Canadian stocks, as measured by the S&P TSX Index rose by 8.86% for the first nine months* of 2023, while global stocks, as measured by the MSCI World Index, increased by 13.56%. So far, the year has featured significant growth in mega-cap U.S. Technology companies driven by excitement around Generative Artificial Intelligence partially offset by financial stress created by the abrupt collapse of Silicon Valley Bank.
Worldwide, central banks are raising interest rates to combat inflation by reducing demand as much as possible. We are beginning to see the impact of these policies on Canadian consumer behaviour, as discretionary spending has come under pressure.
Labour markets in North America remain extremely tight, with near record levels of low unemployment. Historically, rising unemployment has heralded the beginning of a recession and we continue to watch the labour market for signs of a slowdown.
Outlook and Challenges
The shorter-term outlook remains uncertain, with tight monetary conditions expected to have a gradual restraining impact on economic growth and corporate earnings. From a regional perspective, we continue to believe that North American economies remain among the world’s strongest. Europe continues to struggle with low levels of economic growth while China’s outsourcing-driven economic growth model needs to adapt to offset a wave of global re-shoring.
As we look forward towards the remainder of the decade, there are two large long-term changes that we believe will drive outsized risk and reward—the energy transition and a new wave of digitization driven by Artificial Intelligence (AI).
The energy industry is arguably the single most important industry on Earth. Over the past decade, a global consensus has grown that the energy industry must be transformed to limit the impact of human caused climate change. To decarbonize, the world has begun a lengthy switch in how energy is produced, transmitted, and consumed. As a result, we have started the global energy transition—a multi-decade process that will create an inflection in the outlook for many industries.
On the digital side, this has been the breakthrough year for Artificial Intelligence as AI has entered the mainstream through the rapid adoption of generative AI models, including ChatGPT. We view AI as a new wave of digitization, driven by the underlying compound improvement in computing power. While it is still early days, we believe that AI will become increasingly important as the decade progresses.
From an investment perspective, a component of our investment philosophy is focused on finding the key enablers of change. We often draw the analogy to the companies supplying the ‘picks and shovels’ during a gold rush. A small handful of miners will hit it big, the vast majority will find little to nothing, but the ‘picks and shovels’ suppliers will win no matter what.
Periods of transition and technological change create winners and losers, often upending entire industries as newly formed ones take their place. We look to add return while limiting risk by owning the key enablers of structural change while avoiding industries and companies at risk of being displaced. Generally, our businesses are highly profitable, generate substantial—and growing—free cash flow, and have strong balance sheets. Some should have an added growth tailwind over the coming decades as they benefit from the energy transition and the AI wave.
*As at September 15, 2023