Josef SchachterA Comment -- General Comments From an ExpertA CommentaryN/ASep 18, 2017

If everything went completely wrong, markets would probably still go up. That seems to be what's happening anyway. He was sure (as sure as God made little green apples), with the new US Fed chair as Trump's boy, that there was no way they were going to raise interest rates before the midterm elections. They did. 

And the market hit new highs.

Yes, US earnings have been robust. Despite all evidence to the contrary, there's evidence of tremendous optimism still out there in the market. You can say it's because there's nowhere else for people to put their cash, or because of the greater fool theory, or because (in real terms) interest rates are still quite low. (The stated interest rate is 3% or so, but he doesn't know of anything that's gone up only 3% in the last year.) 

There's a lot going on out there psychologically that we don't understand. It's also possible that it's just AI and the first step toward singularity.

It's already catching up. Look at today's news surrounding ORCL and pipeline delays. Energy is an input, and there's a cost to running all of this technology. There are a lot of challenges around energy.

There's a lot of demand for energy that's not going to stop. So the price of energy will continue to be robust, which won't necessarily be a terrible thing for Canada.

He's looking for companies that are able to raise their prices, and that have control over their own markets to a much greater degree. It'll be interesting to see what happens with the banks, Canadian ones in particular, which had a huge run earlier this year.

With this rising interest rate environment, it could be a good thing for the banks. They've done very well in a low-interest rate environment. Typically, falling rates are better for banks. It'll be interesting to see how the financial services sector does from here.

These partnerships can be a good thing. When a big company gets embroiled with an even bigger company, he wonders about the possibility that the smaller company will be taken over. The partnership could last forever. Or the bigger company could just take the technology and run with it, and that would be his concern.

His concern is what if one of those legs gives out? When he hears about the supposed strength of the super-powerful US economy, he thinks AI spending alone accounts for about 50% of the growth over the past year. When you look back at the tech bubble, tech accounted for about 30% of the growth in the US economy. So AI is much bigger.

The rest has been the wealth effect from the higher-end cohort. Their spending has been more reflected in areas such as travel and concerts. But the remainder of consumers in the economy have faced higher food and gasoline costs. That segment isn't as robust -- look at results from WMT, HD, and others.

When you're really riding hard on this AI spending, the stock market continues its wealth effect, and higher-end spending continues, lose any one of those and you're left with a pretty sloppy economy.

His firm has been getting more defensive in their holdings. Thinks that, ultimately, the move in interest rates will be down. Inflation will come under control, and we're not going to see the strength continuing in these rates.

He sold all his banks stocks on high valuation. He'd rather move into other areas that are unloved, out of favour, and where valuations are better.

For this next phase going forward, you have to look for who's going to monetize AI the best? The major cloud players (MSFT, AMZN, GOOG) are growing 40-50% plus. They're monetizing better than anybody else. 

When you look at AI spending and the capex (increasing every year and forecast to go to $1T next year), he's not sure it necessarily continues at that rate. There are a couple of problems. The big spenders are suddenly FCF-negative. They don't have as much money, and they're borrowing at a higher rate. To the degree you slow that down, that's the biggest leg of that 2-legged stool we talked about earlier. 

There's a lot of air underneath all these valuations. 

It was completely on the valuation. He's more trade-oriented, so he can move positions in and out of positions. 

Valuations on Canadian banks are at unsustainably high levels, now around 15+x PE compared to historical levels of 10-11x. A lot of the growth in earnings has been strong. But it's been driven by capital markets, trading activity, and wealth management -- all things that are tied to a strong stock market continuing. Yields aren't that attractive right now.

It's all tied to that 2-legged stool. Continued AI spending leads to a strong stock market. To the degree you don't sustain that, you're not going to get the higher multiples and you're not going to get the same level of earnings growth.

He's on the same page. The debasement trade will go on. Major international investors are pulling out of US treasuries. There will ultimately be downward pressure on the USD, despite the Fed tightening rates a bit (headwind for gold). 

Thinks you're going to see central banks continue to diversify massive US holdings. Even if a few drops of that makes it into the gold bucket, it'll take gold higher.

Stocks themselves are cheaper than they've been in decades. The biggest thing to try to avoid is geopolitical risk. Stay away from the West African players.

He expects the US economy to slow down a little bit, and the US dollar will weaken. Thinks the Fed may raise one more time, and then we're into decreases. Then the gold trade will come back on. Thinks we still have $5-6k on gold quite easily. Doesn't take much money diverting to gold from the massive US treasury holdings by China, Japan, the Norwegians, pension funds, and other major players to make gold go higher.

Very positive. Makes sense that we're doing it, and it's been needed for a long time.

One thing to be aware of is that our ties to the US are so integral, we can't immediately go to Europe, India, or all of these other places. We can deepen our relationships with them, and it makes sense to diversify, but in the end, the US is going to remain our largest trading partner. 

It might give us the best of both worlds. We can start to increase these other relationships (bring more capital in, increase our LNG exports). Then, when there's a change in the US administration to more rational and reasonable relations, then we can start to normalize that relationship. That will eventually happen.

They'll subside. He's been through enough memory cycles on these chip companies that when you start to see increased supply, prices tumble very quickly. In the short term, it's an issue for all of them and probably a big part of their capex. 

They're cyclical businesses, and we'll start to get some increase in supply. We might get product from China at some point, and that would alleviate supply constraints.

It'll have to be more an integration than a competition. In the end, these are infrastructure assets. No matter how you do it, they still have to feed on the systems that are owned by the telcos, and which benefit those telcos. It's like streaming or the internet -- AI will increase traffic. The offset is that prices will continue to fall.

In the end, they mirror each other and work well together.

Stocks, both tech and non, are moving on the same headlines: new AI models, data centre construction or law or AI debates. If you're invested in AI, you're AI. If you're invested in non-AI, the narrative is whether you will be disrupted. PM Carney is making the right moves to diversify the economy (i.e. signing trading deals with Europe) and introducing tax incentives. The backdrop is the US trade conflict, housing remains weak as is the consumer. He sees great value in old-school compounders (strong market share, heavy cash flow, but companies, trading at multi-year low PEs).

No new show. Repeat of September 14, 2026.