Market Update & Portfolio Commentary

May 17, 2024

KEY TERMS REFERENCED

Spring 2024

Geo-political Risk: Geopolitical risk, also known as political risk, transpires when a country’s government unexpectedly changes its policies, which now negatively affects the foreign company. These policy changes can include such things as trade barriers, which serve to limit or prevent international trade. They can also include military conflict and supply chain disruption as a result.

Disinflation: Disinflation is a temporary slowing of the pace of price inflation. The term is used to describe occasions when the inflation rate has reduced marginally over the short term. Unlike inflation and deflation, which refer to the direction of prices, disinflation refers to the rate of change in the rate of inflation.

Stagflation: Stagflation is an economic cycle characterized by slow growth and a high unemployment rate accompanied by inflation. Economic policymakers find this combination particularly difficult to handle, as attempting to correct one of the factors can exacerbate another.

MARKET UPDATE

In the first quarter of 2024 global markets continued their defiant growth story. Equities across the globe shrugged off higher interest rates and performed better than expected. The renaissance in Artificial Intelligence lead the charge, but there were some signs of reduced capital expenditure in the sector as well as signs that inflation is not ready to dissipate. Coupled with geopolitical uncertainty we continue to feel cautious optimism is the most prudent path forward for clients in 2024.

The global economic landscape is in flux. The sharpest monetary policy tightening in four decades slowed growth less than expected in 2023, but long and variable lags between policy changes and economic impact suggest recession risks remain. In recent decades, the United States and China have been the two primary economic locomotives. In 2023, US growth surprised on the upside as consumers depleted much of the over $2.25 trillion of excess savings accumulated during the pandemic. Going forward, consumers will increasingly rely on wage gains and, to a lesser degree, Federal Reserve easing to support spending. This was evident in the first quarter of 2024 as inflation surprised to the upside, but stronger wages and low unemployment pushed global markets higher.

Growth in China faltered as the housing sector, which comprises nearly a quarter of GDP, fell into crisis. This led to a slew of stimulative measures announced by various levels of the Chinese government. This could lift prospects this year, but we continue to remain cautious on Chinese equity exposure.

Japan was the outlier in Asia for 2023 with tremendous growth across their markets. We expect Japan to continue growing through 2024 as the Bank of Japan (BoJ) seeks to redress the negative impact of 30 years of deflation.

Stagflation plagued the Eurozone through much of 2023, but conditions improved in the first quarter of 2024 as inflation levels came down across the zone. While we think this is a positive for Europe as a whole, we continue to keep a lower weight in client portfolios. Our underweight to Europe results from concerns about unfriendly business regulation and the cost of supporting Ukraine weighs on fiscal budgets for France, Germany, and the UK.

The US economy was far more resilient than expected in 2023 and in the first quarter of 2024. The labor market added an average of 215,000 jobs per month, far above the number required to maintain a stable unemployment rate relative to population growth. With disinflation underway, the United States is entering the second quarter of 2024 in a better than expected position economically, but questions and risks remain. The key question is when and how quickly will inflation return to the Fed’s 2% target? Higher than expected energy prices and a US consumer that is currently defiant to cost of capital headwinds have proved this target to be somewhat unattainable in the short term. Fed policy has shifted to a wait and see approach to rate cuts, thus setting up the markets for an interesting 2024 with domestic politics, geo-political concerns, and fed policy all pulling the markets in different directions.

What’s ahead for the rest of 2024:
The well-documented rise of the Magnificent Seven tech stocks has left them looking richly priced. However,

valuations for the sector overall are not excessive based on price to earnings ratios. As Artificial Intelligence moves from building the “plumbing” to more applied benefits for software firms and others, we expect to see wider opportunities in the sector. As a result we initiated portfolio positions in data center real estate. The data center real estate and storage centers are a key component to Artificial Intelligence and quantum computing as they provide the necessary infrastructure for computing. To make room for this addition to the portfolio we exited the cyber security sector ETF but continue to have exposure to cyber security equities through our broader technology holdings.

The U.S. industrial sector is expected to accelerate its profitability in 2024, with net revenues on par with 2023 levels, but lower cost such as rents, commodities, and supplies should fuel further growth. In addition, the defense sector which has overlap into the industrial sector is set to grow as the US starts to replenish their defense stockpiles after supporting Israel and Ukraine conflicts. Industrial companies are often mature and stable given the predictable cash flow and dividends making them ideal investments in periods of volatility. As a result, we initiated portfolio positions in the US industrial sector.

We continue to be diversified and increased holdings in safe haven assets such as gold, high quality corp. bonds, and treasuries in order to mitigate the multiple risks faced by investors. We have however, maintained investments in growth areas such as large cap technology companies, mid cap equities, and sectors with promising fundamentals. We particularly favor dividend paying technology companies as well as mid cap equities with free flowing cash.

We anticipate regional opportunities as the monetary policy cycle turns. US valuations are up but still reasonable in a global context of earnings growth and anticipated rate cuts. The normalisation of monetary policy and improving corporate governance, along with geopolitical tailwinds, support the case for Japanese equities.

In conclusion, we are extremely pleased with how portfolios have fared to start 2024. Yet we remain cautious for looming risks in the economy given persistent inflation, cost of capital headwinds, and geo-political conflict risks.

The expectation of a soft landing is an obvious positive for the macro environment. Consumers will benefit from resilient economies and job markets while a disinflationary environment increases real purchasing power. But we expect volatility around the timing of potential rate cuts, and from elections, which may present opportunities. We will be focused on quality indicators, such as strong balance sheets, cash flow, and leadership, when evaluating companies across growth, value, and income styles.

Areas of Focus Across all Catalyst Portfolios:

Domestic Equities
○ Large Cap Tech & Dividend (Overweight but less than prevous) ○ Mid-Cap Equities (Neutral Holding)
○ Data center & Industrial sector (New Positions)

International Developed Equities ○ Japanese Equities (Increased)

Global Commodities ○ Gold (Increased)

Removed / Reduced Positions

○ Shorter Term Bonds (Reduced)
○ Non Dividend Technology (Reduced) ○ International Broad Equities (Reduced) ○ US Broad Equities (Reduced)
○ Cyber Security Equities (Removed)

Increased Positions
○ Emerging Market ex china equities ○ Japanese equities

○ Gold
○ US Treasuries and Investment Grade Bonds with intermediate duration

We thank you for your continued confidence and trust. We strive to be champions of your financial dreams.

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