AGF Management Limited (AGFB) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to our latest market update webcast. With me are analysts Henry Kwok, Pulkit Sabharwal, and Wai Tong, and I'm David Pett, editor of the AGF prospectus blog and your moderator for today's discussion. Before we begin, as always, I need to cover off a few administrative items related to our virtual event platform. Today's presentation will last no longer than 60 minutes. Those joining us live can submit questions any time during the presentation by opening the Q&A icon found along the side of the presentation screen. Questions will be addressed near the end of the webcast. Additional resources for this session can be accessed in your attendee hub at the top of the page, under the Resources tab. And finally, please note, CE credits may be available for members of our Canadian audience. Okay. So as advertised, the focus of today's webcast is cyclical stocks, of which each of you are familiar in your own unique way. Henry, for instance, you cover the consumer discretionary sector. Pulkit, you're all over the energy sector, and Wai you're on the industrials so to speak.

So let's start with some general impressions on how each of your sectors have performed in relation to the broader markets. As many in the audience know the S&P 500, for instance, has rallied in kind of epic fashion, if you will, it's up around, I don't know, 35% since late October and almost 20% since the start of this year. So again, let's talk about each of your sectors in perspective of that broader market. So Henry, maybe we'll start with you and then I'll go down the line to Pulkit and Wai.

Sure. Sounds good. Thanks for having me. So I cover consumer discretionary. My name is Henry Kwok. That's good to be here. So for the sector of consumer discretionary, generally, the return -- we look at MSCI -- all Country World Index in U.S. dollar, discretions performed kind of in the middle of the pack among the 11 sectors. They are up about 8%, both on 3 months and year-to-date basis and behind the broader market by several hundred basis points though, however. And if you look at the performance from the low point of the market in late October last year, it actually went up about 25%, although it was still 700 basis points behind the 32% return from the MSCI equity world index. So on the other hand, I would say that over the past months that my sector is actually making a come back. It's up about 5.1%, making it the third best performing sector closely behind real estate and financials.

Okay. Thanks for that Henry. That's a great overview. And Pulkit, I'll go to you next, and maybe you can just kind of go through your sector for us on that performance front?

Yes, absolutely. Hi, everybody. Good to be back on here. I'm Pulkit. I cover the energy space. In the energy sector, it has been, to be honest, the perfect word would be a little bit choppy. Crude pricing, as we saw geopolitics come in as well as all the headlines around OPEC, that has influenced how the energy sector has done. From a producer standpoint, from an energy price producer standpoint, it's not too bad because Brent is still sitting at a very healthy $85 mark. And given what OPEC has been trying to do, which is to manage the market on the supply side to make sure that price stays in a stable range, and that's exactly the results you're seeing today. It has been training around a band. You saw more and more geopolitics come into the view last October with the tensions breaking out in Israel-Gaza as well as April of this year, where it looked like the world was going to escalate and that drove a bit of a risk premium in the price. But since then, that has come down and now it's more or less being dictated by the fundamentals. So I would say, overall, it hasn't been too, too bad. I think producers would be happy at this price. But in a -- from an equity standpoint, it has been a little bit choppy.

Okay. Thank you for that, Pulkit. Wai, over to you and maybe just a rundown on the industrial sector for us?

Sure, I'm Wai Tong, I am the industrial analyst here at AGF. Since October, I mean, S&P was up about 37%, while industrials up 26%. But, the returns peaked in about April and has been coming down since then as interest rate cuts are getting discounted out of the market. People were expecting 6 to 7 cuts this year, and now we're down to probably 1.5% to 2%. Recently in last week, it's starting to pick up a little bit again, seeing that we had some weak macro numbers. So some of the industrial companies are starting to pick factor in some rate cuts -- more rate cuts this year. You want to look at something like a Russell year-to-date, Russell 2000, which has a lot of industrials in it. It was flat until a week ago, and it was up 12% in the last 7 days. So therefore, it looks like it's time to finally pick up a little bit.

So I want to get into kind of what's next for each of your sectors. But maybe before we do that, I want to unpackage each of your sectors a little bit and talk about what's going on under the hood if you will. So Henry, I'm going to start with you and I kind of want to get into the consumer, who the consumer is, that average consumer and how they're being affected by the current environment. So things like higher inflation, higher interest rates, how is that manifesting when you think of the consumer and how that might impact some of the stocks that are in your coverage area?

