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

The Impact of Commissions:

Another aspect related to trading stocks that we wanted to touch on was the impact that commissions have. A typical discount brokerage charges a commission of around $10 per trade. There are an increasing number of exceptions here with discount brokerages having cheaper rates and even offering low/no fee trading and free trading of ETFs. For simplicity reasons, we will use the $10 assumption to do a quick analysis to see how this impact returns:

• Let’s say an investor wants to buy a share in a stock trading at $100. The cost of this trade is $100 + $10 (fees) = $110
• If an investor makes say 10 trades a year and all are the same size previously mentioned, that will make for total annual transaction fees of $100 ($10x10).
• This is an important consideration that often gets overlooked because these costs should be factored into return calculations. If the investor here requires a 10% return, then they should bias this upwards by due to the additional fee charges.
• While we used a small figure in our trading value, it equated to 10% of trade size, so an investor would have to bias their total return up to 20%. The investor would need the stock that initially traded at $100 to reach $110 in order to cover costs and $120 to achieve desired return levels.

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That's right. Important to take stock that we've had a very strong year so far. So profit-taking from time to time is natural.

If we weren't talking about all the great things in AI, there are some other negatives bubbling up under the surface. Weaker economic data, headwinds with the consumer and not just those at the low end; high-end consumer is seeing headwinds as well. We're seeing those crosscurrents play out more directly in a quieter earnings season where profit-taking is taking place.

Quality, dividend-growth investing is the foundation of what he does. He keeps an open mind when it comes to companies, whether small or large. Different companies take different journeys.

If you're a growth firm, eventually you'll be on your way to being a dividend aristocrat. At the end of your life on your journey, you'll be more of a value stock on the way down as you reach maturity. It's all about the life cycle of the business, and he likes to stay in the camp of quality with dividend growth.

That's what we've seen, especially with politics. He's cautious to say that this is one of the few areas where politics has come into play in the markets. We've seen more of a value rotation, away from Mag 7, and a lot more into the dividend growers and quality-focused companies.

The reason for that is because we're seeing some questions around AI and the ability to monetize, as well as high valuations. Investors are rotating into more certain companies like utilities and staples.

We do. And where we have that especially is in consumer staples. Think about the Canadian grocers and Canadian utilties. He always differentiates between IPPs (independent power producers) and the regulated utilities.

By utilities, he means FTS, EMA and H. That's quality, defense dividend growth in the Canadian context. He doesn't mean the other IPPs.

You wouldn't really find a lot of mining or energy stocks in his portfolio. Very few. For example, AEM is the only gold stock he owns. It has a safe jurisdiction, safe netbacks, committed to returning capital. All that's hard to find in commodity land, where animal spirits seem to run high.

As a general rule when investing in commodities, focus on the bottom of the cash-cost car. So in energy, where you want to begin is with the highest margins and the last one to go bankrupt.

It depends where you go. If you're thinking the ENB's or CNQ's of the world, he agrees with those choices. If you go down to the intermediates and the juniors, that's where those animal spirits tend to come back as well. 

The core thing when it comes to oil is that, at the end of the day, it's really an OPEC+ decision. We live at the mercy of OPEC+ and what they want to do with their supply.

The rate cut in Canada has flowed through into a slightly higher equity multiple. But Canadian telcos are indebted, so their leverage levels are not low and they do have to make some non-core assets sales. 

But the main point is that the marginal cost to get a new subscriber is nearly zero. This potentially makes for a very competitive environment no matter where you go. So he's more cautious, because every extra subscriber that comes in the door is that much more problematic, if everyone else is fighting for them.

You can break it down into the high-growth, momentum stocks (aka "the Magnificent 7 and then some"). What we've seen there are questions around the profitability of AI. It's also important to say that summer is here and liquidity is lower, so stock moves tend to get more pronounced. As a whole, it's not a great environment to be missing on earnings.

Two main reasons why tech stocks started to see more weakness. First, more export controls to China. Second, GOOG saying they're going to invest but don't see that clear a path to the killer app that will make AI useful for the masses.

Absolutely. And this has been the characteristic and hallmark of every single technology adoption cycle. The dark fibre era of the early 2000s became the lit fibre era, because all that technology in the ground ultimately got used.

But investors are focused on the quarterly sequential beats for NVDA, and how that flows downstream. One stat that many might not know is that GOOG spends more as a percentage of its sales today on hard, capital expenditures than GE did in its heyday of the industrial boom. These companies are way more analog in their investments than most people realize.

If you're a long-short fund, which is very popular in the US, you are long NVDA and short IBM. So if you're selling your NVDA to flatten out your exposure as a hedge fund, you're buying back the IBM that you were short. So that's a lot of the technical momentum that we've been seeing. NVDA's at the top of the list for hedge funds.

Best way to think about it is that the geography in which a stock is listed is not important. It's about where it's positioned in its overall value chain. Whether it's a can of Coke, semiconductors, or a pair of yoga pants, you have to start from the very beginning and the product's inception. Go from which companies serve that category all the way down to the end retailers.

For example for yoga pants, start with the cotton and end with the retail store. Learn where the ROIC is the highest, where the defensibility of that ROIC is the highest, and where the growth and reinvestment runway is the greatest. 

For heavy machinery, TIH is in a great position, but so is CAT. Find out where the consistent returns are, and wherever it's located in the world, that's where you go. The answer here is to go with CAT.

Absolutely. When you look at some of the performance numbers that have come out over the past few months, despite the rally, the Russell 2000 is still basically flat since the end of 2021. Still lots of room for companies within that index, and certainly Canadian small caps as well, to catch up on valuation appreciation and fundamental appreciation alone.

He's still optimistic about this sector. Q2 earnings for this group are going to be quite dramatic. He's expecting north of 15% EPS growth at the index level, which should provide an extra tailwind there.

Certainly that's part of it. That's part of a secular trend that's going to continue for technology. 

But what really happens is that there's only so much money to go around. So when large-cap stocks, and tech stocks in general, are taking a lot of capital in, that takes money from other areas of the market. We're seeing that with valuation depression in a lot of the small-cap names.

So if that rotation happens a bit (think big pension funds and institutional managers), capital is going to start shifting away from the larger-cap stocks into some of these more depressed areas of the market. When you get these dramatic moves in the market, it usually marks a shift change. Compared to the S&P 500 and the NASDAQ, the Russell 2000 is seeing the greatest outperformance since the 1980s.

Even more encouragingly, we're clearly in an environment of loosening financial conditions. We saw this with the Bank of Canada yesterday, and we're seeing it with central banks around the world. If you look at when small caps started to underperform, it was when interest rates started to go up. So interest rate certainty is very important to this subset of the market, because they have more variable debt and more debt on their balance sheets.

Finally starting to see interest rate cuts. He feels that these cuts should have been a bit sooner, based on the data he was seeing. Nevertheless, it's encouraging. If you look at the next few meetings, north of 70% probability of more cuts is what the bond market's pricing in. Likely to see more cuts as the year progresses. Hopefully, the economic data doesn't fall too much off a cliff between now and those meetings. 

Should be a tailwind for a whole bunch of sectors that have been struggling over the last year -- REITs, utilities and telcos. It's a broadening of breadth, not just in small caps, but in areas of the market that haven't been feeling much love since tech stocks started to take off about a year and a half ago.

Based on the data he's seeing, he expects the BOC to cut again on September 4. And that's built into the markets as well.