We at MPW are happy to call 2023 a success. Barring turbulence in the final weeks of December, most of our clients have posted double-digit returns for the year and are beating their respective category averages by 2-4%. This is despite the fact that Canada’s stock market is up only 5% over the same period. The key thing we did right: we stuck to our guns and held a strong position in quality stocks, particularly those that were hit hardest in 2022. Granted, we did make some mistakes this year – for instance, we were overly optimistic on the prospect of China’s economy to bounce back. On balance, however, we were able to create significant value for clients in 2023 and are now focused on doing the same in 2024. We therefore thought it would be useful to provide a quick overview of our thoughts on fixed income and equity markets as we move into the year ahead.
Fixed Income: The best balance of risk and reward
We have been positioning our portfolios for a peak in interest rates for most of the past year. To this end, we increased the amount of fixed income in our portfolios to the highest levels in the past decade. We aggressively pursued discounted bonds since they have the added tax benefit of converting interest into capital gains. These were locked in at tax-equivalent rates between 6.5-7.5%. We also extended our bond duration – meaning we bought bonds with longer maturities (think 7-10 years out) – in anticipation of rates coming down. Come November, inflation expectations dropped meaningfully (taking rates along with them) and our positioning paid off.
We continue to build on this positioning as we head into the New Year because we believe rates will continue their downward move, as shown on the table below. This has two important implications. First, current bond yields are still above most clients’ financial planning return targets. In other words, it is still a very good time to get invested in this space. Second, high quality bonds bought today have the potential for short-term gains if rates continue to move downwards. This makes their risk/return profile more attractive than any other asset class, including stocks and alternatives like real estate.
On a related note, we believe CAD will eventually strengthen relative to USD over the year ahead. For this reason, we have opted to hedge a good portion of our USD exposure and will continue to do so for the foreseeable future.
Equity Markets: Expect turbulence but recovery in sight
Our view on stocks is fundamentally optimistic despite the heightened possibility of a global recession. That said, we expect periods of higher volatility next year as the economy works through a weak patch and the US presidential election takes center stage. Historically, such elections have been a positive for markets but have usually resulted in turbulence throughout the year. This, coupled with the attractive risk/reward of bonds, means we now hold a lower exposure to equities than our normal portfolio targets (think 55% instead of 60% on a Balanced mandate). This is one way we are managing volatility proactively moving forward.
Notwithstanding this, the nature of our stock holdings is geared for growth. From a sector perspective, we remain most excited about technology. The demographic trends we are seeing globally (baby boomers retiring, shrinking workforce, etc.) lead us to believe that the need for technological advancement is going to increase in importance over time, regardless of the economic cycle. Beyond tech, we also have meaningful weights in the industries we expect to grow faster than the economy at large, particularly in North American industrials and health care. We are paying special attention to names beyond the “magnificent 7” (Nvidia, Amazon, etc.) that have dominated market performance of late. This includes companies in the small/mid-cap space, which we expect will outperform when we ultimately come out of the current global economic slowdown.
The bottom line
We are more cautious than we were last year and so are limiting the amount of risk we’re taking by keeping the relative balance of stocks and bonds tilted towards the latter. This aside, within equities, our focus remains on quality companies positioned for growth. This will allow our clients to participate meaningfully as we enter the next leg of market recovery regardless of any noise that might occur along the way. We remain vigilant for opportunities and will continue to prioritize capital preservation above all else.