Market Commentary

May 2022

Consumer Check-Up

Coming into 2022, prevailing wisdom held that strong household balance sheets and sustained reopening spending would be counterweights to rising interest rates at the Fed.  With more than two thirds of North American GDP still driven by Personal Consumption Expenditures (PCE), these arguments were at least plausible.  In May, however, a series of corporate profit warnings have shaken confidence in the consumer, with key companies citing slowing demand and higher costs in the face of sustained inflation. 

As the largest retailer in the U.S., Walmart Inc. (NYSE: WMT) was perhaps the most damaging as it reported a 25% drop in first quarter earnings and cut its 2022 profit forecast to 1% below 2021 levels, which still requires a strong second half to achieve.  Target Corporation (NYSE: TGT) followed shortly thereafter, posting a 52% drop in first quarter profits, blamed on higher costs and supply chain disruptions, as well as a consumer shift away from bigger ticket items, resulting in bloated inventories.  In the tech space, Snap Inc. (NASDAQ: SNAP) cut its forecasts citing macro weakness in the online advertising market, highlighting the fact that many tech companies are also highly dependent on the consumer ecosystem.

Parsing through data from the U.S. Bureau of Economic Analysis (BEA) and U.S. Energy Information Agency (EIA), we note a few important trends.  With U.S. retail gasoline prices up more than 60% year-to-date and U.S. CPI running at 8.5% in the year ended March 31, 2022, inflation has finally begun to weigh on consumer confidence.   The effects of inflation are not uniform, however. 

Inflation hurts from the middle down:  Based on U.S. BEA data, for a median income household in 2021, we estimate average U.S. household spending on 'gasoline and other energy goods' is equivalent to between 4.0% and 4.5% of pre-tax income.  A 60% increase in that spending would be meaningful but potentially manageable.  At the 80th percentile, the same spending takes up just 1.0% to 1.5% of income, which makes the higher costs a drop in the bucket. 

At lower income levels, however, fuel price increases are much more damaging.  Average household fuel spending represents 7.0% to 7.5% of 2021 household income at the 30th percentile and 10% to 10.5% at the 20th percentile.  Which is likely why retailers serving mid-to-lower income households are feeling more pressure, sooner.

Consumer spending is shifting:  With new COVID variants weighing on consumers last year, the recovery in PCE services (travel, recreation, food services, etc.) was relatively anemic in 2021, up just 3% versus 2019.  In contrast, 2021 U.S. PCE spending on Goods rose 22.4% above 2019 levels, as consumers spent more money at home and on lifestyle changes.  With global supply chains still in disarray, pushing through such a large increase in goods spending, which requires massive investments in inventory and distribution, has naturally been inflationary.

2022 has seen a shift back to services, as consumers prioritize areas of spending they had reduced during the pandemic (travel, leisure, entertainment, etc.). The result has been renewed strength in services and non-durables spending, up 11.8% and 12% year-over-year in Q1 2022, respectively, and a slower growth rate in durable goods spending, up 8.7% YoY. 

With durables spending only slightly ahead of inflation in Q1, it is perhaps not surprising that retailers have felt competitive pressures to slow price increases and increase promotions, all while managing rising labour and logistics costs.

Consumers appear eager to spend and dip into savings:  Based on BEA data, we calculate that from March 2020 to December 2021, U.S. households cumulatively saved in excess of US$29.3 trillion above what they would have saved at 2019 monthly savings rates.  That is about 11.6% of 2021 personal income levels.  This has reversed in 2022, with consumers willingness to spend ramping up dramatically, producing the lowest savings rates seen since 2013. 

Tailwinds remain from higher incomes and spending:  With a tight labour market, the first four months saw total U.S. employee compensation up 18.7% versus 2019 levels, with PCE spending up a comparable 18.4%.  We estimate the 2022 gap versus 2019 savings rates represents a $2.2T tailwind from January to April 2022, contributing about 330 basis points of the 18.4% growth in U.S. PCE spending in 2022 versus 2019.

Rising consumption is a tailwind, but not a panacea:  Even with consumer spending outpacing inflation, corporate profits remain under pressure as rising commodity prices and wage pressures filter into corporate margins. As a result, we think there is considerable risk that revenue and earnings revisions will continue for companies in those pockets of the market serving mid to lower income households where inflation carries the greatest bite.

Spending remains more robust at higher income brackets, where food and energy inflation take up a lower share of income and where pandemic savings and investment gains have been the highest. Even at the higher end, however, we still see pressures mounting on durables, faced with increased competition, price inflation and a shift in consumer spending back to services.

