Investment Commentary Q2 2023

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North American equities advanced in the second quarter, enabling investors to partially recover losses after a dismal 2022 where almost all publicly traded asset classes lost money. 

After a steep drop last year, US large cap equities, as measured by the S&P 500, were one of the best performers in Q2, gaining 6.3% (in Canadian dollars). The TSX Composite was only up 1% over the quarter, although it had much better relative performance last year compared to US equities.

Stock market gains so far in 2023 have surprised many given that central banks have continued to raise interest rates in an effort to moderate economic growth and reduce inflation. However, U.S. market returns this year have been uneven: the seven largest holdings in the S&P500 represent 75% of the year-to-date June 2023 gain in the index, while the other 493 companies in the index are responsible for the remaining 25%. 

Perhaps of even greater note, US stocks are not as expensive as they appear if you look past high-level statistics.  Price-to-earnings (P/E) multiples are often used as a measure of valuation for both individual stocks and indices: the higher the ratio, the more expensive equities are since an investor has to wait longer to collect enough of a company’s earnings to recoup their investment and ultimately earn a profit. At the start of 2023, the P/E multiple (based on estimated future earnings) for the S&P500 was approximately 18x, about the same as the 20-year average.

Looking at the average weighted P/E multiple for all 500 companies in the index can be deceiving though  as the top seven largest companies had a forward P/E ratio of 23x, while the P/E ratio for the other 493 companies was 16x on January 1, 2023. This valuation gap had expanded significantly by June 30 as the PE multiple on the top seven holdings grew to 38x, while the multiple for the other 493 companies in the index actually dropped to just under 14x. This suggests that most large cap US stocks are not particularly expensive right now on a P/E basis, ignoring the top seven companies. 

The top seven are many of the technology-oriented giants:  Microsoft, Alphabet (Google), Amazon, Meta (Facebook), Apple, Nvidia and Tesla. Digging deeper, some of these companies are arguably more expensive than others. For example, chipmaker Nvidia has had a good run this year as investors believe it will benefit from wider adoption of artificial intelligence. It is now trading at 55x its estimated earnings for 2024 and is valued at over $1 trillion. For reference, an investor could buy all of Coca Cola ($258 billion) + Costco ($238 billion) + McDonalds ($215 billion) + Nike ($165 billion) + Starbucks ($115 billion) + Hershey ($48 billion) for the same price as Nvidia.  Time will tell whether Nvidia will grow into its valuation, but right now we think the better bet would be to own the collection of other businesses.

The US and Canadian fixed income markets were basically flat over the quarter.  In Canada, the five-year government bond yield climbed 0.7% to end Q2 2023 at 3.7%. The Bank of Canada has raised rates nine times since early March 2022, moving its benchmark rate from 0.5% to 5%.  Over this time, the inflation rate has responded to this monetary tightening by dropping from 8.1% to 2.8%. The consensus is that we are getting close to the end of this monetary tightening cycle with the possibility of a rate drop in 2024 assuming inflation continues to decline toward a 2% target level.

At Bridgeport, we have continued to focus on what we do best, which is to research and invest in high quality assets that are attractively priced across both publicly traded and private markets. With one exception, our various Bridgeport portfolios made positive return contributions to client portfolios in the second quarter.

Bridgeport High Income Fund gained over 2% in the first six months of 2023. With the increase in interest rates over the last year, the Fund’s fixed income component (80%) now has a yield to maturity greater than 8% and its equity component (20%) has a current dividend yield of 5%. This should lead to strong returns going forward as our bond positions approach maturity and steadily appreciate toward their face value. One recent purchase in this portfolio was a bond issued by Triton Continental, a large container company. Despite being a very strong credit, we purchased the bonds at a significant discount and a yield to maturity of 7%, although they were initially issued at par with a 2.05% interest rate back in 2021 when interest rate levels were substantially lower. The drop in Triton’s bond price and corresponding increase in its yield is broadly representative of what has occurred across the corporate bond market in the last two years.

Bridgeport US Equity Fund is up 10% on a year-to-date basis (in Canadian dollars). We added a number of new positions to this fund during the quarter including CDW Corporation. CDW provides IT solutions and services to more than 250,000 business, government, education and healthcare customers in North America and the UK. We also reconfigured our energy investments in this portfolio, taking profits from our position in British Petroleum and adding exposure to ConocoPhilips and Pioneer Natural Resources, two companies we believe have greater upside.

Bridgeport Canadian Equity Fund has returned 6% so far in 2023. We made only modest adjustments to this portfolio in Q2 2023, adding to positions in Saputo, Suncor and Bank of Montreal while trimming holdings in a few other areas.

Bridgeport Small & Mid Cap Equity Fund has earned 7% year-to-date. The fund initiated a new investment in Waters Corporation, a provider of analytical instruments and software that is used to ensure the safety of medicine, purity of food and water and the durability of everyday products. We also increased positions in Superior Plus, Northern Trust and Dentalcorp Holdings, while selling investments in Pershing Square, Openlane and Chesswood Group.

Our three private asset funds which focus on private credit, private equity and real assets have generated muted returns so far in 2023 after generating strong relative performance in 2022. Year-to-date June 2023 returns were 2.2% for Bridgeport Alternative Income, 1.2% for Bridgeport Private Equity Opportunities and 0% for Real Estate & Infrastructure. Overall, returns for these funds have proven to be less volatile than Bridgeport’s public equity and liquid fixed income strategies, although they are also generally lumpier as valuation increases from our underlying portfolio holdings are less frequent and can be affected by a number of factors. We are also seeing that many managers are investing at a slower pace in an attempt to capitalize on future opportunities at lower prices.

In terms of new private asset activity, we have been most active in Bridgeport Real Estate and Infrastructure Fund where we recently allocated capital to Brookfield Asset Management’s $25 billion, fifth generation global infrastructure fund as well as making two modest co-investments in multi-residential, rental real estate developments in Toronto and Miami alongside existing institutional fund partners.

We wish you all the best for a wonderful summer.  As always, please feel free to reach out if you have any questions.