1. Healthcare – Pandemic Hangover is Eclipsing and setting up for outperformance relative to the S&P500
Healthcare has historically been one of the steadiest sectors; above average growth, strong profitability, and a below average risk versus the market. The sector was also one of the primary beneficiaries of the first two years of the pandemic. Vaccines, testing requirements, lack of hospital visits either improved margins or led to rapid growth in sales for many sub industries.
This came to a sharp reversal in 2022 and 2023 with forward earnings growth temporarily dropping to zero and amid another election cycle stirring the usual fears of change. This has removed the premium valuation the sector enjoyed versus the S&P 500 and is experiencing its largest relative drawdown from over the last decade.
As we move through 2024, election jitters will abate, and the resumption of earnings growth should return. This is the classic contrarian setup of poor performance, weak sentiment and cheaper valuations.
2. Equal Weight Will Beat Market Cap Weighted Equities
After the strongest year (so far) since 1998 for the market cap weighted S&P500 versus its equal weighted brethren, an argument can be made for a mean reverting 2024. On average, there used to be a 2x multiple gap (16x vs 14x price to earnings ratio) between these two indices, today it is 4x (18x vs 14x). In other words, other equities within the index might start pulling some weight so watch for more participation among the 500 names.
3. Attractive Risk Reward in Shorter Dated Investment Grade Fixed Income vs Longer Duration Fixed Income
We believe there is value in shorter-dated (under four year) investment grade bonds. While it is always important to be selective, some of these securities offer yields to maturity of over 6.5%. We believe these yields are attractive, particularly on a risk-adjusted basis. Investment grade bonds generally have better trading liquidity and should have less credit risk than their high-yield counterparts do. This could be particularly important if the economy enters a slowdown/recession. If interest rates decline, these bonds should appreciate in value and present an opportunity to sell them and realize a capital gain. If interest rates rise, the coupons still seem attractive and the bonds can be held to maturity.
4. Avoid/Short U.S. Regional Bank Debt
We believe U.S. Regional Banks (and by extension their debt investors) face multiple headwinds:
a. Costs of deposits remain elevated and should stay elevated until we begin to see interest rate cuts
b. Continued non-interest expense inflation (labour, rent, utilities, compliance, technology upgrades)
c. Over $150 billion of the US regional bank debt currently as a negative outlook by at least one of the three major US ratings agencies. These outlooks raise concerns on credit quality and the possibility of higher financing costs
d. Commercial and industrial loans outstanding have begun to decline in recent quarters, less loans = less revenue all else equal.
e. Although still relatively low by historical standards, credit losses have begun to tick up in the 3rd quarter of 2023
f. In the aftermath of the March 2023 banking crisis regulators have begun to propose new long-term debt requirements for banks with assets over $100 billion. If approved, banks would have 3 years to reach a level of compliance. While the details are still being ironed out, the bottom line is that one should expect more debt issuance(supply) from US regional banks over the next 3 years to reach new compliance requirements. All else equal, more supply should lead to higher rates and lower prices in the space. As an add-on we would expect compliance requirements to continue to tighten, adding to costs.
g. US regional banks do typically have more exposure to commercial real estate lending than their large bank competitors. Higher rates and occupancy challenges could lead to lower property values which could lead to credit losses for the US regional banks.
To be clear, we are not calling for widespread insolvencies of U.S. regional banks in 2024. We simply believe that a credit spread of less than 150 basis points does not adequately compensate bond investors for the risks they are taking.
5. CUT! There it is.
While the last two years have all been about inflation and in turn the hiking of interest rates globally to combat it, we are on the page that the US central bank begins cutting interest rates sooner rather than later. The official prediction is that we will see one interest rate cut by the March 20, 2024, meeting. As of writing this, the market is currently pricing in a 43.2% chance of this happening, but we think that number is too low primarily due to the idea that central banks are going to have to lower their inflation forecasts and their restrictiveness. Currently, the FED has its core inflation estimate at 3.7% for December. For this to happen, the economy would need to see an increase of 0.5% for both November and December. To compare how unlikely this is, the October number came in at 0.16%. Not only is inflation momentum slowing down but there is also further disinflation in the pipeline seen in major segments in the calculation which should lead to a recalibration of FED policy and a new regime.
6. Oil continues to Disappoint
While maybe a bit of a tough prediction since the majority of our readers are in Calgary, “we call ‘em how we see ‘em”. The first 11 months of 2023 have seen WTI averaging a price of $77.48 down from the 2022 average of $89.71. We see this lower trend continuing and believe that the price of oil will experience an average price in the high $60s for 2024. The main reason for the weakness in our view is US production (sound familiar?) which surged in 2023 to new all-time highs. US oil production is currently at 13.2 million barrels of oil/day up from 11.8 million barrels/day at the end of 2021. All this while OPEC continues to agree on their production cuts. Saudi Arabia alone has seen production decrease over the last 12 months by just under 1.6 million barrels/day. Our view on continual weakness in price stems from the idea that US production continues to go up or perhaps more dire for the oil market in general a dissolving of the OPEC cut agreements.
