Investment Commentary and Outlook

October 2024

 

Why have equity markets surprised with their resilience over the course of 2024? Investors often talk about the proverbial “wall of worry” – when equity markets rise in the face of seeming uncertainty and bad news. And we have plenty of that. Ukraine and Russia remain locked in conflict. The war in the Middle East has spread to Iran and Lebanon. The US election is almost upon us, with no clear leader between Trump and Harris. In Canada, the Liberals have lost their governing coalition and could face an election at any moment.

As always, all this uncertainty dominates the new headlines, with the media using worry and stress as a magnet for attention. Yet the major market indices in North America are at or near all-time highs. Why is that?

The Good Behind the Headlines

Beneath all the concern and negativity, there are positive developments. The US surprised investors in early October with an excellent jobs report. The Federal Reserve cut interest rates by 50 basis points to ease borrowing costs and stimulate growth. China, facing a significant slowdown, has also responded aggressively with plans to stimulate its economy.

Innovation in critical areas such as artificial intelligence also continues unabated, with both mega-cap companies and venture capitalists pouring money into this burgeoning technology. Industrial companies are benefiting from long-term trends in the onshoring of manufacturing, driven by geopolitical tensions.

As for Canada, its Energy sector is benefiting from higher prices and its Technology sector, full of underappreciated and undervalued investment opportunities, is finally attracting some investor enthusiasm.

In other signs of strength, merger and acquisition activity has picked up and the initial public offerings market is showing signs of life. The era of “cheap money” –  i.e., zero interest rates – is likely behind us, which is seen as a headwind for equity valuations, but it also means that responsibly managed companies with strong balance sheets and free cash flow are back in the driver’s seat, less challenged by competitors with questionable business models.

Our Approach to Current Markets

Pembroke’s investment team continues to have a strong focus on quality companies. Specifically, the firm invests in companies that can fund their own growth. This is particularly important given the increased cost of external financing from 2022 onwards. In addition, well-funded companies are well positioned to survive and even take advantage of weakened competition should a recession set in.

To be sure, the waters remain turbulent. Some companies, including some of those held by Pembroke, continue to struggle with the aftermath of the pandemic as customers work through excess inventory accumulated during the pandemic. Retailers face consumers squeezed by two years of inflation. Some technology companies face questions about their future as artificial intelligence threatens to reshape the competitive landscape.

Pembroke has made the decision to exit challenged positions and redeploy capital into companies with a more positive outlook. Where the short term is challenged but the multi-year investment opportunity is intact, Pembroke opportunistically builds positions when attractive entry points present themselves. As always, the investment team views volatility as an opportunity rather than a risk.

Overall, Pembroke’s portfolios remain characterized by growth, strong balance sheets and compelling business models, all of which should support long-term gains. In most cases, the noise surrounding the current economic backdrop and quarterly earnings reports is just that, noise.

Pembroke’s investment team spends time understanding each holding’s competitive advantages, long-term growth prospects and management acumen in order to identify and hold companies that are positioned to grow earnings and cash flow per share, and therefore shareholder value, over many years.

 

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