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

The more economically sensitive sectors are gathering steam. Healthcare, for example, isn't one of them; US government is trying to hold cost inflation down. Healthcare doesn't have a lot of pricing power right now to pass costs through. He's trying to focus on companies that generate tons of cash, growing cashflow, with a nicely growing dividend stream.

Massive buildout in infrastructure. Massive pickup in adoption. As with every major technology that comes along, the newest one gets adopted faster than the last one. Adoption is very high across companies. We're still learning where it's going to be most useful. Some of the largest of the large caps (META, NFLX) are the biggest beneficiaries.

One of the things his team's looking at right now is that it seems some of the regulations surrounding the semiconductor industry will be reduced (specifically China, but other countries as well). That could mean an expanded market for the semi manufacturing equipment companies such as KLAC. AVGO has also been a strong performer, and he owns some NVDA. Those two names have strong relative price performance, are economically sensitive, cyclical, and have pricing power.

Chemical stocks have been weak over the last 2 years. So you can't pin that on tariffs. Within the space, the fertilizer stocks are much more interesting and have a better technical setup.

The big themes that led into the tariffs were all economically sensitive. Rare that one piece of news, even a big piece of news, completely changes the picture. Biggest structural change we've seen in years is the generational low in interest rates we saw in 2020. If so, as in the late 1940s, we'll get 20 years of rising long-term interest rates. Defensive stocks and bonds have a hard time in that environment.

What's working are things that benefit from inflation. Even though near-term data's a bit weaker, the stocks that benefit from inflation are leading, and so his team is leaning towards those things that give them an inflation hedge.

A.I. Themes To Watch: Advanced data analysis and pattern recognition

AI systems can analyze vast amounts of financial and alternative data at speeds and scales far beyond human capability. These systems identify market patterns, trends, and investment opportunities that traditional analysis might miss, leading to more informed and timely investment decisions. This data-driven approach is especially valuable in sourcing deals, uncovering hidden market trends, and flagging emerging industries or undervalued assets before competitors notice. That being said, this trend is more likely to favour traders than long-term investors. Longer term investors still have time, if a company or trend really is going to be the next greatest thing. If you buy a stock that is going to compound 10,000 per cent over a decade, you do not need to be there for the first 200 per cent.
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China: The US needs their rare earths for smartphones, semis, EVs, lasers, fighter jets, tablets and other devices. What were we thinking when we slapped tariffs on China before settling the rare earths issue?? Brazil: Need an immediate deal with them, because they have one-fifth of the world's rare earths.  Vietnam: Also we need to strike a quick deal with them for their rare earths. Australia: same.

Markets want to go higher after the earlier 15-20% pullback. He expects markets to eclipse all-time highs later this year, but there will be periods of volatility, especially with the U.S. crazy at times. The World Bank was correct to downgrade global growth this year, given data. In slow-growth periods, tech tends to do well and will lead to interest rate cuts. The U.S. is pricing this in as yields decline, but positions markets to move up.

Investing 101: Proper Position Sizing

The first key risk management practice we want to discuss is proper position sizing within an investment portfolio. Position sizing is a personal decision, but there are a few key factors to consider when deciding how much weight an individual position should be given within a portfolio:

• The position should be large enough that if an investor is right, it contributes to their net worth
• The position should be small enough that if that investor is wrong, it will not be a major setback
• The volatility of an individual name should be taken into consideration – less volatile names can have a higher weighting and vice versa
• Beware of overconfidence – if it seems too easy, it probably is

A lot of the practices around proper position sizing involve effective diversification. While this is a personal decision, in general, we are comfortable with letting a position reach a maximum weighting of around 7%. The theory is that on average the market returns somewhere between 6% to 8% per year, and if an investor has a stock position at a 7% weighting that subsequently goes to 0% while all other positions in the portfolio remain flat for the year, the investor is only setback by about one year (assuming the market returns ~7% in that year).

There is no right or wrong number of stocks that an investor should hold in one’s portfolio, however, many studies have shown that a portfolio with 20 or more stocks helps to remove company-specific risk from a portfolio. To use an example, at the extreme end, a portfolio with only one stock will be severely exposed to the individual risks of that company, whereas an investor that increases the number of stocks in a portfolio will reduce the individual risks from the underlying companies. The investor is then theoretically only left with the risks of the broader market (interest rates, inflation, recession, etc.). There is also a risk of over-diversifying, where too many individual stocks will begin to erode one’s ability for higher returns.
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The TSX has lots of gold, silver and mining equities which are doing well along with tech. Bank stocks are doing OK too. The TSX is in sort of a catch-up trade since it is not as related to the domestic economy as other markets are. He is definitely seeing a softening in Canada, more than in the U.S. We should begin to see sales and tariff effects reflected in GDP numbers.  The second quarter should be hugely positive but in the back half of the year we'll see how consumers and businesses are reacting. We can expect some global tariff resolution but not as in the past. Companies are going to become more efficient, more lean, and implement more AI.

