Thoughts on the Market: October Edition
Interest Rates are down. Interest Rates are up.
The U.S. interest rate cuts widely telegraphed by the Federal Reserve began in earnest in September with a 50 basis point cut (50 basis points, or bps, is equal to 0.5%) to the overnight rate, followed by a 25 bps cut in early November. Overnight rates are the rates the Fed and other central banks use to achieve their monetary goals and drive floating rate products like prime rate and variable rate mortgages After two years of elevated overnight rates, the decrease has brought some reprieve to short-term holders. Additional rate cuts will flow through as they occur.
The remaining term structure is set by the bond market. Just like a fixed rate 5-year mortgage, governments and companies often term out their financing by issuing 1-to-50-year bonds. These rates are set by the market and are based on factors such as the expected shape of short-term interest rates, credit risk, inflation risk, and economic conditions that affect supply and demand for bonds. The longer the term to maturity, the less influence overnight rates have on market rates.
This is evident in looking at the yield curve for U.S. Government Bonds. In mid-September, shortly before the U.S. Federal Reserve lowered overnight rates, 1-month rates were above 5% given the 5.25% in-force policy rate. However, term rates were anticipating a long easing cycle,
with rates 1-year and beyond all priced below 4% (Figure 1 – orange line). Nearly two months later, longer term rates have increased despite the 50 BPS cut in September. Why? It depends on who you ask, with some commentators highlighting stronger economic data while others point to risks of inflation re-accelerating or large U.S. deficits.
Figure 1: U.S. Yield curve September 13 and November 5, 2024
Source: Refinitiv Workspace, The Murray Wealth Group
In Canada, long term rates have followed the lead of the U.S. and thus are hovering at 2-month highs. We still believe that the Bank of Canada lowering short-term rates will support yields and dividend stocks as investor money flows from GICs and savings accounts in search of yields over 3%. However, economic conditions may need to deteriorate further for markets to price in further interest cuts.
On Tuesday night, the Trump Administration was elected for a second term. There is early optimism that a Republican sweep can lower taxes and improve economic growth. Less certain is whether there will be any headway on reducing the deficit, although that would certainly be welcomed by investors. We recognize that governments and policies come and go, thus we place little emphasis on these factors when making an investment decision with a three-year plus time horizon unless we view changes that would materially affect our investment thesis. Of course, we continue to prefer geographies with the strong democratic values and free markets found in most of the Western World.
GLOBAL EQUITY GROWTH FUND
The MWG Global Equity Growth Fund was down by 0.1% in October, slightly below the 1.0% rise in its benchmark. Year-to-date, the Fund has returned 22.9% versus the benchmark return of 22.4%. The Fund’s top three performers in the month were Morgan Stanley (16%), Air Canada (+15%) and Lululemon (+13%), while Converge (-35%), Aritzia (-12%) and LVMH (-11%) were the biggest detractors.
Portfolio Managers Summary
While technology stocks have recovered back to their previous highs, they have not broken out to new highs. That crown belongs to financials, with the XLF up 20% since June 30, 2024. Where is the pressure? Energy remains a laggard, with gasoline prices back at 2018 levels. Oil prices remain subdued, with strong non-OPEC supply growth (including in Canada), but may see upside if the Trump Administration increases pressure on Iran and other bad actors.
During the month, we sold Manulife, one of our longstanding investments. The shares had rallied to reach all-time highs (dating back to 2007), owing to the strong management team now in place. The team has increased return on equity, monetized under-earning assets and improved book value growth. We redeployed the proceeds into TD Bank, which now has the highest upside to our target price in the financials space following its regulatory issues. We continue to hold Manulife shares in the Income Growth Fund.
INCOME GROWTH FUND
The MWG Income Growth Fund increased 1.4% in October, above the 1.1% increase in its benchmark. The Fund is higher by 19.8% year-to-date versus the benchmark increase of 20.2%. Capital Power (+15%), Cogent Communications (+9%) and Doman Building Materials (+7%) were the top performers, while Kering (-10%), TD (-9%) and Northwest Healthcare (-9%) were the top detractors. The fund yield was 5.7% at month-end.
Portfolio Managers Summary
The portfolio performed quite resiliently in October, a month during which bond yields increased by 40 basis points. As expected under these conditions, real estate focused companies were weak, with returns in that cohort between -3% and -8%. Most of the companies in the portfolio used the 6-month window of low rates to refinance their long-term debt or sell assets and now have much more resilient balance sheets. Thus, should inflation re-emerge, our companies should be better positioned to manage their debt. We are also going on year three of lower construction starts and thus the potential for a supply gap is growing as rates remain high. This could create tight market conditions for real estate assets later in the decade.
Capital Power is our largest holding in this fund and has continued its strong performance in November. The company is receiving indications of demand for new datacenters in Alberta, where Capital Power has excess capacity at its Genesee Power Plant. If electricity markets tighten as expected with major new loads from AI datacenters (which require massive amounts of power currently), Capital Power will see more demand across its portfolio of independent power plants.
This Month’s Portfolio Update is written by our Head of Research, Jamie Murray, CFA.
The purpose 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.