Q1 PIMG Commentary: Ignoring the noise

The first quarter was once again a testament to a few key principles to successful investing; 1) avoiding investment decisions based on short-term noise, and 2) the importance of focusing on company specifics as opposed to markets as a whole. Entering the year our view was that many of the factors that contributed to last year’s negative returns were showing signs of transitioning. We expected inflationary pressures and central bank policies to shift from a headwind to a tailwind. However, the quarter was filled with some new noise as the impact of recent interest rate increases started to show up in unexpected ways. While these developments may have “spooked” some investors, those who favour high quality businesses and have a long-term outlook were given yet another opportunity buy good investments at reasonable prices.

Data over the past few months has indicated that inflation continues to trend in the right direction. Many inputs such as commodities, utilities, wages and core goods have all been moving lower. Unfortunately, core services such as shelter and transportation remain stubbornly elevated and these are key metrics to central bank forward guidance. In response to improving data, the Bank of Canada did pause raising interest rates while the U.S. Federal Reserve revised their previously expected 0.50% rate increase to 0.25%. Should these trends continue, the 14 month interest rate tightening cycle is likely near its end. Bond markets are telegraphing this potential outcome with yields trading lower across most maturities while futures markets are pricing in interest rate cuts in the latter half of this year.

Volatility throughout the quarter remained mostly subdued relative to 2022’s heightened levels. The only exception was a two week spike in volatility in mid-March as the U.S. banking sector witnessed three regional banks seek creditor protection. As noted in our podcast and email update to clients, we believe the issues that impacted Silicon Valley Bank, Signature Bank, Silvergate Capital and Credit Suisse were specific to these companies. While all banks and financial institutions are dealing with the impact of rising interest rates, some have proven not to be managed as well as others. The issues that each of these banks faced were wide ranging. In the case of Silicon Valley Bank, a highly concentrated depositor base coupled with overexposure to long-term bonds created a sudden decline in available capital. Silvergate and Signature appeared to have too much exposure to crypto currency. Finally, Credit Suisse, which has been hampered by difficulties since 2008, finally succumbed to its myriad of widespread issues. The rapidly rising interest rates of 2022 was the common culprit that exposed these banks weaknesses. While some blame the fall on regulators who seemed to miss some obvious warning signs, ultimately the poor or over aggressive management of these banks must be held mostly responsible. With measures taken by the Federal Deposit Insurance Corporation (FDIC), the U.S. Treasury and the Federal Reserve, the threat of contagion was “ring-fenced, and volatility subsided within a few weeks.

Are these cracks in the financial sector the only concern for the markets and economy? Likely not as the impact of the fastest interest rate increase since the 1970s will continue to filter through both personal and corporate balance sheets that are highly levered. Commercial real estate, auto loans and credit card debt are already starting to see delinquencies edge higher while the personal savings rate has come down after spiking during the pandemic. Bank lending standards are also tightening, proving access to credit for small and medium businesses will be scaled back in the coming quarters. Conversely, the household debt to service ratio is near its lowest level in 40 years, and the overall unemployment picture remains robust. As for financial institutions, tier 1 capital ratios among the biggest banks remain strong while banks facing similar issues to those noted above are presumably making all efforts to reduce risk and avoid similar fates. Our base case scenario for the remainder of 2023 is a slowing economy with the prospects of a deep recession a low probability.

Fortunately, our managed accounts and portfolios produced positive returns this quarter. Leadership was strongest across exposure to technology and consumer discretionary. Not surprising, U.S. banks were noticeable laggards, yet Canadian financials once again displayed relative strength. Tactically, we added to core financial sector positions we already held such as Brookfield and JP Morgan while also adding a new position in Fortis.

We also harvested some gains in a few companies that had run up in valuation. Microchip, Otis and Chubb were all trimmed in size while maintaining a position in the companies. Fixed income investments continue to look attractive with investment grade corporate bonds offering yields near 5% with the additional benefit of capital appreciation as most are trading at a discount to par value. For balanced investors who seek a mix of cash, fixed income and equities, the investment backdrop continues to look attractive as we see opportunity in all asset classes. This is a markedly different environment to a year ago when cash and bonds were offering very little in yield. Once again, diversification across sectors, currencies and geographies is among key attributes to portfolio return and muted volatility.

This was another noisy quarter in what has been a volatile few years. In addition to the bank concerns there were increased geopolitical issues that emerged. However, despite these issues our strategy remains the same; our intention is to continue to focus our time allocating clients assets to strong businesses that will endure the ups and downs produced by the short term noise. As Charlie Munger, Warren Buffett’s partner, said in their recent shareholder letter, “Warren and I don’t focus on the froth in the market. We seek out good long-term investments and stubbornly hold them for a long time.”

This investment philosophy has worked through periods of high inflation, low inflation, peace and war, and through a multitude of market and economic environments and we don’t expect this to change.

Your Plena Wealth Advisory 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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