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

When you look at the S&P 500, recall that it is a market-weighted index. So larger companies are going to push the index more, and that's what we've seen this year and last. S&P 500 is up 18% YTD, but up only 9% if you take out the Magnificent 7. The top 10 names take up 30% or so of the S&P index. 

Should you own that type of index at this point? Who knows how long that momentum will go? It is expensive because of the tech weighting. So he prefers equal weight, factor strategies, or picking individual names.

People need a reality check. His fund is up just under 20% right now, almost quadrupling the broader TSX, and almost matching NASDAQ. Energy stocks are working and winning. For global oil inventories, the deficit to normal levels just hit an all-time low, which means bullish for price, continuing through this year. Demand is beating bearish expectations. 

People don't appreciate how unbelievably profitable companies are today, and how much free cashflow is being generated. Oil is at $83 right now. We don't need the oil price to go up any further from here for these companies and stocks to do spectacularly well.

The path for stocks to continue to do well relies on buybacks. We're seeing record share buybacks. Seems to be skepticism around this. Most companies have a very heavy spend at the beginning of the year. In Q2, 3 and 4, they harvest that free cashflow, and that's what we're seeing. Take BTE, which he thinks can buy back 10% of stock outstanding over the next 6 months using just half of its free cashflow. There are multiple examples of that.

He remains bullish on oil, likely to be at $80 oil on average through 2025, and triple digits beyond that. An environment that's stronger than what consensus believes. OPEC should be able to return all its discretionary barrels to market, which can reabsorb them, despite mediocre demand growth forecast for 2025, and without being price disruptive.

The sector's trading at a 14% free cashflow yield, and most companies are giving all of that, or most of it, back to shareholders in the form of buybacks. The ongoing buyback of shares and retiring them will eventually force share prices to go up. Balance sheets have never been stronger, free cashflow never higher.

The generalist investor is waking up, very slowly, to the attraction of the energy sector. We're still in an environment where people buy into the false narrative that we're in this rapid transition. The whole narrative is crumbling before our eyes. Look at Volkswagen this morning saying it might have to shut a factory due to slowing demand for EVs. A McKinsey report said that half of Americans who bought an EV are going to go back to gasoline next purchase.

No. He deployed his cash quite a while ago, anticipating a selloff. He's down to 2% cash as of this morning (maintained for any client redemptions). So he is, essentially, fully invested.

Biggest metric he looks at is free cashflow yield at $80 oil, $4 natural gas, $12.50 WCS differential in 2025. He then looks at how many years of inventory a company has. What are other catalysts? 

Then look at what the target free cashflow yield should be, and this is tough to figure out. In the past, he'd have said 10%, but US companies are trading at 6-8%, and Canadian companies are better. Shale companies are challenged, and this is becoming more obvious. He thinks Canadian companies will trade at a premium to US companies. So now he thinks an 8% free cashflow yield, getting it back via buybacks or dividends.

Then he can get a theoretical target price on every company he models.

Right now, he's very bullish on oil, especially heavy oil. Bullish, long-term, on natural gas. Quite bullish on services, especially drillers.

Concerns that sins of the past will be repeated and the reserve will be used for political reasons. Doesn't see it as a risk at $83 oil, perhaps if it gets into the $90s. Also concerns that if Trump gets in, it will be all systems go for drilling, but he doesn't buy that argument. 

Whether the US President is Democrat or Republican has zero impact on the spending behaviour of shale companies. But if Trump is elected, he'll be much more hawkish on Iran, which will be bullish for oil.

Market Update:

The TSE Index was down 1.77% in the month of June, up 4.38% YTD and 8.54% over the past year. Canadian GDP was up 0.4% in the third quarter of 2024 and 0.50% for the full year; in the USA the GDP was up 1.4% for the third quarter and 2.90% for the full year. Canadian inflation rate was 2.90% annually in June 2024 and the US annual rate was 3.30% in June 2024.
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Historically, the market rallies 75% of the time and averages a 7.5% gain. Historic charts show that the Dow tends to soar in the first week of August, then pulling back in October, then rallying up to and after election day. August is usually a terrible month for stocks, outside election years. So buying opportunities are in late July and late October.

They have a big weighting in AI related stocks - 27% of the portfolio, and had a great first quarter. He doesn't think there will be a recession and the world is still recovering from the pandemic. Used car prices are still high indicating there are not enough new cars.  Canada is in the Global Growth Fund with a 25% weighting. Canadian banks are just chugging along but doing better and better over the years. There is good growth in U.S. banks but they can and do go bankrupt. 

Believes upcoming statement by J.Powell will be indicative of the strength in the economy. Easy financial conditions, and relatively low interest rates have created strong markets. If US Fed wants to slow the economy - there are many tools to do that. Expecting weakness in the markets as consumers are starting to turn the corner (fragile). If Trump becomes President - will be interesting to watch. Full control of US government by Republicans might not be viewed positively by markets. 

Would buy silver at this time. Commodities going to valuable going forward. Electrification will require more silver. Good time to buy.

Business of forecasting markets is impossible - 38 years of experience has proven this point. However, economic indicators ('economic surprise index') are pointing towards recession/hard landing. Rising interest rates will have impact on markets - just not sure when it will occur. Overall, structure of markets is very fragile. Yield curve has been inverted for almost 2 years. Expecting economic pain - just a matter of time. Large amount of US debt also a major concern. 

Company Profile: Cadence Design Systems (CDNS)

CDNS provides software, hardware and intellectual property for semiconductor design and manufacturing. Essentially, CDNS can be thought of as an ‘architect’ of chips, which can benefit from the current high levels of AI spending. It supports the creation of integrated circuits, systems on a chip, and other devices by using GenAI for its customers to improve their own semiconductor designs. Its customers operate in various industries including automotive, aerospace, and healthcare, and its customers include the world’s most innovative companies.

Its growth has been around 13% on average, driven mostly by organic growth. It has a strong balance sheet, a net cash position of $500 million, and a track record of repurchasing shares. Currently, it has a buyback yield of 0.9%. It is not cheap at a 49X forward earnings multiple, but strong sales and earnings growth are expected in the next few years, with a healthy level of margin expansion expected.

Looking at its financials we see an incredible track record of beating earnings estimates, and long-term EBITDA expansion. Its valuation is rich, but it has contracted from 2021 levels, while its price has moved materially higher. We view CDNS as a high-quality name with exposure to the AI spending theme, and long-term secular tailwinds of bridging the gap between the digital and real world. 
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Believes slowing job growth in the USA indicating economic contraction. A slower economy is actually a good thing - gives consumers and markets time to cool off. Unsure on direction of markets, but eventually strength in the markets will broaden out (not just "Mag 7"). Over valued tech stocks present growth, but very risky in terms of downside. If markets collapse like 1999, investors could lose a lot of money. Direction of semi-conductor business is undeniable, but the problem lies in over valued stock prices. Also, there are other competitors in the market to NVIDIA - will eat away at earnings.