Christine PooleA Comment -- General Comments From an ExpertA CommentaryCOMMENTMay 08, 2018

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 as a benefit. 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.

Oil will stay elevated until the end of the year because of damage to infrastructure and it will take time to get it back on. Also there are declining strategic oil reserves around the world. The physical world market is trading at a significant premium to the financial world - the financial market is being manipulated by the US administration. He doesn't see the end of the war with Iran in sight. 
Natural gas is different - it is primarily a heating fuel and we are heading into an El Nino winter. However Europe is short of natural gas. 
Besides Iran, outside catalysts for stocks might be production increases, announced joint ventures, acquisitions, or cheap valuations.

Every industrial revolution spends capital before it creates productivity, and the AI revolution is no different. 

The next phase is what needs to be built, who finances it at what price, and who gets to bear the risk? There's a 3C framework. Capability: what have we invented? Capacity: can we physically build and deploy it? Capital: how do we finance it, at what price, and where does the risk end up?

Investors should ask not only which technologies will win, but who gets paid to finance the buildout, whether the price they're paying is sensible, and who owns the infrastructure everyone needs.

Lots of talk about yields and inflation. For him, it's not simply whether rates go up or down. It's why the market's demanding that price for long-term capital. A 5% yield can tell you different things. It can mean that an economy has great projects for capital. It can mean that there are more projects than the economy has the capacity to build, and higher rates are a means to ration that capital. Or, investors want more compensation for inflation deficits and policy uncertainty.

Today, AI investment is competing for capital at the same time that governments have very large financing needs. Also has significant portfolio implications. Canadian bond market's yielding about 4%, US is around 5%. For a long time stocks didn't have much competition from bonds, but now they do.

This puts a premium on 3 things: income, valuation discipline, and scarce productive capacity.

Some of it was funded internally, because the hyperscalers had huge cash reserves. But they've also tapped bond markets and private equity players. At the same time, we have these huge financing obligations from government. So it's evolving.

The price of that financing could be telling you that there are concerns around fiscal and monetary uncertainty. It also could be telling you there are just really good projects to be done and they need to be financed.

The hyperscalers are replacing copper with fiber-optics cable. Also, rising interest rates hurt commodities, though the impact could take time.  Comparing the valuation of copper vs. the dollar index, we now see overvalued levels, which tends to trigger a copper sell-off. Lately, small speculators have become heavy buyers of copper, and the last few times that happen, it triggered serious declines. Meanwhile, the commercial hedgers have the largest net short positions in years, because they're betting copper prices will decline--and past history says they're right.