The market has produced strong year-to-date returns. There appears to be much comfort in the structural themes driving today’s markets because there is seemingly duration behind them. A sampling of these themes includes artificial intelligence (“AI”), cloud migration, biotech innovation, GLP-1 drugs, onshoring, commercial aerospace growth, electrification, data centre power and Japan. As stock pickers, the environment has been ripe with correlations low and dispersion high. While hopeful for continuation on this front, the market is becoming increasingly narrow in leadership at a time when the economic data appears to be slowing at the margin. We continue to be watchful of the trend of inflation as interest rate cuts potentially loom. If we are truly in a soft landing, the market should be broadening out and focus should be placed on companies where growth is accelerating. It should be noted that Mag 7 growth rates will likely decelerate in the second half of the year. Ultimately, if one wants to be defensive in their positioning, that means owning breadth.
Sectors that contributed to absolute performance:
Information Technology
Information Technology was the top contributor to absolute performance across our long positions. The sector compounded its Q1 2024 strength with the best performing subsector being semiconductors, AI winners such as Nvidia Corporation, followed by internet stocks.
We remained cautiously optimistic on the outlook for Information Technology for Q3 2024: falling inflation could lead to lower rates and more consumer spending and capital investment, as well as ongoing multiple expansion. In semiconductors, we expect the AI bifurcation to continue, and are increasingly focused on companies that will likely be beneficiaries as this theme moves beyond the data centre. Within software, we expect a similar split in which those proving they can generate AI-associated revenue pickups will see investor demand, while others suffering from a shift in budget share will lose sponsorship.
Financials
Financials also added value across our long positions. Financials lagged the broader market in Canada and in the U.S. in Q2 2024. In the sector, capital-markets beneficiaries have shown relative outperformance, while the more credit sensitive regional banks have lagged. We continue to be a little more cautious about banks, especially in Canada, because revenues are slowing, and credit losses are trending higher. In Canada, we believe we are headed for a period of more rapid deleveraging that will likely hold back growth and profitability for the banks’ domestic banking businesses. Among financials, we favour less credit-sensitive companies with good idiosyncratic growth tailwinds, irrespective of the macroeconomic backdrop.
We remain very bullish on life insurance: we believe there is a structural rerating opportunity provided by a higher rate regime than the zero-interest-rate policy that followed the Global Financial Crisis. Additionally, many of the life insurance companies we like have built large capital light wealth/asset management businesses that will likely continue to benefit from numerous secular tailwinds and strong growth.
Sectors that detracted from absolute performance:
Energy
Oil prices experienced significant volatility in the second quarter. Brent crude reached a peak of USD 92 per barrel in late April before retreating to a low of approximately USD 77 per barrel in June. The initial surge in prices was driven by supply concerns due to OPEC+ production cuts and geopolitical tensions. However, prices have moderated recently due to several factors, including an easing of geopolitical risks, rising U.S. crude oil inventories, a stronger U.S. dollar and fears of an economic slowdown. On the demand side, growth from non-OPEC countries continues, yet OPEC remains restrained, extending its output cuts of around 1.6 million barrels per day through 2024 to support prices.
Natural gas prices surged in the second quarter, primarily due to a decline in U.S. production. Producers reduced output earlier this year due to lower prices, leading to upward pressure on current prices. Additionally, natural gas has seen increased attention from AI demand over time, as it remains a key power supplier for data centres. Natural gas offers reliable, low-cost energy and can be developed quickly to meet power demands, unlike wind and solar energy, which face intermittent supply challenges that do not align with the consistent energy needs of data centres.
In the portfolio, a prominent theme is investing in oil and gas equities with large, long-life resources, while avoiding equities with short reserve life indexes. Companies with short reserve lives, typically mid-cap and oil-weighted equities, have underinvested in exploration in recent years, and are often forced to engage in dilutive mergers and acquisitions to expand their reserves.
We generally favour companies that have substantial and sustainable resource bases, which provide a more stable and positive outlook compared with companies with shorter reserve lives.
Small Cap Spotlight
We would like to highlight our position in Computer Modelling Group (CMG CN) – Computer Modelling Group is a software business that provides advanced reservoir modelling capabilities in the cloud for seismic interpretation in the energy industry. While this is a long tenured company founded in the 90’s, they are currently undergoing a reinvention of the business which they call “CMG 4.0”. This process has included bringing in a new CEO, new Board members, and a new mindset to how the business will operate going forward. They have adopted more of a growth mindset, and took steps to engrain this into the culture by reorganizing and refocusing the sales team, and offering products to compete in the conventional oil market. This has led to the organic growth rate of the business, which was historically stagnate, reaching double digits. Complimenting this accelerating organic growth is a new potential arm for the business, executing on merger and acquisition. Certain new members of the Board who come from Constellation Software Inc. (CSU CN) should be able to provide important input on this given their expertise in the software space, and provides a nice optionality given their substantial net cash position and ongoing free cash flow generation to fund deals. We view these changes happening at the business positively and see the potential for long-term outperformance as a result.
Outlook and Opportunities
As at period-end, we observe that markets seem to be all but assured of a soft-landing (or alternatively “no landing”) from softer economic conditions observed over the past year. That said, in conjunction with the resilience of the world’s largest economy to date, the U.S. Federal Reserve finds itself in a somewhat “sticky situation,” whereby goods inflation has decisively rolled over, but services inflation remains stubbornly firm. Until the latter abates, the Fed seems to be signaling that they are not able to cut interest rates as swiftly/deeply as the market had hoped when entering 2024. Yet, staying on hold too long may prove a risk as cracks are appearing in important leading indicators including the job market.
As for the rest of the world, the relative attractiveness of certain geographies will increasingly hinge upon key aspects of de-synchronization. Not just the relative timing and pace of interest rate cuts relative to the U.S., but also the reshaping of trade and risks to critical supply as geopolitical risks remain on the front burner. We continue to believe that investors should remain adequately diversified and to seek opportunities to purchase risk assets on pullbacks, though we do not completely rule out a deeper pullback should the narrative of sticky inflation keep central banks tighter than investors’ desire, for longer than risk appetite can bear.
1M (%) | 3M (%) | 6M (%) | 1YR (%) | 3YR* (%) | 5YR* (%) | Since Inception* (%) | |
Picton Mahoney Fortified Equity Fund (Class F) | 1.50 | 4.07 | 16.79 | 22.22 | 9.11 | 12.72 | 9.59 (Oct. 29, 2015) |
Picton Mahoney Fortified Active Extension Alternative Fund (Class F) | -0.20 | 1.32 | 11.29 | 15.72 | 7.19 | 13.33 | 12.29 (Sept. 27, 2018) |
Picton Mahoney Fortified Market Neutral Alternative Fund (Class F) | 1.04 | 3.57 | 8.19 | 8.60 | 6.07 | 8.12 | 7.82 (Sept. 27, 2018) |
Picton Mahoney Fortified Long Short Alternative Fund (Class F) | 0.70 | 2.76 | 9.12 | 11.08 | 6.81 | – | 14.52 (July. 7, 2020) |
(*) Annualized performance
Source: Picton Mahoney Asset Management