As a result, we recommend paying close attention to cost structures, consumer exposures and competitive dynamics in each industry.  What companies disclose about these areas of risk matters now more than ever, which is why we continue to place a high importance on the quality of each company's financial reporting, the sustainability of their cash flows, and the candour of management teams.

To this end, we benefit from the in-depth accounting and due diligence work being done by the team at Veritas Investment Research, who continue to produce some of the best equity research on the street.

Year-to-date through May 31, 2022, the NASDAQ was down 22.5%, the S&P 500 was down 12.8% and the S&P/TSX was down 1.3%.  Over the same period, our Canadian Equity Fund rose 1.2% and our Absolute Return Fund was up 0.9%.  (Performance based on F series). 

We thank you for your continued support.

Your fellow investors,

Anthony Scilipoti
Sam LaBell

Veritas Absolute Return Fund May 2022 Performance Sheets
Veritas Canadian Equity Fund May 2022 Performance Sheets

Source: Source: Refinitiv, Veritas Asset Management estimates as at June 8, 2022; SEC 10Q filings for Walmart and Target for the quarters ended April 30, 2022; SNAP 8K for the quarter ended March 31, 2022; SNAP 8K update filed May 23, 2022; U.S. Bureau of Economic Analysis; U.S. Energy Information Administration; U.S. Bureau of the Census. Portfolio weights refer to end of day weights for the period ending May 31, 2022. 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. 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. 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. (“VAM”) 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. VAM 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. VAM is a client of VIR and receives research reports from VIR at the same time as VIR’s other clients. VIR and VAM 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 Asset Management Inc., 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.

April 2022

Market Commentary

April 2022

Staring Down a Bear

In April, the S&P 500 continued to edge toward a bear market, defined as a 20% drop from recent market highs; through May 11th the S&P had dropped 18% from its January 3, 2022 high. The NASDAQ, on the other hand, is well into bear territory having peaked on November 19, 2021 and dropped 29% since then.

Looking at past bear markets suggests bracing for further declines. For the S&P 500, there have been 14 post-war corrections of 20% or more. Each bear market featured an average peak-to-trough decline of roughly 32% and an average duration of just under a year. In other words, if history is any guide, the downturn we have experienced over the first four months of 2022 is likely to mark the early innings of a larger repricing.

We have been writing since late 2021 about the litany of risks facing markets in 2022, including: the need for the Fed to raise rates to combat rising inflation; the extension of 2021 supply chain difficulties; the roll-off of pandemic lockdown/reopening tailwinds in many sectors; and the difficulty of achieving earnings growth in the current environment. Add to that list an ongoing war in the Ukraine along with a Chinese economy grappling with a new wave of Covid, and the outlook for most companies has become downright bearish.

The one bright light may be that, following its recent drop, the S&P 500 is less expensive relative to earnings. Based on current tallies, analysts project S&P 500 earnings of $236 in 2023, which produces a forward multiple of 16.7x.

However, earnings estimates are a weak link. Reaching $236 in 2023 requires earnings growth of 6.5% in 2022, followed by growth of 19.2% in 2023.  It is safe to say that any 2023 rebound is unlikely to happen if inflation remains high and global growth continues to slow.  For context, earnings grew at a compounded annual rate of 6.4% in the five years prior to the pandemic, when inflation averaged 1.8%.

The challenge is that most low growth scenarios imply weak or negative forward returns for the S&P.  Consider that if:

  • Index earnings grow by 5% in 2022 to $208;
  • The 10-year U.S. Treasury climbs to 3.50% by year-end; and
  • The earnings yield premium falls to 2% based on trailing earnings.

… then the implied S&P 500 target through early 2023 is just 3,782 ($208 divided by 5.5%) down about 2% from current levels.  In other words, with rising rates and investor jitters, earnings growth is the only thing preventing a potential bear grazing from turning into a bear mauling.  Which is why we see the pendulum now shifting away from growth-at-any-price, towards profitable growth and quality of earnings. 

Even though analysts have been slow to revise their estimates, the market is catching on to the risks posed by companies with low to negative earnings, many of which are seeing growth slow this year.  The priciest of these companies have been crashing.

Given the current backdrop, we remain defensively positioned and are sticking to investments in companies with strong balance sheets, sustainable cash flows, transparent accounting disclosures, and forthright management teams. In our Absolute Return Fund, we are capitalizing on weak and volatile conditions to add to our short book and earn additional premiums from option writing.

As always, we benefit from the in-depth accounting and due diligence work being done by the team at Veritas Investment Research, who continue to produce some of the best equity research on the street.

