Vitali: Hello, everyone, and welcome to another edition of Portfolio Manager Views. I'm your host, Vitali Mossounov. I'm the Head of Public Equities at TD Asset Management. And I'm very excited to be joined by two of my favorite colleagues, Tarik Aeta and Juliana Faircloth. Tarik and Juliana are co-leads of our fundamental equity research franchise. Tarik, Juliana, welcome to another edition of Portfolio Manager Views. I think your first appearance on the show. So very warm welcome from me.
Tarik: Thanks for having us.
Juliana: Thank you.
Vitali: Now, you are the co-heads of our fundamental equity research team. And I've said it's Canada class. It's world class, really. We have a fantastic team, and you have a lot of responsibility. And I think the first question I really wanted to ask you maybe is the hardest question, but how do you build that and maintain that world-class team that has a repeatable alpha generation process?
Tarik: So before I answer your question, I thought I'd just do a quick, fun thought experiment. So how many names do you think exist in the MSCI world? Actually, sorry, MSCI, ACWI, IMI. So basically, all developed countries, the developing countries, large cap, mid cap, small cap. How many companies do you think, Vitali, are out there?
Vitali: You're putting me on the spot. Can I guess maybe around 5,000?
Tarik: Yeah, actually, as of this morning, it's 8,195, to be exact. So if every day I came to work, and let's say even weekends, I was working and looked at one company a day, it would take me the next 22 and 1/2 years to get through that entire list. So by the time I'm done going through that list, if there's names of really good opportunities, there's a good chance we could miss them, or I might be retired by the end of the 22 years. Who knows?
Vitali: Well, I ask that you stay here until you've covered all of them. So just a couple of more decades left.
Tarik: So, I mean, going back to Econ 101, there's something Adam Smith talked about, division of labor. So if you want to have a productive society that generates more output and high-quality output, we all have to divide the work out there and specialize. And that's how we do well.
And that's basically the philosophy with the analyst team. We have 18 analysts. Each analyst specializes in their own industries. And by working together, we can derive those better outcomes for the portfolios. So in terms of, yeah, delivering better outcomes for the team, there's a couple of elements to it. So building a repeatable process. So we have certain report formats that we have, focused on trying to service those best insights. A big part of it also is trying to surface those insights to the portfolio manager and make sure that communication flow is always there. And we have a lot of ways we do this. So yeah, happy to chat more on those.
Juliana: I would maybe just add that, fundamentally, the role of an analyst can be kind of siloed and independent. As Tarik said, we have people specialize on a particular sector or a few industries. And for us to be able to build a repeatable process to generate alpha over time, we need to be able to move those individual insights and contributions into institutional knowledge.
And that's where the infrastructure and platform that we've built of centralized research reports, scorecards, frameworks, and different ways for analysts to institutionalize that knowledge and communicate it over time to portfolio managers, has helped make that a scalable and durable, I think, advantage for the team.
Vitali: Really well said. And I think it's reflected in the performance numbers over the last handful of years and longer. And certainly, one thing that stands out being a member of the team is just the rapport that the analyst and the portfolio manager teams have. There's that trust in the process but also dependence, frankly, that the two sides have on each other to be doing a great job, to come in every day and focus on investment excellence, on winning. And I think you two are great representatives of that.
Juliana: Yeah, many of us have worked together for quite a long time. It's built a lot of strong relationships on the team, which makes it easier to have healthy debate, maybe contentious conversations, which happen sometimes, and to really make sure that we can have a constant feedback loop to get the best ideas in portfolios on behalf of clients.
Vitali: Ok, now I want to peel one layer of that onion because what you're saying is great. And I think we have that start, and we have the end of very strong performance. But in between, there must be specific processes. Tarik, you alluded to frameworks, tools that you apply that we think makes us different. And without revealing necessarily the secret sauce, can either of you give the audience a hint of some of the more concrete things that make us special?
Tarik: Well, one example to start off with is ideas can come from anywhere. So if you look at ideas that ultimately go into the portfolios, sometimes it will be the analyst will be talking to the management team, different management teams, talking to the sell side, going to conferences and finding new ideas. Also, we get ideas from our empirical team, and they surface ideas from a quant perspective.
