MCT April 2023 Market Commentary

  • Canada
  • MCT April 2023 Market Commentary
M-Asset

March was a turbulent month for equity markets, particularly in the financial sector. Smaller banks experienced significant deposit outflows, three U.S. regional banks closed their doors and UBS acquired Credit Suisse in a forced sale. While Financials returned -7.4% in Canada (in British Pounds), the broader market proved to be resilient with a more modest decline of 1.5%.

Although the banking challenges experienced during March seem to have abated, the outlook for banks remains uncertain. Given the cyclicality of the banking business, the lower a bank’s profitability, the less likely it can absorb higher losses and the impact of those losses almost inevitably encroaches on capital. As a result, banks with low profitability and/or low returns on equity will need to rely on external financing or, as we’ve seen with Credit Suisse, Silicon Valley Bank (SVB) and potentially Deutsche Bank, a bailout is required.

Against this backdrop, the Fund is underweight Financials by approximately 9% relative to the Benchmark. The Fund’s select exposure to Financials is in high-quality Canadian banks which are inherently more stable than their global peers. Canada’s banks benefit from higher levels of profitability and strong capital positions. Between 2017 and 2022, Canada’s banks had an average return on equity of 15.5% which compares to just 5.3% for European banks. The liquidity coverage ratios of Canada’s Big 6 banks range from approximately 120% to 150% which compares to 110% to 120% for the Big four banks in the US. In addition, Canada’s banks pay high levels of dividends which have proven to be very stable historically. Since the second world war, none of Canada’s banks have made a single dividend cut.

The stability of the Commercial Real Estate (CRE) market has also become topical since the collapse of SVB. Most of the concern stems from the office sector, which is estimated to represent approximately 40% of U.S. bank CRE portfolios. Unlike other CRE sectors, operating fundamentals for the North American office sector are weak with vacancy rates near the highs reached during the Global Financial Crisis. In Canada, the national office vacancy rate stands at 17.7%, with downtown Class B space reaching 22.7% in Q1. The Fund does not currently have any exposure to office REITs and we have no plans to step back into the sector even though office REITs are trading at steep valuation discounts.

Notwithstanding the challenges facing office, operating fundamentals across other property types in Canada remain extremely solid. Specifically, industrial, multi-family and grocery-anchored retail are very stable and we expect continued growth in net operating income in 2023. CBRE recently reported that the average market rent growth for Canadian industrial space in Q1 increased 28% compared to last year, with “every market in Canada” posting positive numbers. Demand for multi-family rentals is set to surge amid rising immigration and the high cost of housing facing many Canadians. Retail landlords will also play a key role in providing lower cost housing options through their robust mixed-use development projects. These three sub-industries represent the core of the Fund’s REIT exposure as they offer the most attractive risk/reward dynamic and trade at attractive discounts to underlying value. Canadian REITs are currently trading at a discount to net asset value exceeding 20% on average and valuations are approaching 2020 trough levels — a period when the whole country was locked down. High-quality REITs with rock solid fundamentals and conservative balance sheets look particularly attractive as they are being painted with the same brush as companies with more uncertain outlooks (such as the office sector).

Disclaimer

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. You will usually pay brokerage fees to your dealer if you purchase or sell units/shares of investment funds on the Toronto Stock Exchange or other alternative Canadian trading system (an “Exchange”). If the units/shares are purchased or sold on an Exchange, investors may pay more than the current net asset value when buying and may receive less than the current net asset value when selling them. There are ongoing fees and expenses associated with owning units or shares of an investment fund. An investment fund must prepare disclosure documents that contain key information about the fund. You can find more detailed information about the fund in these documents. Mutual funds and investment funds are not guaranteed, their values change frequently and past performance may not be repeated. Certain statements in this disclosure are forward-looking. Forward-looking statements (“FLS”) are statements that are predictive in nature, depend upon or refer to future events or conditions, or that include words such as “may”, “will”, “should”, “could”, “expect”, “anticipate”, “intend”, “plan”, “believe”, or “estimate”, or other similar expressions. Statements that look forward in time or include anything other than historical information are subject to risks and uncertainties, and actual results, actions or events could differ materially from those set forth in the FLS. FLS are not guarantees of future performance and are by their nature based on numerous assumptions. Although the FLS contained herein are based upon what Middlefield Funds and the portfolio manager believe to be reasonable assumptions, neither Middlefield Funds nor the portfolio manager can assure that actual results will be consistent with these FLS. The reader is cautioned to consider the FLS carefully and not to place undue reliance on FLS. Unless required by applicable law, it is not undertaken, and specifically disclaimed that there is any intention or obligation to update or revise FLS, whether as a result of new information, future events or otherwise.

This material has been prepared for informational purposes only without regard to any particular user’s investment objectives or financial situation. This communication constitutes neither a recommendation to enter into a particular transaction nor a representation that any product described herein is suitable or appropriate for you. Investment decisions should be made with guidance from a qualified professional. The opinions contained in this report are solely those of Middlefield Limited (“ML”) and are subject to change without notice. ML makes every effort to ensure that the information has been derived from sources believed to reliable, but we cannot represent that they are complete or accurate. However, ML assumes no responsibility for any losses or damages, whether direct or indirect which arise from the use of this information. ML is under no obligation to update the information contained herein. This document is not to be construed as a solicitation, recommendation or offer to buy or sell any security, financial product or instrument.

  • Canada
  • MCT April 2023 Market Commentary
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