Year-to-date through April 30, 2022, the NASDAQ was down 21.1%, the S&P 500 was down 12.9% and the S&P/TSX was down 1.3%.  Over the same period, our Canadian Equity Fund rose 1.3% and our Absolute Return Fund was up 0.4%.  (Performance based on F series). 

We thank you for your continued support.

Your fellow investors,

Anthony Scilipoti
Sam LaBell


Veritas Absolute Return Fund April 2022 Performance Sheets
Veritas Canadian Equity Fund April 2022 Performance Sheets

Source: Refinitiv, S&P Global index earnings estimates, Veritas Asset Management Inc. estimates, as at May 12, 2022. Portfolio weights refer to end of day weights for period ending April 29, 2022. 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. 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. 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. (“VAM”) 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. VAM 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. VAM is a client of VIR and receives research reports from VIR at the same time as VIR’s other clients. VIR and VAM 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 Asset Management Inc., 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.

March 2022

March 2022

Staying on Defense

Aside from the headline moves in Energy and Materials in the first quarter, which were tied to the war in Ukraine and to post-pandemic commodity supply challenges, the Canadian market has turned extremely defensive, as shown by Q1 returns for the S&P/TSX 60: 

  • While Energy and Materials ran:  14 of the 17 S&P/TSX 60 Energy and Materials names posted double digit returns in Q1.
  • Just over half of non-commodity names beat inflation:  The list of non-commodity names whose returns beat inflation skews very defensive, with 13 of the 23 outperforming names in Communications, Staples or Utilities.  The remaining names included four Big Six Banks, and two Consumer Discretionary names – Canadian Tire and Dollarama – that Canadians treat like Staples.  Rounding out the list:  Manulife, CP, CNR, CAE, and Waste Connections.

Communications, Staples and Utilities typically outperform when investors are gearing up for weaker economic conditions.  So it is hard not to view the first quarter as a retreat from risk, despite the rebound in the second half of March.

Have markets gotten too defensive or not defensive enough? 

To answer the question, we think it is worth looking back at where valuations were trading around the time of the last interest-rate tightening cycle in 2018.  In the table below, we compare next fiscal year EV/EBITDA multiples from August 2018 to those currently seen in the Canadian market:

The biggest departures from 2018 multiples belong to the Consumer Discretionary (due to autos), Communications, Industrials and Utilities sectors. For every sector, when weighing multiples it is important to factor in the differences this time around, including:  the continuation or roll-off of COVID effects in each industry; the flow-through of inflation into margins; and interest-rate hikes that have yet to fully hit.  Taking those factors into account, in our view the biggest valuation risks are tied to:

  • Information Technology: Despite current Canadian multiples appearing lower than 2018 (outside Shopify), we think consensus earnings remain too optimistic, making the actual multiple much higher.  Prior experience has shown that analysts are slow to revise estimates and routinely miss turning points in the cycle, particularly for technology stocks. The downward pressure will continue to be most acute for high Price-Sales, earnings-light firms.
  • Industrials:  The current high multiple reflects a view that weaker Industrial earnings will be transitory as the global economy regains its footing.  However, we see considerable risk that inflation and supply chain problems extend into 2023 and beyond. And, if central bankers are not careful, rate hikes could tip the global economy into recession by late 2022 or into 2023.  Betting against these possibilities is not for the faint of heart.
  • Financials:  While in very good shape currently, we know that if economic conditions worsen and credit losses pick up through year end, the multiple in Financials is likely to contract relatively quickly.
  • Utilities:  With high current multiples driven by renewable energy premiums, certain Utilities may come under pressure despite their defensive characteristics.

All told, we think the current valuation backdrop continues to support a relatively defensive stance.  As additional interest rate hikes weigh in over the medium term, keeping a close watch on company fundamentals will be key.  We remain focused on picking our spots and sticking to high quality names in those sectors best positioned to manage through the coming uncertainty.  To this end, the research provided by our affiliate Veritas Investment Research remains invaluable.

Through the end of the first quarter, the NASDAQ was down 8.9%, the S&P 500 was down 4.6% and the S&P/TSX was up 3.8%.  Over the same period, our Canadian Equity Fund rose 4.5% and our Absolute Return Fund was up 0.6%.  (Performance based on F series). 

We thank you for your continued support.

Your fellow investors,

Anthony Scilipoti
Sam LaBell

Veritas Absolute Return Fund March 2022 Performance Sheets
Veritas Canadian Equity Fund March 2022 Performance Sheets

Cautionary Note Regarding Forward-Looking Statements

The information contained in this release may contain forward-looking statements. All statements, other than statements of historical fact, that address activities, events or developments that Veritas Asset Management Inc., 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.

