Market Commentary

Q4 2024

 

 

 

 

As we exited 2024, the markets continued their upward momentum through the fourth quarter, with the S&P/TSX Composite Index up 3.8% and the S&P 500 Index up 9.0% in Canadian dollar terms. These strong results built on an already stellar year for both indices, with the S&P/TSX and S&P 500 returning 21.7% and 36.4% respectively for the year in Canadian dollar terms. The returns for the S&P 500 were more in line with the TSX when viewed in local currency terms, with the S&P 500 returning 25% in 2024. The nearly 1,000 bps difference stems from the weakness in the Canadian dollar, which we will touch on later. Equity market returns have been quite strong over the last five years, despite living through a global pandemic for half of this period. As we head into 2025, we find ourselves in a position where valuations are elevated. This is similar to where we stood last year at this time, especially in the U.S., where index returns have been primarily concentrated around a few equities. In Canada, valuations look more reasonable, and the 22% return in 2024 was broad-based, with Royal Bank and Shopify being the largest contributors. Other areas of the market that experienced positive returns included Financials, Pipelines, and Materials stocks. However, for the S&P 500, approximately half of the returns have been attributed to eight stocks, all in the technology space and mostly related to potential growth opportunities from Artificial Intelligence. This is consistent with the theme we saw in 2023. In our view, it is unusual for returns to be so concentrated around a handful of equities for two years. Historically, this type of market leads to a crowding effect with elevated valuations and the risk of significant downside, reminiscent of the dotcom crash of 2001. We see Artificial Intelligence as an important innovation for mankind, and our funds have some exposure to this theme. However, we are careful when managing our investment exposure, as we want to be diversified by idea and sector. We would much rather see broader participation by all parts of the market, which makes us more cautious on the U.S. market.

Heading into 2025, there are a few changes coming to the political landscape in North America. In Canada, we may see a change in political regime after a decade of Liberal leadership. Opinions vary on how effective Liberal policies have been for the Canadian economy. Currently, it appears that Canadians are worse off than they were before the pandemic. This shift in voter mindset suggests a potential change in leadership to a Conservative-led government sometime this year. Several areas will need to be addressed by a new government, including improving productivity growth, tempering immigration, investing in infrastructure and innovation, reducing bureaucracy, and potentially retooling the tax regime.

As we write this, we are a week away from a Republican government taking control, led by President Trump in the United States. There have been many headlines about the Trump administration using tariffs as leverage to influence foreign nations. This could negatively impact Canada, as we are the United States' largest trading partner. While there is a lot of rhetoric around tariffs and their impact on Canada, we anticipate that any potential tariffs will be measured, as the Republicans have to be careful not to reignite inflation, which could occur if a tariff war were to start. The risk of tariffs will be in the headlines for the next few months, but we suspect the impact will be more measured due to the various trade agreements already in place, such as the United States-Mexico-Canada Agreement (USMCA). Unfortunately for Canada, tariff headlines will gain more attention as our government is prorogued until sometime in March, complicating negotiations with the United States in the interim.

Another issue that will continue to make front-page news is the direction of interest rates and the relative strength of the U.S. economy versus Canada, which could lead to differing monetary policies. In the U.S., some areas of the economy have seen inflation come down, but other areas remain high. With inflation still pacing ahead of the 2% target level, coupled with a decent job market and reasonable consumer spending, there seems to be little room for the U.S. central bank to cut interest rates as much as the market is discounting. Furthermore, if tariffs are imposed and tax cuts are implemented by the Trump administration, this could reignite inflation.

 

In Canada, the situation is different. Our economy has seen a slowdown with lower productivity rates and job creation falling below expectations. This will be further impacted by a clampdown on immigration levels and a highly indebted consumer. We believe our banks are in great shape to weather this storm and have provisioned conservatively. Hence, there is a strong argument that the Canadian central bank will be forced to cut interest rates more aggressively than our trading partner to the south. While this will translate into low interest payments for Canadian citizens, it points to a weaker Canadian dollar. We have already seen the Canadian dollar weaken versus the U.S. dollar, stemming from instability in our government, the risk of a tariff war with the U.S., and lower interest rates. We suspect further weakness in the Canadian dollar is possible for the first half of the year until we have clarity on the leadership of the Canadian government and tariffs.

Taking everything into consideration, it should not come as a surprise that we are taking a cautious approach as we head into 2025. The key unknowns are related to the economy and the potential for a recession. This is further compounded by several government elections occurring globally, potentially bringing changes in the ruling party’s political ideology. Finally, elevated equity valuations lead us to be cautious. However, this backdrop sets up an ideal market for stock pickers and those looking for more value-oriented names. This is a positive for the Canadian market due to our high composition of commodities and value-type sectors.

Despite our cautious stance, we continue to believe that, on a relative basis, the Canadian market remains attractive, though there could be some bumps along the way in the first half of the year. Looking back over the last decade, it has been a great run for the U.S. market, while Canada has shown strength in certain periods, partially offset by tough years in 2015 and 2018. As active managers seeking opportunities, Canada stands out as one of the better places to invest for several reasons. First, the Canadian market trades at a discount to its peers, with the TSX trading at 16.5x forward earnings, looking much more reasonable compared to the S&P at 23x and the MSCI World at 19x. Second, we have a very solid banking system in Canada, which has shown its stability in prior financial crises, including the regional bank crisis in 2023, and it accounts for 20% of our index. Third, our large exposure to some of the leading material and energy operators provides a solid inflation hedge, accounting for 30% of our index.

