Quarterly Market Commentary

as of December 31, 2023

Commentary

What's happened since the last report?


The following commentary represents the opinions and analysis of Doug Nelson, Portfolio Manager and Founder, Nelson Portfolio Management Corp. as of October 10th, 2022. Market and index returns noted below are based on the price changes for each quoted item for the period ending September 30th, 2022 and, in other instances, October 7th, 2022. Market Statistics: Source: https://ycharts.com

Market returns from July 1st, 2022, through to September 30th, 2022:

• Over the past three months, the Toronto Stock Exchange Composite Price Index (TSX) declined by -2.21%. The two sectors in Canada that contributed to most of this decline were the Real Estate sector (XRE; -8.52%) and the Energy sector (XDG; -6.65%). The two sectors that contributed positively to the market were the Materials sector (XMA; +1.94%) and the Consumer Staples sector (XST; +0.66%).

• In the U.S., the broad-based New York Stock Exchange Composite Index (symbol: NYA) declined by -7.01%, the S&P 500 Index (SPX) declined by -5.28% while the Nasdaq 100 index (NDX) declined by -4.63%.

• Internationally, the Europe / Asia index (EFA) declined by -4.08% and the Emerging Markets (XEM) declined by -7.14%.

• Defensive investments, such as the broad Canadian Bond Index (XBB), generated a price return of -0.36% for the past three months whereas other defensive investments, such as U.S. corporate bonds (XIG; -7.52%) and U.S. high yield bonds (XHY; -4.10%) all declined.

With these declines in mind, the first half of the past three months had actually seen positive gains, whereas the last half lost these gains back to the market:

• Beginning in mid-June 2022, the market began to believe that perhaps interest rates would not increase as much as previously expected. This created a fairly sizeable rally in both the stock and bond markets between July 1st, 2022 and August 14th, 2022.

• Then, from August 15th, 2022 to the end of September 2022, all of these gains were given back to the market, as you can see in Table #1 below.

• A sample Balanced Growth portfolio (40% XBB, 30% TSX, 30% XWD) generated a small loss of
-0.19%. When you add into this return the same fees incurred within the NFC Tactical Asset Allocation Pool (the ‘Pool’), a comparable return would be approximately -0.50% (vs. the gain we see in the Pool).

• The Pool generated a small positive gain (+0.02%) over these past three months with less volatility.

Table #1: Market Fluctuations Over the Past Three Months: (Data Source: https://ycharts.com)

What happened to create this change in direction?

• On the one hand, nothing much really happened. “The market” began to anticipate that interest rates are not likely to increase as much. Some economic data supported this view while other data did not. This was speculation from “the market” of what may happen with interest rates this coming fall.

• In mid-August, the Federal Reserve reiterated (the U.S. central bank) that interest rates will continue to increase, which then pushed stock prices and bond prices lower. This burst the bubble of the speculators.

• In the end, over the past three months, the markets gained in value throughout July and half of August, then from mid-August through to the end of September, markets declined.

With the past three months in mind, what do things look like so far this year and for the last 12 months?

• The first 9 months of 2022 has seen a lot of downside (January 1st, 2022 to September 30th, 2022), as you can see in Table #2 below. While these declines have had a negative impact on portfolio returns, it has also created a lot of buying opportunity today, and in the coming months.

• The year-to-date returns are in the -13.0% to -32.0% range for most of the broad-based indexes. A sample Balanced Growth portfolio is estimated to have a return of approximately -13.4% so far this year. By comparison, the Pool has a return of -9.587% so far this year. This means that the Pool return is approximately 28.0% better than this sample portfolio.

• Over the past 12 months, returns range between -8.1% and -25.0% for the broad-based indexes. A sample Balanced Growth portfolio is estimated to have a return of approximately -9.07% while the Pool has a return of -5.29%, which is approximately 41.0% better than the sample portfolio.

While we see some sizable declines so far this year and over the past 12 months, the Pool has protected well against these declines.

