THE QUARTERLY COMPASS - ASPIRA WEALTH – MARCH 31, 2024

Summary: Stock markets ended the first quarter of 2024 on a strong note, resonating with optimistic views that we shared repeatedly in our publications. We maintain our long-term optimistic bias, while looking forward to some volatility in the short term.

INVESTMENT PERFORMANCE

In the first three months of 2024, the investment strategies of Aspira Wealth performed well – all of them had a return close, or above, the market averages.

The equities-only strategies (DVD, NCRF, and KMI) had a three month return of 10-13%, while fixed income strategy (FICC) generated a 0.4% return, and preferred shares strategy generated 11% return.

While these results are attractive, we place no weight on short-term results, good or bad, and neither should you. We believe that our long-term focus will serve us better.

Source: Aspira Wealth. *These numbers are relevant only for accounts with Raymond James Ltd. (Canada).

BROAD MARKET OBSERVATIONS

CANADIAN STOCK MARKET

• The Canadian stock market was very strong in Q1 2024, reaching record all-time high levels, well above previous all-time high levels from two years ago.
• The recent strength continues to reflect a better-than-expected economy, improving commodity prices, as well as expectations that the Bank of Canada will start cutting interest rates in 2024.
• The likelihood of a 5-10% decline in the market has increased since our last update (due to above average level of optimism of market participants). We intend to be more selective with buying during the next 3-6 months while maintaining our long-term positive bias. If market does contract 10% later this year, we will in all likelihood:
  • Encourage clients to seize the opportunity of buying more at cheaper prices.
  • Discourage clients from selling their investments in panic.

Chart courtesy of StockCharts.com

U.S. STOCK MARKET

• The United States stock market reached all-time record high levels, too, performing slightly better than Canada’s.
• Most of what we mentioned above for Canada also applies to the U.S.

Chart courtesy of StockCharts.com

USD CAD Exchange Rate

• Over the past 30 years, the Canadian/U.S. dollar exchange rate was quite volatile, but it spent half of the time within the 1.20-1.50 CAD/USD range, including the last 9 years.
• We assume that, over the long run, the exchange rate between CAD and USD will remain range bound, having a neutral effect for Canadian investors with exposure to stocks listed in the U.S., and for the U.S. Investors with exposure to Canadian stocks. Our assumption is based on the depth of economic connection between Canada and the U.S., as well as economic policy similarities.
• We will continue to allocate 50-75 percent of exposure to U.S. stocks, to not be limited by the rather undiversified Canadian stock market.

Chart courtesy of StockCharts.com

Dr. Copper

• Copper price is assumed to predict turning points in the global economy, since it is widely used in most economic sectors.
• Copper price was very volatile during 2022, and less so during 2023.
• Current price level of copper isn’t sending a clear positive or negative signal, while we continue to believe that long term fundamentals are super strong for copper.
• We expect copper prices to exceed $5 level during the next 3 years, as discoveries of new copper deposits are limited (i.e., anaemic supply growth) while the world needs a lot of copper to build and to power electrical vehicles (i.e., solid demand growth).
• Recent development: The exponential growth of AI (Artificial Intelligence) data centres worldwide is expected to accelerate the consumption of electricity. The inevitable expansion to electrical grids will require a lot of copper and aluminium.

Chart courtesy of StockCharts.com

Dr. Semiconductor

• Semiconductors, a more modern version of Dr. Copper, are reflecting what is happening in the most advanced parts of the economy.
• Semiconductor stocks did really well lately, as seen in the chart below. Some volatility is to be expected in 2024 after the solid gains in 2023.
• The recent strength is driven by the AI race, push for semiconductor independence, self-driving car technology/infrastructure, investments in industrial automation, etc.
• Recent development: Microsoft and OpenAI plan to build a $100 billion data centre and include an artificial intelligence supercomputer called "Stargate" in the next four years – it will require a lot of semiconductors and semiconductor equipment.

Chart courtesy of StockCharts.com

Energy

• In Q1 2024, the U.S. oil price (WTI) recovered most of the losses from Q4 2023, driven by OPEC+ production cuts, improving economy and escalation of geopolitical risks.
• We continue to expect U.S. oil price (WTI) to remain volatile but stay in the wide range of $60-100 per barrel.
• We think it is unlikely to go below $60 during the next 3-6 years, considering the relatively low investments in production capacity in the past 10 years.
• We don’t expect it to go above $100, given the continuous efforts to transition to cleaner energy, although Chris notes that the demand for oil continues to grow far faster than most pundits expect.

