A Message from Our CEO
Quarterly Letter to MWG Fund Unitholders – October 24th, 2023
It’s a Good Time to Buy
After a strong late spring and summer, the markets began to climb the proverbial wall of worry as labour day passed and fear of a stronger economy would significantly delay the decline in interest rates. Bond yields continued to inch forward, leading to an almost panic decline in formerly safe dividend stocks. For example, BCE, historically considered one of the ultimate “blue chips” of Canadian dividend stocks, dropped 14.2% from $60.40 on June 30th to $51.85 by the end of September, a decline that was mirrored by Telus. Brookfield Renewable Partners, another favourite, dropped 24.6%. Enbridge dropped 10.1% over the same period, while TC Energy lost 13.6%. These are massive drops and show capitulation among sellers who fear even higher rates. The selloff has continued into October, and many of these stocks now yield well over 7%. Only a narrow group of stocks focused on AI (Artificial Intelligence), GLP1(new weight loss drugs) or energy held up against the onslaught. Nonetheless, the S&P500 is still about 15% above its bottom of a year ago.
We believe the worst is behind us! Panic selloffs like this have often been outstanding buying opportunities. So, let’s examine the current situation:
1. Inflationary pressures are declining as supply shortages ease due to the continued reopening of the economy and lower levels of demand resulting from the higher cost of borrowing. The current trailing inflation rate is 3.7%. While short of the Fed’s 2.0% target, it is less than half the annual run rate of 8% in 2022 and, we believe, is heading lower. Is a recession coming? Most likely yes. Classic recessions result from industries building too much inventory due to an overly optimistic outlook for sales. It’s hard to have a recession when the supply side is restrained, as it was during the pandemic, which explains why one has not yet arrived. As supply increases, suppliers need to hire more workers, which leads to more income with which to buy the recovering supply. Eventually, supply catches up, prices drop, and demand normalizes. Already we have seen a rolling inventory correction in general retailing, which is why we recently bought Target, a leading U.S. retail merchandiser. However, a more general recession may occur next year as larger goods such as appliances and automobiles fill the pandemic-induced shortages. When this happens though, inflation and hence interest rates will stabilize or drop, led by the Fed, a very good sign for an improvement in stock market valuations.
2. On the valuation front, while the current P/E of the S&P 500 seems high at 17.9X, it is distorted by the same stocks we mentioned earlier, which are expected to grow at rates that will sustain their P/E’s. However, the median P/E is now just below 15X, which reflects a more pessimistic outlook.
3. Earnings are expected to grow by 10%-12% in the next 12 months as corporations become more efficient as supply normalizes and strong managers control costs and are able to plan more effectively in a less chaotic environment post the Covid recovery moving forward.
4. Sentiment surveys such as CNN’s Market Fear and Greed Index show that investors are more pessimistic than they have been since the market bottomed in the fall of 2022.
In summary, the best time to buy stocks is when pessimism abounds but rational analysis suggests the future is not going to be as bad as investors expect. We believe that time is now.
Bruce Murray, CEO
This message is written by our CEO & CIO, Bruce Murray, CFA.
The purpose of this is to provide insight into our portfolio construction and how our research shapes our investment decisions. As always, we welcome any feedback or questions you may have on these monthly commentaries.