This Monday edition of Market Factors begins with Citi’s top trading themes for 2026, including large swathes of stock ideas. We move on to how to recognize market bottoms, and the diversion delves into the best cover songs of all time.
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Stock picks
A different kind of GARP
Citi U.S. equity strategist Drew Pettit identified his five top investment themes for the coming year in a Friday research report and one of them – AI at a Reasonable Price – interests me greatly.
Mr. Pettit’s themes are productivity enhancement, inflecting growth, return on growth capex and earnings Sharpe in addition to the AI GARP idea.
Productivity enhancement involves companies improving efficiency and margins through means outside of financial leverage tactics like share buybacks. The companies in this category tend to exemplify structural tailwinds (like demographics for health care, for instance), cyclical improvements (companies that outperform in the initial stages of the market cycle) or restructuring.
Stocks on the productivity enhancement list include Jabil Inc. (JBL-N), Netflix Inc. (NFLX-Q), Ralph Lauren Corp. (RL-N), Honeywell International (HON-Q), Carnival Corp. (CCL-N), Corning Inc. (GLW-N), Boston Scientific Corp. (BSX-N), FedEx Corp. (FDX-N) and Walt Disney Co. (DIS-N)
Inflecting growth: This theme captures cyclical companies poised to increase earnings after a period of declining profits. This idea includes some smaller cap, higher beta names like Electronic Arts (EA-Q), Live Nation Entertainment Inc. (LYV-N), Dollar Tree Inc. (DLTR-Q), CVS Health Corp. (CVS-N), and Ciena Corp. (CIEN-N).
Return on growth capex: As the name suggests, these are companies Citi expects will improve profitability through recent investments or, in Mr. Pettit’s words, “companies expected to show the greatest incremental cash flow generation per dollar of growth capex.” These stocks include Netflix Inc. (NFLX-Q), Toast Inc. (TOST-N), Intuitive Surgical Inc. (ISRG-Q), Microsoft Corp. (MSFT-Q), Palo Alto Networks Inc. (PANW-Q), and Micron Technologies (MU-Q).
Earnings Sharpe: This follows a proprietary measure gauging earnings growth relative to earnings volatility. Stocks on this list are more defensive and include Comcast Corp. (CMCSA-Q), Autozone Inc. (AZO-N), Walmart Inc. (WMT-N), Philip Morris International (PM-N), Procter and Gamble Co. (PG-N), Visa Inc. (V-N) and Arista Networks (ANET-N).
Now for AI GARP. I like the concept because it offers the growth potential of the market’s hottest sectors while minimizing risk. Citi’s research department remains confident in the structural momentum behind AI infrastructure development. At the same time, Mr. Pettit recognizes “growing pockets of valuation concern when we dive deeper within the theme.”
The answer for investors, according to Citi, is a GARP [Growth at a Reasonable Price] overlay on the theme and diversification across the entire AI value chain, from data centre equipment providers to hyperscalers to businesses adopting AI for higher profit margins.
The stocks selected have consensus earnings expectations above the growth implied by stock prices. The business models strongly imply leverage to higher revenue.
The stocks chosen in this category include Adobe Inc. (ADBE-Q), Advanced Micro Devices (AMD-Q), Crown Castle Inc. (CCI-N), Salesforce Inc. (CRM-N), Hewlett Packard (HPE-N), Moody’s Corp. (MCO-N), Dell Technologies (DELL-N), MSCI Inc. (MSCI-N), and Wix.com (WIX-Q).
Trends
Credit default swaps are back in focus
Sell-offs may have a fundamental catalyst but they are afterwards driven by sentiment. This is the reason valuations and fundamental data are useless for any investor trying to assess whether things are stabilizing.
Market tops are impossible to call but really good investors can find bottoms. In March of 2009, for instance, Credit Suisse strategist Andrew Garthwaite correctly called the bottom using the S&P 500 and high yield bond spreads.
Mr. Garthwaite recognized in March of 2009 that the S&P 500 was retesting lows hit the previous November while high yield bond spreads had peaked. This pattern – equities successfully retesting previous lows while corporate bond spreads narrow to Treasuries – has consistently been seen at durable market lows in market history.
The current volatility is a bit unsettling but tame as these things go. Investors can watch technical levels like the 50-day moving average trend line for hints as to when the bumpy patch is over. Things will have to get much worse before we have to watch corporate bond spreads.
The one development worth watching this week is the increase in credit default swap (CDS) costs for the major AI spenders. Five-year Oracle CDS prices, for instance, went through one per cent late in the week which seems odd for a company more or less printing cash. It must be spending veritable oceans of money on data centres to make investors worry about their balance sheet.
CDS data is hard to come by at reasonable cost for most investors so we will try and keep readers up to date as much as possible on the GI website as long as volatility lasts.
Robert Smith of 'The Cure' performs at the Smoothie King Center in New Orleans on Wednesday, May 10, 2023.STAFF PHOTO BY BRETT DUKE/The Associated Press
Diversions
Favourite cover songs
One of the music reaction channels I check occasionally played I Will Survive by Cake recently, a brilliant cover of a Gloria Gaynor song released almost 50 years ago. I didn’t think much of it until Spotify’s algorithm fed me Not in Love, a decent song by mediocre Canadian hair metal band Platinum Blonde from the ’80s.
Not in Love was covered by another Canadian band, Crystal Castles, in 2010. The band cheated too, somehow convincing The Cure’s vocalist (and lead songwriter, and producer, and decider about who gets to be in the band for each album) Robert Smith to sing on it. It is fantastic.
Two Rolling Stones covers, Satisfaction by Devo and Gimme Shelter by Sisters of Mercy, are also among my favourites. What are yours?
As an aside, I think Mr. Smith is the most underrated songwriter alive. Even philistines who don’t like The Cure or the goth aesthetic can recognize at least 15 hooks he wrote.
The essentials
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Globe Investor highlights
Ian McGugan on the four questions every investor should ask in this topsy-turvy stock market
Social media hype can now have an impact on initial public offerings to a degree that can’t be ignored, writes Preet Banerjee.
Norman Rothery on the impressive outperformance of his Canadian free cash portfolio - and its variants
West Fraser is one cheap stock. But David Berman cautions betting on it now would still be risky
Quick hits
I haven’t trusted Chinese accounting since the Sino Forest debacle. The lack of trust in the country’s reporting extends to economic data, which is why I like to use South Korean statistics for a more credible read on regional growth. The South Korean equity index, the KOSPI, is also closely correlated to metals pricing. The 2026 GDP forecast for South Korea has dropped from 2.2 per cent in late 2024 to 1.9 per cent currently.
I think we’ll see price controls on electrical power on both sides of the border. A lot of the industry is already strictly regulated and the AI buildout is already putting a lot of stress on supply.
BofA Securities investment strategist Michael Hartnett’s weekly Flow Show report highlighted an investor rush to health-care stocks last week. The U$1.2-billion he estimates flowed into U.S. health care is the biggest surge since early 2021, at the height of the pandemic.
See our full earnings and economic calendar here
Your chance to participate - and win cash
The inaugural Globe and Mail Trade Off is a 12-week mock-trading contest where contestants construct portfolios with at least five listed companies. You start with $100,000 in virtual funds, but the cash winnings are real: $5,000 for the grand prize winner, plus many more cash awards. Register before end-of-day Nov. 23.