On Wednesday, the Federal Reserve flashed the green light for investors. The central bank not only held rates steady but signaled that it may start cutting interest rates next year. The market took the cue and pushed stocks higher. For several weeks, there’s been a growing gap between what the Federal Reserve has said and what the market expects. While the Fed has tried to sound tough on inflation, the market didn’t buy it. On Wednesday, the Fed admitted that the market is right: the Fed is considering rate cuts. In the Fed’s policy statement, the central bank added something new. It conceded that inflation “has eased over the past year.” In plain English, this means there’s no longer a pressing need for high interest rates. The bottom line is that this was the right decision by the Fed. We saw some panic buying once the once-rigidly bearish realized that “higher for longer” no longer makes sense. Many see the possibility of three rate cuts next year, but it’s important to note that when Chair Powell was asked about real rates during the press conference, he said that “I think the expectation would be that the real rate is declining as we move forward.” Remember that the real rate is Fed funds minus inflation. So, if inflation gets softer without the Fed cutting rates, then the real rate goes up. The Fed actually has to cut rates as inflation softens just to keep the real rates the same. So, to us, Powell suggesting the possibility of declining real rates (as inflation softens) actually means four or more cuts, not just three! Given all that good news, it’s clear why the S&P 500 is now just a whisker away from its record high reached at the very start of 2022. It has almost completely recovered from that horrible year. And the gains are spreading out from the Magnificent Seven that have driven much of the rally. The Dow Jones Industrial Average officially closed at an all-time high this week for the first time since January 2022. It has fully recovered from a -22% drawdown that lasted 23 months. The COVID decline was deeper (-35%) but lasted only nine months. This was the longest drawdown since the Great Financial Crisis in 2008. They say trends correct through either price or time, but this was a healthy dose of both. After two years without progress, the markets have entered blue-sky territory and look ready to resume long-term uptrends. So no, Santa is arriving at exactly the right time.

Should you have any questions or concerns, please feel free to reach out.

Portfolio Notes

(+) indicates a positive development, (-) indicates negative, and (~) indicates neutral

(+) Costco Wholesale (COST-US) posted higher profit in its fiscal first-quarter as same-store sales held steady at the warehouse retail giant. Total revenue rose to $57.8 billion, in line with Wall Street’s expectations. Same-store sales rose 3.8%, the same as in the previous quarter. The company reported a profit of $1.59 billion, or $3.58 a share, in the quarter ended Nov. 26, compared with $1.36 billion, or $3.07 a share, a year earlier. And we are happy to receive a special dividend of $15 a share next year, payable Jan. 12 to shareholders of record as of the close of business on Dec. 28, representing an aggregate of $6.7 billion paid to shareholders. Owned in Core Portfolio.

(+) Netflix (NFLX-US) Technology analyst Mark Mahaney of Evercore (formerly RBC) conducted his 48th quarterly U.S. survey and 10th annual Germany & France surveys (1,300 respondents each). He concludes that Netflix’s leading competitive position remains well intact, and he sees potential upside to subscription expectations and ARPU growth estimates next year, with a potential 10% upside to his current price target. Top 5 findings from the surveys: 1. Netflix’s leading competitive position remains unchallenged: Netflix remains the #1 Streaming service in the U.S., Germany, and France. The U.S. actually saw Netflix’s Penetration rising 1% Q/Q, widening its lead against ALL Paid 6 Streaming competitors we surveyed (most of which saw declines in Penetration), perhaps in part due to Netflix being better insulated from the strike-related content disruptions, and an overall easing competitive environment for Netflix. Netflix also largely kept its lead vs. the closest competitors in France though modestly slipped in Germany. 2. “Core Netflix” better than expected in the U.S., though modestly negative in Germany & France: In the U.S., we saw an uptick in Penetration and a small downtick in Churn Intent for Netflix, though Satisfaction continues to trend down. In Germany & France, “Core Netflix” metrics (Penetration, Satisfaction, Churn Intent) were mixed to modestly weaker, but remain intrinsically robust (e.g., Satisfaction at a whopping 77% for both countries, vs. 46% in the U.S.), which leads us to think that the weaker “Core Netflix” results are more of a sign of maturing markets rather than any fundamental deterioration. 3. SAVOD (Subscription & Advertising Based VOD) may be an indirect Pricing Power Booster: We have seen evidence of SAVOD’s potential Anti-Churn power, as a substantial % of Netflix subscribers who may cancel are “Extremely/Very” likely to change their mind and stay with the Ad-tier.. Owned in Core Portfolio.

