Stockchase InsightsA Comment -- General Comments From an ExpertA CommentaryCOMMENTMay 24, 2024

For the most part, earnings have been roughly in line or slightly ahead. That's been reflected in the markets. The bigger impact on the quarter is the decline in inflation. That's a positive, we'll see if it continues.

Those two things have set a good tone for the quarter.

The challenge with the rhetoric coming out of the White House is that the market's just ignoring it. It's just constant, and it's disconnected from reality. If we're going to have a peace deal, let's have one. Striking around the Gulf is just causing everyone to suffer.

He doesn't see the Iranians giving in anytime soon.

You need to think about 2 segments of the consumer, the classic K-shaped economy. Metrics reported by Visa recently showed sustained double-digit returns and growth. That speaks to a healthy consumer. Median rents in NYC are $5k a month. Though that might be a bit excessive, it points to consumers who are, generally, optimistic.

There's a lot of spending going on in the US with AI and data centres, and that's permeating through the economy. So the US consumer who has a job or is exposed to markets is doing quite well. Those who do not have tended to suffer, and we're starting to see that in the labour markets.

WMT would be exposed to the less economically advantaged consumer (though the wealthy do spend there). WMT results are a bit disconnected from the portion of the population that actually drives the US economy.

Be wary of any stock that benefits from ETF fund flows because when the market decides it doesn't like the stock anymore, everyone just sells en masse.

With the dot-com era, and the promise of what it was for e-commerce, it was very hyped in 2000. But the crossing of the chasm didn't happen until 2020, when everyone was locked in the house and had to buy online. 

If you look at what the promise of AI is, the likelihood of what's being promised now to be delivered now is virtually zero. We have to put some roadblocks around our assumptions. That's the fundamental reality.

From an investor reality, the trend is your friend. You should have some exposure to AI. Be careful how you risk-manage it. If you're playing with the house's money, then trim, take some off the table, and put it in defensive names. If you're a growth investor and 100% invested in AI, that trade will work. Until it doesn't. And you'll be down 50%.

For commodities, his firm tends to favour large companies. This gives you the dividend, share buybacks, and a bit more fiscal discipline. The oil patch has rediscovered its discipline. Wait and see how long that lasts when money starts flowing again -- we might see a lot of drilling or acquisitions that make no sense.

Sees small companies as trading vehicles at the margins, while holding big companies as core positions.

Last 2 years for Canadian financials have seen outsized performance, though that trend has largely been in line with US and Europe. From a macro view, Canada is not actually that healthy -- trade war with our biggest partner, soft labour markets. 

If you're not going to have a capital gains tax problem, trimming here would make some sense. No need to own more than one bank, more than that adds to your systemic risk. A balance sheet recession will affect them all. In 2008, for example, they all sold down.

Messaging from Scott Bessent yesterday is that they're buying back money because the US economy has a major fiscal challenge. This tells us that we have some trouble ahead. You're probably misreading the tea leaves if you don't take some money out of your growth names and pivot to some defense.

Every fundamental factor he's looking at indicates that we still need more compute. At the beginning of last year, we thought we were going to spend $350B in capex for 2026. Now that number's looking like $1T, going up to $1.3T for next year.

We're still seeing a significant amount of demand, which is not being met by the current supply in the market. For now, we still have a couple of quarters of solid demand getting ahead of supply.

Where you have to pay attention is as soon as the margin profiles come back down. You can have periods of glut. At the end of the day, these are more commodity-based assets.

Call him crazy, but he thinks we can buy software stocks again. A lot of applications in some of the horizontal software companies are going to be disrupted in a massive way. It's a function of a lot of alternatives being available on the market.

But you still need a lot of the software infrastructure companies. The ones that enable the AI agents were much more immune to the selloff of the SaaSpocalypse. Any companies you buy have to have an AI angle and have to be reaccelerating revenue.

Safe to get back into software, but it has to be on the infrastructure side.

People looking at these massive capex numbers see the spend side, but want to see the revenue side. Seeing explosive revenue from Anthropic and OpenAI. He's starting to pay much more attention to the return on investment among the hyperscalers.

GPUs have a longer life cycle than people are expecting (9 years vs. an estimated 6). So the payoff period can extend much longer.

His point is that this has been a one-decision type of investment over the last 10 years. The compound is something like 22% over that time, but that's not a realistic expectation for investors. We've ridden a tremendous wave of AI, cloud computing, and electrification of the grid. If you look at the fundamentals of a lot of the NASDAQ companies, especially the Mag 7, they deserve to trade at high valuations.

That said, a lot of companies have come out of nowhere with big increases in market cap. No question, demand is off the charts for AI equipment. If that cools, we could face a period where (though some companies are doing amazing) the NASDAQ and the S&P could do nothing for years. It's simply because of the way the market's structured, with so many companies tied to the AI trade.

This worries him a bit. He wants to make sure his clients have reasonable expectations going forward. For a diversified portfolio set up for your retirement, the equity part of your holdings is looking at 8-10% a year and not 22%.

It's a good economy. Seeing lower unemployment, strong corporate earnings. When people spend $$ on infrastructure and AI, it blends into the entire economy. We're seeing the stock market be very strong, which leads to good vibes, rich people investing, and rich people retiring.

We're in for some pain at some point. He just can't tell you when. We're in the fourth year of strong markets for most of North America, double-digit returns this year. Sometime, the good news will start to fade. 

You need to be selective with your investments. There are so many wonderful businesses that used to trade at 30-35x PE, and now trading at lower valuations even though their growth is just as good. The market's focusing on a lot of nit-picky stuff that's not relevant to long-term investors.

All have done extremely well. Trading at one of the highest valuations of the past number of years. So are US banks, as is the stock market. Banks benefit from the beta of strong stock markets, but the reverse is also true.

The better question is should I be taking some $$ off the table (and that depends on your rick tolerance)? How much of my portfolio does it now represent? Money managers have  to follow rules on position size, but individual investors don't -- for them, it all depends on comfort level.