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

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.

If Bitcoin doubles to occupy 6% of the portfolio, then sell half of that to restore 3%. Rebalance. If Bitcoin slides by, say, 70%, then rebalance again to return to the 3/97 split.

Last time he got into power, he cut regulations and lowered taxes. That was all stimulative to the market. Could be different this time, as this time he's going to be doing a lot of cost-cutting. That will have a negative impact on the economy.

A lot of people don't realize the lags that take place, and we don't know how fast these things are going to happen. His guess is that cost-cutting will come right up front because the current administration has been hiring a lot of employees. The cuts will start to weigh on the economy, though some say it will be better in the long run.

There's a lot of back and forth, it's going to be a bumpy ride.

Yes, but to get there it will require some lumps. If we see freezing in government hiring and spending, in the short term those things will be deflationary, putting downward pressure on the economy. People aren't expecting this. Longer term, it's a good thing because it allows the economy to be more productive. He's optimistic that things will work out long term.

Yes. They are rich here at this level, so he doesn't see huge gains. 2023 saw an over 20% gain in the S&P 500, and here we are again. Doubts that we can do it again. Sees the market being positive, but there's going to be a whole lot of moving around based on the narrative surrounding Trump. It'll be sometimes positive, sometimes negative.

It's changed a bit. Did really well in first half of 2024. 2H saw software stocks take off. Semiconductors have pulled back.

For both Canada and the US, it's the same broad perspective on a yearly basis. Market tends to do better in the 6 months from mid-October to early May. That's compared to the other 6 months of the year. Right now, we're in the strong seasonal time for equity markets overall. So growth sectors tend to do well, and discretionary and cyclicals. Defensive sectors tend to lag.

This past summer the stock market did really well, not typical unless you're coming out of a recession. Before that in 2022, we saw the market in Canada go down a lot from May to October.

Seasonality puts him on a 1-year repeating cycle, where he's in and out of different parts of the market at different times of the year.

Two strong periods for natural gas:  September to mid- or late December, and March - June. Spot price of nat gas has increased. Note that nat gas tends to perform poorly in the last half of December, because US companies get taxed on inventory, so they sell it down as much as possible.

He'd wait for the next seasonal period to get in, and that's March.

Yes, he's expecting that. The US election was resolved in the most market-friendly way possible, with a Republican sweep. Both candidates were running pro-growth and fiscally undisciplined agendas, though probably more so on the Republican side. Once the inauguration is done, that should bode well for growth in the short- and medium-term for 2025. Tax cuts and deregulation are on the runway.

In the meantime, we have the historically strong December seasonality in full swing. 

You have to think about what you like and what you want to avoid. 

On the Canadian side, he's adding new names and adding incrementally to existing positions in interest-rate sensitive sectors. Expecting the cadence of interest rate cuts to be faster and deeper in Canada than in the US, given the ongoing differential in economic growth. Notable headwinds with immigration reform in Canada. This should advantage rate-sensitives in Canada, particularly as yield-hungry Canadians wake up to find their GICs rolling over to a lower 3-3.5% rate.

In the US, Trump team is likely going to run with a fiscally stimulative agenda. That means the Fed would cut more slowly and less significantly than the BOC. 

He's also adding to structural growth champions in both Canada and the US. Sees those names enjoying ongoing global economic growth that's being bolstered by the US election results.

Going into the election, he was fortunate not to own any manufacturing companies in Canada, Mexico, or China that ship to the US. It's not that he's taking the tariff bluster at full-face value, because Trump 1.0 showed there's a wide gap between say and do. But the team Trump's appointed is squarely in the pro-tariff camp, and aggressive tariffs are likely. So he's not looking at any names that might be a target.

Hard-pressed to go wrong owning any of the Canadian banks over the long term. Very profitable oligopoly, well-managed most of the time. A "needs" business, not "wants".

Total return algorithm is to take the dividend yield plus the dividend growth target (usually in high single digits), which lands you easily in double-digit returns. It's been that way for decades, and that will continue.

Telecoms are debt laden, so skyrocketing yields hurt. Wicked price war amongst Canadian telcos. He's warming up to the space. Pressure from interest rates is easing, with more to come. Pace of deep discounts is starting to abate.