February 2022

February 2022

A War on Everyone’s Doorstep

Russia’s invasion of Ukraine on February 24th marks one of those rare times in history where the world order appears upended.  We would say overnight, but the conflict has been brewing since Russia invaded Crimea in 2014.

The battle lines were drawn:  At the risk of oversimplifying, the battle for Ukraine encapsulates two competing approaches to international relations:  the first based on mutual interest, co-operation and international law; the second based on projecting national power among neighbors and allies. 

While Western powers are guilty of using both approaches, Mr. Putin is firmly planted in the second school of thought and its realpolitik.  The Russian president was a young KGB agent in East Germany when the Berlin Wall came down in 1989 and it seems he has been trying to rebuild Russia’s influence ever since.

More damage to globalization:  Events in Ukraine have shattered the belief, mostly held in the West, that open dialogue and economic integration naturally lead to mutual prosperity and peaceful co-existence.  It has also raised doubts about whether the world’s major powers – notably Russia and China – are particularly committed to keeping the current global order intact.   

Stability and rule of law favor growth and prosperity: Growing multilateralism since the 1980s has been very good for markets and wealth creation, certainly much better than the armed conflicts and government posturing that characterized the Cold War. 

To illustrate how regional conflicts have long-term consequences, consider the following:

  • Based on World Bank data, In the seven years after Russia invaded Crimea, net foreign direct investment (FDI) into Russia dropped by close to two thirds, down US$245 billion versus the prior seven years to US$140 billion. 
  • Similar to Russia, those former soviet states not in NATO saw a 62% drop in FDI in the seven years after Russia moved into Crimea, down 62% to US$145 billion. 
  • In contrast, those former Soviet states that were able to join NATO saw a 23% increase in FDI in the seven years after Crimea, totalling US$573 billion.

Being in NATO appears to be very good for business, while the uncertainty of being out of NATO has a real cost. 

Russian stocks were doing well.  Now they’re not:  Despite the drop in FDI, the largest corporations in Russia (and their oligarchs) did very well post-2014.  In the eight years ended December 2021, the Russian stock index (MOEX) was up four-fold, versus three-fold for the S&P 500.   The sanctions brought on by Russia’s latest attacks on Ukraine look set to reverse much of those gains, however; the Russian MOEX was down 34% in 2022 before Russia’s stock exchange closed on the last day of February.  It has yet to reopen, marking a record stretch of closure for Russia’s exchange.

The consequences of war:  The near-term prospects for a peaceful resolution in Ukraine look grim.  Russia will either fight to occupy major portions of the country or continue to degrade Ukraine’s infrastructure and economy to reduce its ability to fight back.  Ukraine is well armed and unlikely to back down, setting up the prospects of a long conflict. 

Europe will need to re-orient its energy supply away from Russia, raising the prospects of much higher input costs and, potentially, a major economic slowdown.  The products that each country exports will be curtailed – Ukraine because of damaged and occupied supply routes; Russia because of sanctions.  Commodities such as grains, fertilizers, oil & gas, nickel, gold etc. will see major advances as Ukrainian and Russian exports are affected.  Russia will further re-align its interests and trade towards China.

In the near-term we expect:

  • A sustained bull market in commodities, triggering further inflation and weaker corporate margins.
  • Increased defense spending with further fiscal pressures pushing up sovereign yields
  • An ongoing flattening of the yield curve with widening spreads on high yield instruments
  • Rising risks of a recession, with the slowdown, if and when it comes, triggering a correction in commodity prices.

Our funds are well aligned with these trends, with significant exposure to Canadian energy producers and overweight positions in defensive sectors such as REITs, Staples and Utilities.  Our Absolute Return Fund also stands to benefit from potential volatility, given its ability to go both long and short, as well as use options. 

As markets renew their emphasis on fundamentals and quality of earnings, we continue to benefit from the detailed research and accounting work provided by Veritas Investment Research.  As always, their research helps our funds identify high quality names and manage our exposures to reduce risk.

Through the end of February 2022, the NASDAQ was down 12.7%, the S&P 500 was down 8.0% and the S&P/TSX was down 0.1%.  Over the same period, our Canadian Equity Fund rose 1.2% and our Absolute Return Fund +1.3%.  (Performance based on F series). 

We thank you for your continued support.