Chart courtesy of StockCharts.com

U.S. natural gas

• The price of natural gas was volatile since our last update. The price halved from $3.4 peak in early January 2024 to $1.5 low in mid-February 2024. In March 2024, it ranged $1.6-2.0. The weakness was driven by smaller-than-expected demand (unusually warm winter).
• It is a great time to remember that “low prices are the best cure for low prices” - this is often true in commodity space. Suppliers are discouraged to produce at low prices, while consumers (like China for example) are seizing the opportunity to increase their stockpile at one of the lowest prices from the past 3 decades.
• We expect it to stay in a wide range of $2-5 per MCF (the gas prices are oscillating more than oil prices, due to exposure to the weather / heating season). Given the North American growing export capacity, we are biased to the upside.
• We do not expect it to stay lower than $2 for a long time since the world is transitioning from coal / oil consumption towards natural gas and other cleaner alternatives.

Chart courtesy of StockCharts.com

WORRY JOURNAL - TOP WORRIES OF MARKET PARTICIPANTS AND BUSINESS LEADERS IN 2023-2024

1. Inflation (in the news in 2021-2023) - inflicted by unprecedented government aid, relief, and economic security payments to individuals and corporations, relative to the number of products and services that the pandemic-constrained economy was able to provide. We expect inflation to continue to decline, as supply chains are recovering from a once-in-a-lifetime shock (pandemic), supported by the tight monetary policy (central banks increasing interest rates).
2. Economic slowdown/recession (in the news 2022-2023) - on assumption that central banks will not be able to quickly fix the inflation problem and/or might increase the interest rates too much. We assume that central banks are near the end of the monetary tightening cycle. Even if they tightened too much, it might not matter in the long term. Higher interest rates and headlines about possible recession led to a slowdown in consumer and business spending (especially discretionary spending), but it seems that the economy is quite resilient. While interest rates are now the highest they have been in 10 years, they are still lower than levels seen in the previous 30 years. Trying to predict the timing of recessions typically does not end well for most investors, so we chose to focus on the longer term. Even if a recession starts tomorrow, we think the downside is limited in the equity market, as typically the bottom of the stock market is usually 6-12 months before the official end of a recession. Equity market is a forward-looking animal, i.e., reflecting the near-term future expectations as opposed to where the economy currently is.
3. Debt ceiling debate/potential of a U.S. default (2023) - a recurring worry in the U.S., where the negotiations often extend into the eleventh hour before an agreement is reached. The crisis was temporarily fixed in June 2023, i.e., discussions delayed to early 2025.
4. War in Ukraine (2022-2024) - has taken a terrible human toll and seems to have no end in sight. While it is painful for people from the region and from around the world, we see that world trade and economy are gradually adapting to it, as it did in previous wars. Europe’s economy continues to grow, and the regional energy crisis seems to have been avoided.
5. Supply chain disruption (2020-2023) caused by the pandemic. There are pockets of concerns related to supply chains (originating from the pandemic and/or recent escalation of U.S.-China trade war), but we think that the current shape of supply chains is significantly better than it was a couple of years ago.
6. Labour shortages, attracting and retaining talent (2020-2023). The recent pandemic induced a major shock to the labour market. We believe the labour shortage is gradually getting resolved – hiring in the technology sector is now more rational, borders are being reopened to immigration, people are more willing and able to re-enter the labour force compared to a couple of years ago. On top of this, automation and AI are likely to continue to boost productivity.
7. 2023 Israel–Hamas war (2023-2024) – is another unfortunate and tragic event on the global scene – tens of thousands of people were killed, and millions were displaced in the past three months. We assume and hope that conflict will moderate or end in the near term. While it is painful for people from the region and from around the world, the global economy is used to major conflicts like this, so we don’t see it as a major investment risk in the long run.
8. Risks and Dangers of Artificial Intelligence (AI) (2023-2024). The pace of innovation in AI continues to grow at an exponential rate. Like with any other new major technology, people are worried about how it will affect their life: Will a lot of jobs disappear due to automation? Will social manipulation and biases escalate? We assume that everything will eventually work out – people will figure out the true value of the new technology and will adapt to how that technology will change our lives. Our main near-term concerns are the possible overinvestment in AI-related equipment and services, as well as unknown short-term returns on those investments.
9. Nothing to fear but nothing to fear (2024). As I was writing the Q1 2024 edition of Quarterly Compass, I realized that there is a sense that everything looks fine – stock markets, inflation, interest rates, employment, consumers, almost everything! Maybe this is just me having a moment of equanimity, or maybe it is a sign that all positives are already priced in, increasing the risk of market volatility. Speaking about volatility, the U.S. market had an average intra-year drop of 14% since 1980, including 5-10% intra-year drops in many years that ended with gains! So far in 2024, the largest intra-year drop in the U.S. market was 3%, well below the averages. Since investors typically underperform when they try to predict the timing of market drops, we don’t intend to make major changes to your portfolios. If your time horizon has changed from long term to short term due to life circumstances, we see this as an opportune time to take some money off the table.

