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Announcer: Hello, everyone, and welcome to Breadth of Experience, a TDAM Talks podcast. In this episode of fourth quarter equity roundtable, our portfolio management team of Jose Alancherry, Damian Fernandes, and Vitali Mossounov have a discussion about the key events, trends, and surprises that shaped the stock market over the past quarter. From market-moving headlines to sector performances, we're here to bring you the insights that matter the most. Now let's dive in.
Jose: Hello, everyone. Thank you for joining us. We're here for the Q4 equity roundtable. I'm joined with Damian, who's a regular guest. But we have a special guest this time around-- Vitali. I know you. Damian knows you. But why don't you tell the audience-- what's your story?
Vitali: I appreciate you calling me a special guest on the show, Jose. Yeah.
Jose: You're special.
Vitali: Fantastic, appreciate it. I'm the co-head of the equity research team at TD Asset Management, our public equities group. So your audience sounds like they know Damian very well. But supporting those portfolio managers, we have a team of about 20 great analysts that are doing all the work-- doing all the work-- but researching companies, meeting management teams, writing research notes, and really working as partners to the portfolio managers to give you the performance track record you're used to.
Jose: The brains behind the operation-- right, Damian?
Damian: It takes a village for outperformance.
Jose: Yes, 100%. And so we have a full slate. It's been an eventful quarter in general, with the major headline, of course-- let me get the elephant out straight away-- the US elections. Now we've had some time to digest it. It's been a couple of weeks. Damian, you were one of our lead US portfolio managers. Just lay of the land-- what's your observation here? What are your takeaways?
Damian: My takeaways is the removal of uncertainty. And I know the initial prognosis is that, oh my god, it's Donald Trump, president-elect. But when I say uncertainty is that, for the last few months, there's capital markets activity, companies thinking about going public. It's actually been-- activity's being arrested because people have been waiting with, like, bated breath for this election.
Jose: No one's been sure, basically.
Damian: Yeah, exactly. And the thing is, the election's come and gone. And, in fact, if I think about who probably lost in this election-- yes, the Democratic Party lost-- but it's the media. And what I mean by this is-- like, think about the narratives that were spun before this election. People are talking about a very contested election. We won't know who won till, like, the end of the year. It's going to be a very, very tight race.
And, in fact, the opposite-- this is not advocating who won. I'm just saying that you have a now President-elect Trump who one-handedly won the popular vote. No one had that on their bingo card, by the way-- winning the popular vote, winning Congress, and Republicans flipping the Senate. So you have a unified government now. And that-- whether policy changes are coming or going-- corporates, CEOs of the businesses have some clarity moving forward. We have a pro-business climate with the current administration. But they can move on.
And I think just the remove-- I like to say this. It didn't matter-- before the fact, I thought the election would be a clearing event. Because we've been saying that investors have been-- and you see this, right? You saw the enthusiasm in markets post-election. And I think that just goes to tell you-- so the biggest takeaway I have from the election is, let's move on and let's focus on the stuff that actually drives valuation-- cash flow growth, revenues, and not talking about, just like, the next-- I don't know--
Jose: Crazy policy that's making the round, that's getting wild, right? Yeah, back to basics and fundamentals. Vitali, what are your observations? Have you--
Vitali: Yeah. Well, I want to get in Damian's bullish camp. The uncertainty's over, and we're not going to have to talk about anything related to this. But unfortunately, I think we've got at least four more years of it. But, look, Damian makes a valid point. And I think you asked me what I do for a living, right? And hopefully, that was a satisfactory answer.
But it's important-- going back to the analyst and what the team does-- there's a great quote out there that we all tend to-- the market's investors-- tend to overestimate the impact of short-term political change and really underestimate the impact of the long-term, social-technological change. So I think we love it when the rest of the market takes their eye off the ball and every single day pays attention only to Trump, only the tariffs, only to the border, whatever it is.
Because that's not what we do. We care about these things. We're analytical. We're competent. But we spend our time finding underappreciated future-free cash flows, paying attention to technological change, doing deep research with the breadth and the depth that we have at our analyst capabilities. So I kind of like this when there's this sideshow because it lets us shine. Because we have a process, we follow it rigorously, and we don't get distracted.
Jose: So that myopia, in some way, is the opportunity.
Vitali: Completely. And I think about what's happened since the election. People are so focused on, oh my god, it's going to be tariffs. If it's going to be tariffs, why is the TSX punching through new all-time highs?
Damian: What you're seeing is that activity in global equity markets has actually improved post-election because people have certainty. And I guess I'll say one more thing to this because we talked about the election outcomes. A thing that we're looking at is, one of the platforms from Trump's previous campaign was deregulation. When you think about deregulation, the cost of deregulation are borne by all companies, but they're borne disproportionately by smaller and mid-cap companies because they still have to have the same number of compliance people. They have to fill out all the forms.
So if you do have some rollback of regulatory capture, you could probably see-- like, everyone will benefit. But the incremental benefit will be more for mid-cap companies-- or not the mega caps-- because it'll be so much more of a bigger portion of how much they spend on it. So that is something that we're thinking about, in terms of like, you could see a change where the-- faster.
