On the Money with Dynamic Funds

PARTICIPANTS

Tom Dicker
Vice President and Senior Portfolio Manager

Jason Gibbs
Vice President and Senior Portfolio Manager

Ryan Nicholl
Vice President and Portfolio Manager

Tom Dicker: Hi, everyone. I'm Tom Dicker, Co-Head of the Equity Income Team. I'm here with my fellow co-head, Jason Gibbs, and our Global Portfolio Manager, Ryan Nicholl. We're going to do a quick check-in just to talk about what we're seeing in the markets, and what we've been doing so far in 2025.

Mark Brisley: You're listening to On the Money with Dynamic Funds. The podcast series that delivers access, insights, and perspective from some of the industry's most respected active managers and thought leaders.

Tom: Ryan, I'm going to start with you. The market was up 26% in U.S. dollars, including dividends last year, and over 30% in Canadian dollars. Are valuations stretched right now?

Ryan Nicholl: What we've had the last two years, is two consecutive years of the same thing, which is essentially a tech-driven bull market, where the largest mega-cap tech companies keep getting bigger and bigger. That's unique in history. We're at the point now where the top eight stocks, which are entirely tech stocks, or tech-related, are now 35% of the U.S. market index, the S&P 500. That's an incredible level.

It has implications on two sides. The first is on risk. 35% in eight tech-related stocks that all have a similar driver related to the AI theme. That just increases the risks for volatility and drawdowns related to that expensive valuation. The second issue is just the implications that has for broader markets. When you have such a large component of the indices being in quite expensive tech stocks, that makes the indices themselves look quite expensive.

We're looking at right now the S&P 500 trading at about 22 times earnings. That's quite elevated versus history. History would be more like a 16 to 17 times earnings multiple. The MSCI World Index, which is the main global index, is at this point now 75% constructed with U.S. stocks. By continuation, MSCI World then at 20 times earnings, also quite expensive, versus an average of about 15 or 16 times historically.

I would say beneath the hood, it's a little bit better. If you exclude those top 10 stocks in the U.S., the remaining 490 S&P 500 constituents would only be about 19 times earnings, which is still a bit expensive, but more reasonable. If you go down to the equal-weighted index, which assumes all 500 stocks are weighted the same, then you're looking at about 17 times earnings, which is pretty reasonable.

Further still, if you're willing to go outside of the U.S., Canada is about 15 times earnings. Europe and Japan are about 14 times earnings. Those are more reasonable levels. I would say, in aggregate, yes. At a market level, valuations are expensive. Risk is actually pretty high if you just own the index, because a lot of the risk in those big names is fairly correlated.

If you're able to go build a diversified portfolio, the opportunity set is a bit better. Now, Jason, I'm interested in your perspective on this. You've been through a few of these cycles. How are you seeing this environment? How are you investing through this period of concentration, and momentum-driven leadership?

Jason Gibbs: There's two things. You can either be an investor, or a speculator. Obviously, speculating is not what we do. When you're speculating, you're just taking a guess at where prices will, or will not go. That's not what we do. However, we are seeing a lot of that now, and in certain securities, and certain things like cryptocurrency as an example. You really have to know your history, and know that this sort of thing has happened before.

It's never exactly the same. You just have to be aware of that. As I think Warren Buffett once said, investing is really two things. It's knowing the value of a business, and then, understanding the psychology of the market. We're very lucky, on our team, we have a team of experts that cover every single sector. Really, all we do every day is look at the companies we own, and the companies we might own.

We're always asking ourselves, "What is this company worth, versus where the stock is trading?" Then, you understand the psychology of the market where things may be getting stretched or not. You go from there, in terms of deploying capital. To be very practical about it, what I would say is, you never know how long these periods can go. When you are in a situation where securities are relatively expensive, you can be patient.

Certainly, we're all students of history if we're investors. There's two things that you can do that can really cause you a lot of trouble for your long-term retirement. One is buying a lot of euphoric securities right at the top. The other thing that can get you in a lot of trouble, is selling everything when there's a sense of despondency. Which did a podcast I think a couple of years ago about the cash trap, when many were fearful of things at that time, and were going into cash.

