North American equity markets finished the first half of 2023 on a positive note. For the month of June, the S&P 500, TSX Composite and the Fund’s benchmark generated total returns of 3.9%, 3.6% and 2.0% in British Pounds, respectively. The sharp recovery in tech stocks has been the biggest driver of relative performance this year. Year-to-date, the TSX, which has more exposure to cyclicals, has trailed the S&P 500 by over 8%.
Our outlook for the Fund’s core sectors remains constructive as we enter the second half of 2023. Recession risks are receding as inflation trends lower and the labour market remains resilient. We have noted a growing list of individual stocks that are starting to break out of recent trends which supports our view that market breadth is improving. Specifically, Canadian financials and energy stocks have recently started trading above their 50 day moving averages. We believe a rotation out of expensive growth stocks into more reasonably priced value names is likely over the coming months, which bodes well for the Fund’s attractively priced dividend-paying holdings. Moreover, a significant amount of capital that made its way into money market funds during Q4’22/Q1’23 is now starting to flow back into equities. We believe investors will be more selective when considering tech stocks with stretched valuations.
Canadian REITs were down as much as 5% in June but rallied during the final week of the month to finish with a positive return. As we wrote last month, REITs have historically outperformed the TSX twelve to twenty-four months after the first Bank of Canada rate hike. We are optimistic that sentiment is starting to bottom and the sector is positioned for a catch-up trade during the second half of the year. REITs continue to act as an effective hedge against inflation. Companies have been able to raise rents on expiring leases, particularly in undersupplied asset classes such as industrial, multi-family and retail. At a 27% discount to net asset value on average, we do not believe valuations accurately reflect healthy fundamentals across most of the sector.
We continue to have a positive view on industrial real estate where vacancy is very low (i.e. less than 3%) in key markets including Toronto, Vancouver, Montreal and major U.S. cities. Although Industrial REITs have been under pressure recently, the US$3.1 billion acquisition of industrial assets by Prologis from Blackstone announced in late June validates the fundamental value underlying the Industrial REIT sector. Two of our largest holdings, Granite REIT and Dream Industrial REIT, are trading at very attractive valuations with implied cap rates of 5.8% and 5.6%, respectively, compared to the 4% cash cap rate paid by Prologis.
We are also constructive on the Canadian energy sector, particularly companies with exposure to natural gas. Canadian natural gas storage is at a five-year low with wildfires impacting production. US power consumption is higher than normal amid a heat wave in Texas and hot weather in the forecast. After a stagnant winter, where natural gas prices hovered between US$2.00-$2.50/mcf, prices are starting to gain momentum and have risen to $2.80/mcf. Historical data indicates positive natural gas price momentum from July to November, with average increases of 18% over the past decade while gas-weighted equities have delivered an average return of 11% from June to November, outperforming energy indices. Tourmaline, a core holding, generated a total return of 10.5% in June and has started to break out above near-term resistance levels. At current strip pricing, Tourmaline is equipped to pay $2.25 per share in special dividends in H2 along with regular base dividends of $0.52, or an implied H2 dividend yield of 4.5%.