So the delta and free cash flow's going to increase. But the incremental-- the second derivative-- might be faster in not the mega-cap companies.
Jose: Yeah. The large caps-- just by virtue of their scale, they can absorb a lot of these [INAUDIBLE]. And so when those costs roll off, they won't benefit to the same degree, let's say the smaller one. So to that point, continuing on that train of thought, the markets have kind of ripped based on this thesis. Has it gotten ahead of its keys? What are the fundamentals telling you both, in terms of looking at the lay of the land since the election?
Vitali: Look. The markets have been ripping not for a month, not for two. So I kind of push back on that expression a little bit because we bought them-- call it in the 3,600 range-- in October 2022. Let's face it. We're in November 2024, right?
Jose: So it's been ripping for a while. Fair.
Vitali: Yeah. And we all know the markets are forward-looking machines. And so I don't want this to devolve into a conversation of, let's figure out the exact market timing when whoever is listening to this might think, oh, you know what? Vitali and Damian are tilting a little more bullish. They've put risk on, right? Because the reality is-- and you know this-- but it's time in the market, not as much timing the market. And I think-- you'll have to fact check me on this-- I'm pretty sure that if you missed something like the 10 best market days--
Jose: Yeah, true.
Vitali: --you've missed half the returns, right? So you look out there and you say, of course we're paying attention to any signals that we're getting out there. But the reality is a lot of really interesting themes that are happening in the economy broadly that are somewhat related to the economy but also related to much broader--
Jose: Broader, big picture.
Vitali: --bigger trends that are interesting for us to exploit. So I kind of wanted to push back a little bit.
Damian: Yeah. Just on markets-- for us, our philosophy's keep calm and compound on. We keep saying it all, and we reiterate it. And it's almost like religion to us, like that's our creed. And what I mean by that is that the reason we're bullish right now is that the underlying conditions are supportive. Economic growth is likely moving higher. You've removed uncertainty with the election. You look at activity levels. You look at things like new orders and how they're growing. All of that is supportive of continued economic activity increasing.
Inflation right now continues to move in the direction of central banks globally, which allows them to continue their rate-cutting campaign. Historically, if you're cutting rates and you're not going into recession, that's been bullish for markets. That's very present. And then to what Vitali's talking about-- secular trends that are not just in the Mag Seven or these large-cap stocks-- you're seeing breadth. It's no longer bad breadth in the market. You're seeing the median stock actually improve and making new--
So all of those for us, until those conditions change, we're going to keep bullish. I don't know if it's going to be-- I know we're trading at 21 times right now next year's earnings. I don't know if we can go-- I don't want to say put a pin in and say, it's above average so we should sell right--
JOSE ALANCHERRY: Yeah, we've always been against that game because that's so backward looking, in some sense. Yeah.
Damian: See until the conditions change. Let's see if inflation rears its head. Let's see if earnings start to deteriorate. Let's see if Trump potential tariffs actually impact margins. And we'll make decisions. But to just believe that you have the flux capacitor from Back to the Future and you can anticipate and pinpoint when the market's going to face-- that's not how we operate.
Vitali: That's great. The breadth part is important. Because for a while during that two-year bull period--
Jose: [INAUDIBLE] stock.
Vitali: --it was difficult because you're sitting there trying to pick stocks, and there's very little breadth.
Jose: Your analysts would have struggled with that, right?
Vitali: It's demanding, right? That's always a demanding job. But right now as you look at that-- yes, that's 21 times market-cap weighted, right? But you're beginning to watch all of these smaller companies that hopefully do benefit from deregulation can open up their employment, can pick up economic activity that's hopefully beginning to be stimulated. That is creating a lot of investment opportunities. That's a stock picker's dream, and that's where we shine.
Jose: They're ready to hunt.
Vitali: They are ready to hunt. That's actually one of our five research principles, hunting for ideas, yes. So you're very correct.
Jose: That is the mindset at the end of the day for stock pickers, in that sense. And just to round off the discussion-- one thing I found really interesting is, the markets where money was at stake-- the prediction markets-- they got it right. But the polls got it wrong. Is this kind of the end of that polling cycle? Or are we looking at a new way forward, where prediction markets are a fairly good indicator of where political events--
Vitali: Someone's going to have a strong affinity [INAUDIBLE].
Damian: Yeah. Well, I actually think there's very, very strong informational content in the wisdom of crowds. And there is tons of academic evidence about this. When people actually put money in stake, it's clear decision-making. And prediction markets, I know there's biases about, like, whale bet here and there. But even after that, they actually normalized. And for the most part, they were predicting Republican Trump win consistently throughout this.
And that happened to be much more accurate than these polls, which are all over the place. I think polling falls to sampling bias. I'm not even sure how they're conducting polls anymore. Do you call people up?
Jose: It feels like they've been calling the wrong people for eight years in a row.
Vitali: Economic--
Jose: Yeah, yes.