Yes. Thank you. That's a good start. So for consumer, certainly, all these macro factors play an important role in how they feel, how they spend. For example, on inflation topic, even though right now, inflation has moderated quite a bit from -- compared to the last couple of years, consumers still face the fact that the prices that have been increasing over the past several years during the pandemic, so far, a lot of them have not been coming back down. So therefore, even though you could say that the peso inflation has slowed down, the actual price they're paying is still quite a bit of a premium over what they used to pay before the pandemic. So many of their industries in my space that get impacted, for example, would be restaurant. Pricing for going to restaurant, generally, we're up like between teens to over 20% compared to before pandemic. So that certainly put a lot of weight on how much the consumers want to spend and where they want to spend money when they go out to eat. Another category would be the hotel. The RevPAR, or revenue per available room for hotel actually were up about teens compared to 2019. And that based on 2 factors, occupancy is a few hundred basis points below 2019. On the other hand, the hotel rates actually were up more than 20% compared to 2019. So with the constrained supply coming into the pipeline for new hotel rooms, this is inevitable that consumer will have to pay a higher price. Although the ability for the hotel companies to handle that is a bit different in that the midscale and the economy hotel actually seeing pull back a bit on the RevPAR. On the other hand, the high end, upper upscale, the luxury, et cetera, we're doing quite well. Another kind of high-level topic from my space in terms of the inflationary impact would be on anything that's big ticket, whether it's auto, whether it's home, whether it's like buying a lawn mower, anything that's big ticket certainly would see the impact lingering follow their high inflation as well. So in terms of the day-to-day spend for consumer, we also see that the total basket for consumption seems to have come down generally because of consumer buying lower average unit per basket. Meaning that, for example, before pandemic, they may be going to a shopping trip, they may be buying 4 or 5 items on the trip. But nowadays, it's more like, okay, I want this particular running shoes. I want this particular dress. So I'm just going to focus on or picking the right item for that one or two purchase rather than saying, "Oh, maybe I can pick up some other things along the way in the store, " like they're doing less and less of that. Other area where we are seeing a pullback as a result of the inflation has been on the auto parts purchase and repair or maintenance. We've been hearing in the channel check stack some of the consumers are now being more selective. So if a garage technician were recommending some service, it is not absolutely required. They're actually going to delay that. So we're going to see that having an impact as well. Another aspect that impact my sector from the inflation indirectly would be consumer trading down from high price point products to lower price point products. And another, I would say, less favorable factor that's been impacting some of my retail companies has been the increase in strength as a result of things getting too expensive. Unfortunately, some consumer just can't afford it, and they go the wrong way to try to acquire the product. So we have been hearing quite a number of my retailers complaining that organized retail crime has been the thing that's impacting the numbers as well. Another macro-level situation, of course, is the job. I would say for the job, it's actually not that bad. Most companies no longer need to actually pay up to keep the staffing levels. So demand for new employees have slowed. But nonetheless, I have not heard massive layoff in my space. So consumers generally are still basically having the drop for the most part. High interest rate would be another area that impact my sector quite a lot. In the housing market, for example, certainly the U.S. existing home sales, the month supply is actually trailing below 4 months now, which is 3.7% in May, which -- and then the existing home sales, seasonal adjusted annual rate was at $4.1 million in May, which is down from more than $5 million before the pandemic and $6 million at the beginning of the pandemic when a lot of consumers are trying to sell their home. So these limited supply certainly is as a result of the inflation at the high interest rate, making the turnover a lot slower, which indirectly hurt many of the categories that rely on home turnover to generate sales. Auto is another thing that also impacted by the high interest rate. For example, in U.S. right now, the light vehicle seasonal annual rate is just about $15 million in June. Fundamentally, it's supposed to go up back up to like $17 million, but we are just at $15 million right now, as a result of all these impacts from the high interest rates.

Okay. That's great. Very thorough answer, Henry. Just to pick up on that a little bit. Obviously, you've described a pretty challenging environment with lots of moving parts for the consumer and the consumer discretionary sector. We've talked in the past and you just put out a video a couple of weeks ago that talked a little bit about -- and that was related to travel stock, but this idea of your space tends to be an alpha-generating space and that there are always winners and losers. And so part of your job is to figure out who the winners and losers are going to be. Just a quick question, I'll ask this that why [indiscernible] later on. But -- what is sort of the makeup of consumer discretionary companies that do well in this environment? What are you looking for from an analyst perspective when you're choosing between one or another, if you will, within a particular sector if that makes sense?

Yes. There's certainly a lot of choices for my sector in terms of choosing the different characteristics of the industries because in my space, we have some industries that are more sensitive to interest rate, homebuilders being one of them and then home furnishing is another one even and then we have some that were actually more driven by innovations, for example, consumer electronics. And then lastly, we also have some that are more driven by replenishment or replacement cycle, which is something like a houseware or these kind of category, they are all under household doables, but on the other hand, there are different characteristics in them. So in terms of where I want to put the money now, certainly, we are now on the verge of finally seeing rate cuts in the U.S. market. So therefore, we actually see that many of the rate-sensitive sub industries like the homebuilders, the home furnishing and home improvement retail are getting better performance in more recent quarters. Although I have to say that the actual we sell probably won't start turning positive until maybe another quarter or 2 later, because, first of all, we haven't even started having the rate cut. And secondly, even with the start of the rate cut, we're not going to see the immediate impact on the consumer. It will take more than just 25 or 50 basis points before the consumer will actually feel the benefit of that. In the meantime though, many of the companies are already trying to help along that line. For example, many of the homebuilders have been buying down rates for consumers so that instead of paying 7% and above mortgage rate, the company buy down to just below 6. So they have a 5 handle on the mortgage rate, and that actually allow many of the consumers who really need to move out or move to a new home to be able to start doing the purchase even before the rate that have started. Other category would be more depending on where consumers want to spend money. For example, in places like restaurants. We certainly would prefer something -- some names that we offer a more value for money kind of menu rather than something that is high end and expensive. And then there would be other categories where we do expect that they are coming from the low cycle back to potentially more innovation driven, but that may actually take a little bit longer to happen, and that includes, for example, the consumer electronics, toy category, the power sports, all these actually would take -- innovation will eventually come back, but at the right -- at the moment, we're not really there yet.

