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

With regards to holding cash, you really want to look at the opportunities that are prevailing at the time. He doesn't really make cash calls. The only time he might increase a cash position is before September, because it tends to be the worst month historically. 

What is the Private Equity playbook in the public market?

Firstly, Private Equity investors do not look for the “traditional compounders” of high-growth, disruptive businesses early in their life cycle and hold on for decades. The primary criteria the private equity industry tends to look for are businesses with a high degree of predictability and a low risk of disruption.

In addition, these investors constantly seek companies with a high degree of recurring revenue, low customer churn, strong pricing power, and consistent cash flow generation. The purest forms of such businesses are subscription-based businesses like software, consumables, consumer brands and other high-recurring revenue products/services, etc. These businesses tend to be highly durable, independent of access to the capital market and able to support a decent amount of debt on the balance sheet even during a tough environment.

One of the primary value-creation engines of private equity investors is to raise prices prudently, control costs efficiently and put a moderate to high level of the amount of debt on these companies’ balance sheets. The debt level tends to vary for different companies, as some are more well-equipped to carry a higher level of debt, but the target leverage levels usually range between 2.0x – 5.0x net debt/EBITDA. The purpose of the debt is to amplify the value creation of the business either through organic growth or cost management.

As the business can grow EBITDA, then the leverage levels naturally go down, and these companies can leverage up again to maintain the target leverage levels and use the proceeds to do some value-creating strategies like acquisitions, buying back shares or paying out special dividends. The model reinforces itself, making even a low, moderate-growth business in EBITDA become a double-digit total return investment over time.
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It was telegraphed that Justin Trudeau would resign as Prime Minister, such as Freeland resigning in December. He's not sure why he took this long. The markets reacted positively. 2025 outlook: so much capital has flowed into the US to bid up wonderful companies like Mag 7, but only 25 companies make up 50% of the S&P market cap. Be careful with valuations and avoid recency bias (the last 2 years returned over 20% annually). Analysts are projecting sky-high targets for the S&P. Valuations matter, and the market is not cheap.

The next earnings can't be okay but way above average to sustain current valuations. The US economy grew well in Q4, but must translate into earnings. A stronger US dollar will be a headwind for earnings, but expectations for the next few years is low/double-digit growth. He doesn't think earnings can maintain these levels. We've had two strong years in US stocks, but that won't repeat. Microsoft's announcement to spend on AI triggered today's rally. Trump: Canada won't be a 51 state, tariffs are disruptive and that's a headwind. Trump's platform will cost $5-7.5 trillion over the next 4 years and how will he pay for that? World governments have not done a good job with tax dollars, which may explain a shift to the right.

The Bank of Canada is cutting interest rates way faster than the U.S. because our economy has been weaker. So, the bond markets has done a lot better here. That said, everything is priced against what's happening in the US treasury market, and this creates upside pressure which therefore limits the Canadian bond market from getting too much stronger. Rates are decent now. We won't go back to very low rates. We could see a few more rate cuts ahead, but not change the 5-year yield that much.

The CAD from the time (8:00 pm EST last night) the Globe and Reported Justin Trudeau would resign the CAD sold off, then rose a little when European markets opened overnight, then jumped higher at 6:00 am after the Washington Post reported that Trump would impose sweeping tariffs, but fewer targeted ones. However, the CAD sank heading into Trudeau's resignation around 10:00 am. Minutes later, Trump tweeted that the Post is wrong and that full tariffs will happen. The CAD sank. So, the CAD will whipsaw in the coming months, based on the forthcoming Canadian election and Trump's tariffs. Over the last 5-0 years, the Canadian dollar has rarely been at levels as in the early-1970s. The last-1900s saw a bottom due to Canada's massive deficits and energy market not working. Today, fair value is around $1.25-1.30 and should return here in a year (or 1.5 years) if US tariffs are moderate and a change in the Canadian government. So, hedge assets with US exposure, including ETFs.

With a change in the political scene we should get a re-embracement and fixing of the economy by returning to good wages and dealing with the cost of living issues. The Liberals have not been good for business and sentiment with entrepreneurs, and have shown a lack of understanding of how jobs are created and where higher wages come from. They come from value out of industries. Money has been put into AI and battery technology but he feels this has not been done on a day-to-day basis. Mark Carney could turn things around for the Liberals but Christia Freeland could get tagged with the previous policies.

