Lester Asset Management, 2023 Year End Letter Excerpt

Lester Asset Management, 2023 Year End Letter Excerpt

January 26, 2024

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2023 was another volatile year for both Equity and Fixed Income markets, as investor sentiment swung from deep pessimism about stagflation and recessionary fears to euphoria that central banks might start aggressively cutting rates as soon as March 2024. Investors who once again panicked during the October lows, as in 2022, missed a powerful rebound in both Equity and Fixed Income markets during the last 2 months of the year. This reinforces one of the most important principles in investing: staying invested. Trying to time the market is a losing proposition, since missing powerful short term rallies can materially affect long term returns.

 As per previous comments, we have always believed that inflation was “transitory” caused by supply/demand imbalances and supply chain disruptions post-pandemic, combined with a spike in commodity prices fueled by Russia’s war on Ukraine. In fact, the rapid rise in interest rates by central banks contributed to inflation through rising shelter costs. The rate of inflation, which ever way you measure it, has declined naturally as these anomalies normalize, not because of the rate hikes. This is why the head of the U.S. Federal Reserve (Fed) Jerome Powell and the head of the Bank of Canada (BOC) Tiff Macklem have “pivoted”. It was only a question of time before bonds would rally strongly on lower inflation data, and that stocks would follow suit. The North American economy is indeed slowing because of the rate hikes, and if it slows down too much, “bad” economic news will be seen as “good” news by the bond market as yields would decline, which would also benefit stocks. Yet, since the job market remains strong and savings rates are still high, a “goldilocks” scenario is possible where disinflation or even deflation occurs along with a sound economy (the opposite of stagflation). 

We therefore see a very positive environment for both stocks and bonds in 2024. As mentioned at this time last year, the high inflation environment has created a uniquely attractive opportunity for investors to benefit from elevated yields on Fixed Income securities because of the aggressive rate hikes by central banks. This remains the case today with yields on short-term corporate debt securities still in the 6% to 8% range, representing equity-like returns with very low risk. After receiving a Top Performer Award in 2022 by Global Manager Research (GMR) for the best 1-Year Annual Return in 2021 in the Canadian Fixed Income Universe category, LAM received two more GMR Top Performer Awards in 2023 for the best 5-year and 10-year returns in the Canadian Fixed Income Plus category for the period ending December 31, 2022. And once again in 2023, we finished in the 1st quartile for the LAM Canadian Bond Fund that we manage for Quebec pension funds as part of the Quebec Emerging Managers Program. 

Despite present market uncertainties and volatile geopolitics, our investment strategies remain focused on navigating short-term volatility and positioning portfolios for strong long-term risk-adjusted returns. As always, we wish to express our sincere thanks to our loyal clients for their trust in us. 

On behalf of the entire team including Lorie, Kate, Elisa, Helen, Olivier and Matthew, we wish you our warmest wishes for a healthy, happy, and peaceful 2024. 

Stephen Takacsy, President & CEO

Tony Boeckh, Chairman

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Macro-Economic Outlook

The Covid pandemic-related distortions to the North American economy and global financial system continue to unwind. These distortions were reflected primarily in massive fiscal stimulus that caused a huge increase in personal savings and expenditures, shortages in the supply of goods, disruptions to supply chains, shortages of workers, a sharp rise in house prices and overall inflation. This caused a roller coaster ride in bond and stock prices as inflation soared to levels not seen since the early 1970s. Equities took off on the initial surge in liquidity which was driven by both fiscal and monetary policy against a backdrop of extraordinarily low interest rates. The BOC and the Fed reacted too slowly, allowing inflation to take root and the economy to overheat. When they did react in March 2022, inflation had already surpassed 6%, and they had to aggressively raise interest rates and withdraw liquidity from the financial system. Monetary policy, being late to react, had to fight stimulus from massive fiscal deficits. As a result, interest rates had to rise higher and faster than otherwise would have been needed to cool the economy and tame inflation. As a result, bond and stock markets were volatile throughout most of 2023 with prices making lows in the latter part of October. 

The turnaround in financial markets was triggered by a return of confidence that the distortions in the economy were finally dissipating. In particular, inflation and the expectation of future inflation moved lower throughout 2023, and by the 4th quarter had reached the BOC and Fed targets of 2%. Excessive savings and a tight labour market, which had supported high consumer spending, is normalizing. The labor market has begun to adjust positively as wage inflation, labour shortages and labour force growth is improving. Some sectors of the North American economy are slowing, however, the U.S. reported GDP growth of 3.3% annualized for the 4th quarter. Canada, on the other hand, has shown no growth for the past six months, in good part due to a weak housing sector and commodity prices. Canadian households are far more indebted than their U.S. counterparts and, with shorter maturity mortgages coming due, are more affected by high interest rates. The disappointing Chinese and European economies have also been a negative factor for Canada which is a more open economy than the U.S. Furthermore, Canadian fiscal policy turned more restrictive as 2023 progressed.

Looking ahead, 2024 will see a continued re-adjustment of the post-pandemic distortions, with inflation continuing to fall and the economy remaining soft due to the lagged effects of the prior restrictive monetary policy and removal of fiscal stimulus. While the overall growth rate in Canada could move slightly below zero for a quarter or two, a recession (as commonly thought of) is unlikely, for several reasons: Canada has a large influx of immigrants, the Canadian dollar is cheap, and the U.S. economy is doing well. Nevertheless, a slowing Canadian economy, weak inflation numbers and an improved fiscal situation will allow the BOC to take a more accommodative stance. The policy rate is likely to be cut significantly which will guide interest rates lower. This will allow mortgage rates to fall significantly, cushioning the blow to indebted Canadian households. Lower rates, combined with 2% core Personal Consumption Expenditures (PCE) inflation, suggest that a soft landing is very much in the cards.

The bottom line is that 2024 should see a softer economy but also increased confidence that inflationary expectations are well contained within the BOC’s target range of 1% to 3%. Rate cuts and a further decline in yields across the maturity spectrum will produce higher bond prices. Stock markets will face crosscurrents, however falling interest rates are bullish for valuations as P/E multiples rise. Despite soft patches in certain sectors, falling interest rates should trump a temporary weakening in profits. The Canadian dollar is cheap, which translates into undervalued Canadian assets relative to the U.S. and the rest of the world markets

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Stephen Takacsy 

Matthew Kaszel 

Olivier Tardif-Loiselle 

Tony Boeckh

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Source

https://lesterasset.com/wp-content/uploads/2024/01/LAM2023Letter.pdf