Your fellow investors,

Anthony Scilipoti
Sam LaBell

Veritas Absolute Return Fund February 2022 Performance Sheets
Veritas Canadian Equity Fund February 2022 Performance Sheets

January 2022

January 2022

Why Investing Needs More than a Forecast

We’ve been asked a lot lately where we see markets heading through the end of 2022.  No problem, we reply.  We have just three questions.  Where will the yield on 10-year U.S. Treasuries be at year end?   Will current earnings expectations be met?  And will investors’ relatively bullish sentiment hold up?  Answer these questions and the forecast takes care of itself.   In 2022 though, none of these questions have easy answers, which makes active stock picking all the more critical this year.

Why the outlook is leaning bearish.  Earnings estimates are already factoring in strong growth – the current S&P 500 earnings estimate of $220 for 2022 implies 13% year-over-year growth.  If U.S. 10-year Treasury yields hit 2.5% this year (they could go higher), earnings estimates are met, and the equity yield premium over Treasuries remains where it is today (~230 bps on trailing earnings) – then the S&P 500 would be roughly flat at year end at ~4,585 ($220 divided by 2.5%+2.3%) – for a gain of zero versus today.  Any outcome with lower earnings, higher Treasury Yields or a higher equity premium could produce a loss.

Uncertainty is the word … sentiment is the lynchpin:  Earnings estimates are hardly a lock given the likely effects of inflation and wage pressures on corporate margins and growth.  While Treasury yields depend on buyers showing up to the bond auctions, which is not always assured. As a result, we think a lot is now riding on the premium investors are willing to take to stay in equities, which is driven as much by sentiment as investment outlook. 

Will investors be ‘forced’ to remain in equities?  Because equities are still the best hedge against inflation – through their potential for growth – equity premiums may fall even as yields rise.  In the 2.50% Treasury yield example, a 50 bps drop in the equity premium is enough to cushion a 10% miss in current earnings estimates and leave investors slightly ahead (e.g. $198 divided by 2.5%+1.8% = 4,605).  We would still expect gut-wrenching volatility if this scenario were to play out.

Defense matters now more than ever:  While on a macro level, markets may yet pull through to gain in 2022, on a micro level a loss in a single stock can leave a permanent scar on your portfolio.  Consider the math involved – if a stock falls by 50%, it has to rise by 100% in order to get back to even.  And we all know how difficult it is to find investments with the potential for 100% returns. As a result, we think the current environment really favours the defense-first investment approach we use at Veritas’ funds.

Through the end of January 2022, the NASDAQ was down 8.5%, the S&P 500 was down 5.2% and the S&P/TSX was down 0.4%.  Through a careful management of our exposures, our Canadian Equity Fund rose 1.0% in January and our Absolute Return Fund was up 2.2%.  (Performance based on F series).  We continue to navigate this year’s markets with a careful eye on risk.

As always, the team at Veritas Investment Research is providing us with valuable fundamental and accounting-based insights to action in our funds.  Veritas’ calls have outperformed in all types of markets over the last two decades, demonstrating the enduring value of independent thinking and analysis.

We thank you for your continued support.

Your fellow investors,

Anthony Scilipoti
Sam LaBell

Please see below for links to client-friendly fund profiles and commentaries.

Veritas Absolute Return Fund January 2022 Performance Sheets
Veritas Canadian Equity Fund January 2022 Performance Sheets

 

December 2021

December 2021

The After Math

What do you get when you add rate hikes and central bank tapering to record equity inflows, stretched valuations and rampant inflation?  Is there any answer to this question that isn’t a headwind for equity markets in 2022?  As we head into the year, we still see a path forward to attractive returns, but it involves careful de-risking of our portfolios and diversification away from specific excesses.

Our working thesis is that 2022 will look a lot like 2018, the last time the Fed attempted to meaningfully shrink its balance sheet. As the Fed steps back from buying Treasuries, bond yields will have to find their own level.  This process of normalization is likely to be volatile, as it was in 2018.

In general, 2018 showed that equity markets can stomach higher rates, but that stock prices are prone to corrections if yields move up too quickly.  That year, markets rallied whenever it looked like Treasury yields would stabilize; however, each time yields tested new highs, markets dropped quickly.  In 2018, the S&P 500 was roughly flat in Q1; made single digit gains in Q2 and Q3; but dropped 13.5% in Q4, after 10-year yields hit 3.2% in September.

What’s different in 2022?  We think there may be even greater volatility this time around given two factors:  complacency and inflation. 

Complacency:  In 2018, the financial crisis hadn’t yet much dimmed in people’s minds.  Now, after a year of record equity inflows in 2021 – more than the prior 19 years combined – and across-the-board gains in almost every sector (except Cannabis), investors appear to be more complacent.  This is evidenced by the punishment we are currently seeing meted out to companies that miss guidance or announce negative news.