You've just got to be aware of your emotions, and no one's perfect. Certainly be aware, do your homework, and follow your process. That's the best you can do, and that's what we do every day. Now, Ryan, I'd like to ask you what opportunities are you finding on a global basis now?

Ryan: It's a unique environment. I think the opportunity today is mostly just looking different. If you need to look like the index, you're going to look expensive. If you can look different, there's a lot of opportunities right now. I'd say, particularly for our style, the Equity Income Team is focused on quality, reasonable price, downside protection.

As part of building that downside protection, the defensive sectors are key. The defensive sectors are incredibly cheap now. Across the board, healthcare, consumer staples, utilities, infrastructure, real estate, telcos. They've all been left behind. Their relative valuations are, basically, at long-term lows. There's some exceptions within there, but for the most part, they're about as cheap relative as they've been for many, many years.

The two I would highlight in particular are healthcare and consumer staples. Healthcare, I've always thought is the highest quality of the defensive sectors, because their economic moats are incredibly wide. They have very predictable demand for their products, and their secular growth, and the aging theme. Basically, all of the different subsectors of healthcare look cheap.

Managed care, the health insurers, they struggled a bit with pricing last year, but they'll fix that in the next couple of years. They look really cheap for businesses that have compounded very strong EPS growth for a number of years. Medtech businesses, ones that have increasing utilization, they look relatively cheap. Pharma is incredibly cheap. The free cash flow yields are absolutely immense in pharma. Tons of opportunities across healthcare.

Consumer staples is unique, especially, as a global investor on the European side. The European staples are very global. They're very emerging market focused, and have good structural long-term growth. They are at the relative cheapest levels, and close to the cheapest absolute levels that I've seen in 15 years covering the sector. We're obviously not only focused on defensives. We're obviously looking for cyclicals as well.

There, I think it's a little bit more pick and choose. I find industrials and discretionary a bit more expensive, not egregiously valued, but they're more pricing in a rosy economic outcome. I would say, energy and financials are the ones that screen more cheap, more attractively valued. Financials had a good year last year, but they just kept up with the market.

On a relative basis, they're still pretty cheap. You can still go buy high quality U.S. banks for about 12 times or 13 times earnings, which is pretty reasonable for businesses that do well in higher interest rate environments, and stable economies. Then, on the energy side, I'll use Shell as an example. We hold in the global funds. It's still-- Despite having performed well since we bought it, has a 13% free cash flow yield.

Those are attractive valuations, good, solid businesses that you can buy, as long as you're not chasing the tech winners. Now, on the tech side, we do still continue to hold positions. We have positions like Microsoft and SAP. What we're doing in tech, is we're just focused on ones where, despite the run-up, despite the AI hype euphoria, what are the businesses where we think the core underlying solid fundamental business is trading at a reasonable value, and where can you get cheap AI upside optionality without overly paying for it?

Right now, we're finding that more in the cloud hyperscalers, and related software businesses, where we just think the valuations for the core business are a little bit more reasonable, and the upside is more long-term and predictable. You can aggregate all that up. What we can build these days is actually a pretty good balanced portfolio.

The global funds that I manage have a PE ratio below 17 times, attractive free cash flow yields, attractive dividend yields. Our beta is actually the lowest it's ever been. Our internal models show beta around 0.68. Our volatility is really low. The opportunity today is really just looking different. If you don't have to look like the expensive U.S. index, you can build funds that are reasonably valued, that are defensive, that have low volatility, and, in theory, have pretty good risk-reward.

Despite it being an expensive market that makes me nervous, the opportunity set is actually uniquely pretty good. Now, Tom, I wanted to throw it to you. Can you maybe run us through your thinking on the opportunity set, and the environment that you're finding these days?

Tom: Sure. I'll start with the U.S., and then maybe finish with Canada. It's tough not to be bullish on the U.S. market right now. You've got a new president coming in that promises to be more business-friendly with less regulation, favorable for areas like financials, which you highlighted are still relatively cheap. Oil and gas is an area that we think could benefit, both from higher production, but generally, the same idea, just less regulation.

