Market Call: Mike Philbrick's outlook on Exchange-Traded Funds

Key Concepts

• Investor Sentiment: The overall attitude of investors towards a particular security or the market as a whole.
• AI Capital Expenditure (CapEx): Spending by companies on artificial intelligence technologies and infrastructure.
• Monetization: The process of converting something into money.
• J-Curve: A graphical representation of the financial performance of an investment over time, often showing an initial dip followed by a recovery and growth.
• Equal Weight ETF: An exchange-traded fund where all constituent holdings have the same weighting, regardless of their market capitalization.
• Covered Call: A strategy where an investor sells call options on a stock they already own, generating income but limiting potential upside.
• Merger Arbitrage: A strategy that involves buying shares of a company that is being acquired and selling short shares of the acquiring company, profiting from the price difference.
• Digital Assets: Cryptocurrencies and other digital forms of value.
• Tokenization: The process of representing real-world assets on a blockchain.
• Cross-Border Flows: The movement of capital between countries.
• Ballast: An element that provides stability and balance to a portfolio.
• Defensive Growth: Investments that offer potential for growth while also providing some protection against market downturns.

Market Sentiment and AI's Impact

The current investor sentiment is described as "fragile" due to market jitters, particularly since the beginning of October. While there was a smooth upward trajectory in markets like the TSX and S&P, volatility has increased, with limited progress. This fragility is linked to the uncertainty surrounding AI capital expenditure (CapEx).

Key Points:

• AI CapEx is Real: Despite market jitters, the AI CapEx is substantial. Global AI spend is projected to reach $1.5 trillion by year-end, with $350 billion spent on CapEx this year.
• Adoption vs. Monetization Gap: While 1.5 billion users are engaging with consumer AI tools, only 3% are paying for premium services. This gap between explosive adoption and lagging monetization is a primary driver of week-to-week volatility.
• Timeline Uncertainty: The fragility stems not from the eventual effect of AI, but from the timeline of its technological manifestation and monetization.
• Earnings Beat: 81% of S&P companies have beaten earnings expectations, indicating a real tech-led beat.
• Not a Bubble: The market is not considered to be in a "bubblicious" state by normal standards. For comparison, the tech bubble saw an 800% rise before its pop, whereas current gains are around 100%.
• Natural Progression: The current market behavior is seen as a natural progression with uncertainty around adoption timelines.
• J-Curve of Resource Production: There's an anticipated J-curve effect related to the resource production needed for AI centers and power generation.

Supporting Evidence:

• Charts showing TSX trajectory with increased volatility since October.
• Figures for global AI spend and CapEx.
• User adoption and monetization statistics for AI tools.
• S&P earnings beat rate.
• Comparison to the tech bubble's magnitude.

Investment Strategies and Recommendations

The discussion emphasizes sticking with quality growth companies that possess pricing power. It also highlights the importance of commodities and natural resource exposure for AI build-out, as well as gold and high-quality bonds for managing uncertainty.

Key Points:

• Quality Growth: Focus on companies with pricing power.
• Commodities and Natural Resources: Essential for AI build-out ("atoms and bricks and shovels").
• Gold and High-Quality Bonds: For hedging against uncertainty.
• Canada's Position: Canada is well-positioned due to significant cross-border flows into its bond and equity markets, benefiting from industrials, energy, and materials sectors crucial for AI rollout.
• ETF Tickers Mentioned: TSX, TSX Mid-Caps (XMD).

ETF Discussions and Recommendations

The conversation delves into specific Exchange Traded Funds (ETFs) for various investment goals, with Mike Philbrick providing insights and recommendations.

BMO Banks ETF (ZEB)

• Description: Equal-weight exposure to the six largest Canadian banks.
• Philbrick's View: Banks remain well-capitalized with strong balance sheets. Earnings growth is somewhat constrained by loan demand and credit provisions. Valuations are reasonable, and dividends are strong.
• Tailwinds: Expected tailwind from rate cuts and rate cut expectations.
• Benefit for Investors: Good for long-term income-oriented investors. Canadian banks will benefit from global flows into Canada and the resource expansion driven by AI adoption.
• Recommendation: A good core holding for the Canadian market.

Harvest Tech Achievers ETF (HTA)

• Description: Actively managed ETF holding 20 technology stocks, including Apple, Alphabet, Arista Networks, Applied Materials, Broadcom, NVIDIA, and Micron. It employs an equal-weight portfolio and a covered call strategy to enhance monthly income.
• Philbrick's View: For a retiree seeking growth with revenue, this ETF is a reasonable option. A lateral transition to another tech ETF might not offer significant advantages.
• Considerations: It represents a significant bet on technology and AI rollout.
• Alternative Suggestions:
  • Energy Sector with Covered Writing: Horizons offers ETFs in this area, focusing on energy required for AI.
  • CI Tech Giants Covered Call ETF: Similar basket of securities, but Philbrick is not convinced it offers substantial improvement over HTA.
• Recommendation: The caller is likely okay with their current holding in HTA.

