How Global Markets Are Breaking Records Despite War, Volatility and Recession Fears | Portfolio Manager Views Podcast

Benjamin: Welcome to the Portfolio Manager Views podcast from TD Asset Management. I'm Benjamin Gossack, managing director and co-head of Global Equity Portfolio Management. And I'm joined today by my other co-head of global equity portfolio Management and also a managing director, Damian Fernandes.

Damian: Thanks, Ben. I find it really interesting this is a “PM talk”, but we're both Co-heads and PMs. So, who's doing the interviewing?

Benjamin: Well, right now I'm just doing the intro, but I'm happy to have this as a dialog as we normally do in our…

Damian: Day to day lives ...

Benjamin: In our day-to-day lives. I was going to ask you; do you think our title is too short or too long?

Damian: I think we just shortened it to probably something like maybe the team that leads to outperformance. You and I have been working together, what, maybe 14 years, but at least. At least and counting. And over that whole time, like, we've been able to navigate what I think is a pretty tumultuous time in markets and we've delivered for clients. So, I'm hoping you'd ask, like we know we can talk about what led to that, but we can just talk about whatever was on your mind.

Benjamin: Well, why don't we start with what's happening within markets from a macro perspective. So, you know, a lot of what happened this year, people are looking back to last year as a guide for the future. Sometimes that works, sometimes that doesn't. History is important, but it doesn't always necessarily rhyme. We have had a big geopolitical event in terms of a war in the Middle East.

There have been a lot of views in terms of the implications on a supply chain perspective, on an asset price perspective and yet where we stand today, Damian, at this recording, markets are breaking out. So, I've heard a lot of feedback questions to myself. I'm sure to you about are the markets getting it wrong. But the better question I want to ask you is what misconceptions have been out there in terms of how people view this market and why breaking out the new highs isn't necessarily the market getting it wrong?

Damian: I think since COVID, what's actually happened is that the market has, or I guess participants of the market and the media and sometimes our clients, they have overestimated the downturn or the fall back of geopolitical risk, and they've just underestimated the fundamentals. And let me just be clear, I think about COVID. The market bottomed out in, you know, March, April of 2020, but cases continue to rise.

Damian: The economy slowed down, and people are like, oh, it's going to get really bad. It's like the market prices at the margin more recently last year, I think like the playbook that you were alluding to, like Liberation Day, as soon as at the margin, there were signs that there was going to be some negotiation and trade things.

The market found the bottom and continued to move higher. There were signs that they were going to at least start negotiating the market said, okay, you know, the Strait is currently the Strait of Hormuz is currently closed right now. But we see a pathway. And so, I think you're right. I think the market is, you know, correctly anticipating that there's going to be an outcome.

And if that changes, of course, we'll have a thing down. But the second part of my statement, it's, you know, we're overestimating geopolitical risk and we're underestimating fundamental needs like GDP growth. We had a five and a half handle last year. We're in the midst of earnings season. It's going to be sixth consecutive quarter of double-digit earnings growth.

And like the companies we have in our portfolios, they're putting up really solid numbers. And I guess it's like every bull market thinks good and what can you tip the applecart? But they're forgetting about the delivery of earnings and cash flow right now. That's my view. What's your view?

Benjamin: I think I like to focus on a market structure perspective in a we invest based on a certain philosophy, but we're not the only investors out there. And you have a whole bunch of people that are investing based on macro micro stock selection, volatility type of portfolios. I think to your point, the market has started to prepare. They saw assets move into the Middle East and whether they had foresight or not.

When I look at it from a market structure perspective, they took out more insurance, or they prepared to short the market in a magnitude that was much larger than Liberation Day and COVID. So, it was almost like they overdid it. And so, we are getting, you know, reps in the market to the highs. I know you like to look at factors.

Yeah, we're getting short covering a whole bunch of stuff, but they overdid it. And so, yes, there are real world implications, but from an asset price perspective, it's almost as if they priced in the Strait of Hormuz being shut down ten times over.

Damian: I'm looking at the banks that reported last week. I'm looking at, you know, core industrials. And a lot of these companies are breaking out to new multi-year highs. What's your view on that? And within more? What's that telling you?

