The first half of 2023 witnessed a reduced pace of interest rate increases and a return to positive performance in the equity markets.
Both the U.S. Federal Reserve and the Bank of Canada will soon complete their fiscal tightening programs. Since March 2022, the central bank overnight rates in Canada and the United States have gone from near zero levels to 5.00-5.25%. The goal of this dramatic increase in interest rates was to tame the inflationary surge let loose by widespread use of expansionary monetary and fiscal policies during the pandemic. The strategy is working, as slowing economic growth has led to a significant decline in inflation. While interest rates may rise marginally further, most of the increases are behind us.
Despite the drag caused by higher rates, the resilience of the economy has surprised many, giving hope that North America may bottom in the form of a soft landing, instead of the recession that has been feared. Equity markets have responded positively to these developments, as investors collectively look through to the next growth cycle. Year-to-date, the U.S. markets have re-established their lead over their Canadian counterpart, which remains dominated by the resource sectors and banks.
Notably, the strong U.S. equity market returns have been achieved on a very narrow base. Seven “mega cap” stocks have generated the vast majority of total equity returns so far in 2023. These stocks, referred to as the “Magnificent Seven”, have rebounded very strongly following a dismal performance in 2022. Beyond these seven, returns in the North American markets have been lacklustre.
The primary factor driving the outsized returns for these stocks has been their exposure to artificial intelligence (AI). With the emergence of ChatGPT, Bard and other AI-based programs, investors have become enamored with the revenue potential of AI and its impact on long-term global growth. While AI will be of increasing importance over the coming years, we believe speculative investors have more than priced in these growth prospects.
While Rempart has appropriate exposure to this emerging technology, it is only one component of the well diversified investment portfolio that we manage for you. We will continue to focus on companies offering superior return prospects within a lower volatility portfolio, obviating the need to speculate on which sector may be in favour at any point in time. During a period when one sector vastly outperforms all others, patience is required as other sectors regain momentum.
With the economic cycle slowing and inflation coming under control, we are increasingly optimistic about the opportunities that will be provided by the next growth phase. We remain diligent in our research efforts to ensure that your portfolio continues to be appropriately positioned.