• While its benchmark reached all-time highs, the Strategy underperformed due to overweights in the interest-rate-sensitive communication services and utilities sectors as well as underweights and stock selection in IT and financials.
• Adds to a fundamentally improved Shopify highlighted surgical trading activity in the quarter that resulted in four new positions and two eliminations.
• Despite recent underperformance, we are encouraged by the rebound in interest-rate-sensitive stocks and see reasons for further rotation. Overall, we maintain defensive portfolio positioning that serves as dry powder to be deployed when better opportunities arise.

Following a surging third quarter, the S&P/TSX Composite Total Return Index (TRI) added 3.8% in the fourth quarter, reaching an all-time high on December 6. The S&P/TSX Composite TRI advanced 21.7% for the year — impressive returns for a market experiencing modest earnings growth with headwinds from higher interest rates, yet with strong expectations for double-digit earnings growth in 2025.

Benchmark 10-year interest rates in Canada and the U.S. reversed course in the fourth quarter, rising 27 basis points and 79 bps to finish at 3.23% and 4.57%, respectively. The increase in interest rates, and therefore discount rates, has direct negative implications for the valuation of equities, all else equal. The U.S. Federal Reserve continued its rate-cutting cycle with two 25 basis point decreases in the quarter; however, the outlook for further cuts is murkier with lingering inflation concerns. For the Bank of Canada, a less robust economy in Canada relative to the U.S. has contributed to its dovish policy stance, resulting in two 50 basis point rate cuts to finish the year. The Canadian dollar continued to decline against the U.S. dollar, ending the quarter at $1.438 CDN/USD, further impacted by threats of broad-based tariffs from President-elect Donald Trump’s second term.

Exhibit 1: Bank of Canada Cutting Rates More Aggressively than Fed

On an absolute return basis, information technology (IT), financials and energy were the top-performing sectors in the benchmark in the quarter. In IT, sector heavyweight Shopify advanced over 40%. In the energy sector, energy infrastructure names were standout performers as egress improves in Western Canada, and as crude oil prices increased 5.2% in the fourth quarter ending at US$71.72/bbl for West Texas Intermediate. Natural gas prices rebounded significantly with NYMEX natural gas prices increasing 24.3% to US$3.63/mmbtu (NYMEX). More broadly, concerns around meeting the energy demand of AI-focused data centers has highlighted natural gas as a solution to meet consumption needs.

As for the lagging sectors, fears surrounding intense competitive pressures among telecom service providers contributed to meaningful weakness in communication services. Following Rogers Communications’ recent acquisition of Shaw, Quebecor has emerged as the fourth national wireless operator, leveraging the Freedom Mobile brand to aggressively compete for market share. Concerns around future capital allocation have been further exacerbated by lingering regulatory and macro fears. In the real estate sector, share prices experienced widespread weakness, with the most significant impact felt in multifamily residential REITs.

Despite posting positive absolute returns, the ClearBridge Canadian Equity Strategy underperformed the S&P/TSX in the fourth quarter. The most significant relative detractors included our overweight positioning in the interest-rate-sensitive communication services and utilities sectors as well as our underweight positioning and poor security selection in the outperforming IT and financials sectors. A few bright spots for performance included an underweight to the underperforming materials sector and strong security selection in the industrials sector.

Communication services was the worst-performing sector in the Strategy, with our overweight a detractor due to double-digit declines for holdings BCE and TELUS.

"The S&P/TSX delivered impressive returns for a market experiencing modest earnings growth and rate headwinds." 

In IT, the Strategy’s underweight weighed on relative results. While the Strategy maintains a position in leading absolute performer Shopify, its significant underweight detracted from relative performance as did weakness in Open Text.

In industrials, strong returns from AtkinsRealis and CAE more than offset weakness in Canadian National Railway and Canadian Pacific Kansas City. The two Canadian railways continue to deal with the effects of labor issues and new concerns over the potential pending impacts of tariffs on cross border trade. In the case of CAE, shares moved materially higher after concerns over a material slowdown in the civil training business due to declines in pilot hiring did not transpire, margins in the troubled defense business moved higher, and the company announced a long-awaited and well-received CEO transition plan.

Trading activity was heightened in the fourth quarter as the ongoing strength in equity markets presented several opportunities to trim on strength and prioritize other positions. We sold into strength both Intact Financial in financials and Brookfield Infrastructure (BIPC) in utilities. Trims were led by large reductions in energy infrastructure names Enbridge and Keyera, Brookfield Renewable and Atkins Realis in industrials.

Additions were surgical, targeting specific circumstances where we see significant dislocations between price and value. We continued to build our position in Shopify following a strong third-quarter showing that further illuminated the improved financial stability and capital allocation mindset guiding the business. The company, as it stands today, is a much different story than it was even two years ago. Gone is the poorly conceived Shopify Fulfillment Network, which changed the capital intensity of the business dramatically. Additionally, the operating leverage and incremental free cash flow margins of the business have proven to be exceptional. The proven profitability and revised capital allocation strategy leads us to believe that management has matured significantly, something we note coincides with the introduction of CFO Jeff Hoffmeister toward the end of 2022. The ever-expanding total addressable market, robust runway of embedded margin expansion and pricing power, improved capital allocation, and a best-in-class balance sheet continue to unlock the intrinsic value of the business at a rapid clip.

