Adapting to Economic Uncertainty: Investment Opportunities Amid Global Shifts

When we last wrote comments this past spring, we said that interest rates had peaked and we anticipated central banks would start cutting their rates. This conclusion was based partly on the feedback we were getting from a number of companies we were researching, informing us that inflationary pressures were significantly subsiding, and labour shortages were abating.

Last week at the annual central bank meeting in Jackson Hole, Wyoming, U.S. Federal Reserve Chair Powell said: “The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”Chair Powellalso said that, “it seems unlikely the labor market will be a source of elevated inflationary pressures anytime soon, [and that they] do not seek or welcome further cooling in labor market conditions.”

One of the big unknowns moving forward is what the supply/demand equation will look like for labour, and this makes it very difficult for central banks to set monetary policy. Sadly, as people fell sick and/or died during the Covid crisis, we saw labour supply shrink. In addition, most have heard that China’s long-standing one-child policy has backfired on them, and we all know the baby boomer generation is seeing its retirement ranks increasing year after year.

Despite the above stresses on labour supply, we are currently hearing from management teams that, in most cases, they are not experiencing a shortage on the labour front. At home here in Canada we saw the central bank of Canada cut rates in back-to-back months during June and July. It increasingly looks like the Bank of Canada is behind the curve, as Canada’s unemployment rate has risen to 6.4% and is 14.2% for younger workers. The 2-year bond, which is often used as a proxy for where a country’s policy rate should be, is currently 3.24% in Canada. I would not be surprised to see a 50-basis point interest rate cut in Canada, as many Canadians face daunting mortgage renewal rate increases between 2024 and 2026.

I am not entirely convinced that we are in a permanent “higher for longer” interest rate environment. Shorter-term, perhaps (this decade). In the longer-term, however, there are many moving parts to consider. For example, there is the issue of labour supply.  A year ago, the chairman of a large Canadian grocer told me that when workers were getting paid $ 15 dollars an hour his company was not too interested in automation robots for their distribution centres across the country.  He then said: “At $25 an hour, we are now investing in robots!” Adding to this labour substitution initiative were comments made by Elon Musk on his most recent conference call: “While others are pursuing different parts of the AI robotics stack, [Tesla] are pursuing all of them. This allows for better cost control, more scale, quicker time to market, and a superior product, applying not just to autonomous vehicles, but to autonomous humanoid robots like Optimus. [They] expect to have several thousand Optimus robots produced and doing useful things by the end of next year in the Tesla factories.”

One company already illustrating efficiency gains from Artificial Intelligence is WalMart. As part of my research process since the 1990’s, I have always listened to their conference call to take the pulse of the U.S. consumer and better understand a major distributor for some of the smaller companies we have invested in.

It was interesting to note that, on their August conference call, WalMart said that they were, “finding tangible ways to leverage generative AI to improve the customer, member, and associate experience. [They’re] leveraging data and large language models from others, and building [their] own. One example is that [they’ve] used generative AI to improve [their] product catalog. The quality of the data in [their] catalog affects nearly everything [they] do, from helping customers find and buy what they’re looking for, to how [they] store inventory in the network, to delivering orders. [They’ve] used multiple large language models to accurately create or improve over 850 million pieces of data in the catalog. Without the use of generative AI, this work would have required nearly 100x the current headcount to complete in the same amount of time. And for associates picking online orders, showing them high-quality images of product packaging helps them quickly find what they’re looking for.”

Another element that makes it difficult for central banks to predict inflation moves is the question of how much of the past generation’s supply chain migration, from overseas to jurisdictions like China, will be repatriated in years to come. To get a feel for the magnitude of this trend, we have asked most every management team that we have met since Covid two key questions. First, in a post Covid world, where do they have assets that they wish they did not? Second, where do they wish they had more assets from a supply chain and talent perspective? Overwhelmingly, we hear that companies have too much reliance on China and too little on the U.S., Mexico and India regarding sourcing exposure. Sadly, Canada does not get mentioned very often. Not surprisingly, at Wealhouse, we have been investing in businesses that benefit from those secular shifts.