Damian: Exactly. And I also think-- this is my own-- and they've written, actually, a few papers on this if you really want to delve into this. If you switch your polling from calling people up or actually interview to actually to call--
Jose: Or what would the neighbor do?
Damian: Yeah, what would the neighbor do? There's stuff like that. What do the neighbor do? Or even if you switch the form of polling-- if you switch to, like, online polling versus in-person polling-- people are crappier online. Have you ever looked at the comments in any of these feeds? People are responding more-- I don't know if it's because you can't see people online. But if you respond to polling online, you actually are a crappier person. You're much more negatively biased. And so that's just a function-- so anyway--
Jose: Anonymity.
Damian: Anonymity, right? So my point about this is that-- to how we started this-- I think betting markets will be much more predictive and will have much more informational content in looking at outcomes than traditional polling. Because I think that it's almost like a bygone era because of these institutional things of biases in traditional polling.
Jose: In a weird way, we might have a lot of certainty heading into elections going forward if we play this out. So stay tuned in that sense. Now, shifting gears a bit-- Vitali, you're a special guest here. You will be a recurring guest. But I'm going to ask you a quick bit of trivia. What is special about November 30, 2022?
Vitali: November 30, 2022?
Jose: Yes.
Vitali: Nothing comes to mind. Do tell me.
Jose: ChatGPT came out--
Vitali: The exact day.
Jose: --exact day two years back.
Vitali: OK. Good, good, good.
Jose: So we're nine days away from the two-year anniversary of this ChatGPT AI-- whatever revolution we want to call it. You quipped once, it's like a common-law marriage now.
Vitali: Yeah. You're now stuck with it.
Jose: You're now stuck with it. Yeah. So two years in, what's your thought? What's your thought process here? Where are we? Where are we going?
Vitali: I think, two years in, I think we can make some pretty firm conclusions. Sorry to say it-- people still, I think, say the judge is out on this, but I'm looking at the way that this technology is being adopted. And really, let's break it down.
All we're really doing here is taking enormous amounts of data-- really, everything that these models are going through is everything that's been ever published out there on the internet-- so enormous, enormous petabytes, terabytes of data-- and figuring out predictive mechanisms for understanding what the next word should be in these massive, parametric models that require huge clusters now of tens of thousands of GPUs or just these raw machines that keep scaling and scaling and scaling and become better and better at predicting.
So two years in, the use cases that we're seeing-- coding has been something that's been very prevalent. So different companies have different disclosure, but call it-- 20%, 30%, 40% of a code base in a large company might now be written by these machines assisting developers. But, of course, tech solutions-- so we've seen, actually, public companies get affected by this, homework-solution tools that support university students. Chegg, yes. You said it, not me. I didn't want to say the name. But we've seen this company just on their most recent conference call go out and say that students are not turning to us anymore because they are just going to ChatGPT and other LLMs for their solutions, whatever it may be.
So I think this is very real. I think that from a consumer perspective, we're waiting for a killer app. I think where it's going to come is in the domain of the giants. And it's really going to come for us as productivity tools, being able to find that appointment, book that appointment, ask a question about a particular element of information or data that you have in your inbox. Whatever it may be, I think those productivity tools, we're underestimating how impactful they'll be.
I think in enterprises where we're beginning to see it's real-- there's a lot of proof of concepts, a lot of IT services firms that are doing this. We're seeing early green shoots from companies like Salesforce and the incumbents in the software space that are putting forward their product. Really, right now, the word of the day is agents. They're putting forward agents that can--
Jose: AI agents.
Vitali: --agents that can perhaps do some of the more-- they've got all the data, right?
Jose: More human in a weird way.
Vitali: Well, it is. And it's beginning to augment and supplement human activity. So, look, I think bottom line is, it's here to stay, two years in. I think that this common-law relationship is going to turn into a long, long marriage-- long marriage. It's going to have ups and downs, like every relationship. But I think it's here to stay. Like any good marriage, it's going to cost a lot of money. We're seeing that-- we're seeing that just with NVIDIA's results.
Jose: And this is before kids too.
Vitali: And that's before kids. Right. Well, and I think-- thank you for completing the analogy. Because I think we're going to have some pretty good kids out of this relationship, and we're going to have them on a consumer side and the enterprise side. And I'm actually pretty optimistic that 2025, when we're sitting here a year from now, we are going to be able to reflect and say, you know what? There was that killer application that made employees more productive or that made your life easier that you were ready to pay for a little bit more.
Jose: So what's that point? Is it like, enterprises taking their time to adopt with the legal stuff, regulations--
Vitali: There's a lot of compliance. There's a lot of legal. There's, frankly, understanding of-- really, it's a new technological paradigm. I hate to use the word paradigm-- but there's understanding what it is that these models, that these parties are doing with the data that your enterprise might be uploading to them.
Jose: Correct.
Vitali: Right? And so that's all taking time. When we talk to IT leaders, those are all the headaches that they have. But at the same time, I think everyone is looking at this now and saying, I can't miss this train.
Jose: I can't miss this boat.