Table #2: Sample Returns So Far This Year and Over the Past 12 Months: Data Source: https://ycharts.com

Below is our typical table that shows returns for different types of investments and market sectors by quarter and over the past 12 months.

Table #3: Asset Class, Region and Sector Returns Over Past 4 Quarters and Last 12 Months:
Data Source: https://ycharts.com. Data compiled by Nelson Portfolio Management Corp.

Over the last 12 months, in the column on the far right, you will see that the Toronto Stock Exchange Composite Index has fallen less than the U.S. indices (-8.10% TSX vs. -16.55% NYA), primarily due to the very large increase in the Canadian Energy Index (XEG, +48.07%). Without this increase, the returns on the Toronto Stock Exchange Composite Price Index would have been much lower. However, even with this being said and with this excellent gain in mind, the Canadian Energy Index (XEG) has declined by -25.0% since June 8th, 2022 (to September 30th, 2022).

Looking back over the past 9+ years, from September 2013 through to September 30th, 2022, the Toronto Stock Exchange Composite Price Index chart is as follows.

Chart #1: Historical Returns of the S&P TSX Composite Price Index: September 3, 2013 to September 30th, 2022. Data Source: https://ycharts.com.

• The Last 12 months: The TSX Composite Price Index: -8.10% vs. the Pool: -3.0%.

• The Last 3 Years: TSX Composite Price Index: +3.45% per year.

• Last 5 Years: TSX Composite Price Index: +3.36% per year.

• The Last 7 Years: TSX Composite Price Index: +4.77% per year.

How Has the NFC Tactical Asset Allocation Pool Performed During This Time?


As shown in Table #2 above:

• Over the past 3 months the Pool gained by +0.02%.

• So far this year the Pool has declined by -9.587%.

• Over the past 12 months the Pool has declined by -5.29%.

To put these numbers into perspective, we are going to measure against two comparative balanced portfolios:

• Balanced Income Portfolio (60% Canadian bonds, XBB; 20% TSX Composite Index, 20% MSCI Global Equities Index, XWD).

• Balanced Growth Portfolio (40% Canadian Bonds, XBB; 30% TSX Composite Index, 30% MSCI Global Equities Index, XWD).

In Table #4 we see the comparative returns of the Pool vs. these two comparative portfolios:

Table #4: Comparative Performance Over the Past 3, 6 and 12 Months: NFC Tactical Asset Allocation Pool vs. a comparative Balanced Income Portfolio and a comparative Balanced Growth Portfolio. Source: https://ycharts.com. Data compiled by Nelson Portfolio Management Corp. Croesus Software.

• The Pool generated a return that was 25% better than the comparative Balanced Income Portfolio so far this year. The comparative difference increases to 45% over the past 12 months (-5.29% for the NFC Tactical Asset Allocation Pool vs. -9.58% for the comparative Balanced Income portfolio).

• The Pool generated a return that was almost 29% better than the comparative Balanced Growth portfolio, so far this year. Over the past year, the difference increases to 41% (-5.29% for the Pool vs. -9.07% for the Balanced Growth comparative portfolio.

Despite the declines of the Pool, we see that the Pool did outperform quite significantly relative to some comparative portfolios. Other defensive holdings that we hold in some client accounts include the Horizon’s Conservative Total Return ETF and the iShares Core Moderate Allocation ETF. For the first 9 months of the year, these defensive ETF portfolios declined by -18.4% and -19.49% respectively (vs. the Pool at -9.59%). Over the past 12 months these two ETFs declined by -14.81% and -18.17% respectively (vs. the Pool at -5.29%).

The current asset mix of the Pool is 55% defensive and 45% growth. This is a “Balanced – Income” risk profile. You can see how the Pool is more defensive today than in the recent quarters. On December 31st, 2021, the cash component was 2.0% whereas today it is 10.83%. On December 31st, 2021 the defensive component was 33.6% vs. 43.95% today. This means that the growth component has declined from being 64.39% on December 31st, 2021, to 45.22% today, September 30th, 2022.