Our primary focus is always on the long term, but we will make tactical adjustments to the portfolio as valuations change. With that in mind, we have taken profits in some companies by either exiting positions or trimming weights where we felt prices had moved out of step with valuations. Currently, our cash weights are a little higher than normal. We are not market timers, and our decision on cash weights reflects the relative opportunities in the market. We would highlight that we are finding more opportunities in Canada versus the U.S., where we feel we are better compensated for risk, which is why our foreign content is on the lower end of the historical range.

In conclusion, we believe markets are emotional and volatile, but our process is not. We continue to be patient and adhere to our discipline, which is to build a concentrated portfolio of high-quality businesses that will grow over the long term and generate compelling risk-adjusted returns through various business cycles. We continue to look for opportunities to invest in high-quality companies where we will be paid for the risks in the portfolio. We want to reiterate an important point: we don’t view volatility as risk. We define risk as a permanent loss of capital, which is why we always focus on preserving capital by constructing a well-diversified portfolio of leading businesses with strong balance sheets. We believe that with thorough research, you can construct a diversified portfolio of businesses that can be owned through different economic cycles.

We thank you for your continued support.

Don Simpson Vice President & Senior Portfolio Manager

Eric Mencke Vice President & Portfolio Manager

Rory Ronan Vice President & Portfolio Manager

 

Fund Update

For the quarter that ended December 31, 2024, Dynamic Canadian Dividend Fund Series F returned 0.4%, underperforming its benchmark the S&P/TSX Composite Index, which returned 3.8%. An underweight allocation and security selection in the Information Technology sector and security selection in the Utilities sector were the largest detractors from relative performance. This was partially offset by positive security selection in the Financials sector. The largest individual security contributors to the Fund were companies such as Onex Corporation (Financials), Atkinsrealis Group (Industrials), and Enbridge (Energy). Northland Power (Utilities), Toronto-Dominion Bank (Financials), and Boardwalk Real Estate Investment Trust (Real Estate) had a negative impact on performance.

The Dynamic Value Fund Of Canada Series F returned 1.2%, underperforming its benchmark, S&P/TSX Composite Index, which returned 3.8%. Security selection in the Information Technology and Real Estate sectors were the largest detractors from relative performance. This was partially offset by positive security selection in the Financials sector. The largest individual security contributors to the Fund were companies such as Onex Corporation (Financials), Enbridge (Energy), and Brookfield Corporation (Financials). Boardwalk Real Estate Investment Trust (Real Estate), BCE (Communication Services), and Toronto-Dominion Bank (Financials) had a negative impact on performance.

The Dynamic Dividend Advantage Fund Series F returned 1.8%, underperforming its benchmark, S&P/TSX Composite Index, which returned 3.8%. Security selection in the Utilities sector and an underweight allocation and security selection in the Information Technology sector were the largest detractors from relative performance. This was partially offset by positive security selection in the Energy sector. The largest individual security contributors to the Fund were companies such as Enerflex (Energy), iA Financial Group (Financials), and TC Energy (Energy). Northland Power (Utilities), Eurofins Scientific (Health Care), and Roger Communications (Communication Services) had a negative impact on performance.

The Dynamic Value Balanced Fund Series F returned 1.0%, underperforming its blended benchmark, 60% S&P/TSX Composite Index & 40% FTSE Canada Universe Bond Index, which returned 2.3%. Security selection in the Information Technology sector and a cash drag were the largest detractors from relative performance. This was partially offset by positive security selection in the Financials sector. The largest individual security contributors to the Fund were companies such as Onex Corporation (Financials), Amazon.com (Consumer Discretionary), and Brookfield Corporation (Financials). Toronto- Dominion Bank (Financials), Canadian Pacific Kansas City (Industrials), and Tech Resources (Materials) had a negative impact on performance.

The fixed income component performed in-line with the benchmark for the quarter. The bond markets sold off over the past three months which has led to a reduction in the expected number of rate cuts to 1 in the U.S. and 1.5 in Canada. We benefitted from spread compression but our exposure to the US yield curve would have been a detractor as US yields rose by more than Canadian yields. We maintain a credit overweight in the portfolio.

 

Performance Update

 

The performance periods in grey represent time periods that start before the current manager’s tenure. Indices are not managed and it is not possible to invest directly in an index

 

¹Don Simpson lead portfolio manager since January 2015. He was co-manager from December 2012 to December 2014.

²Don Simpson (lead manager) and Eric Mencke assumed management on September 19th, 2017.

³On April 17th, 2018 Rory Ronan was announced as lead manager on Dynamic Dividend Advantage Fund/Class as well as co-manager on all other mandates managed by Don Simpson and Eric Mencke.

 

 

^{ADVISOR USE ONLY – Series A units of the Fund are available for purchase to all investors, while Series F units are only available to investors in an eligible fee-based or wrap program with their dealer. Any difference in performance between these series is due primarily to differences in management fees and operating fees. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return are the historical annual compound total returns including changes in unit values and reinvestment of all distributions does not take into account sales, redemption or option changes or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. L.P. Views expressed regarding a particular company, security, industry or market sector are the views of the writer and should not be considered an indication of trading intent of any investment funds managed by 1832 Asset Management L.P. These views should not be considered investment advice nor should they be considered a recommendation to buy or sell. These views are subject to change at any time based upon markets and other conditions, and we disclaim any responsibility to update such views.}

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