Today, I am writing these comments the day before a meeting with a $7B U.S. market cap oil service distribution company from Houston, a 25B Euro market cap digital marketing and technology consulting company from France, and a 13B Swiss franc manufacturer of vacuum valves for leading semiconductor and solar companies. Again, it cannot be emphasized enough that we form top-down opinions based on a consistent bottom-up research process executed by talking to and studying individual businesses. In order to make and protect money for our clients, we believe that these research efforts help us stay ahead of the central banks, who are generally backward-looking, domestic focused and “data dependant.” In my view, our job at Wealhouse is to anticipate versus react–unlike central bankers who are typically behind global trends. At Wealhouse, we are always asking ourselves: “Are we ahead or behind?”

One area in which we have been successfully ahead in our investments is cyber security. Sadly, in a world with increasing geopolitical tensions, companies have had to invest significant sums of money in order to protect their digital assets. As technology advances, it is important to realize that it can be used for both good and bad. Sentinel One is a company that is trading significantly below where it went public in 2021, and has over $700 million net cash on its balance sheet to continue to invest in cutting edge research and development around using artificial intelligence to protect its corporate clients. 

LONG INVESTMENT: SENTINEL ONE (S)

Source: Bloomberg, Wealhouse Capital Management.

The illustration below also shows an interesting secular trend that is occurring in the market and ultimately benefitting Voyager. Quite simply, the supply of stocks is declining. This is due to an overallocation of capital to Private Equity (PE) and Exchange Traded Funds (ETFs). As a result of interest rates being manipulated lower by central banks after the 2008 financial crisis with Quantitative Easing (QE) strategies, more and more money was re-invested from the bond market into private vehicles chasing yield. According to an article from Bloomberg, over 20% of the S&P 500 and 24% of the Russell 2000 is owned by ETFs, with the percentages more than tripling since 2013. We love this, since it means that we at Wealhouse have less competition, as we analyze companies and take advantage of the inefficiencies that we find. As one of my mentors once told me in the 1990s: “Most people will put the most money in the wrong place at the wrong time.”

GLOBAL EQUITY SUPPLY TURNS MOST NEGATIVE SINCE 1999

Source: Financial Times.

Helping Voyager’s performance year-to-date are the take-over offers received by four of our holdings. In addition, two others completed mergers of equals in order to grow, create economies of scale and qualify for inclusion in different ETF products. As interest rates lower around the world and we move past this current U.S. elections cycle, we anticipate seeing more and more of our companies come together to save costs, grow market share, build their talent base, expand their geographic reach, and gain access to new technologies.

As a result of the afore-mentioned over-allocation of resources to PE and ETFs, we are also very bullish on businesses involved with transactions in private markets, and we anticipate a material improvement in fundamentals for these financial intermediaries. The interest rate spikes over the last couple of years have resulted in a mad scramble for liquidity in many corners of the financial world, in order to pay down debt. Since private equity investors became accustomed to easy access to capital during QE, with simultaneous easy access to debt, complacency set in over the last decade. As valuations for businesses declined, many PE General Partners (GPs) have been hesitant to sell assets and realize lower performance and management fees. However, their Limited Partners (LPs) have been growing restless, and an increasing number of LPs are looking for a return of capital in order to meet their own liquidity needs. As the chorus of LP complaints reaches a crescendo, we anticipate that many GPs are starting to pick up the pace of monetization events. As a result, market-leading brands such as Savills from the UK, which has franchises globally, will see an uptick in business activity in 2025 as they sell assets for GP’s to, in certain cases, enable them to return capital to LP’s. Please see the company description below.

LONG INVESTMENT: SAVILLS (SVS)

Source: Bloomberg, Wealhouse Capital Management.

It remains to be seen whether we will see a soft landing or hard landing, and this is why I always advocate being balanced across all three Wealhouse funds that have long/short capabilities in credit (Amplus) and equities (Lions Bay). Below, we balance out some of the risk versus opportunity narratives in a slide. If it turns out that the U.S. Fed has waited too long to cut rates, or they end up cutting too slowly, then there is the risk that a hard landing scenario emerges. We would be happy to discuss these potential scenarios in greater detail if desired.

