Market Factors: A thematic investing approach that's actually working
This edition of Market Factors includes a thematic investing approach uncovering stocks that outperform. New stresses in the U.S. are making it hard to hedge portfolios and a prominent economist talks institutional collapse. As always, we look ahead to important data releases and this time it includes the Bank of Canada decision on interest rates.
I generally don't follow thematic investing reports too closely. They are generally chock full of pie-in-the-sky growth numbers that make them marketing exercises rather than investment advice. Citi's thematic equity strategy team led by Drew Petit might be different, given proof of dramatic outperformance using their process.
The team track more than 90 investment themes and rank them by growth rate (net income, EBITDA and Sales), operating leverage, valuation, correlation to macroeconomic factors and other factors.
Mr. Pettit has been focused on growth themes in 2025 – those with consistently high revenue growth that is converted most efficiently into profits and cash flow. Four themes that currently stand out for these strong growth prospects and also reasonable valuations are Digital Leisure, Contactless Economy, Artificial Intelligence and FinTech.
Digital Leisure refers to companies benefiting from online activity including music, gambling, streaming content, social media and e-sports. Contactless Economy refers to the increasing interactions between consumers and technology as it replaces human-to-human contact. Fintech involves mobile payment, blockchain wealth products and bank services. AI has been covered to death recently.
For interest's sake, the worst performing growth themes currently are Electric Vehicles, Software as a Service, Metaverse, Video Gaming and Connected Car.
The thematic team's analysis of top performing groups is further condensed into 30 recommended stocks they call the Citi Thematic 30. The analyzable data for the list is limited to the beginning of 2024 (I can see five years of strong returns on Bloomberg but only get much less data for performance calculations) but it is impressive.
The cumulative return for the equal weighted 30-stock list in the past 17 months is 46.4 per cent, an annualized 31.3 per cent pace. This compares extremely favourably to the MSCI World Index's 27.3 per cent total return (18.8 per cent annualized) and the S&P 500's 28.3 per cent (19.5 annualized).
To be fair, the thematic list is much higher risk and will almost certainly underperform its benchmarks in down markets.
The stocks on the list include companies in each of the themes mentioned above and also Agriculture Demand, Fossil Fuels, Global Tourism, Pollution Solutions and Value Healthcare Spend.
The stocks currently in the Citi Thematic 30 are Amazon.com, Alphabet, Equinix, DocuSign, applied Materials, Autodesk, Uber Technologies, Doordash, GoDaddy, Analog Devices, Maplebear, Meta Platforms, AppLovin, ROBLOX, DraftKings, Pinterest, Mastercard, Fiserv, Paypal, HubSpot, SS&C Technologies, IDEX, Hormel Foods, Darling Ingredients, Flowserve, United Airlines, Chart Industries, Republic Services, Gilead Sciences and Labcorp.
Goldman Sachs' global market strategist Vickie Chang tried to explain why diversification doesn't work anymore, or at least works very differently in the Donald Trump era.
Bond prices routinely go up when equities go down during times markets are concerned about future earnings and economic growth. Equity and bond prices both historically go down during periods of monetary tightening, but the U.S. dollar tends to climb, offsetting losses.
Recently, the dollar has weakened along with bonds and equities. Ms. Chang attributes this to the wide variety of market fears including tariff concerns, bond market dysfunction (there's been some weak Treasury auctions), central bank independence and sharply climbing fiscal deficits.
The newer concerns of Fed independence and supersized U.S. fiscal deficits will have significant diversification and hedging implications. Longer-dated bonds will offer less risk reduction than previously, for one, and the yield curve can steepen for reasons outside of growth expectations or risk premiums. Hedging against U.S. dollar weakness can likely protect against the new risks and also gold may get another driver of higher prices.
I can only guess at the fallout for Canadian markets. Structural weakness in the U.S. dollar would translate into a stronger loonie, obviously, all things being equal. But higher long-term U.S. bond yields imply a bigger bond yield spread between Treasuries and government of Canada bonds. This pattern has historically been correlated with a stronger greenback. I suspect this is why Ms. Chang did not list the Canadian dollar along with the euro, yen and Swiss franc as appropriate U.S. dollar diversifiers.
Popular economist Kyla Scanlon posted The Four Phases of Institutional Collapse in the Age of AI late last week. The thoughts are a direct descendant of Daron Acemoglu and James A. Robinson's Why Nations Fail, a must-read book I've discussed before.
Ms. Scanlon reminds readers that major economic revolutions like the rise of AI require updates in education, labour laws and financial regulation practices among other institutional changes. Her concern is that this time, change is happening while important institutions are being dismantled, an unprecedented combination.
The economist cites four stages of institutional failure – trust erosion, knowledge erosion, capacity erosion and algorithmic substitution.
The post is on Substack and there is a request for a paid subscription but the single post should be free to read.
Looking for our updates on market movers, analyst actions, stock technicals, insider trades and other daily, weekly and monthly insight? Click here to visit our Inside the Market page.
The bitcoin boom challenges anyone who wants to believe that today's market is an efficient judge of value, writes Ian McGugan.
David Rosenberg says bond investors need not fear the recent surge in long-term bond yields
Tim Shufelt reports on how Trump's trade chaos has foreign creditors backing away from Canada
Megacap technology and growth stocks have retaken U.S. market leadership in recent weeks but some investors say that's not going to last, reports Reuters
Wednesday is the big day on the domestic calendar as the Bank of Canada will announce its decision on interest rates. Markets are leaning toward no change according to options pricing. Labour productivity will also be released Wednesday. On Friday we'll get the net change in employment.
Saputo Inc. on Thursday is the only domestic earnings result of wider interest in the coming week.
The U.S. ISM Manufacturing survey results for May were released Monday at 48.5 versus 49.2x expected. Durable goods orders for April are out Tuesday. The ISM services survey for May will be announced Wednesday and April's trade balance data might be of interest when released Thursday in light of tariff news. The change in non-farm payrolls for May will be out on Friday and 130,000 new jobs are forecast.
The U.S. earnings calendar is light, starting with cybersecurity expert Crowdstrike Inc. on Tuesday when US$0.665 per share is expected. Lululemon Athletica Inc. (US$2.591) profits will be released Wednesday and Broadcom Inc. (US$1.567) is out Thursday.
See our full economic and earnings calendar here (You can bookmark the page – it gets updated weekly)
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