Benjamin: So, I think it's a few things. Yes, we did get decent reporting from the banks, although I do think there is still a lot of risk in the banking system because of the overexuberance and the overallocation of private credit.

Damian: Exactly.

Benjamin: So, we have a big issue in terms of geopolitics. I think we can't lose sight that private credit is an issue that's not going to go away.

Damian: Slow burn,

Benjamin: a slow burn. And we've had a few of these bankruptcies, but it's one where I would say for our portfolios we've divested away from most of the financials, the sort of industrials breakout, I think goes back to what's been really driving markets and GDP.

It's a lot of AI and we've had the HYPERSCALERS talk about their 800 or $700 billion in Capex. Then you and I have looked at utility companies, and you could talk to 16 utility companies and which I did in January, and they all had 30 to $60 Billion Capex. So capital spending programs for the next 3 to 5 years, there's a lot of spending and it's a lot of stuff on the hard stuff.

So, I hear people talk about, yeah, we're worried about AI, not worried about either. Focus are hard assets, but it's the demand for these hard assets to fill the data center as to why these stocks are working and why we're seeing earnings acceleration.

Damian: Look, the tax incentive policies in the one (big) beautiful bill act like that was passed, we are pulling forward demand right now. If you're building a data center, if you're building infrastructure structures, there's a tax credit you get where you can expense depreciation. So of course, you're going to like to invest as much as you can today, and that's showing up in the numbers, both the GDP numbers and the earnings numbers.

And I think people are still thinking about, okay, when is the Strait going to be open? It's like, no, we're in the midst of like, you know, like take the bird in the hand. The bird in the hand is, you know, pretty significant outsized earnings and free cash flow growth. And I think, you know, we should be comfortable with that.

That's just what I know. We're talking macro. That's just how I feel.

Benjamin: So, cash flow growth has been a core ethos of our philosophy. And we like cash flow and cash flow compounding. I know you've been working on a research paper, but maybe you could illuminate what the relationships you're seeing in terms of cash flow compounding and how that might then translate into stock outperformance?

Damian: Thanks. Thanks for the shout out.

Benjamin: Ben and I have no problem giving you lay ups.

Damian: We will. We will. We will publish this. And it's for those that don't know what we actually have and you know this we actually have a separate team that does quantitative research-based work. And we've always talked like when you and Ben, you and I meet clients, you talk about how the marketplace is underestimating how much cash the companies we invest in are going to generate.

So, we thought, let's actually test that out. Let's assume you can find, you know, before you can find a selection of companies. And within those companies, find the companies that three years from now grew cash flow the fastest. How did those companies compare sector neutral. Like if it's an industrial sector or if it's a consumer sector, the companies that grew cash flow the fastest from, you know, in from today versus three years in the future subsequently, how did those companies perform?

And we back tested this and, you know, lo and behold, it's nothing surprising. The companies that grew cash flow the fastest actually had significant outperformance. And that's what our edge is right? Our edge is today, being able to look at our portfolios, look at what the marketplace, what's in the marketplace and try between a mix of our research efforts, our insights, our quantitative tools, what the charts and the tactics are telling us, you know, try and place bets on which companies we think will grow the will grow cash flow the fastest.

And like lo and behold, I'm pretty sure what the evidence will tell us is that if we're successful at finding these companies today, that will grow free cash flow the fastest versus their peers in the next few years, our clients will be will benefit from some degree of outperformance. I thought I thought it, you know, validated what we've been doing for the last 15 years, which is trying to find these cash flow compounders that you talked about.

Benjamin: So, so many people are so focused on analysts and their expectations for sales and growth and earnings. And if you provide in-line results for your quarterly earnings, the market doesn't like that the market wants outperformance. But if you're telling me that these companies are compounding their cash flows and they're outperforming, so then what's being missed by this community of specialists that their only job is to focus on these companies and their and their future growth potential?

Damian: Oh, that's I think what's being missed is time horizon arbitrage. And let me be a little more clear about that. Right. You talked about the analyst community right now, the sell side analysts who work at the big banks and cover these stocks, they are they have a fair amount of they're stretched. They have a lot of companies to cover.

So, they're thinking about the next quarter. And you and I don't really play the next quarter. We're not trying to buy the company that's going to beat earnings by $0.05 or less or sell the company that's going to miss earnings by $0.10. We're thinking about what is being mispriced over the next, you know, multiple years, like where do we see ...