Also in IT, we initiated a position in Constellation Software (CSU), which specializes in acquiring vertical market software (VMS) companies. VMS targets specific industries or markets, often niche but crucial to end users, resulting in sticky recurring revenue and minimal competition. CSU’s flexible approach has led to an impressive capital deployment track record. By ensuring high hurdle rates for every investment and redeploying nearly 100% of free cash flow, CSU is a compounding success story. Historically, we have been cautious on the stock due to valuation; however, our assessment of the intrinsic value of the business has recently increased materially with superb execution of the business plan.

"Trading activity was heightened as ongoing market strength presented opportunities to take profits and prioritize other positions." 

New addition MEG Energy is a Canadian oil sands operator focused on sustainable in situ thermal oil production at its Christina Lake Project in the southern Athabasca region of Alberta. The company employs advanced steam-assisted gravity drainage technology to efficiently produce bitumen while also prioritizing environmental responsibility and long-life asset optimization. MEG is uniquely positioned for long-term growth and shareholder returns, driven by its high-quality Christina Lake asset, efficient operations and disciplined capital allocation.

Parkland is a leading marketer, distributor and refiner of fuel and petroleum products, with operations spanning Canada, the U.S. and the Caribbean. The company operates over 4,000 retail and commercial locations, offers a broad range of fuel and convenience products, and owns the Burnaby refinery in British Columbia, which is highly integrated with its Western Canadian distribution network. Despite challenges in 2024, including shareholder activism, weather disruptions and weaker crack spreads, which have led to negative revisions for guidance, we remain positive on Parkland’s potential. The company is actively deleveraging, benefits from a strong free cash flow profile and is focused on shareholder returns through buybacks.

At quarter end, the Strategy’s largest sector exposures were financials, industrials and energy. Relative to the benchmark, the Strategy is overweight the generally defensive/non-cyclical consumer staples and utilities sectors, as well as industrials, and most underweight the typically value and cyclically oriented financials, materials and energy sectors.

Despite their stubborn underperformance over the last two years, we are encouraged by the rebound in interest-rate-sensitive stocks in recent months in connection with declining market rates and believe these higher-yielding segments remain attractive. The Bank of Canada’s previously aggressive monetary policy attracted disproportionate fund flows into low-risk fixed income products including term deposits, money market and high-interest mutual funds and ETFs. However, the central bank’s recent shift to a more dovish policy stance and the likelihood of additional rate cuts are expected to pave the way for a further rotation into higher-yielding equities.

The economy, although still resilient, is showing signs of deceleration as the lag effects of a tight monetary policy that commenced in 2022 are starting to surface. Despite central banks having made significant progress in controlling inflation, consumer sentiment has recently turned more cautious, leading to a slowdown in spending. This trend has been particularly evident among the middle- and low-income consumers who are facing greater financial constraints due to rising interest rates and inflationary pressures. The once tight labor market has stabilized more recently and is displaying signs of gradual slowing as the pace of new hires moderates, wage growth cools and jobless claims rise.

With the equity market still optimistic about a seemingly favorable scenario for rate cuts, continued economic growth and a solid corporate earnings profile, there appears to be little margin for error. This is especially true for areas of the market with more extreme valuations, where there is considerable downside risk should the economy fare worse than expected. Accordingly, we continue to maintain a relatively more defensive equity positioning in the ClearBridge Canadian Equity Strategy than is typical.

Effectively, our defensive positioning serves as dry powder that we will deploy when better opportunities arise. We look forward to uncertainty and increased volatility in the market environment, whereby our strategies could benefit from this patient and deliberate positioning. When this time comes, it should also allow the Strategy to shift toward a more aggressive stance and benefit from short-term market dislocations.

During the fourth quarter, the ClearBridge Canadian Equity Strategy underperformed its S&P/TSX benchmark. On an absolute basis, the Strategy generated gains in six of the 10 sectors in which it was invested (out of 11 total). The primary contributors were the financials and energy sectors while the main detractor was the communication services sector.

Relative to the benchmark, sector allocation and security selection were both negative. In particular, a sector overweights to the significantly underperforming communication services and utilities sectors detracted. Negative stock selection in IT and financials detracted further. On the positive side, relative contributions came from stock selection in industrials, real estate and materials and an underweight to materials.

On an individual stock basis, leading absolute contributors included AtkinsRealis, Bank of Montreal, Brookfield Corp., CAE and Shopify. Top absolute detractors included BCE, Toronto-Dominion Bank, Canadian Pacific Kansas City, TELUS and Canadian National Railway.