This Market Factors starts with a stock selection process that looks well suited to current conditions and most investors. The second section describes a peripheral play on the AI data centre construction race and I talk country music in the diversion section.
Stock picking
Profitability improvement is good for all types of investors
Citi strategists provided an investment strategy offering advantages for both conservative and growth-oriented investors, making the process ideally suited to a market environment characterized by significant geopolitical uncertainty.
Citi head of U.S. equity strategy Scott Chronert reiterated his currently most preferred investment methodology in a Tuesday research report. In his words, the screening strategy focuses on “companies with expected ROE [return on equity] expansion driven by improving margins and total asset turnover, not financial engineering.”
Improving profitability is a sure fire route to higher stock prices. The focus on asset turnover - the ability of a company to produce assets that quickly result in revenue - is an important qualifier that uncovers and underscores accelerating business activity. The emphasis on avoiding financial engineering helps avoid investment where profitability improvement stalls after the accountants are done dressing up quarterly results.
The focus on improving ROE is clearly suited for growth investors as it identifies improving profits relative to shareholder equity (that’s basically the formula for ROE) and thus the companies generating the best earnings growth without excess capital expenditure. Importantly, companies successfully implementing artificial intelligence will be captured by Mr. Chronert’s strategy as ROE will be among the first valuation measures to show the progress.
The Citi methodology also has advantages for risk-averse investors. For one, it helps avoid value traps - stocks that are attractively valued but stay that way for years at a time without a stock price recovery. Cheap stocks with improving profitability on the other hand rarely stay cheap.
An ROE-orientation also helps uncover companies that provide downside protection in weak markets. During recessions, for instance, very few companies are capable of improving profitability and those are usually the last to be sold, and could even see stock price increases as investors burned in other stocks gravitate towards the few winners.
The strategist’s report includes the top and bottom 25 stocks by ROE trend. The companies on the attractive list most likely to grab Canadian investor interest include (in the order they appear on the table where best results were at the top): DoorDash Inc., Warner Music Group, Omnicom Group, Broadcom Inc., Newmont Corp., CBRE Group, Amcor PLC., Boeing Co., Estee Lauder Co.s Inc. and Medtronic PLC.
There were some surprises for me on the list of lowest ranking companies by ROE improvement. GE Vernova, a stock I’m really interested in currently, is near the top of the list (top equals bad in this case). Investor favourite Paypal is right behind GE Vernova and Enphase Energy Inc., Him and Hers Health Inc., Electronic Arts, Costco Wholesale Corp., Pfizer and Qualcomm Inc. are also on the list.
AI
Engineering companies benefiting from data centre expansion
It might seem like it’s all-AI-all-the-time for readers but in a time when the path of global economic growth is almost impossible to predict, the spending on new data centres is the most reliable trend in markets right now. Reports from the Data Centre Dynamics Connect conference held in New York on March 23 included no signs the trend is slowing.
BofA Securities industrials analyst Andrew Obin met with 15 companies at the conference servicing electrical, engineering and HVAC providers. In a Tuesday research report, Mr. Obin wrote that “despite the increased geopolitical uncertainty, the tone was upbeat.”
The inevitability of direct current (DC) power for data centres was one takeaway for Mr. Odin. This benefits Eaton, GE Vernova, Schneider Electric, Siemens, and Vertiv, according to one of Mr. Odin’s previous reports. The change from alternating current may not begin until next year, however.
Industry executives believe most data centres will need to include their own power supply for at least three-to-five years before connection to a wider power grid is possible. Energy storage systems - big batteries basically - will be an important part of the plan. This trend is profitable for GE Vernova.
One of my takeaways from reading the report was that I need to learn more about two-phase liquid cooling. One phase means cooling liquid stays a liquid whereas in the more complex two-phase system the liquid increases effectiveness by turning in to a gas a some point (scratching my head).
Guitarist-singer Jeff Tweedy from the US rock band Wilco performs during the "Las noches del Botanico" festival in Madrid on June 27, 2022.PIERRE-PHILIPPE MARCOU/AFP/Getty Images
Diversions
Long live Uncle Tupelo
Country music can be a sketchy topic but it’s not necessary to associate it with MAGA-loving mouthbreathers as some do. There is a thread of country from the early 90s that eventually got called ‘alt country’ that I really love and the YouTube algorithm got me back to it recently.
I was recently joking on Bluesky about the radio Beaver Pile - the term that describes the list of Canadian artists that used to fulfil Canadian content regulations. For some reason Youtube led me from Eyes of a Stranger by the Payollas to Jeff Tweedy singing New Madrid live in 2010. It sounded incredible.
Jeff Tweedy is one of two songwriting geniuses - the other is Jay Farrar - who formed Uncle Tupelo just outside of St. Louis in the early 1990s and gave birth to alt country. Mr. Farrar was older and the leader and his ambition was to defy the trend of pop music-y AM radio country music and return to roots influences.
Uncle Tupelo made some of my favourite music ever. New Madrid, Still Be Around, Moonshiner, Acuff-Rose and Steal the Crumbs are just a few of the songs I currently have on repeat. The Anodyne album has the rare no-skips status for me. The band became so popular that the magazine founded to follow alt country (it converted to a website), No Depression, is named after an Uncle Tupelo album.
Mr. Tweedy and Mr. Farrar fell out after only only a few years - it was due to a misunderstanding regarding the latter’s girlfriend according to Mr. Tweedy’s recent autobiography - and do not talk at all anymore. Each went on to form important bands- Son Volt for Mr. Farrar and Wilco for Mr. Tweedy - which is a testament to their incredible talent.
The essentials
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Globe Investor highlights
As inflation worries jolt bond yields, Andrew Galbraith reports that some investors are spotting opportunity
Sam Sivarajan on the quiet story from the Middle East war that is hitting millions of retirement portfolios
Jamie McGeever says it’s time to rethink the safe-haven asset
Worried about rising inflation? David Berman points out these Goldman Sachs economists aren’t
Quick Hits
I’m not panicking about the investment implications of the Iran conflict yet even if the risks are rising. I would worry more about (from an investment standpoint, not humanitarian) signs that the AI spending binge is slowing - that would cause a huge chunk of the S&P 500 market cap to fall fast and hard - and more unraveling of the private equity (PE) sector. It’s not easy to project the fallout from a PE meltdown because the companies and assets are private. Most of them have publicly traded competition, however, and valuations everywhere would likely get hit as investment assets move out.
George Mason professor Alex Tabarrok cited a study showing that American doctors make two to four times as much as Canadian doctors. But, the income of doctors relative to other professionals, their ranking, is the same in both countries. American professionals, not just doctors, make A LOT of money, which Mr. Tabarrok interprets as a shortage of skilled workers in the U.S.
The intraday action in the S&P 500 has looked a lot like repeated failed attempts to roll a giant ball up a hill as it slowly dawns on investors that the bumbling U.S. president has lost control of the Iran situation. Investors may be coming to terms with the market stuck in limbo, waiting for peaceful conditions. Optimists keep trying to look through the Iran conflict and being stopped by bears looking for bids so they can add more cash.
Read this week’s earnings and economic calendar here