Canadian equities: Short-term challenges, long-term opportunities

IN Partnership with

Garey Aitken, head of Canadian equities at ClearBridge Investments, a specialist investment manager of Franklin Templeton, on opportunities in the US and Canadian markets

THE GLOBAL equity landscape has shown remarkable strength, particularly in the US, where economic indicators continue to demonstrate resiliency despite broader global uncertainties. However, persistent inflation and market concentration are the primary risks that need ongoing monitoring. In contrast, Canada has felt the impact of higher interest rates on its economy and inflation more acutely than the US. Canadian stocks are generally priced lower than US equities, with longer-term secular trends looking favourable. In the US, despite high core inflation and stretched valuations, government funding is increasingly directed towards technology sectors and reshoring initiatives. ClearBridge Investments’ head of Canadian equities, Garey Aitken, sheds light on the resilience of the US market and the strategic positioning of Canadian equities.

Franklin Resources, Inc. [NYSE:BEN] is a global investment management organization with subsidiaries operating as Franklin Templeton and serving clients in over 150 countries. In Canada, the company’s subsidiary is Franklin Templeton Investments Corp., which operates as Franklin Templeton Canada. Franklin Templeton’s mission is to help clients achieve better outcomes through investment management expertise, wealth management, and technology solutions. Through its specialist investment managers, the company offers specialization on a global scale, bringing extensive capabilities in fixed income, equity, alternatives, and multi-asset solutions. With more than 1,300 investment professionals and offices in major financial markets around the world, the California-based company has over 75 years of investment experience and more than US$1.6 trillion (approximately C$2.2 trillion) in assets under management as of March 31, 2024.

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US and Canada inflation trend

“Given our inherently more defensive current positioning, it’s typically challenging for us to keep pace with a robust benchmark over short periods. Our disciplined approach generally meets our performance objectives, delivering results to clients with a suitable investment time horizon”

Garey Aitken, ClearBridge Investments

US equities, though stretched in valuation, seem poised to benefit from several emerging and sustainable growth themes. Aitken elaborates: “Despite high valuations, US equities are benefiting from significant themes like artificial intelligence, manufacturing reshoring, and renewed infrastructure investments.” These elements are expected to drive the US market forward, maintaining its positive trajectory amid potential global economic pressures. “The US market hosts a greater number of what we might call AI enablers – companies that are significantly integrated with large language models, bolstered by comprehensive cloud infrastructure and substantial data resources,” Aitken explains. “In contrast, Canada’s involvement is more on the level of AI adapters; there, companies might benefit from implementing AI to enhance their business processes. Undoubtedly, this AI growth has been a significant catalyst for the performance of US equities in recent quarters.”

As we observed a dovish pivot in central bank signals, particularly from the US Federal Reserve chairman in late 2023, market expectations were initially set for six to seven US interest rate cuts this year. However, these expectations have shifted significantly due to solid economic growth, stable employment conditions, and persistently high inflation, leading to a revised forecast of potentially fewer rate cuts.

For equity investors, long-term rates, such as the 10-year rate, are often more indicative of market conditions. Both the 10-year Government of Canada bond yield and the US Treasury rate have seen increases over the last few months, influencing the broader equity market, though not uniformly across all sectors. Particularly in Canada, Aitken highlights, sectors sensitive to interest rates, like utilities, telecommunications, and real estate, have faced considerable pressure. Despite a strong start to the year for the equity markets, there’s been a clear divergence, with some sectors struggling due to these rate dynamics. This scenario stresses the significant impact that interest rate movements could have as we progress through 2024. The possibility of the US 10-year Treasury rate reaching or exceeding five percent again remains a concern, as higher rates could potentially exert widespread pressure on equities, echoing the stresses observed late last year. While there was some relief following the initial rate increases, the persistent nature of inflation and the challenges of resolving it suggest that interest rates could continue to be a critical factor in equity market dynamics.

Aitken remains optimistic, saying, “As a bottom-up manager, we maintain optimism by identifying investment opportunities across various market settings. Despite the prevailing challenges, recent transaction activity has shown that we can find value in sectors performing both well and poorly. “Even in sectors like Canadian telecommunication services, where companies have faced significant downturns and negative sentiment due to industry-specific challenges compounded by higher interest rates, we see substantial opportunities. Similarly, to a lesser extent, utilities also present potential, despite the pressures from rising rates. “Our approach involves a detailed analysis of these conditions, putting market data into perspective and context. We recognize that while these sectors face short-

term pressures, the fundamental aspects of their underlying businesses remain robust. The market may be overly discounting their risks, which we view as a chance to capitalize on where the sentiment is most bearish. Essentially, we find potential in areas where others may be most apprehensive, leveraging these conditions to uncover undervalued investments.”