Table #5: Historical Asset Mix of the NFC Tactical Asset Allocation Pool: Source: Croesus

We use the Pool returns because this will either represent 100% of your portfolio or 60% of your portfolio and it is a good proxy for your overall portfolio returns depending on your fees and risk profile.

What have we been doing over the past few months?


In July I wrote the following: “As markets, and our individual holdings, fluctuate, we continuously assess the trend. Is the investment trending higher? Is it trending sideways? Is it trending lower? Based on these trends, we will then make a decision as to whether we should add to the position, leave our current allocation as is, trim the position so as to take our profit and set it aside or if we should exit the position in its entirety.”

We have continued to apply this same strategy:

• As markets have declined, you can see in Table #5 that both the cash component and the defensive components have increased in weight, from 33% in June 2021 to 55% today (September 2022).

• The Pool has approximately 11% held in cash. We will keep this money in cash and allocate it to those investments that we believe have excellent long term growth prospects. These securities are where we see the prices today and are also considered to be very good entry points for new investments or adding to existing securities.

• Of the 43.95% that is allocated to defensive investments:

o 10.5% is allocated to individual bond holdings. Most recently we have added a longer-term bond issued by Capital Power Corporation, with an interest rate (coupon) of 7.95% per year. The overall bond portfolio now has an average annual yield to maturity of approximately 7% per year.

o 2.0% is allocated to individual preferred share holdings. With rising interest rates, the prices of these securities have declined, and so we have made some additional purchases at lower prices. The current yield on these investments is approximately 5.95% annually.

o 31.0% is allocated to the private markets: private lending, private real estate, private equity and other actively managed credit strategies. This is the area that will help provide regular income (6% to 8% annually) with minimal volatility.

o The defensive component of the portfolio is expected to contribute annual returns exceeding 7.0% per year in the years to come.

• Of the remaining 45.0% is held in equities: Over the last 3 months, this component of the Pool GAINED in value by +0.491%. (vs. the TSX Composite Price Index that declined by -2.21%). We continue to actively manage these individual holdings by watching their trends week by week. We may add to a security, or add a new security, if the price looks attractive. We may trim a current position if the trend appears to be changing. We may sell out of a position if we believe the downside risk is considerable. We may also sell a position if we wish to take the tax loss. The tax loss offsets previous gains in the Pool.

• Over the past 12 months, the returns in the growth component (i.e.: equities) of the Pool are approximately -8.70%. By comparison, the TSX Composite Price Index was -8.10%, the New York Stock Exchange Composite Index (NYA) was -16.55%, the Nasdaq Index (NDX) was -25.31% and the MSCI World Index (XWD) was -12.50%. This means to me that our equity portion of the Pool also performed very well relative to other indices.

To summarize, we have been very busy actively managing the portfolio with the goal to protect against further losses (should this market continue to move downward), add to positions at much lower prices (looking forward to generating future profits when markets recover) and add to the diversity of the portfolio (so as to generate a consistent return with less risk).

Where Do We Go From Here?


In July I wrote to you the following:

At this time, there continues to be three main disruptions that are impacting the investment markets:

• Disrupted supply chains and shortages of labor (due mostly to Covid-19),

• War in Europe and the supply of oil, natural gas, materials, and food (due to Putin’s war in Ukraine),

• The resulting impact on inflation, forcing central banks to increase interest rates.

As in all times, these disruptions could either find a solution in a) the short term, b) the medium term or c) the longer term.

If a solution is found in the short term, then we may begin to see stock prices begin to rise again in the coming weeks. If it is determined that these problems are going to be with us a little longer, then we could see another 10% downward move in the equity markets between now and the fall. Finally, if these problems take longer to solve, then my view is that we could see these markets continue to trend lower into the spring of 2023. Some project that markets could move 15% to 20% lower from the current levels. Should this occur, then the correction of 2022 – 2023 will not be unlike the corrections we saw in 2000 (to 2002) and 2007 (to 2009).

