Paul Gardner, CFAA Comment -- General Comments From an ExpertA CommentaryN/AOct 07, 2015

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.

The 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 renewed after a couple of years of treading water. His team 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.

He's seen his share of bubbles, and we're now seeing that with the AI tech stocks. Eventually, tech will flatten or fall, and the rest of the market will catch up. Yes, AI is here to stay, but AI stocks are overvalued.

Trump's efforts to tame gas prices is in vain. There's no short-term fix before the U.S. Midterms in 2 weeks. Siding with Putin in the Russia-Ukraine war could be the knife in the back for Trump. Given where the US economy is in the first two years, and the Republicans will lose the House to the Democrats, there's no saving grace for Trump anymore. His political capital can be measured on one hand. This week, he's waiting for what the big tech companies say when they report, namely how much capex they will spend next year. Even if companies beat and the guidance looks fantastic, investors remain concerned, because valuations are so rich. The question is: When will these companies become profitable? It's coming, but don't know when. The data centre pushback is already effecting the market, but AI is real an will have a big impact on eeryone.

All the AI is causing a demand shock to the market. Meanwhile, the polymarkets predict a 65% chance of the Democrats taking the Senate, and a complete (91%) chance the Democrats take the House. This means gridlock in Washington which is very good for stock markets, though this market is different given the concentration in AI, which has caused huge returns in recent years. It's projected that US$878 billion will be spent on AI capex in 2027. The AI trade is the only thing keeping the economy going. So many sectors, like housing, are in recession while the US deficit is running at 6% of GDP. Meanwhile, we have to double energy production by 2030 to feed data centres. All this is inflationary. We're reaching an inflection point where the US S&P equal-weight ETF is the better buy and no longer the laggard.

He has seen some early warning indicators. Volatility picked up a few weeks ago and the breadth of the market is becoming very narrow and large cap focused. There is a transition between technology stocks to some of the staple and utilities sectors. He has seen investors rewarding defensive sectors but this is not sustained yet. Health care and consumer staples have made moves up. Interest rates are starting to move up before the Fed's decision and this will affect companies that are borrowing money and servicing debt.

There is also concern over the uncertainty of AI spending and the effects of tariffs. Higher inflation, oil prices and interest rates could impact earnings in the first quarter of the new year. If the central bank waits too long to see where inflation goes before raising rates, they could be forced to hike into a slowdown.

The question was on his view of income stocks or ETF's. Some ETF's hold a basket of stocks and therefore have less individual stock risk. Regarding growth his daughter could look at companies or products she likes, knows and understands, see if they are publicly traded and together they could work on building a portfolio of these companies.

Editor's Note: The name of the company was indistinguishable, both verbally and in captions,although the first part of the name was Energy. No chart was shown. It is in the renewable energy business with waste being turned into natural gas. He has referred to this company in the past. It is improving its balance sheet and should have better quarters down the road.

There's so much to focus on: tariffs, trade wars, geopolitical tensions, interest rates, oil prices, inflation. When you boil it down, it's rates and the impact on inflation. The market projects two more US hikes, and 3-4 in Canada in the coming year which is harder to understand because Canada's economy is weaker than America's. The US dollar's strength surprises him. There's a lot of angst with markets at highs, but facing Trump's policies. You may need to harvest stock gains and buy stocks. The 60/40 portfolio split remains good as the US yield rises to 5%. Are there too many ETFs? He can't keep track anymore, though not one for Canadian defence which he'd like to see.

The middle of October is usually a pretty dark period for equity investors. Midterm elections, an Alberta election, a Toronto election. And then all these gate points that have missed -- CPI yesterday was worse than expected, PPI today worse than expected, US retail sales not so good without gasoline.

Investors are, rightly, reassessing risk. Whenever you have bond yields move the way they have in such a short period of time, people take a great deal of notice. How will that impact business decisions?

Essentially, the bond market has done the work for the Fed and the BOC on rate hikes. The thing that investors have to analyze is whether, in that higher interest rate world, they're still comfortable with their equity exposure? From tech baskets to neoclouds. That's the angst we've had for the last 6 weeks.

Easy to point it out, but the bigger question is how does it resolve itself? Where do we go from here?

Doesn't think so. Normal and very healthy for investors to have this gut check. We're still climbing that wall of worry, and people are still sober. People aren't seeing the once-in-a-generation opportunity that is before us.

This is a 4-year bull market, and it's been pretty generous. But it can be way, way more generous -- as long as we don't have exogenous shocks or really big policy mistakes by the Federal Reserve. If we can contain inflation, and if yields are where they are for the right reasons, that is growth. And there are great places to be.

However crowded the tech stocks are (and the whole world's looking at them), they're still not expensive. Many are trading at a multiple relative to the S&P. S&P's trading at 19x PE for 2027, and that's its 10-year average.