AI remains dominant, but be selective and diversified

With correlation spiking, investors need to dig deeper for diversification, says Jyotsana Wadera, senior investment director, equities, in the Global Investment Strategies group at Putnam Investments.

Wadera said as assets that normally move independently of each other start moving in unison due to large macro drivers and market stress, broad asset-class diversification now offers less protection.

“The focus on diversification should be on a company-by-company level,” she said. “We want to have a mix of companies. We want to have structural growers … but there’s also what I would call steady growers.”

Speaking on the latest episode of the Soundbites podcast, she said she specifically looks for companies with strong balance sheets, cash flow durability, growth drivers and different segments of exposure.

“When we think about diversification, [it] is having exposure to different types of companies, not just those exposed to AI, but those that have a negative correlation to [the] dominant force in the U.S. markets today,” she said. “That’s how we think about diversification.”

Names she likes

A good example is Caterpillar, a global manufacturer of construction and mining equipment, diesel-electric locomotives and industrial gas turbines.

“Caterpillar has typically been considered a cyclical name within the industrial sector, but today has unusually strong secular tailwinds, and that’s the type of companies we like to invest behind — those secular growers,” she said.

The company will benefit from growing U.S. infrastructure spend, the global energy transition, and the skyrocketing demand for power as it relates to AI data centres.

“The power and energy segment —generators, gas engines, grid support for the U.S. — is now a major driver of earnings,” she said. “That business was up over 37% year-over-year.”

Also tangential to the AI theme, she likes American Tower and Vulcan Materials — both of which are ‘picks-and-shovel’ types of companies with true moats and competitive advantages expected to grow steadily through a variety of market environments.

She pointed out that American Tower is one of the largest tower companies in the world, with properties throughout the U.S., Europe and Latin America.

“When you use your cell phone outside of your Wi-Fi zone, you’re going to probably hit an American Tower tower somewhere,” she said. “They will continue to generate revenue. And we like that model very much.”

She also likes Broadcom, a global technology company that designs and develops a broad range of semiconductor and infrastructure software solutions. The company doubled its revenue year over year to $8.2 billion, and it has a backlog of contracts that portends continued revenue generation even in downturns.

“It doesn’t specifically classify as a Mag Seven,” she said, “but nowadays, some folks talk about a ‘Mag Eight.’ Broadcom would definitely fall into that.”

Wadera warned that after a couple of year of solid AI-driven growth, investors may need to shake off a growing complacency and recommit themselves to being cautious and prudent.

“Everything has gone up and to the right. So, I do agree there’s some laziness or assumption that that will continue to be the case,” she said. “Be selective and be diversified. Active management is critical and will matter going forward.”

She said the long-term winners in the AI space have not yet been determined. And if the dot-com bubble is any indication, there will plenty of bankruptcies as companies jockey for position.

“Not to say that the mega-cap names can’t continue to outperform, but I do think even within that cohort of stocks, there will be winners and losers,” she said. “I continue to see very meaningful upside to U.S. equities, particularly with earnings growth and, of course, AI-driven investment. But now more than ever, advisors need to be selective. And that’s the bottom line.”

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.