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

You bet. That's one of the biggest fears right now -- every cycle you're going to see something that falls by the wayside because it can't compete anymore with the new technology.

Manufacturers should be OK. Biggest issues have been in healthcare, software, and consumer products. 

Not necessarily AI to blame, but other trends are going on. Think of PEP -- people are taking weight-loss drugs, going no-carbs, or not eating ultra-processed foods. Demand for snacks and sugary drinks is starting to ebb. FDA is set to get rid of red dyes and such. At the same time, shrinkflation is taking hold. Be leery.

Extreme overvaluation

Bubbles can occur when market valuations far exceed historical norms relative to fundamentals such as earnings or book value. Common metrics include the price-to-earnings (P/E) ratio or the cyclically adjusted P/E (CAPE) ratio; when these remain well above long-run averages, it often signals excessive optimism. Many pundits think the market is overvalued right now, but we don’t think it is, at least to the same degree as many think. Earnings are rising and interest rates are falling. This should allow for higher valuations. The S&P 500 is at a forward price-to-earnings of 23 times right now. Certainly not low on first blush (it was as low as five times in the early 1900s), but if we look at data past 1990 the average has been 24 to 25 times. Most would say it is “fairly priced” not “bubble priced.” The index price/earnings multiple has been as high as 130 (in the dark days of the financial crisis, when companies were hardly making any money, if at all).

Over the past year he's steadily taken down his tech exposure, now only about an 8% weighting. He does own NVDA and GOOG. 

There are parts of the market that have really started to perform, giving him an opportunity to diversify. And not just in the US. In fact, his firm's US weighting is probably as low as it's been in 5 years. His international exposure is now much higher.

Over the last couple of months the market has been narrowing in the US, meaning that fewer and fewer stocks are participating. That's not generally a super-healthy thing.

Sector weights in international markets are quite different than the S&P. For example, 31% of the MSCI All-World Ex-US Index is in financials. Large banks are doing well everywhere in the world. We have low short-term rates and sticky, high long-term rates. The opportunity to make a margin is pretty darn good.

Banks are pretty inexpensive, such as SAN. It trades at 9x PE compared to MS at 16x. SAN has a great balance sheet and good growth rate.

There's been an opportunity to buy some lower-valuation companies in sectors that aren't as over-owned. He's in Japan, Latin America, and the EU. About 20% of an average portfolio at his shop is international (ex-US). This has resulted in outperforming the US stock market for the last 18 months.

Start your analysis with the market. For example, NASDAQ had 87% of companies in an uptrend in July, now that's only 36%. Breadth has been narrowing. That's why he's been reducing exposure for some time now.

Then look at the sector. The software sector has been relatively underperforming for a couple of months, trading below key support levels. Remember that 70% of your return is being in the right neighbourhood, and this sector's trading below the 200-day MA.

Now you're down at the company level. Don't buy one of the weakest stocks in a weak sector. Instead, look for the strongest sectors on a relative basis and buy the leading stocks within the group. Stocks in a sector tend to move together like a school of fish, but there will be stronger ones and weaker ones. Start with the strongest company you can find because you have to assume that conditions may get more difficult. You want the companies with the best balance sheets, income statements, growth opportunities, and long-life reserves.

International investors are recognizing that Canada may be getting a little more friendly towards investing in energy. Shale companies in the US are having difficulty with decline rates. Canadian long-life assets are starting to trade at a premium, as they have predictable long-term production. These companies offer great opportunities for dividend growth as they pay down debt and have excess cashflow.

Interesting that these long-life producers are behaving as well as they are with oil behaving as poorly as it is. That's generally a pretty good tell. In commodities, you want to look for areas where the stocks are behaving well but the commodity is a little less positive. It tells you what might be coming. 

He takes his cue from the market. When the market's doing something other than what you might be expecting, you need to pay attention.

He has a pretty significant energy weighting, predominantly in oil. See his Top Picks.

Unemployment data has not been overly rosy. Housing market is weak, and that area is what helped fuel consumer spending the last number of years. Be careful on the consumer right now.

His firm is carrying about 15-25% cash in portfolios right now, certainly a shift from the last couple of years. He'd be putting together a farm team of what he'd like to own. What's bucking the trend? Despite all these worries, what's performing better?

Believes inflation will continue to surprise to the upside, so need to own sectors and themes that will benefit in that world. Very hard for banks to make $$ when long-term rates are at zero. Since 2020, long-term interest rates have continued to tick higher and stay higher. 

When the Fed cut rates last September, long-term rates went up. That's a change in behaviour. The spread the banks are making is getting better. Now the power is in the hands of the lender. Loan demand is going up, and the banks can take advantage of that. Everywhere in the world, banks are doing well. Backdrop is really positive.

Canadian banks are really high quality. Great job growing dividends, even through difficult banking environment. Have to watch mortgage delinquencies, which remain quite low. Lots of refinancing this year. Look at how they're behaving while the markets are a little sloppy. That's a great tell.

His firm has a little over 20% exposure to banks, which is a big percentage for them.

A few things are causing this. 

Markets have had quite a run, and you really need the underlying businesses to catch up with that. And a lot of it is AI and gold. The speculative elements have still been moving in the market, whereas everything else has been flatlining for the last couple of months.

Money has, perhaps, been balancing out to other sectors. But if it is, it's the very first stage. We've been waiting for this for a while. Really, the market has to wring out the excess speculation right now. There are a lot of pricey companies out there and a lot of very pricey assets.

Interesting. Some of those that have disappointed the street (though they may have surpassed what the estimates were) have been severely punished. Even companies that well surpassed analysts' estimates saw their stocks go up only a bit. 

So you can see that expectations are high out there, as well as some nervousness on the street.

What this market reminds him a little of is 1999-2000. Even though the tech bubble crashed and markets went down, probably half the stocks continued to go up for the next 2 years. It's really a two-tiered market between things that are overvalued and things that are correctly or undervalued.

His group is looking for a little more clarity on the tariff side, whether we get it or not. Also looking for some economic indicators -- coming through in Canada, but not so much in the US.

Earnings for NVDA are coming out, and that company's really the bellwether for things that have really been running this year.

He can't forecast the price of oil, it's tough. Right now, it's $60 a barrel. In Canada, with new pipelines being built, the spread between Canadian oil and West Texas Intermediate Brent is narrowing. If you want to own oil, CNQ is the place to be.

The AI buildout needs energy, wherever that comes from. Until they build more reactors and wind turbines, oil and natural gas will supply the need.

In this market we're facing a lot more macro uncertainties, as opposed to company-specific problems that you can get a handle on. It's always hard to commit fresh cash in this type of environment. If the underlying business is OK on a stock he likes, he's content just to hold for the time being.

Starting to see more practical applications with buildouts. The NVDA and Brookfield deal for AI data centres will be a huge thing. There's a lot going on in that area. 

NVDA is clearly a winner, but is it worth its valuation? He doesn't know. But it will survive and be dominant.

Companies have the cash, but $7T in capex is a big number. Some will have to take on debt or raise funds. Will it start to look like vendor financing (think Nortel) again? Remains to be seen. AI is definitely here to stay, but can you make money in these stocks, or is it the tech bubble of 1999-2000 all over again?