You had a great example about these utility companies that invested, you know, like billions of dollars in Capex and assume when you were up when you said that the first thing about I was think about is that's probably more, you know, like cables and that's probably more, you know, substations and that's probably more, you know, I guess like gas fired turbines in my head.

I'm thinking of these companies are going to have outsized investment to, you know, support grid infrastructure over the next multiple years in the rest of these companies, but also let's invest in, you know, who this Capex you’re spending is someone else's revenue who is going to see the outsized revenue or the outsized free cash flow growth. And I know we've always spent a lot of time on that.

Maybe - let me switch gears here. Where do you think right now, given your view is like where are you seeing the bottlenecks in where the market is and really pricing in this, you know, stupendous growth over the next few years?

Benjamin: So, the biggest opportunity and I also do think the biggest risk to portfolios is artificial intelligence. I think in replacing.

Damian: Replacing us? Or...

Benjamin: Right now, I think we're okay, but I think we always should have an open mind here. What I do see is, you know, maybe in 2023, 2024, if you had a bullish point of view in artificial intelligence, it was very easy to say, let me own a company like an NVIDIA or a Broadcom, because it seems everyone needs these chips.

Benjamin: And so, these companies provided these outsized returns. But like all things, we start to say, well, now that's consensus. We all know NVIDIA chips are going to be needed. So, then what is the next thing where we can create the outperformance? And to your point, what are that additional sort of pick and shovel items that we're going to need?

And so, what we are finding now is if we follow NVIDIA’s roadmap and their plan is to create a new chip every year with new bandwidth, new speed, all this type of stuff to deliver all the demand that we want from our A.I. models. We're going to need a lot more cables, but an exponential amount of cables.

So, you know, when I think about could the analyst community figure out, is it 3X next year cables, is it 4X next year cables? It creates a lot of opportunities. If they undersize how many blue cables are required, even as something as trivial as that green printed circuit board. So, if I were to open up my computer, I'm going to find all these green boards.

If they got all these chips because of the speed and the bandwidth and the temperatures and electrons are not like fluid, they kind of like to move where they're going and everything is getting miniature. Just containing it and having the right material is becoming key. And there are only a handful of companies. There might be one company that does 70% of that.

And so that's where it's going to be exciting, because I always find for us that, you know, we want to see the signal, we want to see growth. I really do believe markets reward growth and then trying to figure out from a puzzle perspective, okay, well, where are we going to benefit from that growth we benefited from NVIDIA.

And that's not going to go away. But we're not going to get outsized outperformance because what's really important for people to understand the way that you and I talk is always in relation to the fact that we have benchmarks. And, you know, if a stock goes up 15% or says you own a stock and it goes up 15%, you're like, wow, you know, it's up 15%.

I made a lot of money. But for you and me, if our benchmark goes up 20%, that stock, that's 15% that might go ... is actually a big disappointment. And I've really hurt the performance. So, we are always trying to figure out from our perspective because we manage portfolios, the benchmark, you know, is this better than the broader market?

And if it's not, it's a disappointment.

Damian: I guess that's the point of my paper. It's that empirically evidence based, the market does reward growth. If you can find companies that are growing much faster than their peers and cash flows, the market rewards that you said. Also, something about NVIDIA, maybe we'll drill down a little deeper there. Is it that the market doesn't care that NVIDIA is going to generate $500 billion in revenues?

Benjamin: As to why the stock hasn’t outperformed.

Damian: Exactly. It hasn't outperformed. We know this, we own it. It hasn't outperformed me since, I think, October last year. It's just been, you know, moving sideways.

Benjamin: So, I don't think it's an issue about the numbers. I think it's more about more and more people have a better appreciation for how big the market is. Very similar to when we approached the obesity and the diabetes drugs that were coming to markets.

Damian: Like Novo Nordisk and names like Eli Lilly.

Benjamin: Right. So, they were very expensive from a let's say, a P/E or enterprise multiple perspective. But as they were growing and ramping up what we could tell is that the market couldn't appreciate how big it was.

Damian: They just thought it was for people who were.