But basically all those ideas all get aggregated into our Research Management System, RMS system. And then within there, ideas get scored and prioritized and triaged between analysts and portfolio managers. And once we go through that process, then the highest, most urgent ideas get prioritized. For instance, we have these investment pulse and idea lab reports. Those reports will give the analyst room to be creative and look at the ideas from their perspective and bring their own unique insights.
But also, these report format also, I hate saying the word, but force analysts to look at certain key questions that are important across the team. And that ensures that we have consistency over time. So trying to surface what are varying perceptions on the team or what is priced into the stock at the moment.
And one other thing I would also call out is our hub structure. So we do have 18 analysts, but they are spread over 7 sector hubs. And the idea here is, yeah, we want the consumer staples analysts, the consumer discretionary analysts, talking about different opportunities within retail or packaged goods and trying to service those best ideas within those hubs, and then working together to try to service to the PMs within the broader consumer category or the broader financial categories what are the most interesting ideas for portfolios at the moment. So those are a couple of examples.
Vitali: Juliana, let me ask you this, then. There are many analysts on the team, and something you guys I know have put a lot of effort into is analyst training and then being very explicit and deliberate about what it is that makes a great analyst because there's a fine line between a good analyst and a great analyst, and we want to really have, again, a world-class team. Maybe you could share with our audience about what it is that you've done in terms of encouraging greatness, and maybe a little bit more about how you define greatness for the team.
Juliana: We put together in the last few years a very extensive and robust training manual and training series, which we ran everyone through last fall. I think there was 9 segments of training that we went through. And we covered everything from the very beginning of how to look at a stock, how to ramp up on a stock, and went all the way through financial modeling, how to communicate ideas. It was very comprehensive.
Within that training, we were pretty specific in identifying what we think makes a good analyst. Ultimately, I think there's a few characteristics that we're looking for and that we're trying to develop and foster in the analyst team. Curiosity is a big one. Finding people who have that innate curiosity to uncover new ideas, to find the next best opportunity for portfolios, to always understand why certain things are moving in different directions is very important, and I think that is harder to train. That's a little bit more innate and comes more down probably to a hiring decision.
I think that building confidence within the analyst team is also important, and having strong communication skills, which can allow you to put together a thesis that's coherent and makes sense and allow you to deliver that to portfolio managers in a way that's effective and can give them confidence to act on those decisions and to be able to rely on the analyst team.
Vitali: One of the things as well that was implemented that I think doesn't get enough attention, maybe people don't wish to talk about it in certain instances, but the role that technical analysis can play as part of our fundamental and stock analysis and getting the overall picture of the market and the security. That's something, I think, that the team has implemented successfully to really increase their awareness. And Tarik, even to your point to be able to go through and prioritize which of the 8,000 plus potential investments we could pursue.
Tarik: Yeah, and for sure, I think that's one of the strengths of the team is we're not tied to one specific way of surfacing ideas or analyzing companies. We're anchored by the fundamentals, but we have a really strong empirical team. So a team of 5 on the empirical side surfacing ideas using their empirical models. So on a quant perspective, what names are scoring really well? But they've also ventured the last couple of years trying to incorporate technical analysis.
So the way I look at it is we're finding ideas that overlap-- the sweet spot ideally is finding companies that overlap, fundamentally are very strong. From a technical perspective, they're strong. And also from a quant perspective, there's just some positive element happening there, like positive earnings revisions and strong growing earnings growth and strong earnings quality, all these other factors we look for.
Vitali: Let's pivot a little bit here. You've given us, I think, a pretty good glimpse of what's happening on the team and some of the differentiators. I think you'd agree that we could probably have a two hour special edition podcast on that. There's a lot of neat things that all of us together have worked on in the past few years.
I did want to pivot a little bit and talk about markets. There's a lot going on, and we'd be remiss not to address some of the subjects. Unfortunately, our audience is probably tired of hearing about AI, but nevertheless, we'll venture there yet again. So data center, AI, whatever label you want to put on it, that's been a key driver of market really now going into its fourth year.
So, Juliana, I won't pigeonhole you into a specific AI niche, but how are you thinking about that phenomenon in general? Because it's got to be so consequential for the markets and your team, how they go about their work.
