Are tech company valuations justified by fundamentals?

[00:00:00]Meanwhile, continuing with the news of more US tariffs on the way, our next guest says the continued threat of tariffs creates more uncertainty and pessimism among US consumers who ultimately pay them. Joining us now is Melissa Brown, managing director of investment decision research at SimCorp.

[00:00:15]It's great to have you join us. Good morning.

[00:00:18]>> Thanks. It's good to be here.

[00:00:19]>> So, how concerned are you about this next wave of US tariffs?

[00:00:25]>> Uh um I if they go through and if they are at um the the levels that um have been proposed, I don't think it's good news for for anyone. It certainly um is going to hurt the American consumer. Um I think the Canadian consumer if if uh if those tariffs are so high, um I think it's it's going to hurt Canadian businesses and Canadian consumers. I just it's hard to see where the the good is in this. For the last round of tariffs, um it's turned out that it hasn't really generated any revenue for the US government. And so, um and and of course we've got the inflationary forces uh that that tariffs can cause. So, um I think it it could really uh cause a a big hit on um economies around the world.

[00:01:19]>> Yeah, I mean I want to talk about that further just these renewed tariff threats and how they impact the US economy because obviously we know how it impacts the Canadian economy, but a lot of leaders have been trying to get that message across the border for some time now that this hurts Americans, not just Canadians. Uh do you feel like that message is at least starting to be received maybe?

[00:01:36]>> Well, I think consumers are starting to receive that that message and they're seeing that in in some cases uh they are paying those tariffs themselves. Um uh you know, in your in your your last story about the liquor sales, some companies are absorbing them, but that that can't go on forever. Um you know, companies need to generate profits and so you know, I think consumers are starting to see it. I'm not sure the administration agrees yet that that in fact it is not good for the economy.

[00:02:11]>> Okay, we'll leave that there for now.

[00:02:12]We'll take a broader look at the markets in stock because markets are continuing to move higher on renewed AI enthusiasm generally. Do you think this rally is justified by fundamentals or is it getting a little too frothy here?

[00:02:23]>> Well, I think we are looking at a pretty frothy market. If you look at the PE ratio, price earnings ratio for for the US market, it's the highest it's been in 20 years.

[00:02:38]Which is you know, pretty frothy. The last time it was as high exiting out the short period around COVID. On the last time it was this high it was right before the global financial crisis. That doesn't mean this is going to cause another global financial crisis, but it does mean that if some catalyst comes along to start to make investors concerned about stocks in general, they're smarter than a fall because they're starting from a from a higher level. So um I think that is cause for concern.

[00:03:12]It also means that companies earnings need to be really really good in order to justify those levels of valuation. We are seeing earnings come out you know, strong better than expected. But still you know, there's many companies have been punished even on those positive earning surprises because you really you're going to need even higher growth to justify the PE multiples.

[00:03:38]>> And on that note, we've got Tesla, Alphabet, IBM, some of the big companies all reporting earnings this week. What are you going to be watching for from these companies? Is there anything specific? We know Alphabet of course reporting tonight.

[00:03:49]>> Well, you know, I think um a number of things we want to look for, you know, what are what are the management saying about the impact of higher inflation, um of higher oil prices. Has that you know, hurt, um has it hurt more than they expected? But I think the most important thing um that we're going to be looking for is what do they say about the next quarter and the rest of the year and even into next year? Um because you know, the the second quarter is past.

[00:04:18]Um we really need to focus on the on the future and so it's going to be I think really critical uh what each of these managements say about their expected revenue growth and and um and profit margins.

[00:04:32]>> Uh we know that there's extreme concentration. That means a handful of stocks obviously are carrying the market. I wonder if you agree with that and how fragile does that make the broader rally at the moment?

[00:04:42]>> Yeah, I the market is uh very concentrated and with this, you know, resurgence in the AI trade, it's getting uh even more concentrated and it's not just the US market, it's really many markets around the world have this level of concentration.

[00:04:59]I don't I think there are there are many reasons it's not particularly good. It makes it hard to beat very hard to beat the market, which probably drives more investors into indexing, which then, you know, continues this whole cycle of again making it harder to beat the market. Um it also uh kind of paradoxically is it is hard to diversify because so much of the action is concentrated in in so few names.

[00:05:27]Um so uh and you know, we've I don't think we've ever seen this level of concentration um in the market go you know, going back at least 100 years. So um typically when you've got, you know, just a few companies driving most of the returns, um it it can't last forever.

[00:05:47]And you know, we've seen that with with energy in the '80s or with the Nifty 50 in the '70s or and you know, so it it is concerning even for this particular set of stocks that is driving that concentration which is largely in the technology AI semiconductor type names.

[00:06:06]>> Canada in the meantime, it doesn't have that same like tech concentration problem, but on the TSX there is heavy concentration in materials, energy, financials. Does that create its own kind of concentration risk?

[00:06:17]>> Yeah, >> [laughter] >> Canada is not quite as concentrated as what we see say in the US or in emerging markets.

[00:06:26]But it is there is the concentration in both the financials and material sectors.

[00:06:31]Again, not as bad, but there is that kind of concentration that you know, again creates problems for investors in Canada too and in how do you beat the market if you really need to be invested in those couple of sectors?

[00:06:46]>> Okay, we've got to leave it there.

[00:06:48]Melissa Brown, managing director of investment decision research at SimCourt. Really appreciate your time.

[00:06:53]Thanks for joining us.

[00:06:54]>> Thanks.