Benjamin: Well, the initial take was, you know, you wouldn't take these drugs unless your BMI is your body mass indicator. So that's a that would be height to weight ratio was north of 30. The analyst community could contemplate why you would take it if you had to be like less of 30. But I think these stocks can grow as people realize how big and big these markets are.

Benjamin: But now it's not as if Eli Lilly and Novo Nordisk and all the other companies that are putting these drugs are not successful in growing earnings and cash flows. Is that we have I think, for the most part, kind of figured out how big this thing is. And even as NVIDIA was ramping up, you'd get three quarters of outsized growth and you're like, well, it couldn't be the next core.

They couldn't grow as much. And here we are in 2026, and they keep putting up amazing numbers. But I think it's not lost on anybody that the GP is really important, and I think that that's what's factor into the stock price.

Damian: Yeah, like what we call exportable alpha, right. The fact that what would we be in Exploited Alpha, we would really be trying to think is that does the market underestimate or overestimate how big the opportunity set is. And for us they to a point like we, we actually in our portfolios we don't actually have big ... we still own NVIDIA, we think it's a super high quality company it's growing but it's no longer exploitable.

Like people understand that there's going to be $500 billion of revenue at really high margins. And you know, you're talking about bottlenecks and we're finding really great opportunities. And, you know, the makers of the materials have gone to circuit boards or the companies that make the optical cables because as these data centers, you need to connect them together.

You need high bandwidth transmission, and that's optical. So, I kind of like what you're saying. I want to switch gears maybe, and switch to something and then you can talk you go first what you think. And hopefully we don't have the same answer is, you know, we'll end on something where we'll end on a positive note. But like, what's really keeping you concerned right now?

Both either maybe individual stocks in our portfolios or at the market writ large.

Benjamin: So, I would say the biggest challenge I have right now is I like to look at the world less on geography. So, I don't think of, you know, is it Canada? Is this year? This year, is it U.S. year this year? Should we move everything to Europe or Asia? I think that's more of an output of our process.

And I don't also think of the world based on sectors. So, should we allocate to industrials or technology or to utilities? I also think that's an output of our process. What I'm really concerned about, and I think more and more people, especially advisors, if they run their own models, should look underneath the hood and determine, let's say they run a 50 stock or a global portfolio or maybe they run a 40 stock.

Let's focus on the U.S. Let's say you run a 40-stock concentrated U.S. portfolio. Is it possible that 30 of your stocks are actually all the same stock?

Damian: Because they're all tied to the winning AI play?

Benjamin: ... Because they're all tied to AI. And I'll give you an example. So right now, what's in short supply are these natural gas combined cycle turbines that's only produced by three companies, and every utility wants these gas turbines to power the data center. But there's a five-year, six-year backlog. So if you sign a contract with a company like Amazon and you're like, Great, we will build you this, this power that we agreed to that maybe when you put the firm order for these gas cycle turbines, then all of a sudden you've got to wait six years.

Benjamin: So, the industry is looking for short term solutions and they're focusing on these engines called reciprocating engines. But they're effectively sort of backup diesel generators. You could find that in certain industrial companies like Caterpillar, you could find that in energy services companies like a Baker Hughes, you can find it in some other Natural Gas companies that are packaging these solutions and reselling these reciprocating engines.

And so, you may be diversifying.

Damian: So, they own an energy company. I own an industrial company. I own a, you know, tech company, but it's basically the same trade.

Benjamin: It's the exact same trade, and that's the same thing. What bottlenecks in the data center you could own, like we said, you could own the blue cables, you could own someone that makes that printed circuit board, someone that solders it. Someone that puts the little lines on it? In reality, if you're truly being honest with yourself, they're all the same stock because the market is treating them all as the same stock, but it goes across the industry sectors.

So, in the past, I think when you and I would have started working together, I'd say 14 years ago, it actually made sense. Oh, Damian is over index on industrials and financials. He must be you must think there's a cyclical business cycle. I think the market has changed from that point of view, whereas like you said, you can pick up AI and utilities, industrials, technology, discretionary and communications.

And as we've seen with this private credit issue, the.

Damian: Funding for them to.

Benjamin: Right, you pick up on the financials. So, it's all over the board is not impossible, but it is a challenge to find ideas that are that I also growth and diversify you from just this one dominant theme.