PLAYBOOK OF OPPORTUNITIES – HOW WE SEIZE THE CURRENT OPPORTUNITIES

Broad equity market level: we maintain our long-term optimistic bias, while looking forward to some volatility in the short term. The much-discussed recession might be shallow, but this less bad scenario is more than priced in the market prices.

Economic sector level:

• Overweight cyclical sectors – technology, industrials, materials, consumer discretionary, energy.
• Equal-weight –consumer staples, financials, healthcare.
• Avoid - utilities, REITs.

More details on the sectors are available below in the section, Sector Positioning for Dividend Value Discipline ^TM.

SECTOR POSITIONING FOR THE DIVIDEND VALUE DISCIPLINE^TM

TECHNOLOGY SECTOR - Long-term positive. Short term caution.

• Assumptions: Sector to continue to grow above GDP level. Sector is now more mature/profitable vs. 20+ years ago, so we expect future cycles to be significantly less volatile compared to the dot-com bubble. Near-term tailwinds are coming from the AI race and push for semiconductor independence.
• Observations: High profit margins and cash flow generation. Low capital-intensity. Sells mostly productivity tools and solutions that are always in demand. After outperforming in 2014-2021, under-performed 2022 because of increasing interest rates and irrational capacity expansion during pandemic. Significantly outperformed the market in 2023, then modestly underperformed in Q1 2024, as we cautioned.

INDUSTRIAL SECTOR - Medium-term positive

• Assumptions: Sector might grow above GDP level in the medium term - driven by under-investment in infrastructure and in residential real estate; also, from the required investments for transitioning to green energy and onshoring of critical technologies.
• Observations: Industrial sector witnessed major tailwinds and relative out-performance until 2008, helped by growth of China and other emerging markets, as well as from the housing bubble in the U.S. Those tailwinds ended around 2008. The U.S. industrial sector underperformed significantly in 2018-2019 as several countries started rejecting globalism and embracing patriotism (e.g., U.S.-China trade wars), further deteriorated by lower capital investment during the pandemic. Global economic slowdown didn’t help in 2023. In Q1 2024, it outperformed in line with our expectations.

CONSUMER DISCRETIONARY SECTOR - Medium-term positive

• Assumptions - we assume it is a good time to be overweight in the Consumer Discretionary sector, because: (1) peak recession fears are likely in the rear-view mirror now, (2) central banks are no longer tightening, (3) unemployment is very low.
• Observations: Consumer discretionary sector has very diverse and occasionally un-correlated holdings. This likely explains why it doesn’t have a clear long-term trend. U.S. consumer discretionary sector outperformed from 2000, underperformed from 2005, outperformed from 2009, underperformed from late 2021. In Q1 2024, this sector underperformed, in contrast to our positive bias.

BASIC MATERIALS SECTOR - Long term positive

• Assumptions: Multiple strong tailwinds in several segments of materials sector, particularly for industrial metals, uranium, precious metals: (1) energy transition and climate concerns, (2) extreme underinvestment in capacity growth, (3) sector out of favour for too long, including due to climate impact.
• Observations: Sector is very diverse (industrial metals, precious metals, uranium, fertilizers and other chemicals). Sector underperformed after 2008-2009 as growth in emerging markets slowed down, further hit by trade wars, industrial recession, and pandemic. Sector performed in line with the board market since 2021.

ENERGY SECTOR - Medium term - mild positive

• Assumptions: We see pockets of opportunity within the Canadian and U.S. energy sector, based on following assumptions: (1) sector out of favour for too long. (2) sector is significantly more disciplined (focused on earnings and cash flow) compared to previous focus on growth-at-any-cost. (3) this discipline led to fewer exploration and capacity growth. (4) natural gas is cleaner than oil and coal. (5) transition to greener energy is requiring significant effort – including infrastructure, equipment and materials that require fossil fuels to be manufactured or mined. We continue to expect U.S. oil price (WTI) to remain volatile but stay in the wide range of $60-100 per barrel, while natural gas to move significantly above current levels (one of the lowest prices from the past 3 decades).
• Observations: Last big round of outperformance of the energy sector was driven by record high oil and gas prices. These in turn were driven by rapid economic growth in emerging markets until 2008. The sector was hit by the great recession of 2008-2009, over-production of 2014, trade wars of 2018, and pandemic/shutdown 2020, and gradually increasing fight against fossil fuels. In Q1 2024, the energy sector outperformed the broad market, as we expected, helped by higher oil prices, partially offset by lower natural gas prices.

HEALTHCARE SECTOR - Medium-term Neutral – Short term neutral.