(+) Prologis (PLD-US) held their 2023 Investor Day. We were particularly encouraged by the improvement in leasing activities driven by Retailers’ trying to catch up to supply chain standards set by Amazon. While management expects demand will likely fall short of elevated deliveries in 1H24, thereby pushing market vacancy rates higher (sub 6%), we believe the trend will begin to reverse in 2H24. We were also impressed by PLD’s ambition to grow its Essentials business (solar, energy storage, charging stations) from $49m revenue in 2023 to $1.4B in 2030. We like PLD for its scaled portfolio of well-located industrial facilities, which positions the company well to capitalize on the long-term growth in e-commerce as well as increased real-estate demand from on-shoring/near-shoring and supply chain modernization. Owned in US Portfolio.

(+) Uber Technologies (UBER-US) It is now official. Uber is joining the S&P 500 index before the opening of trading on Dec. 18, according to S&P Dow Jones Indices, which oversees the index. The Uber addition isn’t a surprise. At $116 billion, the ride-share company is the largest U.S. company ranked by market capitalization that wasn’t in the S&P 500. Uber qualified for inclusion in the S&P 500 after its third-quarter earnings report showed profitability over the prior four quarters based on generally accepted accounting principles. Stocks often advance on the news of company additions to the S&P 500 as investors buy ahead of index-related purchases on the addition date, hoping to profit from potential gains from the announcement to addition date. Owned in Core, ESG+, US and Opportunity Portfolios.

(~) Pembina Pipeline Corporation (PPL-T) Pembina entered into an agreement to acquire Enbridge’s interests in Alliance, Aux Sable and NRGreen for an aggregate purchase price of approximately $3.1 billion, including approximately $327 million of assumed debt, representing Enbridge’s proportionate share of the indebtedness of Alliance . This complements Pembina's strategy of providing access for world-class, long-life resources from the Western Canadian Sedimentary Basin to premium end markets and increases exposure to lighter hydrocarbons, including natural gas and NGL. Shares of Pembina Pipeline were down as they are funding the deal through additional stock priced at $42.85 per share, a 7% discount to the prior close. Owned in Cash Flow Portfolio.

Sector Spotlight: 2024 Oil Outlook RBCCM expects WTI to average US$79 and US$75 per barrel in 2024 and 2025 respectively, implying upside of ~11% and ~9% from current levels. However, volatility should be anticipated in the year ahead as price action is expected to be by a supply driven market. Recall that OPEC+ announced plans to curb production by 2.2 million bbl./d in early 2024 which would be supportive of higher oil prices. On the other hand, a few non-OPEC countries are on pace to grow production by nearly 1.9 million bbl./d, largely offsetting the production cuts. Furthermore, new refineries are expected to come online, and electric vehicle sales just reached 40% of the total market in China within the last month. The former implies that refining margins are at risk of being squeezed while the latter speaks to the sustainability of long-term oil demand. Overall, we believe oil producers are well positioned to weather volatile commodity prices given their efforts to strengthen balance sheets. Put differently, we believe producers will continue to return capital back to shareholders via dividends and share repurchases. we continue to have neutral exposure to the energy sector across portfolios.

Weekend Reading

RBC MacroMemo - December 12, 2023 - January 8, 2024 Everything rallies / Strong data but weak trend / Happy inflation / Central bank cuts? / Record elections ahead / Global tax / De-globalization / AI RBC

The Top 50 Rated Holiday Movies 2023 Edition While there are hundreds and hundreds of holiday movies to choose from, which are considered the very best? Rotten Tomatoes gives us a handy ranking of their top 50 rated movies, that range from the early 1940s to 2023. ROTTEN TOMATOES

Canada’s housing market downturn is spreading Most markets are now in correction mode with high interest rates, the loss of affordability, and mounting economic uncertainty holding back homebuyer demand, and supply-demand conditions having significantly eased since spring. RBC

Capitalism, the Keystone of Modern Prosperity Despite the rise of anti-capitalism across the political spectrum, Johan Norberg sheds important light on the benefits and major advances brought about by capitalism. HUMAN PROGRESS

Billionaire Ambitions Report UBS publishes an annual report with insights from its mega-rich clients. You can read it here, it's now on its ninth year. UBS

Why the Magnificent Seven are Magnificent Are the Seven undervalued when earnings growth is considered? ROUNDHILL