Damian: I was hoping it wasn't the same thing, but it is basically the risk factor and I think the risk factor, I'll just put it plainly, you said at the start it's going to be 700 billion in Capex that the data center that that Capex is someone else's revenue and it's someone else's revenue across multiple sectors. The utilities are providing more power output.

The you know, the industrial companies that are helping connect the utilities to the data centers within the data center of the people, the tech companies that provide the optical cables and, you know, the financing companies that are providing the credit to build these data centers, it's all become one big trade in the U.S. market. And the numbers are astounding, right?

700 billion assume 75% of that is spent in the U.S., 75. Multiply by 700, you get to, you know, half a trillion. The U.S. economy is a little over 30 trillion. You're talking about 1.5% to close to 2% growth just coming from data center buildouts, if you like. What I what I'm laser focused on is whether any of these hyperscalers start talking down numbers, because I think that and we know this in our portfolios, that's going to be the big risk because all of those stocks, you can say are diversified, but all of those stocks will feel pressure if we start seeing reductions in the amount of AI Capex build out.

I don't think it's happening, though, because I think you get, you're getting compensated this year for actually putting money in the ground because of the tax incentives. So, if anything, I think this year you'll probably see increases in the cap expected because they're incentivized to do it. But that is a longer-term worry.

Benjamin: I get a lot of questions about views on the U.S. and whether we should diversify away from the U.S. I might know you're your answer. I might not actually I could be surprised here, but from your perspective, do you think it's - people should just dismiss the US and just focus on Europe or Asia or Canada or emerging markets?

Damian: I find it really instructive that we're filming this in the middle of April, and if it was February 28th, you like the amount of the amount of people that told me it's the end of U.S. exceptionalism and the U.S. dollar is, you know, not abroad worth any money and it's going to be diversifying away. Then we had a war and the U.S. market was the best performing market in April.

The U.S. dollar was the only place off like actual that provided you ballast like gold was off 15%, Bitcoin - we don’t even have to talk about that. A lot of defensive sectors and the rest of the world are right, so because a lot of these countries import energy, they will put pressure. Higher energy prices would put pressure on budgets, which means less money for stimulus.

A lot of the rest of the world actually underperformed. But my view of the U.S. is like you still have probably some of the best companies globally growing at much faster rates and almost like a capital return policy in the companies, both with share repurchase, the dividend growth that are quite attractive, like we don't actually pick countries, but I would never be dismissive of the U.S. and you just had a real life example where in a time of like crisis, a war, the US market, the U.S. dollar and U.S. assets actually held up really, really well.

What's your view? Do you think people are just overly dismissive about this?

Benjamin: I think last year it was a very emotional reaction.

Damian: Oh yeah. Because as Canadians.

Benjamin: As Canadians and maybe as Europeans and maybe other countries, because it was you know, we're cutting off trade. And so, there was an emotional reaction. If I'm just looking at it, you know, from just sort of I think more people have to focus on index composition. We're very focused on oh S&P did this. Yeah. TSX that this MSCI World did this.

The reason why Canada did so well last year have less to do with the Canadian economy and which, as you say.

Damian: Is actually not that great to begin with.

Benjamin: And had everything to do with the fact that the Canadian market probably has the biggest exposure to gold stocks. In the S&P 500, there's just one gold stock, Newmont, and it may not be of the same caliber as the other gold stocks. Same with Europe. There is some gold, but it again, it's not going to dominate the index.

What dominates the US and why the US has had all that so-called exceptionalism is the fact that it has the largest exposure to technology. I always find when large cap tech underperforms, it makes Canada look very good, completely, it makes Europe look really good. And if you have a view like, oh, we got to go to Europe, it's a very convenient argument based on large cap underperformance.

And the thing that actually really surprises me and it's not being discussed. So, we do have large cap tech underperformance right now. In fact, people would have said, Hey, Damien, the biggest risk to the US market right now is the fact it's so concentrated in seven stocks, those seven stocks based on, you know, I have market index and we end on March 31st in our snapshot from a year to date perspective, all seven of those stocks had actually had negative stock returns and the S&P 500 broke out to new highs.

Damian: What's behind door number three?