In terms of areas where equity income investors would traditionally invest, were areas that really got beaten up into the end of the year. I think, in many cases, those are just businesses that aren't AI-related, aren't as exciting, aren't as momentum-driven as the things that are driving the market right now. You saw some great opportunities. We've been reducing our underweight in staples, because we've seen some great opportunities to buy staples at much lower valuations than you've been able to buy them at for five or six years.

Certainly, seeing some opportunities in healthcare. I think there maybe are some landmines there as well that we have to keep our eye on, given the regulatory backdrop that we have. We've seen some really interesting opportunities to add to healthcare, and have been adding over the last while across many of the different funds. An area that we definitely like is natural gas.

That can be in Canada, or in the U.S. Some of that is driven by our view of the need for generating power with fossil fuels for AI, and for data centers. We think that's going to continue. The energy transition has not limited the demand for natural gas in any way. It remains very strong. The cash flow is there. Pipelines, we still really like. That's a great long-term area. Those investments tend to be interest-sensitive.

A lot of interest-sensitive areas are pretty cheap. I would highlight real estate in Canada and the U.S. as having had a bit of a relief [unintelligible 00:10:24] rally in Q4. A lot of that sold off when rates came back up after Trump was elected. We're seeing a lot of interesting opportunities in that area. U.S. REITs are pretty cheap. Canadian REITs are really cheap.

We're doing this podcast on January 23^rd. I don't want to say too much about tariffs, because I don't know what's going to happen over the next couple of weeks with tariff policies. By the time this podcast is released, there's likely to have been a lot of news. I don't even know if Donald Trump knows what's going to happen over the next couple of weeks. What I will say is, in absolute terms, the valuations in Canada relative terms versus U.S. have gotten a lot cheaper.

I think the sentiment on the Canadian economy is really, really bad right now. I think some of that is well-deserved, but much of the bad news may be priced in already. We're at the point now where it looks very apparent that we're going to have an election in Canada this Spring. We're going to have a change in government. It is much likelier that 12 months from now, we'll be looking at a much more business-friendly environment in Canada.

One of the areas that we're getting increasingly more bullish on is actually the Canadian economy, where the gap between Canada and the U.S. is so wide, the outlook seems so bad in Canada, that there may actually be some long-term opportunities starting to percolate there. Now, I would say things in Canada, probably, need to get worse before they need to get better.

For long-term investors, if you've made a lot of money in the U.S., you've made a lot of money on the currency, Canada might be a place where you can start kicking the tires, and that's something that we think is really interesting. Two more areas I'd highlight. I think that the office real estate market, I don't know that I'd directly invest in an office landlord, but I think office leasing is bound to come back.

The economy is much stronger, so leasing deals are likely to get done. A way that we would invest in that, and the way we have invested in that, is by investing in real estate brokers, where they don't take on the risk of owning the property, which involves a lot of capital expenditure. You have exposure to insurance and taxes, and all those other issues. Of course, the problems that happen when a building remains vacant, which is a big problem in office leasing, but you do benefit when leasing comes back.

That's certainly something that we've started to see both in Canada and the U.S., so we'd like the real estate brokers. The final area I'd finish on is, broadly, oil and gas, and energy and data centers. Maybe, Jason, I'll throw it over to you. A big growth trend we've seen in the power markets in the U.S. is related to data centers. Can you tell us about what you're seeing, and how you're investing in that growth?

Jason: It is one of the greatest long-term themes that I've seen in quite a while, in the sense that, North America and many parts of the world, simply put, are short power. They don't have enough power. We have had underinvestment in power infrastructure, particularly, the last two decades. We've had decommissioning of fossil fuel plants, some more renewable plants, but we've also had energy efficiency, right?

As a society, we've been getting more energy efficient. Now, what's happened, as you alluded to, we've had a major step change in demand, and it's happened very quickly. It's coming from a lot of sources, but really three of them. The first is AI, artificial intelligence, the need for many more data centers to handle all of the digitization that's going on in the world.

