Overweight equities, focus on sector selection: McMahon

Key Concepts

• AI Build-out: The ongoing infrastructure and software development phase of Artificial Intelligence.
• K-Shaped Economy: An economic scenario where different sectors or income groups recover or grow at vastly different rates.
• Active Management: An investment strategy involving ongoing buying and selling actions to outperform a benchmark index.
• Sector Rotation: Moving capital from one industry sector to another to capitalize on economic cycles or valuation discrepancies.
• Token Demand/Supply Dynamics: The projected imbalance between the demand for AI processing tokens and the supply capacity.
• Deep Defensives: Stocks in sectors that are historically stable and less sensitive to economic cycles, often currently undervalued.

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1. Economic Outlook: Canada vs. The United States

Sébastien McMahon, Chief Economist at IA Financial Group, highlights a divergence between the Canadian and US economies:

• United States: Characterized as "overheating" with significant fiscal deficits (5–6% of GDP) and strong tailwinds from AI infrastructure. Inflation remains a concern, with PPI at 6% and headline CPI at 4.2%.
• Canada: Currently in a "technical recession." Core inflation (excluding food and energy) has slowed to 1.5%, providing the Bank of Canada (BoC) with the flexibility to maintain interest rates at 2.25% without needing to follow the US Fed’s hawkish trajectory.

2. The AI Investment Thesis

Despite recent volatility in semiconductor and tech stocks, McMahon remains bullish on AI for the next decade:

• Supply/Demand Imbalance: Demand for AI tokens is expected to grow by a factor of 24x over the next 4–5 years, while supply is projected to grow by only 12–20x. This supply-demand gap supports continued pricing power for the sector.
• Strategic Adoption: Businesses are currently re-evaluating the "calculus" of AI utility regarding human labor replacement.
• Investment Strategy: Investors should focus on the "build-out" phase of AI, acknowledging that while specific winners are not yet clear, the sector remains a dominant long-term theme.

3. IPO Market and Liquidity

The market is currently facing a wave of "mega IPOs" (e.g., Anthropic, OpenAI, SpaceX).

• Liquidity Perspective: McMahon argues that market performance post-IPO is driven more by liquidity than initial hype. He cites the 2012 Facebook IPO, which dropped 50% in six months before doubling in value later, as a precedent.
• Canadian Market: The recent upsizing of the Apotex IPO (from $1B to $1.3B) signals healthy institutional appetite and helps diversify the Canadian market, which is traditionally heavy on financials, materials, and energy.

4. Investment Strategy: Sector Rotation and Active Management

McMahon emphasizes that 2026 requires a shift from geographical rotation to sector rotation:

• Deep Defensives: Sectors that have been "left for dead" offer significant value.
• Retail Case Study: McMahon favors discount retailers TJX and Ross Stores.
  • Evidence: In Q1, TJX and Ross saw sales growth of 6% and 17% respectively, outperforming broader retail trends.
  • Rationale: In a K-shaped economy, low-to-mid-income consumers are increasingly shifting toward value-seeking behavior, benefiting these retailers.
• Financials: Despite bearish sentiment from industry leaders like Jamie Dimon, McMahon views the sector as attractive. Financials have underperformed the S&P 500 by as much as 17% year-to-date, and potential Fed rate hikes could provide a tailwind for the sector.

5. Synthesis and Conclusion

The core takeaway for 2026 is the necessity of active management and selective stock picking. While the AI theme provides a long-term structural tailwind, the current market environment—defined by uneven valuations and a K-shaped economy—demands that investors look beyond high-growth tech. By rotating into undervalued "deep defensive" names and specific financial stocks, investors can capitalize on pockets of opportunity created by market mispricing and shifting economic cycles.