Benjamin: Exactly? I always find when everyone says there's only two options or three doors, there's always a fourth and fifth. So, I think if we get a renewed return to large cap tech, then all of a sudden, I do believe prices drive sentiment and then there'll be a reorientation of the US exceptionalism and everyone will say, you know what, we should go back to the S&P.

Maybe there's value because we've all been focused on other geographies.

Damian: I think what you talked about before, composition, even when you think about EAFE and stuff, there's just a few sectors within EAFE. Last year the sectors were the best performing sectors globally, you talked about gold but were things like financials and fees over indexes with higher weights to financials. So maybe it's just, you know, people are confusing the sector's composition with the country selection.

And I think you're right. I think the and the second thing you said was, you know, just like I was saying by the tourists, they did a lot of tourists in Europe, a lot of tourists in EAFE. And as soon as like things got like a little dodgy, they started like coming back home and coming back home to North America.

Benjamin: Now, financials, to your point, were outperforming and they over indexed in Europe, but financials have been outperforming MSCI/EAFE for over five years, Damian. But people only discovered it last year because of the large cap tech underperformance. Otherwise, they were happy with the U.S. I think I'd like to sort of move to sort of one final question. I'm curious about your thoughts.

I think you and I get a lot of questions about where do we think markets are going to go. I think we both agree that trying to forecast is year is, you know, if people want a forecast, there's plenty of people that will provide it for you. But what do you think is a better question of if someone was coming to see you talk or an advisor is coming to see you rather than wasting time saying, hey, Damian, tell me where markets are going to go at the end of the year.

Yeah, what, what would be a better question that would create more, more of a value conversation?

Damian: I think the question for me is like, you know, what excites you and what excites me is about, you know, you and I will never tell people that we think the market's going to correct 10 or 20, you know, 10 or 15% technical corrections, like 10% drawdowns happen with a certain degree of frequency every year being able to, you know, anticipate that and be really convinced that you can do that.

Like that's like we're deluding ourselves. But I think what people are forgetting is just the bigger picture thing where the cusp of a massive technological revolution is probably across the board going to lift margins. So, if you add, you know, just like companies that had margins today and there's a chance that margins will move higher in the next few years, that should probably mean higher valuations for those companies, right?

Because they'll generate more cash flow. And I think people are so, you know, they're so in the weeds about thinking about, hey, what could go wrong that they're not thinking about what could go right. But we're in a multi-year bull market like earnings is growing above trend. We have margin opportunities in capture, and we have, you know, governments globally that are spending to incentivize to actually have faster growth.

I think those are all really, really bullish and I'm really excited about that. I'm excited about our products over the next, you know, three months. But I'm extremely excited about our products and our solutions to help advisors over the next three years, because I think that's where we had Alpha, though, the fact that, you know, we can find these companies that have outsized exposure to faster free cash flow growth and like it might not be reward the next three months, but I'm pretty sure the next three years we'll look back at it and say like, oh, wow, that actually happened.

And I think people are you know, people are people are living. People are living in the negativity of the moment without actually seeing what's the upside potential. That's my thing. But if I reverse that question, if someone asked you like they bet they'll give you a forecast for the next 12 months. Tell me what you know really is on your mind for the next three years.

Like what's your thoughts?

Benjamin: Yeah, I think it goes back to our secular trends and in cycles, the areas that we think again, we focus on secular trends and cycles because we think that leads the growth. Find the companies that can capture that growth. We think we can get the outsized returns. I think it goes back to what I was saying before is our objective is to manage and outperform to our benchmark.

And I think for the advisor, it will vary based on client. But you know, do we need to deliver 6% compounded returns for this client because they have certain financial goals and dreams and aspirations and this client requires 10. So maybe from our perspective is we are the ingredients that go into a model portfolio for an advisor. Are we helping them get to those objectives?

And maybe that's where we can have a more, more fruitful discussion.

Damian: I agree completely.

Benjamin: Damien, always a pleasure. I mean, hopefully this gives people an insight into the kind of daily discourse that you and I have.

Damian: Yeah, this, this is, this is, this feels very transparent because obviously we haven't prepared for it. And it's like, let's just talk about what's on our minds.

Benjamin: Right? So, I want to thank everyone for watching the Portfolio Manager Views podcast and we look forward to coming back in a month's time with another content filled episode.