Of course, the change in demand for electric vehicles, and deglobalization. North America is getting back to industry with the war going on in Europe, some of the political issues with China, and some of the bottlenecks that we saw post COVID, we are going back to industry. What does that mean? It means there's going to be more demand for volumes with respect to power, and it also means that all else equal, power prices are going higher.

How we're investing in that, owning independent power producers. Those are the companies that own power plants. Also, regulated utilities, as we've been saying for over a decade now, there's huge demand to improve and rebuild utility infrastructure to deal with all of this. Tom, on the topic of artificial intelligence, I'd be interested to know, and I'm sure our listeners would be interested to know, how we're using AI in our team?

Tom: In terms of things that are available out there that we use, we use Perplexity. What we've found is, what large language models are most usable for. The frontier models like ChatGPT, Google Gemini, they're language models, they're good for language problems. They're really good at giving you qualitative assessments, and qualitative answers, giving you knowledge and information about a subject.

For us, we spend a lot of time learning about a company. What do they do? What drives the business? What drives their revenue? What are the different divisions of the company? These large language models like Perplexity, like ChatGPT are amazing at getting you specific answers around understanding a company and its history. We really like those. We use Perplexity Pro here at the office. I personally use ChatGPT as well.

I know you use it as well, Jason. What we don't use it for right now, we don't use it to make numerate predictions. We find the models just not quite accurate enough, or not quite able to make those sorts of predictions, at least the ones that we have available to us. Certainly, some of our hedge fund peers and folks who have spent tens or hundreds of millions on artificial intelligence and models, they would be doing things like that.

For us, we're still doing things more the old fashioned way, especially, on the modeling. We're making sure that we understand each individual cell, and each individual number in a model. Of course, I would expect that to change. Other tools that we use, we use a tool that's specifically designed around analyzing company transcripts called Quarter.

A lot of our analysts really like that one. It saves them a lot of time. It's a great user interface, and lets them get additional insights into what was said in the quarter. We have our own in-house tool that we're working on right now that isn't fully in production, but is in partial production, that's based on Google Gemini. Within the next few months, we're going to be able to automate a number of our internal processes that will use both the transcript, and either the 10-K, or the quarterly earnings release, and speed up the investment process, and that research coverage process pretty dramatically.

That's really exciting, because if you can get that output faster, it frees up our analysts to spend more time doing things like generating ideas, more time on things like getting those models a little bit more accurate, and being able to generate insights, because they've just got more time available. Time is definitely the one big constraint. A few other things that I've mentioned that I really like, Google has a product called NotebookLM.

I think it's a game changer in terms of how to analyze documents. It's got the ability to look at audio files, YouTube videos, PDFs, and you can synthesize a number of sources, and then ask questions. The quality of analysis I've found is really amazing. Looking at things like a company's 10-K reports, 10-Q reports, looking at a company's investor day, and being able to just use all of those sources, and then have an AI model answer questions like, how has their disclosure about China changed over the last few years?

That's a very research-intensive process for an analyst to go through, and find an answer to that. If I were to ask one of my analysts to do that, it might take them all day. That's something that is not available currently for enterprise use. It's only available personally, but I use it all the time. I think it's a really amazing product. Eventually, all investors will be using products like this, and models like this.

They may be totally different in 6 or 12 months from now. The quality and the power of these models is changing so quickly. I'm really hesitant to say what we'll be using in a few months or a few years, because we really don't know. We just know that the tools are really powerful. That moment we were hoping for when ChatGPT was launched, where they're useful, that's here now.

It's definitely a really exciting time to be doing this. Our process and the way we learn about companies has changed more in the last 12 months, than it did in my prior 20 years in this business. That's a pretty exciting time to be investing.

I'm going to leave it there. Thanks everybody for listening. Thank you so much, Jason and Ryan, for taking the time and let's do this again.

Jason: Thanks, Tom.

Ryan: Thanks, Tom. It was great to be here.

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