A Letter from Our Founder & CIO: Tariffs, Market Pressures & Strategic Positioning
My inbox over the last few days has become littered with emails regarding tariff wars and risks. We at Wealhouse are surprised that so many are caught off guard that Canada finds itself in this very difficult present position of being disrupted by a stronger economic force.
I am writing this quick note because I have received a number of inquiries asking what we will do in these capital markets. My answer is simply that we will execute our nimble investment strategies, just as we have done during past periods of volatility and uncertainty. Our strategies have been tailored according to my experience of running money through the Asian crisis in 1998, the Nasdaq bubble burst in 2000, the Gulf War in 2003, the Global Financial Crisis in 2008, and most recently the Covid crisis in 2020. In retrospect, these have all been opportunities to capitalize on the mispricing of capital markets.
Most everything goes in cycles, and I would say that the Canadian dollar is no different. I would also point out that there has never been a period in my career where I have been asked so much about my opinion on the Canadian dollar. We have been bearish on it for some time and anticipate a high probability that we may test the lows it reached back in the early 2000s when the Canadian dollar traded between 62 and 65 cents. The relationship between the Canadian dollar and the U.S. dollar from hereon is tougher to forecast because it will depend on how inflation rates impact the bond market, and there is currently very negative sentiment towards the Canadian dollar. At some point soon we would expect Trump to try and talk down the U.S. dollar. Stay tuned.
We were bearish on the Canadian dollar because our bottom-up research process has telegraphed that Canada has significant structural weaknesses due to weak economic productivity, poor fiscal discipline in Ottawa, overdependence on residential real estate construction as a percent of GDP and a lack of new company formation that creates new jobs outside of those subsidized by the government.
We also believe that many of the U.S. innovative companies with intellectual property competitive advantages will be a major competitive headwind for those Canadian franchises that have survived to this point. It obviously does not help that we have political infighting within the Liberal party at the federal level. Before the tariff announcements, we had consistently heard that parts of the Canadian economy had already been in a recession for the last couple of years. Last month, I heard firsthand through meetings with some of Canada’s largest bank management teams in Toronto, that credit card delinquencies and bankruptcies were on the rise domestically. Thus, we will likely see earnings cuts across many sectors and credit spreads widen for many companies.
In the short-term we can understand why many are fearful of a pop in inflationary pressures. I see no scenario in which retaliation measures will not hurt Canadians already suffering from a cost-of-living crisis, and this will result in a further slowdown in the economy. Longer-term we would not be surprised to see China devalue its currency and continue its recent deflationary spiral. It is the country that has thus far been most negatively impacted by the tariff push back from the U.S. over the last two U.S. presidential administrations. Again, this will likely force a response from Trump around the appreciating U.S. currency which will be a drag on U.S. multinational competitiveness.
As we have been emphasizing since Covid, it is important to stay balanced and have long/short capabilities. Historically, during periods of inflation spikes, like those we saw at the beginning of this decade, there is a corresponding secular uptick in volatility in bonds, equities, currencies, commodities and geopolitics. At Wealhouse, we embrace the volatility that many others fear. It is difficult under a Trump administration to see a scenario in which volatility will be muted. In particular, our long/short strategies in Lions Bay will benefit from these opportunities the most.
It may be politically incorrect to say that we are not surprised that our predominantly unskilled political leadership has been caught flat-footed again, and was complacent in dealing with our neighbours to the south. I am left asking myself if our incumbent federal politicians truly understand all the disruption risk that is coming. There was an interesting article in the New Yorker on January 23rd with Trump’s first-term, right-hand trade negotiator that I hope our politicians have read by now. This quote is especially interesting:
“What Lighthizer would like to see, as he explained to me, is “a new trade system,” in which the U.S. walked away from the disadvantageous trade agreements of the nineties and negotiated a new series of agreements with other democracies, wealthy and not, that fixed those mistakes. Other trading partners would probably be unhappy about this, and “you’d have to fight your way through the retaliation,” Lighthizer said, but in the end he thought other countries would renegotiate because they needed our market to sell to.”
Why Is the Mastermind of Trump’s Tariff Plan Still Sitting at Home in Florida? | The New Yorker
We at Wealhouse have designed investment strategies that avoid complacency and as we always say, “hope for the best and plan for the worst”. For three decades, I have anchored my research process around finding the best management teams, with business plans that have competitive advantages and strong capital structures in order to weather unforeseen storms in the macro and micro economic landscape. We also diversify risk by geography, industry, size of company and asset class. The tariff announcements out of Washington on February 1st validate our investment philosophy and risk management processes.
If the tariffs announced yesterday by President Trump are carried out in full and for an extended period of time, then this will be a hurricane-like economic storm for some Canadian and Mexican businesses, municipalities and provinces/states. We will certainly look to embrace the resultant volatility. Over and over again, our research process has revealed that Canada has become a less business-friendly jurisdiction. I have heard many times from companies that they are aggressively courted to move their operations south of the border.
Over the years we have seen companies like Encana move their headquarters to Denver, where they felt their energy business plan would be better received, since Ottawa had become so hostile towards Alberta-based energy business models. Another blow to Canada came last year when Brookfield announced that they would be moving their primary listing to the New York Stock Exchange from the Toronto Stock Exchange. As Wealhouse recently announced, we too have launched an international division in the Cayman Islands, since the domestic business climate has become so less friendly.