This remains my view today.

In July I continued to write: With these thoughts in mind, we are choosing to position ourselves for the middle scenario for now. We are going to maintain our defensive stance assuming that markets have a higher likelihood of seeing some further declines this summer. (Which we did, but this didn’t happen until mid-August.) But as these declines occur, we will continue with the same strategies that we have used over the past few months: actively trimming positions to hold on to profits as they occur while actively adding to positions as stock prices move further downward, thus setting us up well for the next market rally. We do expect to see interest rates continue to climb this year, possibly by another 1.5% to 2.0%, which is very significant.

With these thoughts in mind, the markets today are looking for some good news, which could come in any number of different forms: i) corporate profits are better than expected and future projected corporate profits remain strong (we will see these results over the next several weeks), ii) some resolution to the war in Europe, iii) less global tensions with China, iv) supply chain disruptions beginning to ease, and v) lower energy prices. Some of this would contribute to lower inflation, which in turn would lead to stabilized interest rates or even declining interest rates. My personal view, however, is that we may see higher interest rates for a longer period of time. Rates may not increase much further, but they may also not be cut any time soon, whereas some predict a more significant recession in 2023 that will be accompanied with interest rate cuts.

Depending on the points noted above, markets could respond positively, or we could see more downside moves to the market of approximately -10% to -15%. To help cushion from these declines, we continue to take an increasingly defensive approach. We are not concerned about any specific area of your portfolio or of the Pool. Instead, we will continue to look at each individual security and manage it accordingly, as it fluctuates during these times: buy more, trim or sell.

No one can predict the future market direction and sentiment changes daily. We will continue to watch the market, and our investment holdings, and act accordingly as the days, weeks and months unfold.
Should you have any questions or concerns about this commentary, our approach, or your specific portfolio, please reach out to Lynda or I. We would love to review your portfolio in detail with you any time you wish.

The first nine months have been very dynamic and will no doubt continue throughout the year. To be successful in this phase of the market cycle, we need to take advantage of short-term trading opportunities while also adding to positions once they correct. Both of these strategies increase the odds of longer-term success. Thank you, as always, for the continued trust and confidence that you have placed in us. We will get through these times.

All the best!

Doug

Announcements:

• Book Value vs. Market Value on Your National Bank Independent Network (NBIN) statements: The book value information on your NBIN statement is not your net invested value. Rather, the book value is the total of your invested value minus withdrawals and plus any dividend income received. Thus, part of your investment return over time will show up as part of your book value. Therefore, please do not compare the book value and market value on your NBIN statements and believe that the difference is your investment return.

• Discrepancies between the Nelson portfolio reports and the NBIN monthly statements: We see that in some cases there are some small discrepancies between the total portfolio value seen on the Nelson statements and the NBIN monthly statements. In most situations these discrepancies are caused by the timing of when the NBIN statements are produced and when the data concerning the quarterly distribution for the Pool is provided to NBIN. This is a timing issue and not an error. Should you have any questions or concerns, or if you identify other discrepancies, please let us know immediately.

• Paper vs. Secure E-Mail Link: It is NPMC’s preference to provide to you this quarterly portfolio package by e-mail. However, if you would like to receive this package in paper format, please let us know and we will accommodate your preference accordingly.

"IMPORTANT DISCLOSURES: The comments above are for information purposes only and do not constitute specific financial advice regarding your specific situation. Please consult a professional financial advisor who is familiar with your personal situation before acting on any information presented above. Every effort has been made to ensure this information is presented responsibly and accurately. However, important details may have been missed or these details may have changed since the publication of this note. All facts and opinions noted above must be reviewed to ensure their accuracy is still relevant based on today’s specific situation, whatever that may be. Nelson Financial Planning Corp is not responsible for any action you take regarding this information."