Market Commentary

A Tech Rally but What's Next?

Hopes for an end to the current cycle of rate hikes spurred a strong start to equity markets in 2023.  Much of the rally was due to a resurgent Information Technology sector which contributed more than two thirds of the first quarter index move in the S&P 500 and roughly one third of the return for the S&P/TSX.  Considering the economic effects of inflation and the interest rate hikes already in place, we expect further volatility over the remainder of the year. 

A quick look at the IT contribution highlights the narrow breadth of the first quarter rally. We calculate that:

• IT contributed more than two thirds of the 7.5% first quarter S&P 500 return:  With an average index weighting of 27.1%, the Information Technology (IT) sector returned 21.9% in Q1; the rest of the index gained 2.2%. 
   
• IT contributed more than one third of the 4.7% first quarter S&P/TSX return:  In the Canadian index, with an average IT weighting of 6.2% the Information Technology (IT) sector returned 27.9% in Q1; the rest of the index gained 3.1%. 

The IT rally also looks to be based more on speculation than fundamentals.  We note that:

Optimism for IT overlooks a YTD decline in 2023 earnings estimates:  Sector estimates of 2023 operating earnings have declined since the start of the year, down more than 5% to $101.  In the process, the S&P sector multiple for IT has increased to a P/E of 25.6x to operating earnings, up ~26% from 20.3x entering the year.  The sector is no doubt looking past this year to anticipated growth of more than 17% in operating earnings in 2024, to $119. 

The IT sector consensus also sets a very high bar for 2024:  Getting to the current 2024 operating earnings estimate of $119 requires much stronger performance than we have seen historically, even during the bull market that preceded the pandemic. Therefore either:

• Stronger revenue growth and stronger margins:  10% sales growth this year and next with a 200 bps expansion in 2024 operating margins versus 2022 levels. 
   
• Or spectacular growth, same margins:  15% sales growth this year with no expansion in 2024 operating margins, also sums to $119.

Both possibilities look unlikely because IT sales growth would need to be well above historical trends and face a softening economic outlook. 

For reference, S&P IT sector sales per share have grown at a 7.8% CAGR since 2012 and grew at 6.8% year-over-year in 2022.  As reality sets in, we see a significant risk of reversal for the sector over the remainder of the year.

If the IT sector looks risky and Financials are flashing caution signs because of funding pressures and emerging credit risks, how should investors approach the rest of this year?  We have a few thoughts:

• Energy is looking up:  Energy has seen underinvestment in the current cycle and typically experiences a seasonal rebound in demand in the second half of the year.  OPEC, with a million-plus barrel a day cut, is signalling it will move quickly to counter potential softness in demand.  Even with the prospects of a global slowdown, we are seeing greater discipline in the oil markets and expect significant cash flows for producers.  Our top picks include Canadian Natural Resources (TSX, NYSE: CNQ) and Suncor (TSX, NYSE: SU).
   
• Utilities:   The transition to a lower carbon economy has the Utilities sector directly in its sights, imposing costs, but also creating opportunities.  The retirement of legacy coal plants has raised power prices for existing producers and governments are increasing their funding for green energy programs.  Because the transition drives additional investment activity, we have identified a number of companies with strong capital discipline, established operational expertise, and decent cash flows.  Our top picks include TransAlta (TSX: TA), Capital Power (TSX: CPX) and Hydro One (TSX: H). 
   
• Targeted Discretionary names:  While Restaurant Brands (TSX, NYSE: QSR) and Dollarama (TSX: DOL) are classified as discretionary stocks, based on past cycles, we view these names as well positioned to produce growth and strong cash flows, even in a potential slowdown.
   
• Industrials:  Despite being a cyclical sector, we continue to see opportunities in Industrials for companies that are able to grow and their operational efficiencies. Our core holdings include Canadian Pacific (TSX, NYSE: CP), which recently won approval to combine with Kansas City Southern, increasing its scale and generating network economies; and TFI International (TFII: TSX, NYSE), which continues to benefit from targeted tuck-in acquisitions and growing market share.
   
• Materials:  Generally speaking, mines are operationally complex and carry long investment horizons.  While these features create short-term volatility in output, costs and earnings, they also form barriers to entry and make supply slow to respond to higher prices.  When prices rise, operating leverage kicks in and the best operators are rewarded.  In the near-term, market uncertainty and the eventual weakening of the U.S. dollar should favor gold prices and producers.  Our top picks include Agnico Eagle Mines (TSX, NYSE: AEM) and SPDR Gold Shares (NYSE: GLD), a U.S. gold ETF.

We expect market volatility over the remainder of 2023 to generate opportunities to purchase well-priced companies with strong free cash flows, clean balance sheets and capable management teams. 

