Market Commentary

Q4 2023



By Marc Foran, CIO

Despite Q4 being generally positive across markets and regions, the quarter was anything but smooth or consistent. It began with a continuation of the global market sell-off that started in Q3, which, by mid-October, resulted in many stocks outside of “the Magnificent 7” (Apple, Alphabet, Microsoft, Amazon, Meta Platforms, Tesla and Nvidia), reversing all gains made in 2023. At the same time, the 10-year US Treasury yield surpassed 5%, signaling market expectations that outsized inflation would remain entrenched for much longer than initially anticipated. However, global markets took a sharp U-turn following the release of better-than-expected corporate earnings and positive economic data that indicated inflation slowing to more reasonable levels. The result was one of the most powerful market rallies in recent years across both equity and fixed-income asset classes. As the quarter progressed, we witnessed a shift in the US Federal Reserve’s tone from being previously hawkish to neutral and, more recently, more dovish about the year to come. When it was all said and done, the MSCI World equity index increased 8.7% for the quarter while the FTSE Canada All Corporate Bond Index and the IBOXX US Investment Grade Corporate Bond Index increased 7.6% and 9.4% respectively.

Deal value activity for global private equity and venture capital declined by 34.7% in 2023, reaching levels last seen in 2019. The decline was largely driven by similar macro factors affecting public markets discussed above. During Q4, global venture capital and private equity activity increased 7.2% as fund managers re-entered the market to acquire assets that were presumed to be available at discounted valuations, with technology remaining a key focus area (31% of all 2023 US private equity deal value). Despite 2023 being a particularly challenging fundraising year for private equity and venture capital broadly speaking, we have seen some early indications that fundraising activity for impact products in Canada has picked up, with examples being i) the final close of Cross-Border Impact Ventures’ $135M Women’s and Children’s Health Technology Fund, ii) climate-focused ArcTern Ventures Fund III raising $335M, which exceeded its target and iii) positive early indications of private investor interest for Realize Capital Partners’ Realize Fund I (note: Realize Capital Partners is a joint venture between Rally Assets and Relay Ventures). We believe that private equity and venture capital funds that are able to raise capital today stand to benefit given i) valuations are more attractive relative to the past few years, particularly if the economy enters recessionary conditions during 2024 or 2025 as these funds begin to deploy, and ii) reduced competition for deals which further supports valuation and improved funding terms for investors.

 On the private debt side, we continue to see lower levels of activity for impact opportunities, given that market interest rates remain elevated and that many impact private debt products such as those focused on social equity and community impact tend to offer below-market returns (2-5% range). Having said that, we are seeing an increase in the number of US and global private impact debt opportunities with return profiles that are closer to market (8-10% returns). We also do see select market return opportunities in Canada such as PaceZero Sustainable Credit Fund II, which lends to early-growth-stage venture companies focused on health, education, energy transition, agriculture, and natural capital.

Public equity markets are pricing in a soft-landing scenario; however we remain skeptical that the world has avoided an economic downturn. Global equities have continued to rise in early 2024, particularly in the US where they have reached all-time highs. Meanwhile, bond yields have begun to move 20-30bps higher as recent data pointed to inflation unexpectedly surpassing expectations in December across many global markets including Canada, the US and much of Europe. As a result, the narrative out of the US Federal Reserve and central banks has been one of caution stating that while interest rates may have peaked, they will likely remain higher for longer until there is sufficient evidence to be confident that the inflation battle has been won. At the same time, in late Q4, geopolitical events related to the Middle East conflict and growing tensions with potential for further escalation translated into disrupted supply chains and rising transportation costs, two factors that significantly drove goods inflation after the COVID pandemic. As of the writing of this commentary (January 2024), Red Sea tensions have produced military action that could result in a broader regional conflict and consequently there is the potential for even more upward pressure on the inflation rates.