Okay. That's great, Henry. As I said, very thorough, I'll let you take a break for a little bit, grab yourself a little bit of water, and then I'm going to go to Wai next, and we're going to get into the industrial sector a bit with Wai and talk about some of the opportunities, risks that are involved in that particular sector. I'll start by just saying -- and this isn't news to anybody, but the global manufacturing supply chain was pretty disruptive during the COVID outbreak. Are we back to normal on this front? Why? What's your sense of that?

Most of how we are. I mean industrial is very diversified, so it includes transports, aerospace, defense, machinery. For most part, I mean, the only place that's still coming up a little bit, I think it's probably commercial aerospace. [indiscernible] enough parts in that they take over on the suppliers. But for the most part, especially on the machinery side, arguably, there's too much capacity. One of the data points I saw was global construction equipment used inventory of construction equipment, the highest since financial crisis, new equipments piling up highest since financial crisis, prices in Europe and also South America for equipment is starting to come down to a negative. And I'm assuming it's still positive in the U.S., but I'm assuming that's going to turn negative second half of the year as well. So that's going to put a -- put some margin pressure on a lot of these companies.

So the other sort of followed, if you will, from COVID in the supply chain, is this concept of reshoring manufacturing away from China and sort of back home, if you will, or near-shoring to a neighbor or I think there's a term friendshoring to an ally of a company's home country. How has that developed? And can you give us some flavor on kind of how you see that trend developing?

I think people been talking because of the supply chain issues and COVID, you're talking about deglobalization, -- but the evidence seem to show that, I mean, sure, there's tariffs, there's supply chain issues. So it's more -- with the supply chain normalizing a lot of the stuff is back to importing. But that being said, I mean, with the tariffs that's coming through and potentially more tariffs coming at sump wins, that's going to push capacity out of China, but not necessarily back to the U.S., to Vietnam to Mexico, to Southeast Asia. There are higher costs in China, but at least with the tariffs, it might be a lower-cost imported from those countries. That being said, I mean, all the reshoring -- the only thing that's been reshoring is ones that have been subsidized by the government, you're talking about semis. You're talking about EV batteries, biotech. I mean look at the data. I think there's a couple of hundred billion dollars gone onto reassuring, only about 5% of that is going in heavy industrials. The rest is all going into these niche areas that will benefit from government subsidies. So with that, I mean, reshoring I think is going to be a tough sell, the fact that you got 4% on a flow rate, so you lack labor in the U.S., wages are high in the U.S. Energy costs are going up because of the AI transition, so all these AI companies are coupling up as much capacity and power, which makes it less -- makes energy more expensive to reshore for the industrial companies. I mean, in Europe, a lot of those European countries don't want data centers because after the initial production and building data centers, such as very few employees going forward, whereas in the meantime, it sucks up all the power that prevents any other industrial companies like a [indiscernible] industry or steel industry from coming in because they can't compete. So actually, net-net, are net negative once the construction is finished.

Okay. That's really an interesting point on AI. And if anybody has questions about what Henry has talked about or Wai is talking about, please do ask those, and we'll get to those at the end of the call. Maybe just 2 more questions for you, and then I'll get to you, Pulkit. I'm curious to know whether your space, the industrial space and the manufacturing space is impacted and how it might be impacted by what Henry was talking about in terms of that consumer having to make these choices over the last little bit. Has that impacted what's being manufactured to a certain extent? Or how does that kind of work its way through? What's the connection there between the consumer and the manufacturing side of things?

The consumer, I mean -- I covered trucking as well. Truckings [indiscernible] really struggle. I mean, one of the trucking companies reported last night and they missed across the board and the stock is down. I mean that just shows the demand from the consumer is down to weaken. Some other companies within the space had to preannounce because even with the high-end consumer, they're starting to struggle making decisions as far as be spending on pools, be spending or choosing to take vacation on that. So even the high-end consumers start to struggle. So it's impacting some of the manufacturing companies. So demand for long equipment, demand Home Depot, all these areas all starting to weaken, right? Even though you've got still some decent growth, but going forward, I think that's going to have some impact on these people. I mentioned about energy earlier, too. Energy prices started to really go up. Some of the companies that cover engineering companies, they are seeing delays on projects because that spike in energy demand from all these AI demands having them make the utilities go back to the drawing board and we designed the entry production forecast because the current demand is way higher than they expected.

