This edition of Market Factors begins with a heresy - it might be a bad time to buy bank stocks. Section two discusses the importance of finding the biggest losers from AI adoption and the diversion posits a breakthrough in Alzheimer’s disease treatment.
Financials
Beware bank stocks
The S&P/TSX Banks Index has rallied 59 per cent since North American markets bottomed on April 8th. The banks may now be at valuation levels that should give investors pause.
It has been proven in the past that there’s no bad time for long-term investors to buy banks. But the stocks are now so expensive that investors might have to wait for the extreme long term for banks to lead the markets again.
The bank index is currently trading at a forward price-to-book value of 2.0 times, the highest of the past decade. Previously, a reading of 1.9 acted as a warning for investors, indicating periods of performance weakness and pullbacks.
The last 1.9 price-to-book reading occurred in February 2022. The index proceeded to fall 28 per cent from that point to October 2023. The average price to book also climbed to 1.9 in January 2018. Industry stock prices treaded water in the months following, before dropping 25 per cent in the initial stages of the pandemic. Valuations aren’t to blame for the COVID downdraft, obviously, but bank stocks might have offered more downside protection if they had not been at such valuation extremes.
Forward price-to-earnings ratios are also at extremes, above 15 times, although they offer less effective timing as an indicator. PE ratios tend to peak well before actual stock prices, so it’s possible the bank stocks have a few more months to rally.
Still, valuations strongly imply that the sharp rally is close to an end and the odds of a temporary pullback are elevated, perhaps prohibitively so for conservative investors. It’s not time to sell bank stocks - I’m not sure such a time ever existed - but investors might want to hold off on adding more in case better valuations become available in the coming months.
Tech trends
Finding the losers
Late Harvard business school professor Clayton Christensen’s book “The Investor’s Dilemma” in 1997 introduced the idea that during times of extreme technological change it was difficult to predict the eventual winners but much easier to identify the biggest losers. We are at the point when AI is forcing this discussion again.
Independent weavers were displaced by mechanical looms in the Industrial Revolution, the Pony Express was ended by railways, buggy whips were bankrupted by cars, radio popularity was shrunk by television, Kodak was crushed by digital cameras, interoffice envelopes (remember them?) were killed by email and department stores were made dodos by e-commerce. None of these were impossible to predict.
The release of accounting, legal, data analysis and other functionality through Anthropic’s Claude Coworker AI was the main cause of the technology sell-off that began last Tuesday. The news had investors punishing existing software companies selling expensive packages for these purposes, as now companies can use Claude to build software designed exactly for those purposes.
What will AI end up replacing, or at least significantly disrupt? It seems probable that fewer radiologists will be needed. I wouldn’t want to be at school learning coding right now. Accountants must be getting nervous - its a rules-based process and these have been automated before. And fewer new lawyers will be needed to write contracts.
White-collar knowledge will still be necessary but more to oversee the work done by AI rather than to do the actual work. This is a seismic change in many professions where complexity seemingly made them immune to innovation. The idea that machines could do the equivalent of going to university never occurred.
The internet made distance almost irrelevant- physical letters and documents didn’t have to be delivered, new friends could be made anywhere in the world and no trip to the mall was needed for shopping. The commoditization of knowledge is the primary apparent outgrowth of AI. There will be A LOT of losers for investors to avoid.
PET scans at the Center for Alzheimer Research and Treatment (CART) at Brigham and Women’s Hospital in Boston, Massachusetts, U.S., March 30, 2023.BRIAN SNYDER/Reuters
Diversions
Revolution ahead in Alzheimer’s treatment?
The pharmaceutical industry gets a lot of stick for chasing only lucrative treatments and rightly so. Those with rare conditions in the U.S. can expect to pay $10,000 per pill, if the industry bothers developing one at all.
We may, on the other hand, be on the verge of thanking the pharmaceutical industry for their Machiavellian greed. Chemists are hard at work on treatment for Alzheimer’s disease and having success at a time when developed world economies, along with China and Russia, are experiencing a rapid increase in the average population age. Successful Alzheimer’s treatments will be extremely lucrative for the pharma industry.
A search for the term Alzheimer’s on the SciTechDaily results in 499 links to stories outlining research successes of various degrees. There have been two new stories in the past three days: “Three Everyday Drugs Could Be Repurposed To Prevent Alzheimer’s “ and “A New Alzheimer’s Target Emerges: Blocking One Protein Restores Memory in Mice”
There is a lot of investment smoke for investors here but the fire – actual stocks selling successful treatments – are not apparent. Investors should keep their eyes peeled because I think we’re close to new revolutionary developments in Alzheimer’s treatments.
The essentials
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Globe Investor highlights
Ian McGugan says this is an ideal time to ask the question of how much risk you really want in your portfolio. And Jeff Sommer suggests challenging the standard investment advice you keep hearing right now
Dr. George Athanassakos says the appointment of Kevin Warsh as the new Fed chair won’t make any difference when it comes to where interest rates are going over the long haul
David Berman thinks the lows may be in for Constellation Software stock
Larry MacDonald rounds up the latest short positions on the TSX. Turns out, short sellers largely missed the boat when it came to betting against software makers
Sam Sivarajan says diversification is trickier than it sounds
Quick hits
There are four or five research reports that act as my bibles when it comes to analysis. Savita Subramanian’s annual Quantitative Primer is one and Francois Trahan’s Intern’s Guide to Macro’s Influence on Equity Markets" is another. Mr. Trahan wrote that report when he was strategizing at UBS and he was recently announced as chief investment strategist at BMO Capital Markets. A good hire in my opinion. On Friday, he released his target for the S&P 500.
Goldman Sachs reports that software allocations in hedge funds have dropped from seven per cent of net exposure at the beginning of the year to three per cent now.
U.S. private equity funds raised US$278-billion in 2025, which sounds like a lot of money but it’s down from just under $400-billion in 2023. Software stock weakness only increases pressure on the sector and we’d hope they are reflecting more risk in their share pricing. See “US PE firms have to rethink their approach as fund closes hit a decade low” for further details.
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