As a parent, I have always told my kids that one of the ways to succeed in life is to build skills and talents that others do not have. The bad news is that many Canadian policies around income tax levels have encouraged some of our most skilled individuals to leave the country. One piece of good news for Canada is that we can produce certain items at better unit economics than the Americans — such as natural gas, hydro-electricity, potash and uranium. Fortunately for parts of Canada, the U.S. has seen policies that stymied oil production these last few years, or else we may well have seen 25% tariffs on Canada’s largest export product. However, only time will tell if higher prices will lead to demand destruction for this product.
With a lower Canadian dollar, we should see a boost to tourism from both international travelers and those on staycation. It is too bad that great Canadian hotel brands like Four Seasons and Fairmont are no longer publicly listed on the Toronto Stock Exchange. We do own in the Voyager Fund Accor from France, which now owns Fairmont.
This past week in the U.S. we saw technological powerhouses such as Tesla, Microsoft, Meta and IBM report very strong earnings results. The world is very competitive and sadly, Canada does not have any companies that can compete with them in their respective domains of expertise. Further, it is not lost on me that many leaders from these companies were spotted at inauguration celebrations in Washington this past month. The best entrepreneurs I have met in my career have an innate ability to create or invent solutions that solve real-world problems. We are invested alongside many of these entrepreneurs.
When I started my career in the 1990s, I made a habit of listening to every conference call from Cisco and Walmart, in order to get a feel for corporate and consumer landscapes since they were dominant in their respective sectors of the economy. Sadly, in Canada we saw Cisco’s Canadian competitor Nortel go bankrupt and disappear. Then discount retailer Zellers lost the competitive battle to Walmart after the 2008 financial crisis. Sadly, we believe that we are entering an age of accelerating disruption risks. There will be winners and there will be losers. Hopefully, Canada can foster more creative leaders like Dollarama, Shopify, Gildan, Lululemon and Aritzia in the future. We have the CFO of Garage Dynamite in our offices this coming week, after they were the first public listing in Canada for a couple of years. Sadly, their IPO quickly traded below water which speaks to how difficult it has become to get public in Canada.
From a public company perspective, I religiously listen to Tesla’s conference calls. They are a winner in a disruptive environment, and I truly wonder if our politicians understand this. I watch them make decisions to allocate our tax money to electric vehicle subsidy announcements in inferior entities that are being crushed by Tesla and BYD from China on key performance metrics. I think it is very important to share some of these quotes from Elon Musk and his $1.3 trillion market cap company on their conference call last week. Some will say Elon is arrogant but I have learned in my career that it is not arrogant if you can back it up with results. It is also understandable to get a little confident when Jamie Dimon, the most incredible bank CEO of our generation, said in Davos last week that, “Elon is the Einstein of our time.”
Here were some key quotes from the Tesla call last week that were drowned out by the tariff noise:
- In Q4, we set a record and delivered vehicles at an annualized rate of nearly 2 million a year.
- Model Y was the best-selling vehicle of any kind for 2024. That’s worth noting. Not just the best electric vehicle, the best vehicle of any kind on earth, number one, was Model Y.
- We made many critical investments in 2024 in manufacturing AI and robotics that will bear immense fruit in the future, immense.
- I see a path, I’m not saying it’s an easy path, but I see a path to Tesla being the most valuable company in the world by far. Not even close. Like not — maybe several times more than — I mean, there is a path where Tesla is worth more than the next top five companies combined. That is overwhelmingly due to autonomous vehicles and autonomous humanoid robots.
- Very few people understand the value of full self-driving and our ability to monetize the fleet.
- So even let’s say people are asleep, but you can deliver packages in the middle of the night, or resupply restaurants, or whatever the case may be, whatever people need at all hours of the day or night. That same asset — the thing that — these things that already exist with no incremental cost change, just a software update, now have 5x or more the utility than they currently have. I think this will be the largest asset value increase in human history.
- A humanoid robot has probably 1,000x more uses and more complex things than in a car. That doesn’t mean the training scales by 1,000 but it’s probably 10x.
- Optimus has the potential to be north of $10 trillion in revenue.
- There is no company in the world that is as good at real-world AI as Tesla. I don’t even know who is in second place. Like, you say, like, who is in second place for real-world AI? I would need a very big telescope to see them. That’s how far behind they are.
- Our free cash flow for the quarter was $2 billion, and despite CapEx increase of over $2.4 billion in 2024, we were able to generate free cash flow of $3.6 billion for the year.
Longer-term I believe that it will be far more important to listen to inspirational entrepreneurs than politicians focused on their knee-jerk policy decisions in order to reap good results in the polls or ballot box. I truly hope that we will vote for political leadership that will prove me wrong and foster the next generations of Canadian entrepreneurs that eventually can get public one day. Following these companies is especially important if investors want to figure out whether disruption will eventually lead to deflation risks in a world with record amounts of debt.
It is in risky times like this that I am thankful we have liquid strategies that can be balanced between long and short strategies in both equity and credit asset classes, and that we have the flexibility to invest inside and outside of Canada. In the years ahead, we anticipate that there will be more and more disruption of companies and countries that do not keep pace with advancements in Artificial Intelligence and geopolitical shifts in the world. Our funds are invested in well-capitalized and well-managed businesses that will weather this storm, and we are certain that our hedging tools will help protect and grow capital during this tariff war.
Disclaimer
This Commentary expresses the views of the author as of the date indicated and such views are subject to change without notice. Wealhouse has no duty or obligation to update the information contained herein. This Commentary is being made available for educational purposes only and should not be used for any other purpose. The information contained herein does not constitute and should not be construed as an offering of advisory services or an offer to sell or solicitation to buy any securities or related financial instruments in any jurisdiction. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Wealhouse believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based.