If interest rates remain higher for longer or decline at a slower pace than anticipated, we believe the potential exists for policy error (that is, interest rates being held too high for too long), resulting in a hard-landing macro-economy scenario. The rapid and sustained increase in yields to levels last seen in 2007 (prior to the great recession), could curtail what has until now been a consumer-led economy fueled by government stimulus, rising credit card and loan debt, and elevated savings rates. A recent report by J.P. Morgan forecasts that at the current run-rate, “All but the top 1% of consumers will likely be worse off than pre-pandemic by mid-2024” due to declines in personal savings.

We also continue to see increasing signs of consumer stress percolating beneath the surface. For example, US credit card delinquency rates are rising above pre-pandemic levels ,with a staggering 8% of credit card balances at least 30 days delinquent (a 22-year high and up 76% since Q1 2021). In another example, a recent poll found over 60% of US citizens and 47% of Canadian citizens are now living paycheque to paycheque, with a disproportionate share comprised of marginalized communities. In Canada, household debt-to-GDP has now reached levels experienced by the US during the 2008 financial crisis. At the same time, many Canadians with mortgages are renewing at fixed rates 20-27% higher than their current interest rates. As consumer spending slows, we believe business spending and hiring will also slow, which ultimately becomes a catalyst for a recession. This would likely force the Federal Reserve and central banks to rapidly decrease rates to re-stimulate the economy and thus start a new favourable environment for long-term investment.



Despite having a more cautious view on the global economy, we believe that certain asset classes will benefit from an environment of reduced rates resulting from an economic downturn such as those in rate-sensitive industries and asset classes. Thus for long-term investors we favour long-duration bonds with a preference for investment grade credit quality, high dividend stocks of companies with sound fundamentals, select REITs (particularly in healthcare and communications), real assets associated with natural capital (such as farmland and water infrastructure), and short-term impact GICs that are currently offering one-year locked-in rates at ~5% in Canada. We also believe that investors under-allocated to private equity and venture capital will find the 2024 vintage of new funds entering the market to be particularly well positioned to deploy capital towards impact opportunities with less competition for deals and potentially lower valuations than in prior years, which bodes well for strategies acquiring equity stakes in companies during 2024 and 2025 and exiting in 5-10 years’ time. Finally, investors with an appetite for alternative private asset classes, such as impact litigation funds focused on providing justice to underserved communities and regions, would benefit from this non-correlation asset class.

While we remain cautious in our outlook for 2024 we believe there are pockets of opportunity for investors. We see impact opportunities in healthcare designed to reduce the burden and costs of the current system as attractive. We also see food production, particularly in the area of alternative or low-cost proteins and reduced agricultural costs, as being well positioned. In terms of social equity impact targeting marginalized individuals and communities, we acknowledge that over the short term, opportunities may not deliver high returns given the disproportionate negative impact that occurs during economic downturns; however, we also highlight that it is at these precise times when capital is most required. Thus long-term investors, particularly those in private asset classes, will have a significant opportunity for additionality on their social equitable impact investments made over the near or mid-term. We also believe select investments in alternative asset classes such as impact litigation representing the interests of marginalized communities should continue to perform well given their low correlation with global markets. Investments mitigating climate change could face increased volatility in 2024 due to the large number of national elections occurring globally (a record 64 countries in total representing almost 50% of the global population), which could elevate investors’ fears and uncertainty regarding the continuation of clean energy and reduced emission policies. We have already seen holdings related to climate change sell off as the prospects of a Biden-Trump rematch has risen. We view opportunities in water utilities, waste management and farmland as attractive as defensive investments and those benefiting from falling interest rates. Finally, we continue to favour investments in areas such as democratized communications and digital access.

While we see inflation eventually declining, near-term macro factors may keep it steady, resulting in interest rates remaining higher for longer relative to market expectations, ultimately leading to an economic downturn as our base case scenario. We recognize that our view is somewhat contrarian to global market expectations as evidenced by the significant run-up in global equities since Q4, though much of this has been driven by multiple expansion among a handful of mega cap companies, particularly the Magnificent 7, which are now trading at significant valuation premiums relative to smaller midcap peers. Our view would become more bullish in the event of inflation declining at a steady rate and if signs of consumer stress abate in conjunction with a continued strong labour market.