Quarterly Markets Update | Q1 2023

Welcome to Matco's

quarterly

update

. Investment

markets

began the year following the trajectory of Dr. Jekyll and Mr. Hyde. January brought with it quieter Dr. Jekyll

markets

. February passed without incident and the turbulent Mr. Hyde's markets emerged in March. The themes driving these contrasting trajectories, which we will address shortly, may seem familiar. If you had a chance to see our annual outlook for

2023

published earlier this year. So let's start with the developments that were aligned with our annual outlook. First, zero growth in corporate profits during January and February. North American companies reported their corporate

update

s in which we have the opportunity to see if they continue to grow their profits in Canada.

Overall, corporate earnings growth across all S&P TSX companies caused earnings to decline 1.1%. This contrasts with profits that grew 22% through 2022, a sharp and notable drop. This was no surprise to us and our expectations were for a meager 6% and earnings growth for this year, almost all of which is expected to materialize in the second half of the year. Second, central banks will stay on the sidelines throughout 2022. The Bank of Canada and the United States sharply increased interest rates by about four and a half percent. However, our expectation was that both central banks would stop their rate hikes at the end of the first quarter.

In fact, the Bank of Canada paused its interest rate increases in March. The United States reduced its running pace to a crawl in March with a small increase of 0.25%, and is expected to remain on the sidelines after a further increase of the same 0.25%. Now, third, valuation multiples are expanding. Although corporate profit growth was non-existent during the first quarter, the fact that central banks are no longer raising interest rates dramatically has been welcomed by markets. Financial conditions may be tight, but not tightening has allowed valuation multiples to expand and grow in simpler terms. This means that stock prices have been able to rise, which mainly occurred during the month of January.

Despite the lack of corporate earnings growth, as mentioned, those three themes are in line with our expectations for our annual outlook for

2023

. The list of themes that are not aligned with our outlook is shorter but still significant. It would be the emergence of a banking crisis in mid-March. Silicon Valley Bank or SVB faced a run on its deposits, forcing the bank to go into receivership or file for bankruptcy. Other banks, such as Credit Suisse, First Republic Bank and even Pacific Western Bank, have been under similar pressure. SVB was later acquired by First Citizens Bank and Credit Suisse by UBS.

These acquisitions have helped to more critically alleviate strain on the financial system. The US federal government has implemented measures to safeguard bank deposits beyond the typical $250,000 covered by deposit insurance. These things, in combination, have prevented a bank run by depositors and, at the same time, reinforced confidence that the banking crisis would not spread beyond a few select banks. Although markets had maintained their gains through February, increased stress on the financial system due to these particular events caused markets to give up most of their year-to-date gains in the month of March. Developments in the banking sector have begun to highlight the economic implications of rising interest rates.

This summarizes the main events of the first quarter. But where do we go from here? Despite both aligned and misaligned developments during the first quarter, the overall economy remains in good shape. The labor market has continued to show resilience. Unemployment rates in Canada and the United States have decreased by 2% to 4% over the past two years and remain stable at low levels. We have seen some layoffs, particularly in the technology sector. However, there have not been widespread layoffs, as evidenced by the continued decline in the initial unemployment claims indicator. Inflation, the market's main obstacle over the past year, continues to decline, although at a slower pace than desired.

Global industrial production has also recovered, as a result of the easing of COVID policy restrictions in China. And finally, consumer confidence has improved materially over the past six months. In short, the general economic fundamentals are intact. Looking ahead to the rest of the year, we expect markets to continue rising during the second quarter. While volatility is likely to re-emerge in the second half of the year, it will create a difficult environment for markets to maintain their gains. What has all this meant for the Matco Investment Platform? The Matco Balanced Fund is a multi-asset class portfolio with exposure to fixed income, Canadian and global equities.

Our asset mix committee actively manages oversight of the fund's investment mix. Our main risk tool, the investment horizon indicator, rose from the neutral zone and approached the protection zone in January. Approaching the Protection zone indicates that, from a risk management perspective, the fund's investment mix should prioritize capital protection. As a result, the Asset Mix Committee made an active adjustment by decreasing the fund's global equity exposure by 5%, while increasing its fixed income exposure by the same 5%. This will offer the fund a higher level of income while providing more protection as the economy slows. The fund is up 3.2% so far this year.

Matco Canadian Equity Fund invests in large- and mid-cap dividend-paying companies and is diversified across several sectors. During the first quarter of 2023, the fund increased its weightings in the industrials and materials sector. The Fund's two largest sector exposures currently are financials at 29% and industrials at 24%. In terms of resource exposure, the fund has 11% in energy and 5% in materials. So far this year, the fund is up 4% and has an annualized return of 17.5 percent over the past three years. Currently, the fund has a dividend yield of 3.75%. Now, recently one of our holdings, TD Bank, has made headlines because of concerns that they are overpaying for First Horizon Bank in the United States.

TD may renegotiate a lower price given the uncertainty over the US regional banking sector. However, even if they don't renegotiate a lower price, we think TD Bank is still a good investment for long-term investors and we're not worried about that in the long run. Given that, like other Canadian banks, they have a strong balance sheet and excess capital to withstand any concerns of a banking crisis in Canada. The Matco Global Equity Fund is built with a well-diversified mix of publicly traded stocks. Provides clients with exposure to US, international and emerging markets with a reasonably priced and growth investment strategy;

The fund's objective is to provide long-term capital appreciation for investors. So what has happened so far? Well, during the first quarter of 2023, the fund reduced positions in US, Japanese and emerging market stocks. while joining Europe. The evolution of the global financial sector represented a challenge for the markets in general during the period. However, due to the fund's investment process, there was no direct exposure to the troubled US banks. As of 3/31/23, the fund has returned 5% year-to-date and 13.8% annualized each year for the past three years. I'm here to talk about the Matco Small Cap Fund. This fund invests in smaller, dividend-paying companies that typically grow faster than the economy.

During the first quarter of 2023, the fund increased its energy weight in the consumer discretionary sectors and reduced its weight in technology. The reason we reduced our weight in technologies was that one of our companies went private with an 80% gain in the portfolio. So we were very happy about that. Now, today or at the end of March, the fund's two largest sector exposures are energy at 24% and financials at 21%. Big weights in a small cap portfolio. So far this year, the fund is down slightly at 0.5%, but has a three-year annualized return of 15.7% each year for the last three years.

Now, the fund is very attractive in terms of dividend yield, it has a dividend yield of more than 5%. The Matco Fixed Income Fund is a portfolio constructed of investment grade Canadian bonds with the sole objective of preserving capital while generating income. The fund employs a multi-strategy approach that optimizes its exposure to interest rates, credit and the yield curve. Given the more attractive yields offered in the market, along with the prospect of central banks reaching the end of the interest rate hike cycle, the fund extended its duration or interest rate sensitivity by 0.25 years in the first quarter.

The fund's current duration is 7.4 years, with a current yield of 3.3% and a yield to maturity of 4.2%. Overall, the fund is currently positioned to generate healthy income over the next 12 months, with the ability to provide capital appreciation if interest rates potentially decline in 2024.