A significant recent development is the integration of the former Franklin Bissett equity team with ClearBridge Investments, a move Aitken describes as a new chapter in the evolution of the Canadian Equity team. “ClearBridge, with its strong track record and vast capabilities in US and international equities, complements our Canadian team well,” he explains. While ClearBridge may be less known in Canada than the US, it boasts an impressive track record. Based in New York, ClearBridge is a major asset manager with extensive expertise in US equities, international equities, and infrastructure across a variety of investment styles. This integration is expected to enhance research and portfolio management capabilities significantly, with a rebranding exercise planned to further solidify the partnership and expand its market presence. As it has been for more than 40 years, the ClearBridge Canadian Equity Strategy continues to be managed by dedicated Canadian teams based in Calgary. Over multiple time periods and through varied economic conditions, the strategy has consistently delivered

Percentage Sign On Top Of Coin Stacks Before Blue Financial Graph

Strategic growth drivers in US equities

Identifying opportunities

Published Jun 17, 2024

“As a bottom-up manager, we maintain optimism by identifying investment opportunities across various market settings. Despite the prevailing challenges, recent transaction activity has shown that we can find value in sectors performing both well and poorly”

Garey Aitken, ClearBridge Investments

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

2019

2020

2021

2022

2023

Canada headline CPI

US headline CPI

Source: Macrobond. Data as of April 30, 2024

Why choose Franklin Clearbridge Canadian Equity Fund

Focuses exclusively on Canadian equities

Invest at home with a proven team and well-diversified portfolio. The fund offers access to the broad spectrum of growth potential presented by Canadian companies – while providing a true complement to a portfolio of global holdings.

Invests with a distinctive, profit-driven style

For more than 40 years, our focus has been on selecting companies with strong, consistent earnings, which are growing cash flow and have a history of financial strength. We favour stocks selling at an attractive price relative to the company’s fair market value.

A team dedicated to Canadian equity markets

Access the expertise of 11 investment professionals based in Calgary, Alberta, and fully dedicated to the Canadian market with the Franklin ClearBridge Canadian Equity Fund. Our team approach yields a broad range of investment ideas that drive results and set the fund apart from its peers.

The shift towards cryptocurrencies, particularly Bitcoin, marks another key trend. This shift underscores a broader penchant for speculative and risk-on behaviours among investors. A pivotal moment was the US SEC’s approval of spot Bitcoin exchange traded products (ETPs), which dramatically broadened access to Bitcoin for both retail and institutional investors. This has arguably propelled Bitcoin towards being increasingly recognized and adopted as a legitimate alternative asset class. These developments serve as prime examples of the prevailing optimism and risk tolerance in the investment landscape, where investors and speculators have been rewarded for embracing such risks.

Interest rates and market adjustments

Integration with ClearBridge Investments

Balancing absolute returns with risk management

The ClearBridge Canadian Equity Team’s broader portfolio management strategy centres around multifaceted performance objectives, which include generating strong absolute returns to compensate for the risks associated with equity investments. Risk management is critical to their approach, Aitken says; the team are constantly assessing the risks they undertake to ensure they are justifiable. Ultimately, their goal is to achieve favourable risk-adjusted returns, guided by well-defined parameters and objectives for each aspect of their performance strategy. Currently, Aitken describes their approach as more defensive than usual. When he looks at the opportunity set available in the Canadian marketplace, Aitken finds the returns are not available or as exciting to compensate for the risk incurred. “We’re cautious, we’re not overly negative; we think it’s probably below average in terms of near-term return potential,” he says. The funds have experienced some very strong quarters in terms of absolute returns, although the results are more mixed when compared to the benchmark. “Given our inherently more defensive current positioning, it’s typically challenging for us to keep pace with a robust benchmark over short periods,” Aitken says. “Our disciplined approach generally meets our performance objectives, delivering results to clients with a suitable investment time horizon. I remain optimistic about Canadian equities as a venue for capital compounding over time. “Despite the challenges, and perceptions that Canadian equities have not kept pace with the US, it’s important to recognize that equity markets differ from the economy. We see significant opportunities in Canada and believe it remains a promising place for investment.” Since the pandemic lows of March 2020, the ClearBridge Canadian Equity Strategy has capitalized on the equity environment. Over 40 years, the strategy has aimed to meet performance objectives consistently.

strong performance, establishing a solid track record for its investors. The continuity and expertise offered ensure that strategies remain robust and reliable.

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Disclaimer This material is intended to be of general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell, or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The views expressed are those of the investment manager, and the comments, opinions, and analyses are rendered as at publication date and may change without notice. The information provided in this material is not intended as a complete analysis of every material fact regarding any country, region, or market. Commissions, trailing commissions, management fees, brokerage fees, and expenses may be associated with investments in mutual funds and ETFs. Please read the prospectus and fund fact/ETF facts document before investing. Mutual funds and ETFs are not guaranteed. Their values change frequently. Past performance may not be repeated. Franklin Templeton Canada is a business name used by Franklin Templeton Investments Corp.

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