Inflation: There are two emerging aspects to inflation:  1) Commodity and supply chain inflation – with COVID disruptions and strong demand, the Fed must wait for economic constraints to resolve; and 2) Wage inflation – rising wages are the result of a pandemic induced drop in labour participation rates and growing pressures on an already tight employment picture. The good news is that the last period of Fed tightening coincided with rising participation rates, which could moderate wage inflation over time.  The bad news is that we still don’t know if the pandemic will have long-term effects on the labour market.

Why the inflation/complacency mix is dangerous:  Inflation and higher borrowing costs are likely to eat into corporate margins in the short-term, raising the risk of earnings disappointments.  And the average investor is not prepared to be disappointed.  Right now, every blip is being blamed on supply chain disruptions, but when do short-term disruptions become the new industry normal?  If long-term expectations for equities get re-rated, markets are in for a rough stretch.

Our strategies for 2022:  We continue to invest in companies with capable management teams, strong balance sheets and sustainable, growing cash flows.  We are watching industry conditions closely, with a view to avoiding negative changes in the direction of growth and margins at individual companies.  We retain a preference for larger cap names over mid and small cap, at least for this year.  We think Consumer stocks, Utilities, Energy and REITs are likely to fare better than most, with Financials offering decent returns as well.

As always, we rely on the analysis and ideas generated by Veritas Investment Research, whose fundamental and accounting-based research has performed well in all types of markets dating back to their first report in 2000.

In 2021, our Absolute Return Fund returned 22.8% and our Canadian Equity Fund returned 23.8%, both with low correlations to the market.  (Performance based on F series).     

We thank you for your continued support.

Your fellow investors,

Anthony Scilipoti
Sam LaBell

Please see below for links to client-friendly fund profiles and commentaries.

Veritas Absolute Return Fund December 2021 Performance Sheets
Veritas Canadian Equity Fund December 2021 Performance Sheets

November 2021

November 2021

A Brief History of Buy-the-Dip

After tapering fears and news of the Omicron variant drove the S&P 500 to a lower close entering December, investors bought the dip, temporarily pushing the index back to its mid-November highs.

The strategy of deploying more money in the weeks following an index decline – buying the dip as it were – performs well in most markets because, more often than not, stocks go up. 

But just how risky is the strategy now, with uncertainty over interest rates and inflation swirling, and valuation metrics pushing towards all time highs?

Buy-the-Dip since 1980: Based on Friday-to-Friday performance, the S&P 500 has provided an average weekly return of 23 basis points since 1980, and a positive return in 58% of weeks.  In the period following a negative-return week (i.e. the week after the dip), the index has posted an average return of 41 bps, and a positive return in 61% of weeks. So when buying the dip, returns are in fact stacked in investors’ favor.  Results on the S&P TSX are similar since 1995, with the probability of a positive result increasing by about 130 bps following a down week, and average returns about 15 bps higher.

Except when the market is correcting: The main exceptions to buy-the-dip occurred in years that most seasoned investors will recognize:  1987, 1990, 2002, 2008 and 2018. In these years, average returns following a negative week were negative 37 basis points, versus the all-week average of negative 23 basis points for those years.  In other words, investors who bought the dips in these years generally did worse than those who did not. For the S&P TSX, the list of years where buy-the-dip did not work also includes additional years affected by commodity price turmoil:  1998, 2001 in place of 2002, 2013, 2014 and 2020.

Will 2022 join the list?  As we look at the years listed, the most relevant of the group may be 2018, as this was the last year in which the Fed tried to meaningfully ratchet down its balance sheet. Markets entered 2018 on a tear, as the October 2017 Fed announcement of planned ‘balance sheet normalization’ (a.k.a. tapering) was seen as a sign of a strengthening economy.

Lessons from 2018:  The year is a cautionary tale on periods of tapering: expect volatility, many rallies and corrections, and a potential flight to safety. In Q1 2018, as the Fed backed off bond purchases, U.S. 10-year rates jumped 44 bps to 2.84%, and the S&P 500 dropped 0.8%. In Q2, as rates stabilized below 3.0%, the S&P was able to post a 3.4% gain. The period of rate stability continued in Q3, allowing the market to stage a 7.7% rally. The trouble came in Q4. By the end of September, 10-year rates had moved above 3.2%, leading to a rapid sell off of the S&P. Yields flattened once again as investors shifted to safe havens, but the damage was done with the index declining 13.5% in the quarter.