To this end, our affiliate Veritas Investment Research continues to provide us with compelling investment ideas by combing through the financials and asking tough questions of management.

Year-to-date through March 31, 2023, the S&P/TSX is up 4.6%, the S&P 500 +7.5% and the NASDAQ 17.1%.  Over the same period, our Canadian Equity Fund rose 2.2% and our Absolute Return Fund was 2.7% lower.  (Performance based on F series).  Year-to-date returns in both our funds reflect underweight positions in Information Technology names. 

Admittedly, we are not rally-chasers at Veritas.  Our picks are based on bottom-up analysis, due diligence, and our long-term views.  We continue to manage our funds to lower risk and generate attractive returns for unitholders. 

We thank you for your continued support.

Your fellow investors,

Anthony Scilipoti
Sam LaBell

Veritas Absolute Return Fund April 2023 Performance Sheets
Veritas Canadian Equity Fund April 2023 Performance Sheets

Source: Refinitiv, S&P Global, Veritas Asset Management estimates as at March 31, 2023. Past performance is not indicative of future performance. The S&P/TSX Composite Total Return Index is a Canadian dollar denominated, capitalization-weighted index that includes the largest float-adjusted stocks trading on the Toronto Stock Exchange, subject to inclusion criteria. The index provides the broadest representation of market-weighted returns for large capitalization Canadian-listed stocks, including reinvested dividends, making it an appropriate index for diversified portfolios that invest primarily in Canadian stocks, such as the Veritas Absolute Return Fund and the Veritas Canadian Equity Fund. While our funds are benchmarked against the S&P/TSX Composite, we may reference returns for the S&P 500 and NASDAQ Composite, as well as yields on U.S. ten-year Treasury bonds, which we view as relevant investment benchmarks for investors in North American equities. The S&P 500 represents approximately 80% of the total market capitalization of U.S. stocks and remains the most broad-based indicator of large-cap U.S. equity returns. In contrast, the NASDAQ has a greater proportion of technology and growth stocks, which we view as providing additional insight into investors' risk appetite. Where applicable, the ten-year U.S. Treasury rate is referenced as a measure of the lowest-risk investment alternative to equities (‘the risk-free rate’). Contact Veritas Asset Management Inc. ("Veritas") for more information regarding comparative indices. 

The information contained herein is for general information purposes and does not constitute a solicitation for the purchase or sale of securities. The full details of the Fund, its investment strategies and the risks are detailed in the Fund’s current simplified prospectus, annual information form, and fund facts document, copies of which may be obtained from Sedar, your dealer, Veritas Asset Management Inc. or at Veritasfunds.com. Please read the prospectus before investing. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. All performance data assume reinvestment of all distributions or dividends and do not take into account other charges or income taxes payable by any unitholder that would have reduced returns. The performance of the Fund is not guaranteed, unit values change frequently and past performance may not be repeated. Performance is presented in Canadian dollars, unless otherwise stated, and is net of fees of Series F units of the Fund. Veritas is an affiliate of Veritas Investment Research Corporation (“VIR”), which produces and issues independent equity research regarding public issuers to investors and other capital markets participants. Veritas is a client of VIR and receives research reports from VIR at the same time as VIR’s other clients. VIR and Veritas have implemented policies and procedures to minimize the potential for and to address conflicts of interest, which are available upon request.

Cautionary Note Regarding Forward-Looking Statements

The information in this release may contain forward-looking statements. All statements, other than statements of historical fact, that address activities, events or developments that Veritas, the Portfolio Manager, or any affiliates thereof (the ‘Companies’) believe, expect, or anticipate will or may occur in the future (including, without limitation, statements regarding any targeted returns, projections, forecasts, statements, and future plans and objectives of the Companies) are forward-looking statements. These forward-looking statements reflect the current expectations, assumptions or beliefs of the Companies based on information currently available to the Companies. Forward-looking statements are subject to a number of risks and uncertainties that may cause the actual results of the Companies to differ materially from those discussed in the forward-looking statements, and even if such actual results are realized or substantially realized, there can be no assurance that they will have the expected consequences to, or effects on, the Companies.

For a list of factors that could cause actual results or events to differ materially from current expectations, please refer to our Prospectus and the section 'Risk Factors'. Any forward-looking statement speaks only as of the date on which it is made and, except as may be required by applicable securities laws, the Companies disclaim any intent or obligation to update any forward-looking statement, whether as a result of new information, future events, or results or otherwise. Although the Companies believe that the assumptions inherent in the forward-looking statements are reasonable, forward-looking statements are not guarantees of future performance and accordingly undue reliance should not be put on such statements due to the inherent uncertainty therein.