“I bought $6 billion worth of tech stocks, and in six weeks I had lost $3 billion in that one play. You asked me what I learned. I didn’t learn anything. I already knew that I wasn’t supposed to do that. I was just an emotional basket case, and I couldn’t help myself. So maybe I learned not to do it again, but I already knew that.” – Stanley Druckenmiller

Note that the contents of this memo are all my thoughts, and not the views of RBC Dominion Securities. As well, no part of this content was AI-assisted or created.

Friends & Partners,

I hope that quote doesn’t make your heart skip a beat or feel too familiar – we are seeing some investor behaviour reminiscent of the tech bubble days of 2000. You would get laughed off a stage if you were at all cautious on tech stocks at that time, and many of us remember what happened next. History may not repeat but it usually rhymes. I wrote a section below on why, just maybe, we should be approaching the big US tech names (which have done so well and are juggernaut companies no question) with some caution here. Those names are driving the stock market these days, so be a bit wary of what you wish for moving forward.

While the dominance of tech isn’t anything new or surprising, but in past quarters most sectors were rising as well. The recent market is different – not just because half the S&P 500 sectors are negative so far this quarter, but also because the other sectors that have posted positive returns are largely defensive in nature (Utilities and Consumer Staples).

Point being, we have to look under the hood, and the market internals in the second quarter seem to be underscoring the fact that economic growth is slowing (something few believe could happen, which is a warning sign in itself). Laggards have been Energy, Materials and Industrials, which are the typical cyclical sectors we’d expect to underperform if, under the surface, growth concerns are bubbling up.

Economic data in aggregate remains solid but there are growing signs of a loss of economic momentum and that means we must continue to closely monitor economic data because if economic growth truly disappoints, that will be a new headwind for markets to contend with.

We’re also starting to see some real volatility developing in the markets (finally), and it is occurring in three important assets – NVIDIA, bitcoin and lumber. Investors are starting to learn about the downside of chasing returns and the hot investment of the moment. In 3 days, NVIDIA lost 17% of its value for example, bitcoin down 20% in June peak to trough. Everybody loves a stock when it goes up, but they find out their true emotional strength on the way down.

Expect volatility to maybe continue to perk up, especially given it’s a US election year.

Bottom line, if we just focus on the performance of the S&P 500, the second quarter was a strong one for markets high level. But if we look past the headline, market internals are confirming my (and others) concerns about future growth. I’m not saying a growth collapse is imminent, but I am saying that I believe growth concerns will become a more dominant market topic, coming soon to a theater near you.

Just think though, if you owned a sports team, your returns would be tracking even better so far!

 

 

Other Interesting Things to Highlight This Month

Our team was able to support Gutsy Walk, in support of Crohn’s and Colitis Canada. This is something close to my heart and close to home, I am proud of the team and everyone involved.

I have been a proud supporter of Women's College Hospital and it's Foundation, and was proud to sponsor Karen Cairney, Cairney & Co. UK, to be a most distinguished guest speaker with Leslie McCarley, President & CEO, Women's College Hospital Foundation to address McKinsey's research report on the current gap on Women's Health & Wellness globally, and how Women's College Hospital is doing an incredible job of closing this gap with their sophisticated research and many leadership programs. We also discussed the most significant and advancing stewardship of much wealth by women, as women both earn more and equally important, inherit more. Women's College Hospital at the forefront and sweet spot of opportunity to really advance Women's Health and Wellness with much diversity, inclusion, confidence and boldness to serve their patients and communities exceptionally well.

On another note for Women, Worth & Wellness updates regarding health & wellness, we have been supporters of the Collingwood General Marine Hospital, who just released their Impact Report. 2023 was an unprecedented year for the CGMH Foundation based on the extraordinary healthcare needs of the community, and the outpouring of generosity spans far and wide. Healthcare isn’t just about the best equipment and technology – rural healthcare is people helping people, and CGMH is a north star on that front.