CURRENT MARKET DYNAMICS

It is not lost on me that with over $35 trillion in U.S. government debt outstanding, there will be some nasty surprises moving forward. For example, the recent overnight decline in the Japanese stock market was the biggest I have seen in my career—this after their central bank raised rates only 15 basis points. It is simply impossible to know how many investors have borrowed cheap money in Japan in order to invest overseas, on the assumption that the Japanese currency would continue to depreciate.  As a result, we anticipate much more volatility in the years ahead than what we witnessed during the past period of QE money printing. This is very beneficial and helps explain why we added an expert in volatility trading to our team last year, coming from a major Canadian bank. Year by year we continue to invest in talent to make our Wealhouse team stronger.

We have talked so much in the past about an increased volatility regime for equities, bonds, commodities, currencies, geopolitics and weather because of what we call, “disruption risk.” There is little doubt in my mind that the pace of technological change that will happen to the world will only accelerate over the rest of my career. Even now, the business world races to generate advancements in Artificial Intelligence and Quantum Computing that will have unknowable impacts in EVERY industry. To be in a better position to understand the “disruption risk” that is coming, last summer we hired a new analyst who is a recent graduate of Physics from the University of Waterloo. It is important to understand that most Wall Street and Bay Street analysts are still dominated by capital allocators with business degrees. We at Wealhouse believe that hiring such specialty analysts gives us an edge over other asset management firms.

Warren Buffet and Charlie Munger championed the investment philosophy of investing within your “circle of competence.” It is interesting to note that there was an extensive period during a stretch of my career where Warren Buffet was the richest person in the world, championing that investment strategy. Today the richest person in the world is a physicist named Elon Musk, who is best known for his Tesla and SpaceX franchises that have solved problems with electric cars, space travel, and communications. Below is a list of meetings completed by our new analyst, who is helping to ensure that Wealhouse is expanding its “circle of competence” in the future of business. Wealhouse will continue to invest time and energy to staying ahead of the crowd with our proprietary research process. And as more and more investors adopt “passive” ETFs in their asset mix, we are benefiting from actively interviewing of some of the best minds in the world. This approach ultimately allows us to gain very valuable insights, and make better investment decisions. We love when we meet companies, and they tell us that competition is getting easier. As a result of ETF growth, I would add that I have never experienced better corporate access in my career as fewer and fewer practitioners exist in our investment industry.

IN-PERSON RESEARCH MEETINGS COMPLETED

Note: Have interacted with and questioned all companies above whether by 1×1 with management or IR, group meetings/lunches, or facility tour since joining Wealhouse. The appearance or lack thereof above for a company does not confirm we have or have not invested in these companies.

In anticipation of lower interest rates, we have long since started to allocate more investment dollars to companies that we felt would have improving fundamentals in 2025. In particular, we feel certain companies from the Consumer Discretionary, Financial Services, Health Care, Materials, Real Estate and Utilities sectors will see their cost of capital improve and allow them to further grow their businesses. We will always be invested in technology companies since we believe that every industry is essentially reliant on tech.  As always, we will look for growth without having to pay too much for it.

As mentioned above, there are many risks around potential disruption from technology, and uncertainty pertaining to whether this will be a soft or hard landing. Due to high interest rates and/or disruption there are certain industries that we feel are already experiencing a hard landing such as Automotive, Domestic Office, Condo Real Estate and Furniture Sales. Therefore, I always advocate staying balanced while we continue to hunt for great small cap companies that can grow and appreciate in the years ahead. There are many ways to make money and we are happy to say our team is more skilled now than it ever has been.

Voyager

Voyager — as its name suggests — is the fund for the investor who wants to “go for it.” In a world where more money is being run by fewer and fewer firms — and funds are becoming significantly bigger — we feel it pays to be small. Voyager invests in small- and mid-cap public companies overlooked by the big funds because of their size. But we seek out and identify the small companies that will become big companies. We get in on the action before everyone else and hold these investments just as long as we need to, while continually evaluating their performance. Why follow the herd when you can be the first in? That’s our philosophy for Voyager.

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