Juliana: So AI has been a huge driver, obviously, of the market this year. And in the last couple weeks, it's taken a little bit of a pause, and that has sparked a number of narratives around AI was a bubble. We need to wind this down and look for opportunities elsewhere. I think the challenge with that is parsing through whether this is a fundamental shift in the story around AI, or whether there's something perhaps technical going on. Like Micron is up 240% this year, but down 20% in the last, I don't know, month or so since the peak in, let's say, mid late June, which has been concerning for people around that AI trade.
Our sense is of what's really been going on is it's hard to say. There's really been much of a fundamental shift. There's a lot of technical reasons for a bit of a check back in that trade, whether it's retail investors in Asia that have been buying triple levered SK Hynix ETFs or options trading that sort of magnify some of the moves or hedge funds degrossing after a huge amount of profit that they've realized so far this year. So that's the technical side.
On the fundamental side, there's been enough news flow for people to create that narrative. So the Kimi K3 model that came out of China, some of the big IPOs being delayed and pushed, there's enough to spin a narrative that the AI trade might be over with some of those pieces of news. From a company perspective, we're not really seeing that. The hyperscalers are going to spend more and more money in the next few years on CapEx.
We're getting earnings reports from Micron, from companies across the power landscape, electrification, semi-cap that are all extremely supportive and they see no slowdown in sight. So that's the framing of where we're at in terms of AI, and that's what the team is navigating on any given day is that balance between is there a fundamental shift? Is this technical? What is really our long term outlook on the story with AI?
Vitali: Yeah, I love how you're breaking apart the fundamental versus technical considerations as we think about stocks and really therefore helping us isolate signal from noise. And the signal to noise ratios is probably as poor as we've seen it in the last decade at least. It's just there's noise everywhere.
And with I'd say the AI data center bears, I mean we were having this discussion before we went live today, but there are people that there's always that voice that this is the end of a trade, of an investment theme, that the fundamentals are deteriorating. That voice is always wrong. But when there's a technical breakdown and there's a reason to suddenly amplify and yell off the rooftops that, look at me, I'm right, but often that same voice ends up being wrong again. So we tend to gravitate to these loudest voices, but they're not necessarily the loudest ones.
Juliana: A transformational technology is never linear, so we should expect that there are these bumps and volatility along the road. But our job on the fundamental research team is to think through the actual opportunities of what's the addressable market. What will these companies grow into? What's a realistic growth rate? Where are our estimates currently clustering for the foreseeable future? And then try and triangulate an outlook from that.
Vitali: Well said. And I think you've also organized the team to think around themes, including AI subthemes, Tarik, if I'm kind of summarizing this correctly. But we have the security kind of ledger of TD Asset Management broken up worldwide, but then every security is classified according to a potential theme that it belongs to. Maybe you can unpack that.
Tarik: Yeah, so over the past, I guess now it's 2 years, we've started categorizing securities that we own across portfolios and within the benchmark and try and understand what underlying themes are they all benefiting from. So yeah, whether it's AI, even within AI, there'll be names within the industrial bucket or utilities that are also AI beneficiaries.
And then the idea is also to be very aware, understanding, where are these growth opportunities and understanding do we have the proper exposure in portfolios to those verticals? Whether they are AI driven, whether there are some of these smaller niche growth areas within health care for instance. But they're just trying to find those niches and try to make sure that we're investing in them and we're looking at them closely.
Vitali: Right. And as a former health care analyst, are you particularly hard on the health analysts and demanding?
Tarik: I'm always very demanding. I always ask them a lot of questions. But I mean it is a tough sector, to be fair. Clinical trials often fail. You get a lot of binary outcomes in terms of these pharma and biotech stocks.
Vitali: Being early is being wrong. Want to emphasize that to our audience as well, because that's not how everyone does it necessarily. I think there's a lot of status quo where people would say; I've done the work. I believe it's a great company. I've made the investment. And then the security proceeds to fall in value relative to the benchmark or in absolute terms and lose value for clients.
And there's always an easy button to press to escape, to say, that's OK, I'm still invested in a good company. Eventually, it'll go up. And I think the culture we have on the team is that's unacceptable. Because in a universe of over 8,000 securities, guess what? There are lots of great companies, and we demand of ourselves that we own the ones that are also performant in terms of helping the portfolios be among the best. I'm glad you brought that up.
Tarik: Yeah, and I guess on the analyst team, we do track performance of different recommendations and see how they're performing on a relative basis, on an absolute basis. And this is not to give anyone a hard time, but it's to have that continuous virtuous cycle of learning from your mistakes and trying to refine it on a go forward basis.
