Buy the dip in software?

Key Concepts

• Sell America Theme: Investor concern stemming from potential protectionist policies and geopolitical tensions initiated by the US administration.
• Safe Haven Assets: Investments like gold that maintain or increase in value during times of market uncertainty.
• Market Concentration (MAG7): The dominance of a small group of large-cap technology stocks (the "Magnificent Seven") in driving market gains.
• Incumbency Advantage: The benefit a company has due to its established position and customer base, making it difficult for new entrants to disrupt the market.
• Operating Leverage: The degree to which a company can increase operating income by increasing revenue.
• EBIDA: Earnings Before Interest, Taxes, Depreciation, and Amortization – a measure of a company’s financial performance.

Market Reaction to Geopolitical Tensions & Investment Opportunities in Canada

The TSX experienced a decline mirroring global market trends, triggered by escalating tensions surrounding the US administration’s stance on Greenland and broader geopolitical uncertainty. This sparked a “sell America” sentiment reminiscent of previous tariff-related anxieties. Jeffrey Tori, Portfolio Manager at Penrook Management, believes this presents buying opportunities within the Canadian market. He notes the current climate evokes “a little PTSD” from last April’s tariff concerns, highlighting the volatility introduced by unpredictable policy decisions. As stated by Tori, the situation is “a bit disquieting” when the US President appears to assert dominance over North America, as evidenced by the recent posting of the American flag over Canada.

Gold as a Safe Haven & Central Bank Activity

The discussion turned to gold, which saw gains due to the increased uncertainty. While not explicitly “gold bugs,” Tori acknowledges gold’s crucial role as a portfolio diversifier and a hedge against currency debasement. He points to a physical metal shortage and increased central bank buying as factors supporting a “very interesting floor” under gold’s price. He emphasizes gold is currently “doing what it should do” – acting as a safe haven for investors during turbulent times, advising retail investors to include it in diversified portfolios but avoid speculation.

Market Broadening & Canadian Opportunities

The market began to broaden out in late 2023, a positive development. However, Tori believes further broadening is needed. In the US, the S&P 500’s gains in 2023 were largely driven by the “MAG7” (a group of seven large-cap technology stocks). While small-cap stocks showed some improvement, their growth was limited. Canada’s indexes were dominated by mining and gold stocks last year. Despite this success, Tori remains “a bull on Canada” from a macroeconomic perspective, citing its strong education system and abundant investment opportunities. He believes many Canadian companies are undervalued and “aren’t getting recognition in the public market.”

Software Sector & the Impact of AI

The conversation addressed concerns surrounding software companies, particularly those impacted by anxieties about Artificial Intelligence (AI). Tori believes opportunities exist, particularly in companies that have experienced significant drawdowns. He highlighted Constellation Software as an example, praising its long-term track record as a capital allocator and noting its current undervaluation. He also pointed to VHI, a healthcare software company, trading at less than 10 times its 2027 EBITDA, with a strong cash position and acquisition potential.

Tori emphasized the importance of “incumbency” in the software sector, arguing that replacing mission-critical software is a complex and risky undertaking. He stated, “ripping out mission critical software is not as simple as people think.” He believes investors should focus on companies where replacing their software would create significant business risk, rather than betting on unproven solutions from startups. He explained that organizations are “fairly highbound and they wouldn’t take the risk of of throwing out something that works.”

Logical Connections & Synthesis

The discussion flowed logically from the initial market reaction to geopolitical events to specific investment opportunities. The focus shifted from broad market trends (gold as a safe haven, market broadening) to specific sectors (Canadian equities, software) and individual companies (Constellation, VHI). The common thread throughout was identifying undervalued assets with strong fundamentals and a degree of resilience against market volatility.

The key takeaway is that while geopolitical uncertainty creates short-term market turbulence, it also presents opportunities for discerning investors. Tori advocates for a long-term perspective, focusing on companies with strong competitive advantages, solid financial positions, and a degree of protection against disruption. He ultimately conveys a positive outlook on the Canadian market, highlighting its inherent strengths and undervalued potential.