Alternative/Fixed Income ETFs for 7-8% Yield

• Caller's Concern: Seeking alternative or fixed income ETFs with a 7-8% monthly yield, moving away from covered calls on treasuries.
• Philbrick's View on Covered Call Treasuries: Not a fan of this approach as it sacrifices the safety and counterweight function of government bonds during growth shocks. Covered writing on long-term government bonds loses upside potential.
• Recommendation for Canadian Bonds:
  • BMO Government Bond Index ETF (ZB): Yields around 3%, which is lower than the desired range.
  • XTB: A shorter-term option.
• Recommendation for US Dollar Exposure (Higher Yield):
  • SBA (Return Stacked Bonds and Merger Arb Portfolio): Stacks the merger arbitrage risk premium on top of government bonds. This is not correlated to equity markets, unlike credit exposure which can be correlated.
  • Note: SBA is a US dollar ETF managed by Resolve Asset Management and trades in the US.

Crypto ETFs (ETH, BTC, SOL)

• Caller's Holdings: ETH, BTC, and SOL ETFs.
• Philbrick's View: Digital assets have high volatility, so correct position sizing is crucial. Small exposure can add diversification and significant asymmetric upside.
• Use Cases:
  • Bitcoin (BTC): Digital gold, base layer infrastructure, scarce asset.
  • Ethereum (ETH): Smart contract platform, layer one, enabling real-world asset tokenization and stablecoins. Legislation in the US is clarifying the crypto space.
  • Solana (SOL): Facilitates transactions on the blockchain, offering faster settlement than traditional methods, especially on weekends.
• Future Outlook: Tokenization of assets is expected to drive extreme growth in this area.
• Recommendation: All three are considered wonderful holdings to continue with, provided position sizing is managed appropriately. "A little bit of salt makes the dish much better."

XRP (Ripple)

• Philbrick's View: XRP has a specific, narrow, institution-specific use case for cross-border flows and liquidity cycles.
• Personal Stance: Philbrick does not personally own XRP but acknowledges its compelling use case for cross-border international flows.
• Recommendation: Invest in the right amount, without trying to guess the "category killer."

US Cash ETF

• Caller's Problem: Holding US cash and wanting to avoid currency conversion fees.
• Philbrick's Recommendation:
  • Global X 0 to 3 Month US T-Bill ETF (UBIL): Currently offers a distribution around 4%. This ETF keeps funds in US dollars and holds short-term US T-bills, providing a stable solution.

Past Picks Review

Global X Gold Covered Call ETF (GLK)

• Performance: Recommended in January at $28.49, now at $54.72, a 92% return (over 100% total return).
• Philbrick's Action: Trimmed the position due to the significant gain.
• Current View: Still considered a good piece of a portfolio.
• Underlying Drivers for Gold:
  • Scarcity: Gold is a scarce asset.
  • Geopolitical Events: Confiscation of Russian assets after the Ukraine invasion was a watershed moment, prompting nations to re-evaluate sovereign reserves and increase gold holdings.
  • Debasement Theme: Ongoing budget deficits lead to consistent debasement of the US dollar.
  • Sovereign Demand: Nations have been buying 1,000 tons of gold per year for the last four years.
• Gold Miners: A proxy investment with leverage, offering more upside.
• Covered Call Benefit: Provides income, especially during gold consolidation periods.
• Volatility: Expect continued choppiness, with periods of consolidation after significant runs.
• Strategy: A combination of covered call gold miners (like GLK) and un-covered gold miners (like XGD or GDX) or underlying gold (like GLD) can make sense.

BMO Equal Weight US Banks Index ETF (ZBK)

• Performance: Recommended at the start of the year at $39.82, now at $40.40, a 1% return (3% total return).
• Philbrick's View: The US banking sector is in a good position, supported by strong capital ratios and a resilient consumer. The yield curve is slowly steepening, which should help.
• ETF Structure: Equal weight avoids over-reliance on mega-cap banks.
• Outlook: Loan growth is modest, but buybacks are returning. This ETF offers cyclical exposure to US financial strength without single-name risk.
• Future Potential: Expected to have a banner year and benefit from technological innovations, including blockchain.

Roundhill Magnificent Seven ETF (MAGS)

• Performance: Recommended at $55.59, now at $66.31, a 19% upside and total return.
• Focus: Exposure to the seven largest tech companies (Apple, Microsoft, Google, Amazon, Meta, NVIDIA, Tesla).
• Philbrick's View: Still likes this ETF as it allows focus on the AI theme.
• Considerations: Volatility is present, and there's some rotation out of mega-cap tech.
• Portfolio Role: Should be a smaller weight in the portfolio.
• Benefits: Easy way to get extra exposure to AI infrastructure, chips, cloud, and software.
• Valuations: Higher valuations, but not entirely "bubblicious" given investments like Warren Buffett's in Google.
• Recommendation: A higher volatility ETF, but a good option for aligning with core AI drivers.