And by doing that, we can all become better analysts over time, and certainly I've learned a lot from the PMs here at TDAM. And trying to understand, in terms of how position sizing and how early is early and trying to think through all these different factors for sure very important.
Vitali: There's AI, but there's the other-- AI is increasing in size, but let's just say there's the other 2/3 of the market. If we look beyond AI, what's happening everywhere else? What patterns, trends, observations do you have to share?
Tarik: If we look at the overall market, one thing that fascinates me is when we entered the year, earnings estimates for the S&P 500 were that earnings this year would grow 14%. As we sit here today, expectation is that S&P 500 earnings will be growing 24% this year. So we've seen a lot of positive earnings revisions this year.
Vitali: Fastest growth since '21, I guess that would be.
Tarik: Yeah, fastest growth since exiting COVID for sure. But interestingly, the S&P, as we sit here today, is only up 10% for the year. So we've actually seen the multiple on the S&P 500 derate from 23 times to 21 times. So actually, investors are being cautious and actually haven't really fully priced in all this really good news.
And then the other thing I'd just call out is that when you look under the hood, you're seeing positive earnings growth across the S&P 500. So yes, definitely technology is leading the S&P 500. So technology earnings are up roughly 50% this year.
But if you look beyond that, energy earnings are up 60, materials up 30. Industrials are up in the teens. Same thing with utilities. The only sectors growing actually less than 10% year over year are health care, consumer staples, and real estate. But they're all still growing on a nominal basis, it's just in the single digits. So we're seeing good performance across all sectors.
The one thing I would just say, though, is that when you're looking at sectors that are more dependent on the consumer, definitely those are softer, and it makes sense. So even though unemployment has been relatively stable, the consumer has dealt with higher energy prices, inflation picking up. Here in Canada more so, weak housing market. So those things have definitely weighed on the consumer.
But the one thing I always remind individuals is that if you look at the S&P 500 today, 60% roughly of the benchmark is tied to the growth we're seeing in AI and data centers, whether it's information technology or whether it is industrials or utilities, even financials. Financials are benefiting indirectly from growing financing activity and more commercial lending.
So really, the market today is not really a market that's really being driven by consumer stocks anymore. It's really being driven by what's happening, all the innovations happening in the AI world. So on the one hand, it's not a great thing to hear, because a lot of the equity market is being tied to AI. But at the same time, from an equity investor perspective, even though the consumer is more mixed position right now, it's not really having a huge negative impact on the market.
Juliana: Well, maybe I'll point out that in the last couple of weeks, there's been a significant drawdown in a lot of semi and that AI trade. But at the same time, the broader market is reasonably flat, which would suggest that the rest of the market is picking up the slack from a broader equity performance perspective.
And you are seeing a broadening out across different sectors, and it's not just AI that's performing well. And Tarik has all the numbers of the earnings revisions behind that. But you see that at the index level where the market has not massively tanked, even though Micron and semi stocks and memory stocks are all down 20%, 30%.
Vitali: The market wants to go higher. So it feels.
Juliana: So it feels.
Vitali: We don't know the future, but certainly we had a narrative last year that where goes the Mag 7 goes the market and the Mag 7 has rolled over, I think, October. Tarik, you're the statistician. I think it was around October that the Mag 7 made its relative peak to the S&P, and it's underperformed.
And nevertheless, the S&P has continued making new highs on the strength of semis and other components. But now I suppose you're saying it's plausible that semiconductors may take a pause. And there are other sectors that are certainly supported by earnings growth, Tarik, that may lead the market higher. Is that a plausible version of events?
Tarik: And even within semis, you've had certain areas that have been really strong, like memory, and they've benefited from a lot of pricing power. But there's still this long, big backlogs of demand within semi-cap and other areas of semis. So even in an environment where let's say memory prices are flatline and the memory companies are not going up as much, you can still have the rest of the market do well.
And if anything, that could be actually a positive catalyst. You have an environment where memory prices are flat or decline somewhat, then it's actually good for all the hyperscalers and they can benefit from their input costs are actually less and they can deliver some of this compute capacity to the market for less than they were initially expecting to spend on it.