Okay. With that in mind, Wai, and you've kind of -- you mentioned some of the areas that might be struggling. When you look at the backdrop today, same question that I asked kind of Henry. Is there a way for you to differentiate the good from the bad. And I don't know if that's a company-specific question or whether it's more within the industrials, we like these the subsectors seem to be well positioned compared to others. So maybe just some color on that for people?

We mentioned earlier about like the aerospace where supply chain still comes up. So those guys still have pricing power. Once the supply chain normalizes, there's very few companies, especially industrials, they have pricing power. They never did before COVID. They got illusion that they did during COVID. And I think they're going to come to realization. They still don't since the supply chain comes up. But that being said, I mean, we talked about a lot of what's driven the stock market, whether the MAG 7s or what not. Industrial has done okay with a lot of multinationals. S&P is most multinationals. So you look at S&P, the industrials make about 8% at S&P. But on the rest of 2000, industrials make up over 11%. So the delta of that 30% difference is mostly small industrial companies that are mostly domiciled in the U.S. So if Trump wins, you're putting up tariffs, these domiciled in the U.S. companies will actually benefit because they get higher tariffs against imports. Number two, as ideally interest rates are coming down later this year or early next year, these smaller companies don't have the ability to tap the bond market like the GEs of the world. So they're going to have to borrow at the bank. So when not if [indiscernible] comes down, it actually reduces their cost of borrowing. So I think you see that recently, you look at last week, I mentioned earlier the fact that Russell 2000 was [indiscernible] returns to a July 9. In the last week, last 7 days, it's up 12% as people start seeing rate cuts because of the weak jobs data, weak macro data and potentially tariffs. But, I think that's the area you should look at. And there's a lot of these companies that are niche specific small companies with 100% of their sales in the U.S. that will benefit from lower interest rates and also higher import tariffs.

Okay. What I said to Henry, you can take a little break, and we'll get back to you at the end. Pulkit, you're up next. So let's talk a little bit more in-depth on energy. So maybe just the first question for you. Are there certain aspects of the current environment that will influence energy prices more than others. So you talked a little bit about geopolitics in your opener, but I'm just curious, what are those bigger themes that are going to impact energy within this environment that we're living in today?

Yes, absolutely. I think the conversation of energy really shifted from geopolitics and all these external factors to good old supply and demand equation. I think the fundamentals today are really driving where the pricing is at. And when I say fundamentals and supply, I am really including the OPEC policy here. So for those that might not be aware, or might not follow this base for a while, OPEC+, that is OPEC as well as Russia and a few other entities involved there, they decided that they're going to make sure that the price stays at a certain level, but they're chasing essentially is anywhere between $70 to $90 and mostly around the $80 mark. So $85 [indiscernible] is what they got. They were doing this by essentially taking 2 million barrels off of the market, 2 million barrels per day. So that, I think, is going to be the governing factor going forward. With the recent revision in OPEC policy, they talked about how they're going to look to bring these -- the cut production slowly back into the market over the course of the next year, but that is really going to be predicated on how the market is shaping up in terms of prices. If it's too low, obviously, it doesn't make sense to bring back more production into the market. If it's too high, they can look at it. So I think that's going to be the driving factor going forward. But that said, we cannot ignore geopolitics and the role it plays, right? You saw around April as well as October and then the Ukraine Russia conflict before that. Any time you introduce geopolitics into this mix, especially in an area that might impact physical barrels. And the Middle East obviously has a lot of production there. Saudi Arabia, Iran, Iraq and a lot of players. You introduced a certain element of risk. So in April, it looked like the war was going to escalate and start touching physical barrels and that's when you saw the price drive up. But now, obviously, that has come down quite a bit. So I think these are going to be the factors going forward when you're looking at it. And then longer term, you could argue energy transition, but how exactly that shapes up, it's going to be, I guess, the million-dollar question or a trillion-dollar question in some cases going forward.

Okay. Perfect. And then maybe I'll -- Wai and Henry provided a bit of color as to if we do get a turn in the cycle, and we seem to be -- we seem to be there, although as mentioned, the U.S. hasn't quite started their cutting cycle we have in Canada. Given that shift and when you look at the energy complex, as a whole. Are there certain subsectors that you expect to benefit more or less than others?

