Equity markets started the year the same way they finished 2023. The S&P 500 returned 1.7% in January and reached all-time highs during the month. The TSX Composite Index had a total return of 0.6% in the local currency but was offset by a depreciation in the Canadian dollar versus the British Pound by c.1%. The Fund’s share price rose 1% in January, causing a reduction in its discount to net asset value.
Recent economic data in the U.S. confirms a resilient labour market and robust consumer spending, highlighted by real personal spending expanding by 0.5% in December. The U.S. represents over 75% of Canada’s exports, making it a very important end-market for many Canadian companies. Solid economic data combined with falling inflation provides a stable demand backdrop for the U.S. consumer. The Goldilocks scenario that has taken shape in recent months should support earnings growth for Canadian cyclicals and support further price appreciation in the coming months. In light of the market’s uncertainty surrounding the timing of interest rate cuts, MCT is positioned in attractively valued, larger capitalization dividend-paying companies which we believe will see significant funds flow when rate cuts are announced as early as Q2 2024.
Domestically, the outlook for the Canadian economy is also positive. The economy grew by 0.2% in November and fourth quarter 2023 is expected to report an increase of 1.2% on an annualized basis. Immigration continues to fuel demand and support economic activity. Canada accepted 455,000 new permanent residents in the twelve-month period ending October 1st with an additional 800,000 non-permanent residents entering the country over the same period. Canada’s population growth rate, which exceeds 3%, is higher than China, India, or any G7 nation. Although we expect the pace of immigration to slow, the high levels experienced in recent years represent a significant demand tailwind for the foreseeable future. MCT’s portfolio will benefit from robust domestic demand through its positions in multiple sectors including real estate, financials and utilities.
The Trans Mountain Expansion Project (TMX), which has been under construction for more than 3 years, is expected to be completed and in service by Q2 2024. The project received a positive ruling from the Canada Energy Regulator in January which removed any outstanding regulatory uncertainty. TMX will add 690,000 barrels per day of incremental export capacity to the country’s only oil pipeline that services the West Coast. The pipeline will provide much-needed egress for Canadian energy producers and give them access to international oil prices. The Fund has approximately 32% of its portfolio allocated to Canadian energy companies, evenly split between producers and pipelines.
M&A has been picking up in the Canadian real estate sector the past two months. In December, it was announced that TPG, a global alternative asset manager, will acquire a 75% interest in a 5.1 million square foot industrial real estate portfolio in the Greater Toronto Area for $1.3 billion. The transaction implies a cap rate of approximately 4% which is significantly lower than the average 5.8% implied cap rates for Canadian industrial REITs. A few weeks later, Canada-based Tricon Residential announced an agreement to be acquired by Blackstone in a transaction valued at US$3.5 billion. The transaction represents a 30% premium to the stock’s previous closing price and highlights the significant disconnect that still exists between publicly-listed REITs and large private institutional buyers. We expect continued M&A activity in North American real estate markets throughout 2024 to serve as a catalyst for upward price momentum in publicly-listed REITs, especially given the disconnect in valuations between private real estate and the REIT sector overall.