Vitali: No, I cannot. And it's going to take time. It all starts with proof of concepts where-- here's a million dollars. Here's a $2 million budget to a particular department to champion whatever it is that may be. So a very low-hanging fruit case that I think is just in early innings proliferating across large companies is customer call centers. So you've got these very-- call it difficult queries-- that some customers like to call and make. You know, can you explain this part of your policy to me?
And we all have that experience where we're put on hold while the associate goes and spends 10 minutes. Maybe they need to talk to their manager. All that is going away. Because right now, you're going to-- right now. This is happening, literally. But later on, we're all going to see it-- you'll be able to have that copilot right there with the customer service associate, recognizing what the query's intending to solve for and being able to provide that information upfront.
And these are big productivity boosts. You're taking hours and hours-- and employees actually can become more efficient. Your employee base can shrink in the long run. Every company wants a higher margin.
Jose: It also frees up employees to think and be more productive. Damian, from a portfolio lens, an overall lens, what's your take two years into this AI?
Damian: So what is our team very, very good at? If you actually boil it down-- and I'm always on-- Vitali's the co-head of research-- so him and Michael Brown as they lead our research efforts. I'm always on their case about these two things. And it's imagination and risk management. Like, risk management does-- and maybe ChatGPT again-- but the imagination part, right? I think ChatGPT is analogous to the iPhone. And, Vitali, 2007 iPhone?
Vitali: Yeah.
Damian: Yeah, 2007. And think about the first iPhone, right? When you first held an iPhone-- prior to the iPhone, our own Canadian awesome company at that time, Blackberry, everyone had a BlackBerry. People were like, no, I need-- they're like, no, I need BBM. BlackBerry Messenger for-- I'm dating myself with the greys. You need BBM to communicate, and I need to be able to type emails.
And Steve Jobs comes around. He's like, people don't want their phones to type emails. They want their phones to be a gateway to the world to access the internet and look at all the apps built. And now-- 2007, 2024-- we're only 17 years in. And think about the transformational change that your smartphone in your pocket has enabled your life.
And so why am I using that? Because I think we're in the early stages of gen AI, generative AI. And whether it's ChatGPT or whether it's Perplexity or whether it's a use case-- I still don't know if you know who the winners are. But we wouldn't be able to imagine the use cases 5, 10, 15 years from now. Because in our own personal lives and experiences, I am seeing much more usage of GPT.
I use ChatGPT to just help with my research efforts or help with writing. And it's almost like I'm using it more as a digital assistant. And I might be considered ahead of the curve. But in a few years, everyone will be doing that.
Jose: Everyone, yeah.
Damian: And Vitali said, you'll be more productive. But where we are today, it still takes imagination to think about what will be.
Jose: So on that train of thought-- Vitali, you have this interesting framework we've discussed about Carlota Perez and her thinking. For our listeners, if you had to think about-- some may be worried bubble x, y, z-- every time there's a technological revolution, people miss sometimes the long arc of technology. So can you walk us through that framework of Carlota Perez and how this time is slightly different? And maybe it's not even an AI thing, it's a cloud thing, like you've been saying for some time.
Vitali: Right. Well, how much time do we have to talk about this? But it is a fabulous framework that a Venezuelan academic, Carlota Perez, brought forward in 2000. What was different about her is everybody had for centuries now-- since Mackay's book in the 1830s, I think-- studied bubbles and the history of bubbles and the South Sea bubble and so many others. And that's very interesting. I think we've all read these books, and we've learned a lot from it.
But she took a very specific lens to study market bubbles in the context of technological revolutions. So those two have to match up. So now let's talk about bubbles when they form around a new technology. That's far less frequent. Because land speculation in Florida--
Damian: So bubbles around speculation or tulips in--
Vitali: All of that is excluded because those are not technological. Exactly.
Damian: Those are not technological or whatever. Yeah.
Vitali: Florida real estate and [INAUDIBLE]. And what she found there was-- obviously, a bubble's a bubble. But what she found there is that the first phase you're going to have is what's called eruption. So it's when this technology kind of first burst onto the scene, but it's only really out there and disseminated across the people that are in the know. So this is really what you had with large language models in '20, 2021, 2022, before the November 30 event. Eventually, a few capitalists, of course, sneak into the equation, venture capital. There's people that talk. And they realize--
Jose: They caught wind of the opportunity.
Vitali: They get wind of the opportunity. There's something there. And you, for a period of usually five to seven years, get into a kind of frenzy around it, where capital dreams the dream. The capitalists come. The bankers come to you and say, here's the TAM. We're going to build a future, and you got to raise money, really. And I'll take that 6% fee. And so the market just grows and grows and grows. And everybody-- of course, we know how these things form. We imagine TAMs that one day with these technologies will be validated--
Jose: For our listeners, it's Total--
Vitali: Total Addressable Market that one day will--
Damian: How big you can grow into.
Vitali: How big you can grow-- so one day, these are often validated, she found, by the technologies. But in the initial five- to seven-year period, we overshoot incredibly. And that's really what you had in 2000 with the internet.