How 2018 played out:  The path back to a Fed-free market in bonds is likely to be a rocky one. As the Fed leans away from treasury purchases, bond yields will undergo their own price discovery, which can trigger a series of rallies and corrections. Not the best climate for buying the dip. For the year, S&P large cap outperformed small and mid cap, and the only sector gainers were Health Care, Utilities and Consumer Discretionary. Communications, Financials, Industrials, Materials and Energy all saw double digit declines.

What’s different this time?

  • Pandemic effects:  Arguably, the economy is in weaker shape today than it was in 2018, despite low unemployment. Growth is far slower and much more dependent on government spending.
  • Rampant inflation:  The global economy is experiencing its highest inflation since 1982, which is pushing real rates down, not up. All things considered, this makes monetary policy less effective.
  • Fed experience:  There were fewer JPow memes in 2018, but Mr. Powell was head of the Fed then too. Hopefully, he learned a few things about pacing the taper that can be applied today.

On balance, we think the Fed is likely to be forced into a go-slow approach on rate hikes and tapering, which suggests interest rates may rise more slowly than many expect. Consumer stocks, Utilities and REITs are likely to fare better than most, with Financials offering decent returns as well. We expect many sectors to be re-rated on lower growth expectations, margin pressures and a renewed emphasis on quality.

Heading into 2022, we are actively de-risking our portfolios with a view to minimizing exposures to companies whose outsized valuations are most likely to be affected by normalizing rates and further inflation. We continue to benefit from the analysis and ideas generated at Veritas Investment Research, which remains one of the best equity research shops on the Street.

Year-to-date through November 30th, our Absolute Return Fund has returned 15.5% and our Canadian Equity Fund has returned 18.3%.  (Performance based on F series).     

We thank you for your continued support.

Your fellow investors,

Anthony Scilipoti
Sam La Bell

Please see below for links to client-friendly fund profiles and commentaries.

Veritas Absolute Return Fund November 2021 Performance Sheets
Veritas Canadian Equity Fund November 2021 Performance Sheets

October 2021

October 2021

How to Land a Helicopter

Quantitative Easing is ending. As we have come to know it, QE is the artificial lowering of interest rates that results from central banks using printed money to purchase government bonds and other assets. Faced with an economic crisis, QE purchases fund government deficits and lower interest rates to keep credit flowing. But what happens when the crisis eases and QE is withdrawn?

For answers, we turn to the parable of ‘helicopter money’ put forward by economist Milton Friedman. If a helicopter flew over the economy and dropped a fixed amount of money on every household, Mr. Friedman asked, what would happen to output and prices? Since there is only so much cash each household would want to hold, he argued, the extra money would find its way back into the economy and the price of everything would go up. The resulting inflation would reprice assets, goods and services, to the new level of money supply. Mr. Friedman didn’t foresee much effect on economic growth since, in his example, the economy was at full employment.

As central banks around the world dial back their bond-buying and governments scale back emergency support programs, how does the latest global QE measure up against Mr. Friedman’s predictions?

Money supply is up … way up: After growing 6.3% in 2019, the U.S. M2 money supply had expanded 36% through September 2021; in Canada, the M2 money supply is up 27% through the end of August.

The price of everything is up … way up: Versus the end of 2019, Canadian home prices are up more than 24% (Teranet composite index, September 2021); U.S. house prices are up more than 27% (Case Schiller index, August 2021). Through the end of October, the S&P/TSX is up more than 30%; the S&P 500 is up more than 43%. Versus the end of 2019, crude is up 36%; copper +62%; and lumber +45%.

Other than stock purchases and homes, households haven’t rushed to spend their cash:  Household savings are through the roof. Based on U.S. data, by the middle of 2021, cash deposits had reached 95% of disposable income, up from about 81% pre-pandemic. Household stock holdings (direct and indirect) now exceed 260% of disposable income, versus 208% pre-pandemic.

Inflation is rising to multi-decade highs:  Canadian inflation hit 4.4% in September, while in the United States, CPI inflation has topped 5% in every month since April 2021. We are watching the big-ticket items carefully. Transportation and Shelter make up about 45% of Canada’s CPI but are driving more than two thirds of topline inflation. Specifically, vehicle prices, fuel costs and home ownership are getting pricier. Demand is bumping up against supply constraints due to past underinvestment, bottlenecked production and/or a shortage of inventory.

Growth remains anemic:  In real terms the U.S. economy has grown by an anemic 0.7% annualized since the middle of 2019. With asset prices way up relative to economic output, the risk of a correction increases by the day.

Which brings us to our current investment strategy. With so much cash on the sidelines, we can’t rule out that the current appetite for equities will continue, at least in the short term. However, many of the forces pushing stocks higher – flush consumers, pent-up demand, supply constraints, shifts in spending on reopening, price inflation – risk seeing near-term reversals. After all, most of these tailwinds are the direct result of helicopter money and the disruptions brought on by COVID.