He deploys capital into businesses when he thinks he can understand what that business will look like in 5, 10, or even 20 years. So short-term noise isn't something he pays attention to, because it's beyond his control. 

Still, when things get cheaper due to downside volatility, he has prices in mind for securities that he already owns or would like to own. Right now, he owns 28 businesses on behalf of clients. He's been nibbling a bit over the last few months. This year, he's only added one business so far. He remains a patient, long-term investor.

He favours exclusively high-quality businesses, though that's a buzzword that gets thrown around. He defines it primarily as a company's ability to generate above-average, consistent returns on invested capital (ROIC). You're looking at the profit in relation to how much capital needs to be invested to generate that profit.

Beyond that, he favours founder-run, founder-owned businesses. Likes to align with people who have significant skin in the game. Asset light, low debt. A company also has to be within his team's circle of competence and comfort zone, so it has to be a business that they can understand. Some things these days are just beyond his understanding or he can't foresee what they'll look like in 5 years.

They're very much bottom-up investors. They screen for their criteria, and they end up with businesses sort of putting up their hands saying "I'm a high-quality business, or a potential one, that you should look at". So he doesn't wake up in the morning and say he should find an energy, healthcare, or technology stock.

Typically, some sectors have a higher concentration of companies that could meet his criteria. Information technology is one area to which he has a fair amount of exposure. The flipside would be sectors where they don't find high-quality businesses; unfortunately, those tend to be the ones (like financials, energy, materials) that dominate the Canadian marketplace. They may require too much capital, or simply don't have the ROIC he's looking for.

As a productivity tool, it's here to stay. It will dramatically change a lot of industries and how people work. What isn't  clear is who's going to win the race from an investment standpoint. Go back to commercial air travel in the 1930s and 1940s, it was obvious that it was going to change the world. Same thing with the internet. 

He likes to use the analogy of a running race. He likes to bet on a runner once the race has already started. He's not looking for AI-specific stocks, but META is really involved with AI. You can see in that case how the application of AI is going to lead to more efficiencies, greater productivity, and hopefully higher returns on advertising spend. META already has an established business, and it's using AI as a tool to drive the business forward.

Otherwise, it's too early in the race to make a call on any AI-specific company to be the winner.

Investing 101: Price-to-sales (P/S) and Price-to-Book (P/B)

Two other ratios, being P/S and P/B, are useful for further comparison or when P/E is inapplicable due to the limitations surrounding earnings and other industry specific factors. The calculation for P/S takes a company’s market capitalization (number of shares outstanding x share price) and divides by its total revenue. The interpretation of P/S is quite similar to P/E as it tells investors how much the market values every dollar of a company’s sales. Similarly, to P/E investors typically want to target a low P/S ratio.

P/B on the other hand measures price-to-book value of equity. The calculation for P/B is the current market cap divided by the book value of equity. To derive book value of equity, investors must look to the balance sheet to determine the difference between assets minus liabilities. P/B has a slightly different interpretation, as it focusses more internally, on how the company is being priced by the market relative to its assets. A P/B ratio of less than 1.0 indicates that the company is being valued less than its equity and can be an indicator of undervaluation. A P/B ratio of 1.0, indicates that the stock is being priced at a fair value compared to the book value of the company.

Although P/E is typically the most widely utilized of the three ratios, P/S and P/B display some advantages. For example, if an investor is analyzing a high growth company that is operating at a loss or has recently suffered a setback in earnings, P/S can provide a better insight. P/B can also be useful in identifying high growth stocks that are severely undervalued due to the company’s early stages. P/B can also be useful in analyzing capital intensive industries such as real estate and energy where earnings are not the primary indicator of current or future success.
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The way equity markets are positioned, we're seeing technically a new intermediate term, 3-6 month rally phase take hold. That should have upside into August.  

His team is kind of perplexed where we are in the market cycle. At the start of the year, they warned clients that a 4-year-cycle reset was going to take hold. Typically, that's a 15-20% correction lasting around 34 weeks. He thinks that's what we saw during the tariff tantrum, but the recovery was so quick. The real risk is that we are starting a cycle reset. He needs more confirmation of which way the economy is heading.