the trades we made this quarter and why?

In Pension Portfolios:

  • We sold a Manulife bond that had a coupon of 4.08% and came due in 2015.
  • We bought a Manulife bond that has a coupon of 5.06% and comes due in 2041.

Rationale – The short term Manulife bond had a yield to maturity of 2.57%, and we replaced it with a bond from the same company that has a yield to maturity of 6.02%. The 2041 bond also has a current yield (the coupon payment of 5.06 divided by the purchase price of $86.50) of 5.85%.

We will not likely hold this bond to maturity, but feel that the significant increase in yield (while holding the same company), will benefit investors in the short to medium term, while we remain confident that long term interest rates will remain low (or lower) over that time.

  • We sold Barrick Gold

Rationale – This was a difficult decision. The stock was purchased for most clients around $40, dropped to $31, and came back to $37 when we sold it for Pension clients. The volatility is what made us sell the stock. It remains in our Core portfolios as it passes the financial hurdles of the Core model and the speculative nature and volatility of the stock is more appropriate for that mandate.

In Core Portfolios:

  • We did the same Manulife bond trade as noted above in the Pension portfolios.
  • We bought Tesoro Corporation. It is up 16% since our purchase.

Rationale – Tesoro is an independent petroleum refiner and marketer in the United States with two operating segments: refining crude oil and selling refined products in bulk and wholesale markets and selling motor fuels in the retail market. They had a great earnings report this quarter and continue to prove themselves as one of the best operators in the refining space. Growth wise they have two expansions that should contribute positively to earnings shortly and help accelerate growth. The stock ranks very well and is breaking out of a 11/2 year range that should provide substantial support.

  • We sold Discover Financial Services.

Rationale – The stock had a really good run and was up 45% YTD when we sold it. There was some concern about high valuations and their entry into new market segments such as student loans. So far the stock has continued to do well in August and September.

Our Investment Outlook and how it will impact your portfolio

We believe that some of the market gains in Q3 have been driven by ‘hot air’. By this we mean that it is relatively easy for governments to print and throw money at a major economic problem. What is difficult is seeing fundamental economic improvements on the ground and in the economy.

On the positive side there continues to be signs that the US housing market is stabilizing, with price gains in many markets. Housing market changes tend to move slowly, and a turn from one direction to another can be a significant signal. We are hopeful that this slow shift in US housing will provide one of the foundations for an improving economy.

The other big positive is that historically when the government provides economic stimulus and provides lower than average borrowing costs for consumers and companies, the markets tend to benefit. We have certainly seen some of this benefit in the U.S. market, and think that in the medium term that will continue.

On the negative side, there are a few items:

  1. The China Purchasing Managers Index is at 47.8. This is very low and suggests weak growth in China.
  2. Eurozone Purchasing Managers Index is at 46.0, historically a very low level, and one that indicates a continuing high unemployment and low (if any) growth in the region.
  3. Spain, Greece and Italy have been out of the news for a while, and markets have seen solid increases. At some point, they will make negative economic headlines again and the market will see a pullback.
  4. The U.S. “Fiscal cliff” is the popular shorthand term used to describe the conundrum that the U.S. government will face at the end of 2012, when the terms of the Budget Control Act of 2011 are scheduled to go into effect.

Among the laws set to change at midnight on December 31, 2012, are the end of last year’s temporary payroll tax cuts (resulting in a 2% tax increase for workers), the end of certain tax breaks for businesses, shifts in the alternative minimum tax that would take a larger bite, the end of the tax cuts from 2001-2003, and the beginning of taxes related to President Obama’s health care law. At the same time, the spending cuts agreed upon as part of the debt ceiling deal of 2011 will begin to go into effect.

TriDelta’s defensive stance (with higher than average cash balances) will remain until we see a meaningful 5%+ pullback in markets, so that we can find some better entry points. An example might be outside of Canada. We currently have a meaningful position in the U.S. markets. We will likely be expanding our non-Canadian positions for two reasons. The first is that the Canadian dollar is currently very strong, and we believe it is at the high end of the range making it a good time to invest outside of Canada. Also, we continue to look for greater diversification from the core energy and materials that Canada has in abundance.

When we look at the movements of the markets in the last quarter, through the list of positive and negative items that we are facing, we believe that one of the list of four negative items will be the focus of markets’ attention at some point this quarter, and will lead to a pullback that we can take advantage of.

In the meantime, our portfolios (while a little conservative) are well positioned to continue to see some growth in most market situations.

TriDelta Investment Counsel Investment Committee – October 2012
Cam Winser, CFA, VP Equities
Edward Jong, VP Fixed Income
Ted Rechtshaffen, MBA, CFP, President and CEO
Anton Tucker, CFP, FMA, FCSI, VP, TriDelta Financial Partners

 

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