So it could be an environment where, let's say, memory prices come back a bit. It'll benefit these hyperscalers. That positive tailwind will more than offset maybe the negative tailwind on lower memory. So to your point, even if some areas of semis take a pause, I would not take that as a reason to be concerned about equity markets more broadly.
Vitali: Tarik, you mentioned this amazing earnings growth this year. And I think fair to say we'll end up with a two handle on things. And things go really well, it might be a three handle, but at least let's stay conservative with the two handle. Now, the market's a discounting machine, right? We're going to have to lap this kind of growth come 2027. So what will your rebuttal be to the bears who would say that, yeah, this is as good as it gets. So now is the time to run for the hills and sell your stocks.
Tarik: Indeed, you might have earnings growth slow down in '27, '28. But there's no reason why they would slow down below historical norms. So yeah, let's say earnings slow down and you have a high single-digit EPS growth for the S&P 500 in '27, '28. It's not a bad outcome because right now, the S&P is not terribly expensive. At 21 times earnings, you look at history for the past decade, it's been more expensive. It's been cheaper sometimes. But the market is fairly valued relative to recent history.
So you can have an environment where earnings growth is more pedestrian and in line with historical average, and I think it would be fine, because market multiples are already pricing in more pedestrian growth at these multiples. But the upside, actually, I think the asymmetry is to the upside. Because if earnings continue to be strong and this momentum does continue for another year or two, there's always a potential. The market takes things higher and revalues and appreciates that growth.
But I think in the near term, given some of the concerns about the war in Iran and tariffs and a lot of geopolitical noise, I just feel investors haven't been willing to price in that blue sky scenario and have been generally actually more conservative than not, I would say, looking at the broad indices and what they're pricing in.
Vitali: The bricklayer that is the market keeps putting a new brick every time in the wall of worries right. We got the climate, but as a result, we keep going higher. I had a question for you, Juliana, but you look ready to jump in there on Tarik.
Juliana: Well, I was just going to say something that I think is interesting is-- so PMI is inflected positively at some point this year, or maybe it was late last year. Either way, we were in a state where over the last 3 years, PMIs were in contraction, and the whole manufacturing economy globally was basically in recession if we strip out all of the spending around AI.
So now we're at a point where things are expanding. There's a lot of spending on manufacturing capacity in the US, and maybe part of that is tariffs. Maybe part of it's onshoring. Maybe part of that's data center. But you are seeing growth in the industrial economy, and I think it's interesting because you're seeing that at a time where the consumer is not exactly in that strong of a position. Consumers are spending, but it's not nearly as robust as what we saw in 2020 and 2021 with all the COVID stimulus. People have worked off those massive savings that they had built up through that time.
So I think that's kind of a bullish setup, because you have some manufacturing recovery happening, which was coming off of a very prolonged down cycle in industrial activity at a time when the consumer isn't really even there yet. So if you have some incrementally positive developments from a consumer perspective, I think that can fuel kind of an extended period of recovery or growth in the broader economy, which I find an interesting setup.
Vitali: And I think you know what you're talking about. You also had been a consumer and an industrials analyst. You can marry those two sides of it. So we hope you're right.
Juliana: Hopefully.
Tarik: And I would say the other thing is, rates have definitely backed up this year given inflation concerns and just spillover of higher energy prices and impact of tariffs and what that means for inflation. But let's just say you have a midterm coming up. Congress is split between parties. Things get jammed. Tariffs don't move forward. Geopolitical environments quiets down. You can have an environment where inflation decelerates. Maybe rate cuts can come back on the table in the US.
And in an environment like that, if you look at what's really been holding big segments of consumer spending, if look at in the US housing, you look at autos, these sectors are very interest-rate sensitive. If you have an environment where inflation decelerates, rates come down, then suddenly you have these consumer geared areas of the market that can get reinvigorated and can start performing and can help broaden out this AI trade. Because at the moment, yeah, AI is driving a lot of areas of the market. But in an environment where rates come down and inflation might come down, then you might have an even bigger broadening out of the rally and especially in these consumer areas that have been more challenged.
Vitali: Tarik, Juliana, thank you very much for coming on the Portfolio Manager Views podcast. It was great to hear not only the market insights but also for you to reveal a little bit about how the team is structured and how you're pushing them towards investment excellence every single day. So thank you very much for everything you do and all the contributions that you make.
Juliana: Thank you.
Tarik: Thank you.
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