Comfort and Returns

‘Comfort is the enemy of returns as you can have comfort, or returns, not both’ – Mark Yusko.

Behaviorally, an investor's willingness to sell stocks increases as the market declines, as it becomes more uncomfortable to hold on to a losing position. In order to feel more comfortable, those investors will sell the declining positions in order to ‘stop the bleeding’. In some instances, selling a losing stock is certainly warranted, where the fundamentals have changed or it is going against the market, but in other instances, it can simply be attributed to systemic selling across the broader markets. The same principle applies to buying at the very lows, it can be uncomfortable buying a stock after it has declined significantly (such as what we are seeing across many stocks today), but historically these periods have represented some of the best long-term buying opportunities.

Of course, the principles of ‘buying low and selling high’ and ‘buying when others are fearful and selling when others are greedy’ are well-known mottos to most investors, yet in practice, these are much harder to execute on than in theory. Almost every investor would prefer to buy at the exact bottom of the market or sell at the exact top so that they do not have to hold through the uncomfortable waiting periods in between, but part of a long-term investment strategy involves holding through both bull and bear markets. Many studies have shown that missing out on the few best stock market days of the year can be detrimental to an investor’s portfolio, and while holding on during bear markets may be uncomfortable at times, it is in the depths of the bear markets where bull markets are born. 

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Stocks will do well, if the yield peaks and goes lower, even at 4.5% or 4.6%. But if it climbs to 5%, the stock exchange could be miserable, at least short term. Remember in the mid-1990s the yield hit 6.6% and that was a great time to own stocks.

Anything below 5% unemployment is considered full employment. He expects the labour market to remain strong. But if Trump orders massive deportations, it could trigger a massive labour shortage. Could the labour market get too tight and could wage inflation?

He hopes we achieve this if the consumer stays strong and there's deregulation in capital markets and China bouncing back from the pandemic. More corporate tax rates could help, too. Then again, consumer spending could decline, tariffs and higher interest rates could curb the EPS. 

Bullish sectors in 2025: aerospace, HVAC and anyone selling into data centres, financials (because of expected deregulation), pipelines, legacy tech (like Dell) as long it keeps generating growth, cybersecurity (hacks will continue), robotaxis. Bearish sectors in 2025: agriculture, defense (too expensive), anything sector needing a lot of finance because long rates remain high, packaged food (headwind of GLP-1 drugs), energy (Trump will encourage too much production and drive down prices), retail REITs, materials and commodities (need to see lower interest rates and Chinese demand must increase), quantum computing (a bubble in unprofitable companies).

Believes it will be important to stay diversified and defensive in 2025. Will be important to keep gains from 2024 and 2023. After a period of strong gains - history of markets is towards average gains (~10%). Expecting China to remain important player in the global markets. Chinese markets could be a risk to recession if tariffs are placed on Asian markets. Even if investors don't own Chinese stocks - mush be observant. A.I. stocks show potential, but as a whole, is difficult to  measure cash flow/valuations etc. Will take time to determine winners in the A.I. race. 

Market Update:

The Canadian Manufacturing Purchasing Managers’ Index (PMI) rose to 52.2 in December from 52.0 in November, marking the fastest pace of manufacturing activity in two years driven by inventory accumulation by U.S. clients in anticipation of tariffs. On the other hand, the US manufacturing PMI also rose to a nine-month high of 49.3 in December, up 1.1 from November due to a rebounding in production and new orders, but the outlook remains uncertain amid the threat of higher tariffs. The Canadian dollar was 69.16 cents USD. The U.S. S&P500 ended the week down 1.3%, while the TSX was up 0.9%.

A lot more greens this week than reds. Energy and materials gained 4.3% and 2.8%, respectively. Real estate added 0.7%, while industrials edged up by 0.7% and 0.1%, respectively. Technology gave up 1.6%, while consumer staples slipped 0.2%. Both consumer discretionary and financials ended the week flat. The most heavily traded shares by volume were Bank of Nova Scotia, Toronto-Dominion Bank and Bitfarms.
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Second straight year we've seen returns of over 20% per year, at least in the US. The last time this happened was 1997-98, and we know what happened subsequently when the dot-com bubble burst. She's not saying this market feels like a bubble, but it definitely feels expensive with valuations stretched, and more so in the US than in Canada.