Yes, I would say so that there are certain sectors that do benefit from this environment. I mean, when you're looking at a very stable high oil price, the upstream producers tend to benefit the most from it because they can take the lion's share of the production -- or sorry, the lion's share of the value chain in that sense, right, because they have a fixed cost and because of the previous decade, where pricing was not very supportive, they decided they wanted to delever and cut back on making sure that they're very profitable, and that obviously is coming home to us today because now you're at a situation where you have driven a lot of the cost out of each barrel that you're producing as well as there's hardly any debt on the balance sheet. So these guys will obviously make a lot of money. The other thematic that I think to be aware of, in this case, would be gas -- natural gas, the pricing today does not look very good. But I would really be looking at this pace because what's happening is that there is a demand defining moment that goes on. So LNG capacity, LNG export capacity in North America is set to increase by 85% to 90% over the next 5 years, that's going to drive a lot of the gas that we have in North America that we're going to trying to ship overseas. So this is going to be a defining sector as well, right? So all these natural gas producers are going to see a huge tailwind in the pricing they get for gas just because there is so much more demand for it. Aside from that, though, I would really say it's a stock pickers market. In a stable price environment, I think the stories are starting to become more and more diversion, you see good companies and good management execute on their plans a lot better. And I think those are the companies you want to own as opposed to just trying to own broad sectors.

And on that front, Pulkit, and maybe not everyone might understand, but when you're analyzing energy companies, what are your kind of -- what are your go-to metrics? Like what are you looking for from a company? Is it a cash flow kind of metric? Or like how do you do that, Pulkit?

Yes. I would say certain [indiscernible] company, whether it is a low price environment or high price environment hasn't really changed. So in a commodity-like business like ours, you're really looking at companies that have a very good resource base, first of all, lower prices that they can produce at a lower netback that we would call is much better. I mean if you can break even at $30 a barrel, you're going to succeed in any environment versus $60 a barrel, right? So there's companies that have been able to do that. And then the other thing you're looking at companies that are able to acquire assets at a decent multiple during decent cycles. And then do the exact same thing again. So you would acquire a company and acquire a resource at X and then you're able to produce Y out of it, that always benefits you. So what you're looking for, obviously, is a very good resource base, a decent amount of cash flow coming out of that resource base, that gives you a lot of optionality, a very nice balance sheet, lower leverage, the better. And then finally, a management that actually has a track record of being able to acquire as well as execute and make sure that they're keeping production stable at a very low cost.

And maybe Wai and Henry, may I'll just bring you back into the conversation. I'm just curious, given what Pulkit said is kind of what he looks for, is it any different for you guys in terms of -- I imagine the -- it's slightly varied, but obviously, you want good balance sheets and strong management. But are there other things that you guys look for from a company profile fundamentally? Wai maybe I'll start with you, and then Henry?

Thank you. I mean -- I remember one of the things that my strategy [indiscernible] said, it's a university is that a good management team and crappy industry go to the room is usually the [indiscernible] industry that comes out of the room with this reputation back. So you look at your airlines and those things, we saw that. So for me, I mean, valuation and balance sheet is great. I also look at market structure, especially industrial. There's market structure, how many players are in it? How much -- how much pricing power you have? I mean that's why I was talking about some of the small cap companies. Going through some of them, there's companies that are completely dominant, 80% market share in the industry, so -- domesticated in the U.S. So those guys will have much more pricing power than you talked about something like a Caterpillar globally, it has 10% market share. So they have no pricing file, right? The global competitors could easily bring prices down, whereas if you had something like a commercial aerospace for those guys, they have -- a lot of those companies are sole sourced, like the only buys parts from only one company. So those guys have pricing power. So I prefer market dynamic, valuation obviously, which is cheaper, the better. Good management team it would be great as well. If you can find some of those, combined, those make good companies. Low valuation, good balance sheet, market dominance and ideally good management team that you can trust.

Okay. Great. And then, Henry, maybe just some color on that from you?

Agreeing with what Pulkit and Wai have been saying in terms of the balance sheet, in terms of the execution of the management. And I think for my space, in particular, because of how diverse it is, for example, just within the restaurant space, you could be looking at fine dining restaurant, you can be looking at what we call the fast cash [indiscernible] or you could be looking at the fast [indiscernible] -- these actually would have different use case or use occasion for a consumer when they want to dine out. So in terms of you can put into the mix, for example, some of the topics that we've been talking a lot recently has been the GLP-1. So over time, which category is probably going to be impacted more by the use of the diet drug versus those that would be impacted by less or actually the benefit from that situation will make a difference in terms of the longer-term investment. But in the shorter term, I would say, for now, value for money category would still likely to be winning out, like something that I've mentioned recently in a video -- the cruise line industry, for example, would be perceived as a good value for money. Off-price retail, among all the apparel retailers also will be perceived as a good value for money. And then you would say that experience versus good, it's still good. It's still a pretty important factor to consider for consumers where they want to put their money. So even though you could say that, okay, during the pandemic, consumers are not able to spend on experience. And once we reopen, there's a reverse spending on a lot of things related to travel, whether it to experience, going to contract, et cetera. And that actually is not just a matter of the short-term reversal. There's actually a more sustainable factor in terms of consumer changing their priorities even when things are more or less normalized. So that's something that we definitely need to consider as well. Innovation is another factor that I put a lot of [indiscernible] for my companies, especially those on the consumer durable goods -- like the sportswear, the powersports, even the auto, which there's a lot of chatter about EV, PHEV, all these kind of discussions is important in terms of what actually are the company able to innovate and what they are offering for the company for the price that they are charging. And then lastly, of course, for industry that actually have a favorable demand versus supply situation, similar to the energy space in Pulkit's space. In my space, there's also categories where supply has been about demand, but sometimes because of the affordability issue, consumer are not able to buy as much as they want, meaning being the housing market and the auto space. Even right now, demand is actually higher than supply. But because of the affordability issue, the demand is not as strong as we would have expected. But over time, when things come back, for example, in terms of the incentive that the dealers are offering to the consumer back to more normalized level, and then interest rates start to come down, then certainly the demand would be able to be coming back a little bit stronger than what it has been. So these will be the factors that I would consider in terms of where to put the money as well, just because my sector is so diverse, there's a lot of options for me.