7. Slow growth for longer
We have been seeing contraction and slower growth for the betterment of 2023 and continuing into 2024. According to our market cycle clock, we have actually been seeing mostly contraction in the economy at lower growth rates. Now, the market sectors started predicting market expansion a few months ago as more positive returns were being seen by more cyclical sectors, which assumed higher growth rates. But the PMI has yet to prove it; therefore, questioning whether or not we are going to start seeing a growing economy again soon. In addition, there are rate cuts being priced in, implying that the economy needs a little help to get going again. Staying more defensive and aware of what is working and not working will prove value in active management this year.
8. Boring but true
Without too much being predicted going into 2024, besides a US election, we are thinking it’s going to be an average year for both bonds and equity returns. You will naturally see some seasonality and volatility but at the end of the year, it will be an average year. Any surprise by the FED/Bank of Canada or a global macroeconomic event will change the boring part of this prediction, but at the end of the year we are expecting average returns. The bond market in the past 15 years hasn’t offered much in returns, but now it is offering bond holders more attractive returns (pre-tax). Equities, in general, are not considered overvalued or undervalued – prices seem fair. This means we will need to be selective within the equity asset class as growth will likely drive returns again this year and require more active management to determine the allocation.
9. Fueled by the 2024 halving Bitcoin follows a similar price path to previous halving's
The OG blockchain crypto Bitcoin(BTC) has a couple of catalyst events in 2024 that have us intrigued.
a. A BTC spot ETF is near approval in the US.
b.The fourth halving of BTC is estimated to happen mid-April of 2024
Why do these events matter? A spot ETF is the holy grail for retail investors in the US. Until this is approved, US investors have either needed to HOLD their BTC through a digital wallet or use a futures-based ETF for exposure. A futures-based ETF does not actually own any BTC but tracks the price of BTC less any fees. Canadian investors have had the luxury of investing in a spot ETF since February of 2021. We’re already seeing anticipation of this approval with BTC up 165% YTD and up 26% this past month as of this writing.
What is a Bitcoin block halving event?
Block halving events happen every 4 years or 210,000 blocks on Bitcoin blockchain. Bitcoin's initial block reward was 50 BTC. The current block reward is 6.25 BTC, the next block reward will be 3.125 BTC. This lowers the rate at which Bitcoins are generated. The halving is periodical and is programmed into Bitcoin's code. – nicehash.com
In the 12 months post halving (2012, 2016, & 2020), BTC has gone on tremendous runs to the upside. Prediction: BTC exceeds its ATH, $68,789.63 USD, in 2024.
10. Canadian retirees rejoice-the dividend growth investment style has a much better relative year
2023 has been a year with a difficult lesson being learnt for investors who focus solely on the dividend yield being generated by a company and not the total return. Although US headline indexes are primarily up double digits, yield focused investors have not experienced that at all. As of this writing, yield heavy Utility US sector ETF XLU is down 5.5%(including yield) with many other prominent dividend focused strategies moderately down or only slightly up on the year. The main culprit? Better than expected growth and interest rates surprising to the upside. While our internal Dividend Growth equity strategy has outperformed most of those strategies it has still lagged the broader market slightly.
Our view is that this trend will reverse in 2024 so long as those investors focus not just on the yield being generated but also by the growth on that yield. In our opinion, the proper yield strategy within the equity asset class pays attention to not only the yield being generated by a particular name or strategy, but also the growth within that yield. With equity investors focusing only on the yield of a strategy, we find that they essentially are just creating a bond-proxy portfolio and leave themselves susceptible to serious underperformance in a year like 2023.
“GO Kipling Enhanced Dividend Growth Investment Mandate GO”
11. Ready, set, VOTE-election year produces exactly what it typically does.
2020 - 2016 - 2012 - 2008 - 2004 - 2000 all have more in common than just the number 2 and divisive by 4.
We’ve begun another election cycle that undoubtedly will lead to lots of heated conversations at family dinner tables and lots of dominance in news headlines. Ultimately, we believe that this year, like most election years, will play out very much according to script. Historically speaking, election years have a bit of a different seasonality tilt than your typical year where markets tend to see a very choppy first 8 months of the year with uncertainty on which color of tie is going to be in charge followed by a rally in the latter 4 months as it begins to become more clear what the answer to the question will be. That is exactly what we are expecting for 2024. Couple the typical path with the fact that the market pendulum has swung to a very “dovish” central bank narrative, now we expect a choppy but go nowhere market for the first 8 months of the year followed by a strong rally post-election.
12. What about that soft landing?
Although the narrative shift seems to have gone from “worst recession of all time” to “soft landing gear deploy,” we don’t think that market performance has reflected this. Equity performance success in 2023 has been all about secular growth, duration (equity style) and quality compounders which isn’t exactly the type of business that should be the best positioned for a “soft” landing recovery. If this is the case, we expect that there should be mean reversion trade to be felt as the soft landing is being experienced. As such, while not necessarily struggling out right, we would expect that the best performing sectors of 2024 to be more “old economy” type sectors such as Industrial type business and traditional consumer discretionary type businesses. After learning a hard lesson in 2023, our prediction is “If we have a soft landing economically, technology, and in turn the Nasdaq, will not lead equity performance.”