Gordon ReidA Comment -- General Comments From an ExpertA CommentaryN/AApr 30, 2014

It's a day-by-day thing: one day, tech rotates in, another day it rotates out. We haven't seen a full rotation though, because AI remains a dominant theme, but investors are asking when and what the returns will be, and when the capex spending will end. Who knows? Capex is massive, not since the railroads of the 1800s. He solds some Meta, Alphabet and Microsoft which he entered last spring. A lot of businesses are sitting on their hands, uncertain, like the car and steel sectors. We will feel this impact in the next few quarters.

It's suppose to be an inflation hedge, but the price has been going down. It's at a peak valuation. Can't say where the price is going. But gold doesn't pay interest, like a T-bill. From 2015-2023, gold moved sideways. He prefers buying stocks.

Until very recently the market became very narrow, with only the largest of large-cap tech hanging in. As of this week, about 45% of companies in the S&P 500 are down more than 30%. With 60% down over 20%, 80% down over 10%.

The index has been looking pretty resilient, but there's a lot of weakness under the surface. Part of that has been from companies hurt by rising rates (defensive assets such as staples, utilities, etc). For companies that borrow fairly heavily, their borrowing costs have been going up. 

In particular, the strength has been from companies generating lots of free cashflow and showing pretty steady dividend growth. Those have been his firm's focus.

In the last 2-3 weeks, this sector has seen significant weakness. It's probably the area of the market that attracts the most focus. Now two of the big tech companies have gone from generating gobs of cash to having negative cashflow due to all their investments. In particular, that's META and GOOG.

That's generating questions for people who look at long-term rates going up on one side and cash generation going down on the other.

Everyone will point to what should be a spectacular earnings season, and ask why there'd be any weakness in, say, semiconductors? Earnings numbers are eye-watering on things like memory stocks and AI chip producers. It always comes down to what's the multiple, and how sustainable is it? Market's asking some questions about that right now.

Today, only ~9% of his firm's assets are in tech. That's very low compared to the S&P. 

Across client accounts, they have between 20-40% cash (depending on the mandate). If they get stopped out of a position, and market breadth is weakening (underlying strength is ebbing), they do not put on new positions.

They build a farm team of things they like to own. If they start to see improvement in breadth, then they look at putting new $$ to work.

He's not a big believer. Putting more $$ into a position that's pulled back just adds risk to a position that's not currently working.

Definitely seeing winners vs. losers. Some companies risk being replaced. Others are able to use AI adoption to their advantage. 

Bank indices around the world have very nice long-term price patterns. They're in a secular, multi-year bull market (unless you think we're going to face a major credit event). Banks have been pretty good at managing credit risk. During that run, stocks pull back to the long-term MA from time to time. All the banks have done this. 

Likes financials as a group -- one of the 3 core groups he's focused on. With long-term rising rates, power is in the hands of the lender rather than the borrower. As long as banks can hold those long-term MAs, rising NIMs should be a pretty strong driver.

Wealth management in pretty good shape. Risk currently to capital markets revenue if some of the big IPOs don't happen. 

What's little known out there is that, while headline numbers are showing markets at (or close to) new highs, the underlying market isn't quite as healthy. In fact, the latest statistics show that 41% of all stocks in the S&P 500 are 30% or more below their record highs.

Of course it's a cap-weighted market, so the biggest companies have the greatest effect on the index. Those big companies are kind of carrying the index along, but the underlying companies are being sold. That's actually creating opportunity.

Textbooks would probably say that it's an unhealthy market. You want breadth in the market and participation. To have so much money focused on so few stocks isn't a healthy market. 

We're starting to see some signs of capitulation and extreme bearishness. In Q4, this may lead to a broadening of the market. That would tie right in to the effects of both seasonality and the US midterms.

There are certainly concerns about whether there will be a true return on close to $1T of investment by the mega-cap tech companies. Players are positioning and new products are being introduced. 

It creates some nervousness among investors, but experience tells him that these types of things are normal in the early stages of a capex cycle. They will resolve themselves.

Q3 earnings have started to trickle in. Expecting 25% YOY growth, which is very strong. Corporate profit margins are at record levels, around 15%. 

There are a lot of opportunities outside communication services and mega-cap tech. Healthcare, for example, has been revived after a couple of years of treading water. His firm has had an overweight position in healthcare since last year, and it's now paying off.

Other areas also deserve some attention. Industrials have sold off hard, but a lot of them are growing earnings and cashflow at accelerating rates. Yet prices are falling. That tells him that valuations are becoming compelling and very quickly.

It's whether these data centres are actually going to be built. Will there be a political windstorm that puts up roadblocks?

His ongoing thesis is that opportunity will follow money. If there's a lot of money available with the returns that these data centres offer, there will be solutions. Some of these concerns are environmental, and some involve the cost of electricity. Some are disruption to communities. 

Over the long run, these things tend to be resolved if there's monetary opportunity.