Q2 PIMG COMMENTARY: RESILIENCE IN THE FACE OF A SLOWING ECONOMY?

The second quarter witnessed a consolidation of early 2023 trends as artificial intelligence (AI) captivated the markets’ attention. Inflation and interest rates mostly continued along their expected trajectories - softer inflationary pressures and slightly more aggressive monetary policy. Geopolitics remained tense but very little on this front moved markets. The formula to do well last quarter was simple, talk up your company’s exposure to AI and the longer term benefits that this advancement could bring.  

While most of the economy continued to weigh the probabilities of recession, the technology sector shrugged off the majority of concerns. The Nasdaq 100, which loosely reflects the largest 100 technology companies in the U.S., has risen close to 40 per cent year to date. Compared to the much more diversified Dow Jones Industrial Average and TSX Composite which were up 3.5 per cent each, it is clear that buyers were focusing on the latter sector within equity markets. To be sure, many large technology companies that are familiar and have less obvious association with AI are participating with the likes of Apple, Amazon, Google, Microsoft and other big tech names, showing strong leadership this year. Looking outside of technology though, most other sectors were muted in performance with utilities, healthcare and energy in negative territory.    

While we hope AI will bring advancements to all of our lives, we remain somewhat sceptical of its immediate contribution to the fundamentals of businesses related to it. As portfolio managers who focus on value, we are hard pressed to see valuations of companies at 40x sales as attractive opportunities. Some of these valuations resemble the dot-com era of the early 2000s where the grand promise of the burgeoning internet caused investors to lose sight of economic reality. Many of the technology companies mentioned above are likely still great purchases for those with a long term time horizon but, in the near term, these companies may need to see a period of revaluation. Along these lines, we have been reducing exposure to select technology in client portfolios as part of our rebalancing process. We also continue to reduce our commodity exposure as falling inflation has pushed underlying prices lower.  

Conversely, we have been adding to names that have been pushed lower by higher interest rates or concerns of a deep recession. Fortis, Telus, BCE and the Canadian banks currently offer attractive valuations with an added benefit of decade-high dividend yields and cash flow to investors. All of these companies are part of the “dividend growers” theme that we continue to believe in and has been a cornerstone of our investing principals. In an era of rising prices, a consistently growing dividend is a great incentive to stay invested and helps protect investor’s income and purchasing power over time. History also illustrates that dividend growers display less volatility – a recipe for comfort during turbulent times.

Concerns over an economic slowdown remain front and centre. Higher interest rates and the effect on consumer demand will undoubtedly continue to be a second-half story. Can consumption and travel trends be maintained in an era of 5+ per cent mortgage rates? Can the personal balance sheet continue to be drawn down without risk? Central banks are certainly expressing their monetary authority to cool strong demand, with the main tool being higher interest rates. While there is undoubtedly a lagged effect to this data, another component that is often overlooked is the story of demographics. Baby boomers hold the largest amount of wealth in Western society and are entering a part of their life cycle in which they want to enjoy the use of this hard-earned capital. They have little in the way of debt and an appetite to travel and enjoy the fruits of their labour. Will higher rates impact their spending? Anecdotally, we haven’t seen this show up yet.     

The markets surprised many, in the first half of the year, with its resilience in the face of a slowing economy. As we have been suggesting since last fall, the negative performance of most assets throughout 2022 was pricing in some level of economic weakness. Perhaps the worst of the economic slowdown is behind us and the proverbial soft landing has been achieved. It’s entirely possible that the performance in the technology space is the first sign of a return to growth that the rest of the market will soon start to participate in. With inflation seemingly under control, it’s not hard to imagine a pause in interest rates and a resurgence in parts of the economy that have been hamstrung by debt. A broadening out of market performance would be a very positive sign and something we will be watching closely for, in the quarter ahead. We were encouraged as the quarter came to close, as this trend began to emerge and we saw many sectors start to produce positive returns. AI as a theme will continue to attract attention but we expect new themes to emerge as this overheated area of the market subsides. We can only imagine that these quarterly commentaries will soon be written by our robot friends, but until then, our insights continue to be issued in the “old fashioned” way by our portfolio management team.

This newsletter has been prepared by Plena Wealth Advisors. Statistics and factual data and other information in this newsletter are from sources Raymond James (RJL) believes to be reliable but their accuracy cannot be guaranteed. This newsletter is furnished on the basis and understanding that RJL is to be under no liability whatsoever in respect thereof. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. RJL and its officers, directors, employees and their families may from time to time invest in the securities discussed in this newsletter. This newsletter is intended for distribution only in those jurisdictions where RJL is registered as a dealer in securities. Any distribution or dissemination of this report in any other jurisdiction is strictly prohibited. RJL is a member of the Canadian Investor Protection Fund.

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