In the absence of stronger growth, once demand normalizes and conditions in the supply markets catch up, we would expect price momentum and margins to reverse, potentially quickly. Which is why central banks are not rushing to deal with current inflation, in the hope that it will be transitory. In the near term, the rebound in household spending will continue to drive inflation, but central banks go-slow approach on rate hikes; a weak economic backdrop; and investors’ growing desire for safety, bond yields and interest rates are unlikely to rise by as much as many expect.

Now, more than ever, we think a close read of company filings and detailed fundamental analysis are the keys to identifying which business models and industry trends have staying power, and which are likely to fade as economic conditions normalize. For individual stock selection, we continue to benefit from the great work being done by the independent analysts at Veritas Investment Research, which remains one of the best research teams on the Street.

Year-to-date through October 31st, our Absolute Return Fund has returned 17.7% and our Canadian Equity Fund has returned 21.4%. (Performance based on F series).     

We thank you for your continued support.

Your fellow investors,

Anthony Scilipoti
Sam La Bell

Please see below for links to client-friendly fund profiles and commentaries.

Veritas Absolute Return Fund October 2021 Performance Sheets
Veritas Canadian Equity Fund October 2021 Performance Sheets

September 2021

September 2021

TINA and the Taper

As the market begins to look beyond the reopening trade, expectations become more important. We see a stark contrast between the market’s current outlook and its outlook prior to the pandemic. Despite a clear deterioration in growth and inflation forecasts versus pre-pandemic levels, forward valuation multiples for the S&P500 are up more than 25%. At this stage in the recovery, we think it’s worth contrasting the market’s current consensus with its outlook prior to the pandemic:

 

 

Sep 30, 2019

Sep 30, 2021

S&P500 closing price

2,978

4,307

Consensus next calendar-year operating earnings

$180

$217

Consensus YoY growth in operating earnings

+12%

+10%

U.S. 10-year Treasury rate

1.68%

1.57%

5-year expected inflation rate

1.71%

2.23%

Multiple of forward operating earnings

16.5x

19.8x

Increase in forward multiple vs. 2019

 

+28%

Source: S&P, Refinitiv, Federal Reserve data (FRED), Veritas

Today’s much higher forward multiple for the S&P500 is in stark contrast to the deterioration in outlook for growth and inflation. With real rates on 10-year Treasuries now in negative territory, equities appear to offer the only real possibility of getting ahead of inflation.  FOMO (Fear Of Missing Out) on the rally has given way to TINA (There Is No Alternative).

In our view, TINA is at best, a weak argument for higher stock prices.  Low interest rates may keep people invested in equities, but there are some things they can’t do: they can’t kick start global growth until consumers are ready to spend and companies are ready to invest; and they can’t prevent global supply disruptions from driving inflation when spending resumes.

Which brings us to the Taper. Of the US$5.2 trillion increase in publicly-held U.S. debt since the start of the pandemic, the U.S. Fed has purchased approximately 55%.  The Fed is now dialing back its purchases, which means rates will have to rise to attract replacement buyers. 

Despite Fed tapering, however, we expect high asset valuations and tepid global growth to work against any quick rise in interest rates.  Even in September 2019, when times were better, real rates were near zero.  We see a greater risk of a valuation reset on lower growth expectations and a bigger bite from cost-push inflation.  In that scenario, stocks may correct significantly if weaker earnings forecasts roll in, without necessarily triggering much higher interest rates.

Veritas’ portfolios are positioned to counter inflation through our ownership of companies with scale and pricing power.  Scale offers the possibility of reducing unit costs to absorb inflation (think global services companies and IT).  Sectors coming out of a supply crunch, with inelastic or rebounding demand are also good bets to pass on their costs (think commodities, utilities, autos and business jets). 

But it does not end there because individual company performance, even in the most protected sectors, ultimately drives stock performance.  For individual stock selection, we continue to benefit from the great work being done by the independent analyst team at Veritas Investment Research, which remains one of the best research shops on the Street.   

Year-to-date through September 30th, our Absolute Return Fund has returned 16.1% and our Canadian Equity Fund has returned 17.7%.  (Performance based on F series).     

We thank you for your continued support.

Your fellow investors,

Anthony Scilipoti
Sam La Bell

Please see below for links to client-friendly fund profiles and commentaries.

Veritas Absolute Return Fund September 2021 Performance Sheets
Veritas Canadian Equity Fund September 2021 Performance Sheets