A Comment -- General Comments From an Expert (A Commentary)

Market Update:

The TSE Index was up 6.16% in the month of November, up 23.93% YTD and 26.73% over the past year. Canadian GDP was up 0.30% in the fourth quarter of 2024 and 2.00% for the full year; in the USA the GDP was up 2.80% in the fourth quarter and 2.70% for the full year. The Canadian inflation rate was up 2% annually and the US inflation rate was up 2.60% annually in November 2024. With this background, the following Table presents the highest and lowest performers for the month of November 2024.
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There's value outside North America as the valuation gap between US stocks and ex-US wider than ever. Add to that the strong USD, so those foreign companies are cheap. He likes Japan, UK, and Europe, though many do business in the US. 2025 Canadian outlook: bullish because of further interest rate cuts, and Canada is dividend-driven.

He doesn't like the sector and he expects natural gas prices to trade off a little. Wait and see with energy as a whole. Nat gas stocks are too high given the nat gas price, and he expects a pullback and opportunities.

Not recommended. Preferreds don't do well during rising or even declining rates. In Canada now, rates are low around 3% for a 10-year bond. He suggests instead a simple laddered portfolio of bonds, 1-5 years, plus a couple government bonds and some high-quality corporates. Hold and don't trade. It will buffer volatility. 

The end of the Assad regime in Syria will impact North Americans through oil prices and energy stocks. We saw an initial uptick in futures and ultimately this will translate into inflation. Also, Trump wants to pump, baby, pump oil, which will lead to a supply offset. He read that because the US is the top producer, there's already underinvestment going forward; in a few years, US production numbers will come off due to this under-investment. Tech: we're in the early stages of the battle for tech supremacy and semis are in the middle of it. China: given Trump's rhetoric, expect volatility next year in emerging markets.

That doesn't exist. The premium derives from volatility, but there's less volatility in shorter-term bonds, because the price doesn't fluctuate much. However, in the US, you can buy an IEI, which is a bond note that gives 3-7-year exposure and you can't write your own calls to get the additional premium.

Minor exposure and limited impact. Foreign investment in Canada, if that money leaves (due to a weaker investment climate here), it will have little impact on Canadian markets and multiples; the flows are not that big.

The Bank of Canada this week is expected to cut interest rates again, likely by 50 points. He expect by the end of 2025 the BOC will cut only another 50-75 points for all of 2025. Next week, the US Fed will cut too, though they are cutting less aggressively, because the US is seeing an uptick in inflation there, though Canada will. If US inflation data this week is hotter than expected, the Fed will pause. The BOC will cut because the Canadian unemployment rate is now at 6.8% because the participation rate has ticked up. Back up to 2023 through much of 2024, Canada saw a decline in that participation rate. He estimates that if the participation rate returns to normal, which is higher, then the unemployment rate will hit 8%, which is the 50-year average. We're quickly returning to those levels. Employment is driving the BOC decision. Therefore, the BOC will seriously slow down rate cuts in 2025. Also, expect more weakness in the CAD. In the US, inflation this week could come in hotter than expected, which will limit the US Fed's rate cuts.

The market is complacent, taking its gains for granted, which is something that rarely ends well. The VIX is very low, about 14. He sees worrying signs in the junk bond spreads, based on the ICE BOFA US high-yield index option-adjusted spread. The spread between treasuries and junk bonds has fallen to its lowest level in 5 years, even lower than the spec mania of 2020-1, as low as summer 2007 (not good). He predicts that at the Dec. 18 Fed meeting that if the Fed talks DOWN the number of interest rate cuts for 2025, this will cause a huge sell-off in stocks--which may be buyable.

Company Highlight: VersaBank (VBNK)

VersaBank (VBNK) is a Canadian-based, digital-only bank focused on specialized lending and deposit services. Established as one of the first fully digital banks in Canada, it operates without physical branches, leveraging technology to keep overhead costs low and streamline services for niche markets, including point-of-sale (POS) financing and commercial real estate lending. It mostly operates in Canada, but has recently expanded some services into the US. 

Its stock price has recently seen strong momentum, up 58% year-to-date, and 125% on a one-year basis. It pays a small yield (0.4%), but both sales and earnings growth are expected to be strong in FY2025 and FY2026. Its historical growth rates have been robust, with a five-year sales and earnings CAGR of 16% and 19%, respectively. Net profit margins are expanding and with a market cap of $595.7 million and a reasonable valuation of 11.4X forward earnings, we think VBNK looks interesting here. 

We can see that its net profits have really taken off over the past couple of years, and its outlook is increasingly positive. It has ongoing plans to expand its POS financing offerings in North America, and its cybersecurity segment, DRT cyber, is also expected to see growth in the coming years. 
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We are seeing growing warning signs of a market correction because of increased speculation and leverage. There is more money now in leveraged ETF's than ever before. Sentiment is the highest in recorded history back to 1987. Also Google queries for day trading , swing trading, etc. are at all time highs. The market though could still go up. The S&P is on track to have two 20% back to back years which could indicate a third positive year. 

The question was on what sectors to look at in 2025 as well as stocks to consider. You have to be wary of a correction after the big run-up. In a down year stocks that often do the best are the ones that were already lagging. He is looking for companies that have not performed this year. He isn't picking a sector - all sectors have had a decent lift. Look at it company by company and their special situations.

The question was on mid cap energy stocks in Canada.They have had a bit of a lift and are low in valuation. Service stocks are quite low in valuation on an historical basis.

Companies that can operate efficiently without equity capital and the case study of many great businesses:

The reason for a negative book value is that the company has consistently raised dividends and repurchased shares over the years, and the amount of capital being returned to shareholders is more than the equity capital initially issued in the first place years ago. This is just an accounting record, which becomes less important as the company has grown significantly over the years.

In fact, very great businesses with superb Returns On Equity (ROEs) can run their businesses with negative equity capital without any difficulty in liquidity issues. These companies are few and far between in the public market and usually trade at a premium valuation and the commonalities between these companies include:

• The underlying business has a very healthy cash flow generation, and it made sense for these companies to return all of the cash they have generated and sometimes borrow some (conservatively) to increase dividends or share repurchases to investors.
• These companies have a very favourable cash flow cycle, where they tend to receive cash in advance and pay suppliers much later.
• These businesses tend to have very stable, predictable business volumes, possess pricing power over time and some kind of sustainable competitive advantage.
• These businesses have limited needs for capital expenditures and tend to be considered by the investment community as cash cows.

All these companies consisting of Domino Pizza (DPZ), Lowe (LOW), McDonald’s (MCD), Home Depot (HD), and Dollarama (DOL) have run a negative book value for years. They have been through a tough financial environment like 2008 or the pandemic but still managed to compound capital for shareholders at attractive rates. We don’t think the negative working capital should be a concern for these companies as long as the leverage level (in terms of net debt/EBITDA) is manageable. In addition, ROEs may not be an appropriate metric to evaluate these companies; we think Return on Invested Capital (debt + equity) is a better one for investors to use. Great businesses are the ones that do not need equity capital and can still grow.
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ETF inflows have reached their highest lever since 2021. History says that 7 out of the last 9 times we've had so many new highs on the S&P in a year, what happens is that the next year is on average -6%. Though, not every year. Secondly, there's lots of momentum in crypto ETFs and he's bullish.