January 15, 2024

The Reporter – Fourth Quarter 2023

At the beginning of the year, we like to take a moment to celebrate our successes over the last 12 months. Did you reach the goals you set for yourself at the start of 2023? If not, don't despair! It's normal not to reach every single objective. In fact, research shows that only a minority of people manage to see their long-term commitments through to the end. This idea highlights how we should probably rethink the way we come up with and pursue goals.

In this spirit, author and lecturer Jon Gordon recommends picking one word you'll turn to for inspiration this year.^{page note 1} Instead of crafting extensive lists of resolutions, he suggests picking one word that will guide you throughout the year. This carefully chosen word will become your mantra. By referring to it again and again, it will help define and streamline your goals. Gordon believes that simplicity is the key to overcoming distractions and fostering deeper purpose, commitment and success.

We decided to apply this principle to our portfolio management approach, and chose the word "caution" to guide our current investment strategy. Luckily, caution didn't prevent us from achieving great results in 2023, namely with respect to our management models.

As far as relative performance is concerned, the gap in our Growth portfolio is mainly due to our important share of liquidities as well as the way that American tech stocks unexpectedly bounced back. With preferred shares, our added value lies in our ability to be discerning when selecting issuers. For example, our decision to invest in bank securities was particularly profitable, as was our decision to remove securities that weren't performing well, such as Brookfield Asset Management. In the bond segment, the gradual extension of its term throughout the year helped create added value. For the Balanced Tax Efficient portfolio, adjustments made to asset allocation have made it possible to offset stagnancy in the Growth category, which has led to a negligible 1% drop compared to the reference index. In these conditions, we're satisfied with the relative performance of our portfolios, especially given our cautious approach.

2023 PERFORMANCE SUMMARY

Q4 2023 PERFORMANCE REVIEW

2023 PERFORMANCE REVIEW

In November, Warren Buffett's longtime partner and investment expert Charlie Munger passed away. Munger is well known for his evocative quotes about investing, and I want to draw your attention to the following quote, which really illustrates the concept of caution: "Quickly eliminate the big universe of what not to do, follow up with a fluent, multidisciplinary attack on what remains, then act decisively when, and only when, the right circumstances appear."^{page note 2}

This maxim encourages us to carefully assess the consequences before making decisions and stay away from investments we consider risky. It also encourages us to focus on our resources and a small number of investment opportunities that merit our full attention. This step requires adopting a careful approach, which is only possible when we have all the elements needed to make an informed decision. It's about avoiding certain actions, but it's also about knowing when to act without giving into impulsivity.

Now let's take a look at how we were able to apply the concept of caution over the course of 3 distinct phases the financial markets went through in Q4 2023.

1. High interest rate environment (October)

On September 20, Federal Reserve Chair Jerome Powell announced that interest rates would remain high for longer than expected. This decision was made due to the strength of the economy, in hopes of bringing inflation back down to 2%. It was a defining feature of the beginning of the quarter. Following this announcement, the 10-year Treasury yield nearly reached the psychological barrier of 5% for the first time in over 15 years.

In this economy, corporate shares offering significant dividends that are affected by higher interest rates (due to high debt ratios, major financing needs or investments backed by infrastructure) were strongly affected. Compared to bonds, their appeal waned and market participants started anticipating a possible reduction in dividends.

At the beginning of October, we invested close to 4% of our liquid assets in shares belonging to the 3 pillars of the Canadian economy at attractive rates. This enabled us to remain true to our cautious approach—only taking carefully calculated risks that were in line with our 3-for-1 principle.^{page note 3} These companies, which include ECB, TC Energy and Telus, were chosen for their financial stability and their ability to keep paying dividends.^{page note 4}

2. Reversal of lower interest rates (from November to December 12)

The Fed has a dual mandate, which includes seeing to the country's economic stability. The 2 fundamental objectives of this mandate are to keep prices stable and keep people employed. That means: 1) Keeping inflation rates low and stable to ensure a predictable economic environment for both consumers and businesses, and 2) Maximizing employment so that a majority of people who want to work and are physically able to do so can find a job.

By adopting an especially restrictive monetary policy, the Fed is trying to bring inflation down to normal levels while limiting negative consequences for the job market. Historically, this has always been difficult to do. This aggressive strategy has been fruitful so far. In fact, in the United States, consecutive policy rate hikes have helped slow inflation without fully holding back job growth. For example, after reaching a peak of 9.2% in June 2022, the annual inflation rate fell to 3.1% in November.^{page note 5} As far as employment is concerned, 150,000 jobs were created in October, compared to 170,000 expected jobs. This indicates a slowdown in labour market dynamics.

The day before the Fed announced plans for the policy interest rate, the 10-year Treasury yield fell below 4.20% on December 12. This decline has been interpreted as a change in narrative on the part of the Federal Reserve, potentially signalling an end to monetary tightening. Canada's 10-year interest rate is seeing a similar change.

Namely, thanks to a cautious stance characterized by a slightly longer duration than the benchmark index in the bond holdings and by a relatively high bond weighting within the Balanced Tax Efficient portfolio,^{page note 6} we were able to capitalize on this shift towards favouring bonds.^{page note 7}

3. The Fed's change of tone (from December 13 to the end of the year)

As expected, the Fed confirmed that it was ending its monetary tightening policies and announced 3 interest rate cuts for 2024. This decision was welcomed by the financial markets. In the US, the 10-year Treasury yield continued to drop, reaching 3.87% at the end of the year. Meanwhile, the S&P 500 closed the year slightly under 4,800 points—just shy of setting a new record. It's important to mention that, like the bond market, the major stock indexes had started to recover in anticipation of this announcement.

Despite this encouraging news, we decided to maintain our cash level at approximately 20% for our Growth portfolio. With a closing price of 4,770 points on December 29, the S&P 500 forecasts seem too optimistic. In fact, they are 19.5 times higher than the projected earnings of $245 per share in 2024. These earnings represent an 11% increase over the $221 share price recorded in 2023.

This kind of market valuation would be justified in an optimistic economic environment, especially without a recession. We'll be exploring our analysis of this perspective in more detail on January 23, at our online conference to kickoff the new year. We hope to see you there!

Sources:

Gagnon, J. (2016). Les enseignements de Charlie Munger, Les Affaires.

The Daily Coach (2024). The Power of One Single Word, The Daily Coach.