Sure. Okay. Great. Thanks, guys. Really appreciate letting me get inside your heads a little bit. I think it's kind of fascinating how you guys look at your sectors. In the same way, but also just a little differently given the different types of businesses that you're covering, one last question from me, and then I'll get to some questions that have been rolling in. When you look at the second half of the year, we are kind of at that midyear mark right now. Simple question. Are you more bullish about your space going forward? Or are you still a little bit bearish on the space? So just maybe a thought on that, given everything we've talked about where we are in the cycle, Pulkit I'll start with you. And then I'll go to Wai and then Henry.

Yes, absolutely. So I'm about neutral to slightly bearish on the space just because -- right now, we're going through the summer period. Summer periods, obviously, the summer driving season, which is really beneficial for gasoline demand and therefore, for crude demand. So you're going to see some nice support of pricing. But I think post that, you're probably going to see a little bit of a decline just because you get into a seasonal decline and -- as well as the fundamental equation where you have demand seemingly slowing down in the U.S. macro policy is certainly looking at being able to cut rates just so you can -- I mean, Henry and Wai both touched upon these factors. So in the event that the U.S. economy does slow down, you're going to see demand for crude obviously decline a little bit, and that's what gives me a little bit of a pause, and that's why I'm more neutral on it. But that said, I think the OPEC supply management has been working well. So you still should see crude trade in a band that they'd be trying to get to?

Okay. Great. Thank you, Pulkit. And then Wai, I'll go to you next.

I guess I'm a little more negative for the reasons I mentioned before, the fact that inventory is starting to pile up. They overproduce, has so much overpriced in the last couple of years, now they have to probably give some of that pricing back for some other companies. That being said, I mean, I mentioned about the small caps, there are opportunities in that area, especially if you look at the valuation of the S&P 500 versus the Russell 2000 is at historical. S&P is trading at historical multiple premium to the Russell 2000. So there's going to be opportunities in that area. So I have a focus in that area. But that being said, I mean, my view is if the rate cuts, it's usually because the economy has slowing down. You're not rate cutting just because you went from 8% down to 2%, 3%. It's because unemployment starting to pickup. And the Fed will never say this, but I think the Fed -- the only way to keep inflation down, you're going to increase -- you need higher unemployment. They won't give you a target on that, but 4, 4.1 I think it's too low still. I think you probably start with a 5. So, I think they're going to wait holding up on the rate cuts until we start getting some real pain in the market.

Okay. Thanks. And then Henry, a quick thought from you. A little bit more bullish going forward than maybe you were at the start of the year or the reverse?