 

 

Could Artificial Intelligence Stocks Be In A Bubble?*

Saying that AI could be in a bubble would likely get you laughed out of the room – after all, all things AI are the darling of the day. But if you feel dumb saying it, that just may be a sign that you just might be onto something…

Any company that adds an AI angle to their story is blessed by Mother Market, but few seem to be talking about the real economics of AI. Here is one though, a recent article noting that the financial benefits of implemented AI projects have been dismal.

Yes, these stocks could go even higher, and yes, they could pull off the earnings growth required to justify it, and it may well be different this time…

The relevant question for investors is whether the top US stocks will continue to outperform the rest of the index. The US market is roughly 70% of global market capitalization, but only 4% of the world’s population and only 18% of global GDP. So, to justify the large share of global market cap, these companies need to capture a similar share of global profits over the coming decade. Do you think AI will help materially drive the US to become three quarters of global GDP, from the current 18%?

No matter what way you cut it, the biggest stocks in the US are massive relative to the rest of the market. Can these stocks continue to get bigger? At some point they begin running into the law of larger numbers, they would need to become the entire US economy.

The Magnificent 7 are larger than any other countries total market cap:

The top 10% of stocks in the US are 75% the size of all other US stocks. Concentration levels not seen since prior to the great depression:

And finally, just maybe the leaders in the space may get an earnings hit from the AI foray?

Source: Jesse Felder

I am excited about further AI deployments and advances, within reason. But will markets take things too far? Absolutely. That is what markets do. And it may have already.

 

 

Thing Have Been Pretty Good, Can We Party Like It’s 1995?*

Goldman Sachs notes “we think this year has a 1995 flavor to it. 1995 was last time we got a soft landing. The Fed cut from 600bps to 525bps, and the S&P 500 made 77 new all-time highs in 1995 and that was just the appetizer with the epic run through...you guessed it...1999. 2024 year to date the S&P 500 already has 29 all-time high closes (and the best start to an election year ever)."

Source: Goldman Sachs

But wait, can the Fed cut interest rates with markets screaming like they’ve been? The answer is yes – they’ve done it 20 times since 1980 and the S&P 500 was higher a year later all 20 times. Bulls will be putting their faith in history while bears might argue we’ll only see this magnitude of cuts if something is “broken”. I suppose time will tell on this one.

We all know that stocks aren’t “cheap”. Many are downright expensive. But expensive markets can stay expensive for quite a long time, so don’t expect a pullback to be purely driven by elevated valuations alone:

But here’s the cautionary tale… Volatility is currently low and credit spreads are tight. This is a deeply calm risk-on market. We are also in the neighborhood of where both of those things tend to find a floor…

And this is a one horse town in the US stock market, so far. Stocks outperforming the Index are at extreme lows, which is a flag of risk. This chart prompts Richard Bernstein Advisors to remark, “investors who think today’s market is somehow vastly different from 1999/2000’s bubble simply aren’t paying attention.”

And many investors are ‘all-in’. That’s not good as they often all run for the exits at the same time too when that day comes.

And lastly, this market ain’t cheap. Market price/earnings valuation at 35 year highs…

 

Have We Won The Battle On Inflation?*

We are winning the battle on inflation, sort of. The fact is that prices are permanently higher, which is what real people care about. But economists and the market celebrate the trend and changes over shorter periods.

Source: Morgan Stanley

After reaching a decade-high peak in 2022, inflation has been gradually coming down back to targeted levels. The BoC uses a target annual inflation range between 1-3%. The past few readings of core consumer price index (CPI) have raised central bankers’ confidence that inflation is sustainably within the target range, though the most recent one was a bit ‘hot’.

Source: Statistics Canada, RBC GAM. Monthly core inflation (CPI-common year-over-year). Period ranges from May 1, 2004 to April 2024.

In the U.S., inflation is also moving in the right direction, although at a slower pace than Canada. As you can see below, at the latest reading of just over 3% year-over-year, CPI has been heading in the right direction, but still sits well above the 2.0% target - and admittedly, it’s been stickier lately than the Fed would like. This deviation from Canada is largely in part due to U.S. consumers being less interest rate sensitive, among other factors.