Jose: So do you think we're in year two of this overshoot since it's like we're two years in this [INAUDIBLE]?
Vitali: What we've been debating here is whether we're really in an overshoot. Because I think the common, I would say, narrative is that we're somewhere in that overshoot. And so I want to be in it if it's in year one. I want to get the heck out if it's year--
Jose: Year four.
Vitali: --four. Yeah, exactly. And so, well, and then hence the valuation question, I guess. But what I think is really that-- and it goes back to what you were saying, Damian, with the iPhone analogy-- to me, I bring in the cloud. And the technological revolution of the cloud-- which, really, we should trace back to, I suppose, decentralized computing with AWS-- we'll just pin that around 2005, 20 years ago, for rounding and convenience.
Jose: When AWS comes in. But 2013 is really when--
Vitali: 2013 is really when we take off. But call it for 10 to 20 years. What we've been doing is, companies have been modernizing their IT architecture, their stack, generating enormous amounts of data-- 100 times more than they were 10 years ago-- and then putting that all, effectively, in central repositories that are readily accessible by the most cutting-edge tools. And we've seen prior-- we're talking about CapEx now, but we already saw 100-plus billion in CapEx deployed by the client hyperscalers. Those guys were spending a lot already, right?
And so now, to me, what I think is, this may be the frenzy. But what if this is actually-- so after the frenzy, just to fill this in, there's usually a bubble. But then there's the golden age of that technology after the bubble. And that golden age is when engineers and architects have had a chance to actually figure out all those millions of details that are really necessary for the full-fledged adoption of that technology. Because-- and when was this?
It was in the late '90s, I think. But Larry Ellison with Oracle, he brought forward what I think was called a Net Computer or something. But it was effectively what a Chromebook was 20 years later. The problem is that parts of the hardware were not ready for prime time-- things like touch screens, things like--
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--high-bandwidth connectivity. And, of course, the internet was not developed. There was no use case for that sort of visionary idea for another decade or two. But if you get to the golden age--
Jose: And you bring out that--
Vitali: And you bring in that technology, then you have actually a 10 to 15 year of just compounding the big tech of that in the last 10 years that is going to overshoot any estimate of the addressable market anyone's ever had. And that's--
Jose: Because you can't even imagine it, right?
Vitali: Yeah. Just like people probably said, 2011, I'm not to buy Apple stock. And it's quadrupled since then. So, cutting to the chase, what I think is that, actually, the cloud investment was really kind of that frenzy that we actually saw culminate in the bubble that we had of 2021, Damian. Remember--
Damian: Yeah, it was--
Vitali: --when all of the software stocks were bid up. Everybody dreamed a dream. We had the snowflakes of the world [INAUDIBLE].
Jose: So then, in that analogy, you think that the current AI, gen AI, is actually the application of existing infrastructure that was put in place. And even though people think of it as novel, it's actually like, think of it as more as the maturation phase of this.
VITALI MOSSOUNOV: Or the beginning of a golden age. Just like the social media applications of Facebook and the productivity application with Google--
Jose: Because of the Fiber.
Vitali: They were the golden age for the internet of '99, but they only came out after the iPhone allowed it to happen in '07, '08. So that's why I think your iPhone analogy is perfect. And I would posit that we are in the early innings of, actually, a golden age, and people who are looking forward to a frenzy may be sorely disappointed. So we have to be very careful, very careful.
Jose: Yeah. Because quality is-- the unprofitable tech bubbled in 2021 has gone sideways. Quality tech is--
Vitali: Quality tech is back to its all-time highs.
Damian: And the way I think about this is that we're in this period right now-- in AI specific-- where the arms dealers, the NVIDIAs, the Broadcoms are helping arm these companies, these hyperscalers, and building out capability. And for me, the golden age really is when-- how does the consumer company intelligently use AI to create better customer acquisition costs, to create higher margins?
How does the bank that we work for increase productivity by using AI to help-- and so I think that is--
Jose: So is that the next-- like, when does it go from AI or CapEx to AI monetization or use case--
Damian: I think we're there--
Jose: Where--
Damian: --happening now.
Jose: So we're in that transition phase where now use cases are just going to gradually--
Damian: Well, look at-- and Vitali can talk about this. But I was just thinking about more-- like, Meta, Facebook. Meta has been very, very successful in having AI recommend and ad placements, ad timing, and curating how-- it's all AI-driven now. So I don't know if you want to talk about just-- we're already seeing use cases for existing massive companies monetizing their AI spend in real time and seeing returns on it.
Vitali: I think Damian nailed it. I'm going to pivot back to Microsoft because-- let's just say it this way, actually. All of this is really bullish for margins, OK?
Jose: Correct.
Vitali: And why it's bullish for margins is what we've been discussing-- these are going to be good developments for unlocking the creativity of your employees, for training to do different tasks that create more value for your organization. And ultimately, though, you will have a lower cost base.
And why I bring that to the Microsoft example is, right now, as with a lot of this AI discussion that I think is misplaced, there's a lot of skepticism and a lot of almost animosity for this. So you hear this around Apple where people will go out and say, Apple Intelligence, that's not any good.