I would say my sector is probably going to be performing slightly above the median, primarily because a lot of the sub industry are actually interest rate sensitive, but with a high demand, just like what I mentioned just now in terms of the homebuilding sector, the auto space and like home improvement, et cetera. These are all heavily driven by the interest rate environment, and at the same time, it's not a matter that the consumers don't want to spend money, but it's just from them, it's just the cost for putting money into these kind of categories, it's just a little bit too prohibitive at the moment with the high interest rate. So when the rate cuts start to kicking in because of the need that these consumers need to spend in these categories, I do believe that the sales from these companies should continue to trend up. And in fact, you could say that, say, for example, the home builders, they have been actually doing well since early last year, not even starting this year, primarily because -- even though we are way before we're talking about rate cuts primarily because the private homebuilders have been able to pick up shares from the fact that many of the existing homeowners are not putting up their house for sale because they don't want to flip to much higher mortgage rate. So therefore, the new builds become a primary -- a much bigger source of home turnover or new home purchase than what it used to be. It used to be they were like teens in terms of the market share, but they've been increasing to like more than 30% in more recent periods. So those factors certainly will come in and believe that when the rate cut starts, many of these categories will benefit. And then on the flip side, geopolitics, which I haven't talked about on my space is also going to be an important factor in terms of where you're sourcing your products from. Many of consumer goods actually were making Asia and China used to be a pretty big factor. But since 2018 and '19, when last Trump, the President of the U.S. with all these tariff talks, there has been a lot of transition from China to many other regions, whether it's Latin America, Mexico or the rest of Asia like Vietnam, Cambodia, et cetera. So that migration has already been ongoing for several years now. But still, there are quite a number of companies that were stuck with a certain percentage of their production coming from China because China still represents the best way and the most cost-effective ways to make those goods. So we have to really look at, for example, if some of the suppliers say for sportswear, they may have, say 25% of their production is still coming from China, but if the sales to the Chinese economy overall is similar than that means they are really going for making China for the Chinese kind of strategy. Then, in that case, you would say, okay, even though the quarter of the production is coming from China, they would be safe. Because most of the Chinese main product would be targeting the Chinese market. But on the other hand, they will have the Vietnam, they would have to India, for example, that would be goods coming from those markets, supply to the region where tariff could be a concern like, for example, in the U.S. And then on the other hand, there would be some category that basically making China is kind of unavoidable. Many of those would be like something similar to the dollar store, something similar to many of the [indiscernible] discounter store, vast majority of the products actually are making China and it's unlikely that these will actually get changed. So inevitably, when there's going to be targeted in those categories, the price will be passed on to consumers. And then there are yet another category, say, for example, the auto parts where a good chunk of them also will make in China, including the private label. And because the wholesale category is basically sourcing from those markets in certain particular type of components, and because it is seen as a necessity, the retailer, for example, basically have no reason to try to change the source because everybody is going to be under the same pressure when it comes, so they can try to negotiate with the government, maybe to try to exempt some of the products from tariff, that's a possibility. But in other words, those categories, I don't expect a lot to change. But nonetheless, at a high level, geopolitics coming into November with the election will be a big factor for many of my companies.

Okay. Thanks very much, Henry. And going back to one of your comments about consumers deferring some of the things they're purchasing, I don't feel so bad about not putting my summer tires on my car. I still have my winter tires on. So now I feel like I'm not just on my own on that front. Okay. Let's get to a couple of questions from the folks listening to you guys. Here's one. So I'll give this to Wai because it relates to a lot of that you talked about, about small caps, Wai. So obviously, we've seen a bit of a resurgence in small-cap stocks performance over the last little bit. I guess the question here is given that choice between small cap and large cap, would you probably -- would you air a little bit on the small-cap side of things going forward? And does that maybe help broaden out this bull market a bit? Because as we all know, it's been driven by primarily a handful of big tech companies to date?

For example, when we talk about valuation, I mentioned earlier, say, for the last 20 years, S&P trades at 18x and Russell trades at say 15x, I'm just making these numbers just as an illustration. Right now, S&P is trading at 20x and the Russells trading may be at 14x, 13x. So we're talking about the valuation gap on average earnings, right? Yes, I think when you look at the small caps because in the last year, basically, you get anywhere over 25% to 45% return without looking at anything. You just buy NASDAQ, why bother, right? So I think that [indiscernible] starting to come in, you see the last couple of days, Russell's gone up as mentioned 12% last week. But in the meantime, the NASDAQ was actually down on a couple of those days. So you see the rotation or selling out of the mega gaps and moving into the smaller gaps. And I mentioned earlier, I mean there's really great small companies in there. I mean we're talking for example, I won't name the company, but we got companies in there that have special niches that have 80% market share trades at like 9, 10x earnings as 9%, 10% free cash flow yield and a great balance sheet. But those guys got [indiscernible] in the last year or so because the mega caps have destroyed the entire market. Now if the mega caps are no longer driving the market, you're going to start looking at some of these niche companies that are undervalued that should trade probably double the price that they're trading now. So I think that's what I'm going to be focusing on in the second half of this year.

Okay. And then -- and then this is just a general question for you guys. So if we do get this broadening out that in the market. I'm guessing that's good news for each of your sectors that you're covering, right? Maybe that's a no-brainer question. You could just nod your head, but I guess you're all looking for that time where we get there. And maybe we are on the cusp of that based on what you've just talked about Wai. I've got one last question here, and this is for you, Pulkit. And it's about the geopolitical environment and the impact on oil and it's kind of 2 tiered. So the first part is, are you at all surprised that what's been going on in Ukraine and what's been going on and hasn't had a more profound impact on oil prices. And then the second part, if -- is there one event in those two that you maybe worry a little bit more of being at risk -- a bigger risk going forward. So it's 2 parts to that one.