New Top Picks

BMO Equal Weight US Healthcare ETF (ZUH)

• Philbrick's Stance: Does not personally own this ETF as Resolve Asset Management uses futures for exposure. However, he has a broad understanding of asset classes.
• ETF Structure: Equal-weight approach to healthcare, avoiding concentration in mega-pharma. Includes pharma, biotech, and healthcare services.
• Characteristics: Lower volatility, defensive growth, steady demand, strong balance sheets, low economic sensitivity.
• AI Impact: Significant innovation in healthcare driven by AI, genetics, diagnostics, and devices.
• Valuations: Good valuations.
• Recommendation: A defensive sector benefiting from AI, offering good valuations.

iShares Core Canadian Government Bond ETF (XBB)

• Philbrick's Stance: While Resolve uses futures for Canadian bond exposure, XBB is a recommended ETF for individual investors.
• Focus: High-quality exposure to Canadian federal and provincial bonds.
• Benefits: High liquidity, duration for potential growth shocks, and significant cross-border flows into Canada due to its resource exposure.
• Portfolio Role: Acts as ballast, providing stability and flexibility for rebalancing.
• Yield: Offers a real yield again.
• Recommendation: Incorporate more bonds for risk management and rebalancing optionality.

SPDR S&P Biotech ETF (XBI)

• Philbrick's View: This ETF is considered "spicier" than the healthcare ETF, focusing solely on biotech.
• ETF Structure: Equal-weight methodology, capturing early and mid-stage biotech without domination by large incumbents.
• Areas of Focus: Gene therapy, rare diseases.
• AI Impact: AI is accelerating drug discovery, leading to potential cures and long-term remissions.
• Potential: High asymmetry, with biotech recovering faster. The chart shows explosive growth and is near new highs.
• Correlation: Offers uncorrelated growth from big tech.
• Strategy: A "shotgun" approach to capture broad opportunities in AI-accelerated discoveries across various companies.
• Recommendation: Offers uncorrelated growth with significant upside potential, a complementary growth factor to AI.

Other ETF Discussions

BMO High Dividend Covered Call ETF (ZWE) and BMO Europe High Dividend Covered Call ETF (ZWK)

• Philbrick's View: Likes the combination of both US and European exposure.
• Preference: Leans slightly more towards ZWK (Europe) due to greater persistence and less drawdown, offering more diversification.
• Rationale: Europe provides diversification beyond Canada and the US, which are often overweight in Canadian portfolios.
• Recommendation: The combination is fine, but Europe offers a slight edge in diversification.

iShares Global Utilities ETF (XUT)

• Caller's Need: Global utilities with a decent monthly dividend and no leverage.
• Philbrick's View: This ETF has been on their recommended list previously. Utilities are a good place to "hide money."
• Characteristics: Pricing governed by regulatory environments, respond well to interest rates. Expected tailwind from interest rate cuts.
• Covered Calls: Covered writing on utilities is less effective due to their lower volatility.
• Structure: Equal weight, avoiding individual stock risk.
• Recommendation: A good solution for the caller's requirements.

Vanguard FTSE Developed All Cap ex-North America ETF (VIU)

• Caller's Need: Developed world ex-North America.
• Philbrick's View: Seeing more calls for global diversification due to good performance in international markets.
• Characteristics: Solid performer, challenging all-time highs. Offers diversification to equity markets outside North America.
• Valuations: More reasonable valuations across Europe and Asia compared to the US.
• Benefits: Diversification across business cycles and currencies.
• Recommendation: A strong approach for global diversification.

Schwab US Dividend Equity ETF (SCHD) and Canadian Dividend ETF (e.g., VDY)

• Caller's Need: Dividend investor seeking income and dividend growth.
• Philbrick's View: Both are "great go-to's."
  • SCHD: US large-cap dividend stocks with strong dividend history and financial strength.
  • Canadian ETF: Large-cap high dividend stocks, with exposure to financials and energy.
• Canadian Market Advantage: Benefits from the AI boom due to resource requirements. Canadian dividends are eligible for tax credits outside registered accounts.
• Outlook: Expecting a broadening of the market rally, with other names catching up.
• Recommendation: A nice pairing for dividend investors seeking income and growth.

iShares Global Infrastructure Index ETF (CIF)

• Caller's Question: Potential for further growth and whether it's a buy at current prices.
• Philbrick's View: This sector is benefiting from AI build-up.
• Characteristics: Good for portfolio diversity, includes companies related to engineering and energy (e.g., NRG Energy, Stantec).
• Complementary to Tech: A nice complement to tech ETFs, moving "upstream" to provide the infrastructure for AI.
• Volatility: Generally less volatile than pure tech stocks, though volatility can creep in as valuations rise.
• Recommendation: An underappreciated play with potential for nice dividends, but manage risk and reduce positions if volatility increases.

Conclusion

The discussion highlights a market characterized by investor sentiment that is currently fragile, primarily due to uncertainties surrounding the timeline and monetization of AI technologies. Despite this, the underlying AI CapEx is substantial, and the adoption of AI tools is explosive. Investors are advised to focus on quality growth, commodities, natural resources, gold, and high-quality bonds to navigate this environment. Canada is seen as a well-positioned market due to its resource sector and cross-border capital flows. The conversation extensively covers various ETFs, offering specific recommendations for different investment objectives, from income generation and defensive growth to more speculative plays in biotech and digital assets, all while emphasizing the importance of diversification and appropriate position sizing.