Jose: This is the Luddites from before?
Vitali: Well, but they're getting a lot-- I'm not defending or saying--
Jose: No, this is just where-- like, the Luddites being the people who--
Vitali: I know, yeah. The people who are just--
Jose: --who are against the steam--
Vitali: No, but I think there's some justification because Apple has not been at the forefront of some of these newer technologies. But let's not get into the rabbit hole. All I'm telling you is that whether Apple Intelligence is ready for prime time as of November 2024 or ready for prime time as of May 2025 is such a moot point. And we should really not get lost in a few months of difference.
In Microsoft's case, just where I started-- Copilot. So Microsoft Copilot, they've got a very successful version of that for coders [INAUDIBLE].
Jose: For GitHub, right? Yeah.
Vitali: But there's a productivity one that integrates into Microsoft Office that can suggest to you how to write an email, can draft an email for you, can autofill in a more complex way some cells in Excel, format your presentations-- a lot of hate for it as well right now. So you've seen big firms adopt. Others are saying, you know what? This isn't saving me four hours a week. It's only saved me 15 minutes. I hate this thing.
And I think, again, it's just so myopic because these tools are not finished. These have not been shipped as their final--
Jose: In a way, they're the worst they'll ever be, in some sense.
Vitali: That is such a good way to put it-- and their cost. So think about-- the average knowledge worker in the US, $5,000 of salary-- I'm not even talking about the social benefits and everything else that's crept in. But Microsoft Copilot, the list price is $30 a month. So to me, of that 6 trillion pool of knowledge worker labor in the US, the addressable market we're talking about-- it's so enormous. Because for a company, deriving even a 1% of the probability already validates the price tag on all these things, even in their very initial, "the worst that it's ever been" version.
Jose: Yeah. No, that's fascinating. And yeah, these big, technological changes, when they happen-- if you--
Damian: It's hard to see the forest for the trees. Vitali said something that just-- Vitali says a lot of things that trigger me. But he said something that--
Vitali: I haven't heard that word in a while.
Damian: He said something about how margins and how this is going to be additive to margins. And it ties back to something you were talking about, Jose, about valuation. When we think about valuation, we don't think about just traditional. We think about like, cash-flow generation. And a big component of cash-flow generation is whether you can expand margins.
And people-- what I mean, people, I mean, the marketplace has been skeptical of the US market expanding margins now for two and a half decades.
Jose: Pretty much, it's just been on a straight way up.
Damian: And so people are using a mean, an average valuation multiple, even though margins are 2 and 1/2 times where they were in the 1980s. It's just a more profitable, higher-margin market. And I'm not even talking the best case. I'm just thinking the normative-case scenario of AI allowing companies to be more productive and having improvements in margin. That should be higher free cash-flow generation, which should warrant a higher value valuation. Sorry, Vitali. I know. But I loved how that all came together.
Vitali: No, that makes sense.
Jose: That's a great way to wrap up this segment itself. Because it's two years in. We may feel a little like-- what do you say-- overexposed to this idea. We've heard it a lot. We might be a little bored about it. But it's real. There's something completely tangible about it, and it's going to shape the way--
Damian: Well, yeah. My-- this is not advice-- but I think everyone listening on to this should probably start-- well, maybe ChatGPT use for search for [INAUDIBLE] use, like [INAUDIBLE]. You have WhatsApp account, use Meta AI for free, or download [INAUDIBLE] cloud or download the other search engine. Who am I thinking about? Perplexity, perplexity.ai. And it's use case, right?
Jose: And get used to the feel with this as general people because this is coming. And if this is a tool, it's in your advantage to actually get familiar with it and go with it. So that's a good segue. Now we're in a Christmas season. This is a shopping season. I'm not asking you what you're going to buy.
What are you expected-- what do you think consumers-- going ahead for next year. What has been the story this year-- in terms of consumers, the health of consumers, where they are-- are they now back in an optimistic mood in the US and maybe, by association, Canada? And what's ahead next year? We're in that holiday season. Is that cheer going to sustain?
Damian: Yeah. Well, I think consumption still remains bifurcated. And what I mean by bifurcated is that the median- to high-income consumer is fine. They've been fine the entire time. They continue to take extensive vacations, continue to consume in high-end luxury. I think the low to mid consumer is challenged. But when you look at just things like University of Michigan or conference surveys and stuff and you stratify it, you're even seeing improvements there. So people are feeling better.
Like, we're filming this on a Thursday. Initial jobless claims are out today. There at 213,000-- got to go back five decades to be this low of a number. So consumption, I think people-- and I'm not sure how to-- people feel worse than it is.
Jose: It is, yeah.
Damian: And maybe it's the election. Maybe it's uncertainty. Maybe it's-- like, the [INAUDIBLE] talking about we're on the brink of like nuclear annihilation. But I think that too is subsiding. And as we go into the holiday season, I'm pretty optimistic about consumption. But I want to give Vitali a chance to highlight our research team on this.
