Opinions Stockchase InsightsA Comment -- General Comments From an ExpertA CommentaryCOMMENTJan 20, 2025
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The message, loud and clear, in recent weeks of earnings is the market is becoming more selective. Companies that delivered that earnings that would have been exceptional a year ago, are now facing pressure--strong earnings are no longer enough, but also need to justify high valuations, sustainable profitable, and a tangible return on AI. That enthusiasm about AI has shifted to seeing returns on investment and cash flows. This is healthy for the broader market, happening during surprising resilient economic growth. However, there's rising inflation above the US's 2% target. She's looking at companies' underlying cash flow and watching the bond market. Overall, the market looks constructive and you don't need to be defensive.
Based on polls, it looks like Trump will lose the House which will turn him into a lame duck president, then he will default to more executive orders. Meanwhile, central banks will keep raising interest rates. Yesterday, Google got hit, so the market is asking who will pay for AI. Overall, he's trimming and pull back, including Google after more than doubling, energy and precious metal.
For new money, telcos (as well as REITs and other sectors) have been hit as interest rates keep rising. The telcos, though, have aleady cut dividends, so they are relatively defensive. Getting more income into your portfolio now makes sense. So these sectors act like a bond proxy, which are buys.
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The market expected today's Bank of Canada interest rate hike to 2.5%, given rising inflation fueled by rising energy prices from the U.S.-Iran war. It probably won't impact the TSX much because the index is heavily weighted in commodities and financials, which may actually benefit from higher rates. The hike follows the U.S. one. AI stocks are driving the market and there's a lack of market breadth. About half the S&P is tied to AI and data centres. But two-thirds of the S&P are trading below their 50-day moving average, mostly those not linked to AI, but that's where opportunities lie. He also likes energy.
The market is volatile. Everyday there is a sector or theme that works: one day AI works, the next AI isn't working, then it's energy or the hyperscalers, then not. We're all slaves to the algo trading and causes people to lose focus on long-term investing. He doesn't trade every two seconds; he focuses on the fundamentals, on quality businesses, over 3-5 years, companies that can grow EPS 10% annually and cash flow. He won't overpay for the enthusiasm for potential AI growth. He's attracted to niche US software and IT now, and the hyperscalers.
There's still room to run in global stocks in this rotation period, shifting away from U.S. tech, because investors are adding up the costs and returns in tech--and it isn't adding up. So, the shift has been to the opposite: energy, just energy thrived in the sluggish 70s. Washington: How lame duck is Trump? We'll likely see a Democrat Congress, though who knows what will happen to the Senate? Probably, we'll see gridlock, which markets like. Markets would be more bearish if things shifted entirely to the left, because of tax policy. Trump lowered corporate taxes, but there won't be tax changes for at least 6 months.
Anthropic IPO: Few surprises in today's prospectus and so far, so good. US Midterms: Historically, gridlock is good for stock markets, but what's different now is the colossal amount of US debt. Expect a shutdown in the first few months, but he hopes it won't be too disruptive. AI: Democratic states don't want new data centres in their backyard (NIMBY), which will force companies to adjust their building plans. This week, the Bank of Canada is expected to raise interest rate to keep pace with other central banks, given inflation. The world needs more housing supply and for wars to end.
Anthropic will IPO next month. Revenue growth per employee is far higher in the Mag 7 then the rest of the S&P 500, which has flatlined for the last 7 years. A chart of profit margins over that span is the same, with Mag 7 far outperforming the S&P 493. Anthropic touts AI is the most important tech to ever hit the planet given better productivity. Among the AI ETFs, AIQ is the passive way which outperforms when things are bad, but BAI outperforms when things are good. Both ETFs are the same now, and they both include SpaceX. Like SpaceX, he expects huge volatility from Anthropic, but buy the dips for a long-term hold.
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.
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.
Advantages of ETF's for Investors:
They are a great tool for investors transitioning from passive to DIY
In investing, there is no need to choose between being an exclusively passive ETF investor or a DIY stock investor. There’s certainly room for investors to do both and create their own hybrid strategy. Investors who want to make the gradual switch to DIY stock investing can also take a hybrid approach by starting with broader market exposure through ETFs as core holdings, then selecting individual stocks as “satellite” holdings. As one gets more comfortable with the risks and concentration of owning individual names and develops a more refined strategy, an investor can slowly sell off units of core ETF holdings (or take new cash that come into the portfolio) and move more towards individual names.
There are many ETFs with niche exposures that allow you to differentiate from the market
There are enough ETFs and variety out there for an investor to create a portfolio of ETFs that he or she views as more optimal than the broad market. An example we often use is owning a TSX ETF which would be overweight in financials, materials and energy. A more optimal allocation may include increased exposure to technology, industrials and other cyclicals for investors looking for growth or utilities and REITs if one is looking for a higher yield than TSX. These adjustments can be achieved via specific sector ETFs. One can also tilt their portfolio towards smaller market cap ETFs that may have higher growth potential and are not well represented in market-cap weighted indices.
Why buy one or two stocks when you can buy the sector?
While this sounds like a rhetorical question, there is an actual reason for this: superior returns by being concentrated in a winning stock of course! But the trick is getting to a level of conviction where one can believe the particular stock is a winner in a specific indsutry. Of course, this can require a lot of time and energy researching a company and its competitors. Meanwhile, one may want exposure to this sector until deciding which name(s) to be more concentrated in. The solution: ETFs. For example, you want exposure to the cybersecurity space and are bullish on the sector in general. To not rush the decision of which cybersecurity stock(s) to pick while getting exposure one can purchase an ETF like the First Trust NASDAQ Cybersecurity ETF (ticker: CIBR) or ETFMG Prime Cyber Security ETF (ticker: HACK) to benefit from industry tailwinds and ultimately let the market decide which individual companies get a higher weighting in the ETF (assuming a market-cap weighting).
Low knowledge areas
Related to the point above, another benefit to ETFs is that they give investors access to instant diversification in areas that are far out of an investor’s realm of knowledge. For example, an investor may want emerging market exposure in their portfolio for geographic diversification. If one knows barely anything about emerging markets, it can be a daunting task to learn the ins and outs of companies in foreign countries that have very different economic cycles, regulatory and competitive. Many investors may not even want to own individual securities outside of North America and this is understandable. Again, ETFs offer a solution to gain this exposure of broader regions or specific countries. Of course, low knowledge areas for an investor can also be specific sectors in local or North American markets.
Final Thoughts
ETFs have many other uses that we can on and on about such as hedging a portfolio’s broad market exposure through inverse ETFs, getting exposure to commodities, currencies and precious metals or even using as a proxy for exposure for the 30-day period one needs to wait before buying back a stock sold as part of a tax-loss selling strategy. The point is, given how easy ETF make it for an investor to customize a portfolio and quickly gain diversified exposure, ETFs can find a place even the most active investor’s portfolio.
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