• Assumptions: We expect the healthcare sector to perform in line with benchmarks, like it did since 2017. The favourable demographics (more old people in total population) is largely offset by an excessive (unaffordable) level of spending per capita, and recent promising results in diabetes/obesity medication space.
• Observations: The healthcare sector was outperforming significantly from 2011 until 2015. Large underperformance followed in late 2015 and 2016 because of uncertainties related to health care policies in the U.S. as the government was trying to slow the rapid rise of healthcare costs. The sector continued to underperform in Q1 2024 (in contrast to our expectations), as it did in 2023.

FINANCIAL SECTOR - Medium-term neutral.

• Assumptions: While the sector was struggling with old headwinds, a fresh major headwind hit the sector in 2023 (Silicon Valley Bank failure). We don’t expect major investment opportunities in the long term as the sector might face continued / increasing regulatory pressures on top of legacy headwinds.
• Observations: Sector suffered massive losses relative to the broad market during 2007-2008. Profitability affected by losses from mortgage-backed securities as well as increased regulation and low interest rates. Eroding competitive power as fintech companies are attracted by industry profits. The sector performed in line with broad markets in Q1 2024, as we expected.

CONSUMER STAPLES SECTOR - Medium-term neutral.

• Assumptions: We see limited opportunity in participating in this sector: (1) companies often have slow growth and difficulties in expanding their profit margins; (2) everybody is expecting / discussing recession risk for ~2 consecutive years – a good time to stay away from defensive sectors like this.
• Observations: The 20-year return of the consumer staples sector is very similar to broad market indexes. It usually outperforms the market in a recessionary environment; however, those periods are relatively short. The sector continued to underperform in Q1 2024 (in contrast to our expectations), as it did in 2023.

COMMUNICATIONS SECTOR - Avoid (limited options)

• Assumptions: We see little opportunity in participating in this sector. (1) Legacy communication companies are slow growth or no growth, as their moat is eroding. (2) New generation of companies don’t meet our dividend requirements. Even if they paid dividends, they are mostly mega-cap companies followed by dozens of analysts and investors - i.e., a very crowded space.
• Observations: Sector witnessed significant outperformance after 2008, led by a new generation of communication services companies (Google, Facebook, Netflix, etc). Significant underperformance followed in late 2021 and 2022, due to the same holdings, as it happened with the technology sec In 2023, the sector recovered half of the relative losses from 2021-2022. In Q1 2024, the sector modestly outperformed the broad markets.

UTILITIES & REAL ESTATE (REIT) SECTORS - Avoid (too small and complicated)

• Assumptions: While we occasionally have short term exposure to these sectors in other strategies, we largely avoid them in our core strategy, The Dividend Value Discipline^TM
• Observations: (1) Weak performance due to slow growth, (2) Complex, heavily regulated sectors, (3) Huge sensitivity to interest rates, (4) Clients presumably already have significant exposure to residential and commercial real estate.

Alex Vozian, CFA
Co-Founder and Associate Portfolio Manager Aspira Wealth

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Chris's take on interest rates and inflation

It seems that the overwhelming consensus on both Main Street and Wall Street is that interest rates are heading south. Simply put, I am not so sure, and it wouldn’t surprise me if the longer-term rates move higher.

Here’s why:

I am suspicious of anything where everybody is expecting the same outcome – markets just don’t work that way. Often, taking the opposite tact is the right course of action. You pay an awful price for a rosy consensus.

U.S. Fed Reserve Board Chair Jerome Powell and his team set the world’s benchmark short-term interest rate. Their decisions are supposed to be politically agnostic – if you believe that I have some ice in Siberia to sell you 😊. We are in a U.S. election year – the temptation, and I believe the outcome of the Federal Reserve Board actions will be two rate cuts of say 0.25% each between now and November. Their tardiness to actually increase rates will only fuel an already robust U.S. economy. Furthermore, they will be reluctant to push rates higher during the new president’s honeymoon period and then they will be behind the eight ball – ergo, forced into catch up mode.

The current action in the bond market is pointing to higher long-term rates, not lower. Markets tend to lead the actual happenings by 6-ish months.

Chart courtesy of StockCharts.com

On the inflation front, I am admittedly baffled. The rate of inflation is falling but not as quickly as the U.S. Fed would like – ditto for the Bank of Canada. When I look at the price of oil, copper, and services of late, it begs the question, how much longer can the dropping last. How do you fight inflation? Higher rates.

Chart courtesy of StockCharts.com

Chart courtesy of StockCharts.com

Let’s remember, we just came out of a 40-year period when interest rates ground south. Inflation reflected a similar track. Do we really expect the trip north to be over in the span of a couple of years? Unlikely, in my view.

We make our decisions accordingly,

Chris Raper, CIM, CFP ^®
Co-Founder of Aspira Wealth

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