But the consumption dollars, how they're being spent in the companies we invest in is changing, like the business models. Today is the day after Target reported, and Target's got a bull's eye in the wrong sense. It's--
Jose: Bull's eye and terrible performance.
Damian: Yeah, right. And maybe-- I think that's more interesting, like how the consumption dollars-- which I think are growing and people are going to spend is going to be--
Jose: But where they're going is changing.
Damian: Yeah, but where-- what gifts, what's under the tree-- I think is very, very unique and different. And that might be what we're focused on.
Vitali: And it's interesting because there's what the consumers want, the change in consumer preferences, the ability of the consumers to afford. What about the companies, right? And I think that's-- Damian teed that up very nicely with Target. Because Target results were terrible, right? And yet, you look at the performance this year of Amazon on the retail side. You look at the performance of Walmart, look at the performance of Costco. And the numbers are very different.
Damian: Yeah. And just on that right, put some numbers to that-- so all of those, by the way-- Target, Costco, Walmart, Amazon-- are aggregators. They sell these stuff that other people make. Target's sales yesterday, I think it's 0.3% same-store sales, 0.3 or 0.8-- either way. By the way, for those on the call sales, same-store sales are, your existing store base, how much your sales have grown. They were flat at Target, below inflation. Inflation's 5% or, like, 3% or something. so target's not growing with inflation versus the other companies.
Vitali: And what we do as analysts-- there's focusing, of course, on the demand side of the consumer. But then the supply side of the company, we're in a world where these column aggregators-- column monopolists to some degree, but the big players-- have such enormous reach and capital and really power of data that they're harnessing. Walmart's now kind of becoming known for that--
Jose: Of that data company effectively, yeah.
Vitali: --that they're beginning, if executing correctly-- which is what we monitor. What is the strategy? How is the execution of that strategy? But if done well, it's the great powers-- not just of tech anymore, but the great powers of every industry-- that can harvest economics. So those three companies this year-- our analysts did some really good work on this. I think the number he flagged to us-- it was Julian-- is 2/3 of incremental consumer dollars are flowing into just these three companies' coffers as opposed to 20%, 30% in years past.
So probably there's a demand side element to that where customers are looking for deals. But there's also supply side where the value proposition that Amazon has been able to bring you with Prime and next-day shipping, Walmart's new subscriptions, the pickup at the store, what they've done with their pricing, Costco's-- and even, you see right here in Canada-- look at Loblaws, a company that had such good execution. And they've picked up-- much like Dollarama. You see Dollaramas now everywhere, taking advantage, I would say, of the need for consumers to find affordable goods out there.
But Loblaws-- you might have noticed downtown-- they've had the no frills springing up everywhere.
Jose: It's now opposite my condo now.
Vitali: Well, and what a testament to a company's strategy and execution, smaller footprint, going and identifying what the consumers want, what the need is in the market, and executing very well towards it.
Damian: I think what's changed-- and I've been in markets for-- it's going on 20, 23 years or something and--
Jose: Almost getting your silver jubilee now--
Damian: Yeah, I know. I'm very--
Jose: --a couple of years more. Yeah.
Damian: What really changed is that people used to-- mean reversion used to work. And now what's actually happening-- and Vitali's talking about business models and consumer that have been taking up the lion's share of new consumption dollars. You're having this winner-take-most concept.
And it's uncomfortable for people. People are like, oh no, this company has done really, really well, and it's been taking so much share. It can't continue. And then you look at Amazon and you're like, OK. Retail sales when Amazon started were, like, 4% of total sales. And now there are 11 or 12 of what you can-- and they can go up to like-- I don't know. What's the upper limit? In the UK, they're over 20. It's more dense, the population base there.
But the thing is that people feel uncomfortable. And that's where I think fundamental due diligence and thinking about how these companies can grow and, What is the competition? and, what is the TAM, the addressable market-- that is super important.
Jose: So just thinking ahead-- this has been an interesting time for consumers. You go back five years back. There's no inflation. There is no COVID. Life is different. But fast forward five years later, there's a once in four decades inflationary spiral that people have not seen-- COVID, obviously.
How have consumers changed? Are they going to be back to 2019 or, in general, people's habits have been altered permanently? And the trick for us is identifying how the habits have changed-- what's your thought process?
Vitali: Well, I think that-- I don't want to-- and Damian's the former consumer analyst. But I don't want to overestimate the permanent change that has happened to the human beings and consumers. We do tend to repeat in-- at least rhyme with-- the past.
Jose: Rhyme, OK.
Vitali: But I don't think we can say there hasn't been a permanent change. What I would say-- that even though, for the most part, we've observed inflation being defeated, one thing that I think needs time for decay is the perception that the price level of things are very different. Affordability has declined.
Jose: OK, elaborate.
Vitali: Well, if your home has gone up or if the cost of money has gone up by 100%, your home-- or if you don't own a home, a home has gone up by 20%. Groceries have gone up by 40% over the course of the last four years. You can hear from the media all day long that inflation-- let's say it goes back to 0. You can hear that all day long.