Yes, absolutely. I would not say I'm that surprised just because with Russia-Ukraine, I'll start there. What you saw was that there was an imminent threat that Russia being a big producer. I mean, they produce around 9 million barrels a day, that's a significant chunk off the market. So there was a threat that all of a sudden that production is going to get sanctioned because of the war and it's going to go away. But Russia was able to get their production and the barrels back on the market in a very efficient manner despite the sanctions around them. That's why you saw that threat disappear. Same thing in the Middle East, even though Israel and Palestine directly, there's no production there, what the issue was that if the conflict broadens and Iran, which produces around 3 million to 4 million barrels a day gets involved, you might start dangering that production, the physical production. So every time you have this trend where physical barrels might come into danger, you start seeing the spike in the price of oil. So that's what it was. I'm not surprised that tension dying down and also led to oil price coming off as well. But I would say between the two, it's the Middle East, that concerns me more just because a potential Trump presidency. President Trump was obviously quite harsh in terms of implementing sanctions. I guess harsh wouldn't be the right term, but -- he was -- he implemented sanctions on Iran, and he was quick to bring that sanction implementation back in. So in a scenario where President comes back in, and he says that, you know what, in this war, I'm going to take one side or the other, but I'm going to bring sanctions back on Iran, all of a sudden, you're looking at production from Iran, which is a major oil-producing country come down. So for me, that is a bigger risk than say, Russia-Ukraine, where the situation despite the war still ongoing, at least from an oil perspective, looks like oil flows have resumed to a large degree.

Okay. I know I said that was the last question, but I have one more and it's just maybe a little bit of a perspective on Canada versus U.S. in terms of your sectors. Henry, the discretionary sector in the U.S. is much more fulsome than I would think in Canada. But maybe just a perspective on -- are you dealing with the same types of sort of challenges, opportunities in Canada as you are in the U.S.?

For me, the Canadian companies in my space actually were pretty unique, I would say. Some of them certainly primarily address the Canadian market or some exception would be -- I would say the coverage of this company, many of the Canadian companies MySpace actually are a global company. For example, some of the powersports company, we have a leader in Canada here. Some companies that actually make underwears, -- they were also a global company. Another company that actually make some of the apparel products on the athletic side or otherwise on the winter outerwear, these companies also a global companies. So when I look at these companies and look at them from a global perspective rather than primarily on a Canadian perspective. Ones that are more Canadian-focused will be more on the -- something like retailer that sells sleeping products, for example. Those are primarily focused on the Canadian market only. And then other would be the dollar store that everybody knows. That's also primarily Canadian-focused, but with some more important potential growth driver coming from the Latin American market. But they're not in the U.S. market. So -- but most of the other names, whether we're talking about the restaurant name, the auto parts, these are all actually global names. So I would look at them on an equal foot basis, compared to the U.S. company when I select them.

Okay. And then Wai, just maybe a perspective on that dynamic between -- in your space, Canada versus the U.S., is there any major differences in terms of what you're seeing out there?

On macro side, I mean, I think Canada is a much worse position than the U.S. just because how indebted the average Canadian consumer is. I mean I think the number I saw is net debt to disposal income was 181%. That's also income, which is higher than before the great financial crisis in the U.S. So I think we're going to struggle a lot more than the U.S. On industrials, in particular, U.S. is much more fulsome. Canada, my space was about maybe 10% of the benchmark. But 6% of that -- 165 of that is CNCP, right? So everything else, having said, the Canada economy is slowing down or impact the other smaller domestic industrial companies, but even potentially Canada go in a recession, I think, next year. That's going to impact CNCP because of [indiscernible] business in Canada.

Okay. Great. And then Pulkit, obviously, energy is a big part of Canada's concentration on the market. So -- is there anything unique in terms of that dynamic between maybe Canadian companies that you're looking at or U.S. companies or even global companies?

Yes, I would say so. I think you've seen the U.S. historically trade at a premium. I don't really see that changing entirely versus Canada, just because a much more well-capitalized market, a bigger market and so forth. Those factors are still there. But I think with the Canadians, what you've seen, though, is that there was a very significant event that happened over the past few months, which is that there was a brand new pipeline that is now shipping crude oil from Edmonton all the way down to the West Coast. What that means, there is more capacity for Canadian oil to lead the markets and go globally and that's exactly what's happening. You're seeing more and more shipments to Asia, India and China, in particular, South Korea as well. So I think that is a factor that has really helped the Canadian market in general. And over time, I would anticipate that heavy oil is going to be more and more valuable versus the light oil that you see in the [indiscernible]? And just I'm talking as a multi-decade kind of thing or, I guess, over the next 10 years, depending on where you stand on the oil cycle peaking. So, in general, I do see opportunities in both markets, but I think Canada had more of a base in defining moment as opposed to the U.S.

Okay. That's a wrap. Great job, gentlemen. As always, thanks to everyone tuning in today on behalf of Henry, Pulkit and Wai, we appreciate your time and support and look forward to sharing our insights with you again next month. Before you go, please make sure to click the ad session button in your attendee hub to register for our upcoming market update events, including our next installment taking place on August 21st. To complete your CE credits today, please complete the survey available to the right of your screen or at the top of the home page in your attendee hub, and please note, you may only submit answers for your survey once. However, you may have the opportunity to go back and edit responses if needed. Have a great day, everybody. We'll see you next time.

Thanks, guys.