Source: U.S. bureau of labor statistics, RBC GAM. Monthly all times CPI change, not seasonally adjusted. Period ranges from May 1, 2004 to May 31, 2024.

Canada is more confident in starting the gradual interest rate decline, while the U.S. is waiting for consistent evidence that inflation has truly been moderated back to acceptable levels. At times, Canadian and U.S. monetary policy can somewhat deviate. This cycle appears to be one of those times.

If we look under the surface, the fast or early movers in the inflation data have been improving for a while. These are the categories that simply change faster, as other components are much slower to react to changes in behaviour. Many goods categories, such as hotels, autos, and restaurants, are examples of areas of the economy that change prices rather fluidly. Rent and insurance are examples of areas where prices change very slowly or are even lagged in their reaction (rents often don’t reset until the end of a lease and are further slowed by rent controls and insurance changes pricing slowly).

Note that core goods (versus services) are now in DEFLATION:

But expect to see inflation normalize higher than where it was in the past (likely 3-4% a year), because of several fundamental changes in our society. My friend Noah Solomon summarizes them well:

• In response to rising geopolitical tensions and protectionism, many companies are investing in reshoring and nearshoring. This will exert upward pressure on costs, or at least stymie the forces which were central to the disinflationary trend of the past several decades.
• The unfolding transition to more sustainable sources of energy has and will continue to stoke increased demand for green metals such as copper and other commodities.
• ESG investing and the dearth of commodities-related capital expenditures over the past several years will constrain supply growth for the foreseeable future. The resulting supply crunch meets demand boom is likely to cause an acute shortage of natural resources, thereby exerting upward pressure on prices and inflation.
• The world’s population has increased by approximately one billion since the global financial crisis. In India, there are roughly one billion people who do not have air conditioning. Roughly the same number of people in China do not have a car. As these countries continue to develop, their changing consumption patterns will stoke demand for natural resources, thereby exerting upward pressure on prices.
• Labour unrest and strikes are on the rise. This trend will further contribute to upward pressure on wages and prices.

 

 

Treat Your Investments Like A House*

The world today provides us access to an abundance of information, all of which is readily available within milliseconds. Cellphones, computers, watches, and everything in between, feed us new information 24/7. Analysis paralysis.

With all this information flowing, many investors feel that they need to constantly watch and monitor their investments and track each and every up and down. However, the stock market tends to have higher volatility in the short term, but lower volatility in the long term. Constantly watching the market’s day-to-day performance is pointless for most, and stressful.

Here’s another way to frame this challenge: compare your portfolio versus the housing market. Many investors frequently check the value of their portfolios or regularly look up individual stock prices. As stock prices can get refreshed every few seconds, they tend to worry significantly more about their investment portfolio as opposed to other assets such as real estate. But homeowners can’t check the price of their home (which is likely one of their largest assets). At best they might get this information as comparable houses come to market. But more realistically, they’d only get this information once – at the time they sell. Could you imagine walking down the street and seeing minute-by-minute prices constantly flashing above every house?

We don’t have the same up-to-date information on houses like we do with stocks. Most people adopt a buy-and-hold strategy when it comes to real estate. They purchase a home, live in it for many years, and re-evaluate when it’s closer to sell.

 This is an interesting comparison for many reasons. When we compare the average appreciation of a house in Canada to the average return of the Canadian stock market, we can see that both display the same upward trajectory. In fact, since 2005 investing in the Canadian stock market has provided a higher average return than Canadian real estate. And the Canadian market has notably lagged other global markets, especially the US! So why do investors fret more about short-term performance in stocks, but not their house?

 It's about perspective.

Source: Morningstar, Canadian Real Estate Association (CREA), RBC GAM. Return period between January 1, 2005 to April 30, 2024. Calculated monthly. Market returns represented by S&P/TSX total return index. CREA returns represented by CREA new housing price index Cumulative returns since 2005.