Jose: But in your mind--
Vitali: But the fact of the matter is, your affordability is impaired relative to what you believed it to be five years ago. And that takes care of itself through economic growth. You would think, in that environment, rates do fall. Economic activity picks up. Wages should grow. And they're still growing at healthy levels slightly above the range of the last decade.
But I just want to have that point that I believe in-- is that it hasn't been a structural change, but I think there is some period of time for that mindset that-- it requires it to thaw and decay. Because it is damaged. There's been damage. There's scar tissue there. And it's not going to be a quick interest rate cut that solves that.
And I think the second thing is what Damian said, just parrot on that. You've had these massive technological aggregators that keep getting better and better and better-- Airbnb, Booking, Expedia, to a lesser extent, of course, the Big Tech giants, the hotels, Uber. So everywhere you go, their ability to serve you data powered by AI, whatever insights, their ability to know you, use your data to serve you a product is like nothing I've ever seen. Hence why Damian said there's no mean reversion.
So we need to be smart. We need to identify how the consumer's the same, how they're different. And then we need to figure out which of these platforms are good stocks to put it bluntly.
Damian: Maybe on the thing on the consumption angle as it ties to inflation-- it is corrosive. I can't remember which Federal Reserve, head of federal-- but they said that we're doing our jobs when consumers are not talking about inflation. Like, the Federal Reserve is doing their job when no one's talking about inflation. Because inflation's, by the way-- on average, they want to target 2%. You can't have zero inflation because you risk--
Jose: Then there's no growth.
Damian: --that you risk on. So right now there's still scar tissue, using Vitali's words, or still muscle memory. Like, oh my god, inflation. And a good way to measure this is to look at wage growth, less inflation. So in the last three years, it was negative. That ratio-- what I mean by that was that inflation was growing faster than your incomes. So when people said they felt poor, that's a statement of fact. They were poorer.
Now, wage growth for most of this year has actually outpaced inflation. But you haven't made up for the shortfall. And so people are like, oh my god. The price of eggs has gone up. And, yes, it's not going up anymore.
Jose: But it's still nominally--
Damian: It's still nominally than where it was pre-pandemic. So I think you just need people to season into that, and it will take time. So that's how I think about inflation. Inflation is in the right direction. But it takes time for people to feel like they're no longer-- they still have scar tissue from the heightened inflation from a few years ago.
As I think in consumption and just what people are looking for-- people looking for, in my mind, two things. They're looking for convenience, and they're looking for individuality-- convenience in the form of--
Jose: Personalization and convenience.
Damian: Convenience, like personalization and convenience. Like, Amazon-- I don't know-- the Fernandes household are Amazon Prime members. I think, how much can Amazon raise my Prime membership, and what is my pain point where I say no? It's probably-- I shouldn't tell this to Jeff-- but it's probably 50% higher. I have no idea.
Jose: Yeah. You wouldn't really think about it--
Damian: Because it's just so much more convenient, having access-- and by the way, I get Prime Video thrown in for free and I get all these other additives thrown in. So I think there's a convenience aspect that is very, very valuable. But then there's also the personalization. And what we're finding in consumption stocks that we like is that they actually have been able to provide-- consumer surplus being the economic term but-- value for their consumer. And that is truly unique.
Jose: No, it's interesting, yeah. Even GLPs, the eating habits-- a lot of things in flux in the consumer world.
Vitali: Technological disruptions.
Jose: Technological disruptions. I would say, for stock pickers, this is probably one of the best environments to actually operate in. Because there's dispersion. There's change. There's a lot of turbulence in complete industries being turned over.
Vitali: Stock pickers with process--
Jose: With process, yes.
Vitali: --which makes it especially good because-- and there's also herds, herds of speculators and "investors"-- quotation marks-- that are swinging securities far outside relative to their intrinsic value and hence process opportunity.
Jose: Nice. I think that's a fantastic discussion. And to wrap up-- I said I wouldn't ask, but what's on your Christmas shopping list, on a personal level? Yeah. What's on the agenda? What are you dreaming of, Vitali?
Vitali: I'm dreaming of what gift to get for my wife so that she's happy.
Damian: I was exactly going to--
Vitali: I don't think about myself at all.
Damian: They were like, what does the family want so they won't be disappointed on Christmas Day? Yeah, I can't think of any really cool gadgets out there that--
Vitali: I'm hoping for your generosity again because-- no. No, because my older guy, I think 90% of the clothes he wears are hand-me-downs from Damian's boys. So every time we look at it, it'll say [? Gabe ?] on it. My wife's like, where'd did we get this again? I'm like, Damian's kid. So I'm looking forward to your continued generosity.
Damian: Yeah, there we go. We're--
Jose: On that note, season's greetings to everyone. Merry Christmas. It's been a fantastic year for the markets and for many of our strategies. And we have an all-star team that continues to strive to keep performing and delivering the goods. So thank you, gentlemen.
Damian: Always a pleasure chatting.
Vitali: Thank you.
Damian: Thanks, Jose.
Jose: Perfect.
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