Jordan Wong

Alright. Hi, everybody. Welcome back to Tech Talk. Of course, if you're tuning in for the first time, Tech Talk is a monthly web series where myself, alongside Marcello Montanari, managing director and senior portfolio manager on the North American equity team, as well as Rob Cavallo, senior portfolio manager on the North American equity team, sit down to talk about all things to technology and healthcare related.

Marcello, Rob, welcome back.

Marcello Montanari

Thanks for having us.

Rob Cavallo

Thank you.

Jordan Wong

Well, we’re more halfway through the year. I was thinking for this month's episode, you know, there's still a number of headlines worth, worth discussing. Of course, on the tariff front, we're getting new developments seemingly every week, so I do want to talk to you guys a little bit about that.

We have seen, you know, through the course of the first six, seven months, this rotation within healthcare, so, Rob, I do want to get your thoughts on the healthcare sector in general and maybe how you've tweaked positioning within portfolios like the RBC Life Science and Technology Fund. It was a strong earnings season for a lot of the Mag 7 cohorts. So, I'll want to get your thoughts on some of the takeaways from that.

And then I do want to touch on a topic that’s a prevalent theme within your funds, but I think just with all the excitement around AI, we haven't really talked about cybersecurity all that much on the program. And so those are some of the topics I'm hoping to hit at today.

And maybe if we start on the tariff front, like I said, things seem to be changing, you know, week by week. So just broad thoughts on where we stand with tariffs today. But also, I want to get your thoughts on Section 232. Now Section 232, for our viewers, is aimed at tariffs largely on steel and aluminum, but it also includes manufacturing and goods deemed necessary for national security.

This, of course, spills out into the biopharma and semiconductor space. So, if I could get your thoughts where we are at with Section 232 with regards to biopharma and semiconductors. And then, you know, Rob, if I can add a part two to this question, also on the policy front, there's been lots of talk around this most favored nation pricing model with regard to the healthcare sector. So maybe I could get your thoughts on where we stand with that as well.

Marcello Montanari

Okay, maybe I'll just start off and make a couple of general comments, and then I'll hand it off to Rob because, you know, he's more into in the thick of things, given the semiconductor focus that he has and given that tariffs have been kind of impactful, more in that area than in software.

So, a couple things. So, the Trump administration, when it comes to technology and AI, in particular, is kind of taking a little bit of a step back. And I think there's two things to keep in mind here that may have caused this.

The first one, I call it, you know, “your adversary gets a vote in all of this.” And as the Trump administration has gone around throwing tariffs on everything that can move, the Chinese showed that they actually have some cards to play, and they flexed some of their muscles. And in particular, what they did was they started putting restrictions. The Trump administration was talking about denying access to AI chips and things like that.

The Chinese retaliated by basically putting restrictions on rare earth minerals that are used for all sorts of uses whether it's batteries, electric motors, guidance systems for military equipment radars, you name it, there's rare earths in everything. And it doesn't take a lot of missing components inside a value chain to basically bring an entire assembly line to a stop, or bring a factory to stop, or an entire industry to a stop. So, the Chinese, they started flexing their muscle on this, and the Trump administration quickly realized that they're not operating in a vacuum. So that's number one.

And then the second part, I would call it “be careful of unintended consequences.” And this whole noise around AI chips and everything has all been about, you know, trying to “stymie” China's competitiveness in this area and keep the U.S.'s lead in AI. There's a school of thought out there that says, the unintended consequences might be that you end up just pushing the Chinese --and they're very intelligent people and they got great engineering--you'll just end up pushing them to develop their own ecosystem and their own value chain.

Now that would obviously take a lot of time because the U.S. lead is quite something, but it's probably not completely unsurmountable. What China does have in its arsenal that the Western world doesn't, is it seems to have no trouble getting access to power. And so, you can use a lot of power with a lot more weaker chips to get some of the same results.

So, there was a steady flow of tech luminaries that were going to visit the White House, like Jensen Wang, saying, in order for the US to keep its lead in this technology, it's better that, that you know, we allow China in. And instead of being completely adversarial, maybe China ends up contributing to some of the technology that's been developed here. So, I mean, I'll just leave it there and hand it off to Rob where he's got a lot more insight in terms of the specifics.

Rob Cavallo

Yeah, yeah. I'd say, first of all, things are changing by the day and the things that we're hearing in discussions with industry folk and senior management at companies, are that things are really still very fluid and very unknown at this point.

Pharma and semis are interesting from the same perspective in that these are very long dated manufacturing and supply chain. So, it's not as easy as to say we don't want to ship for the Christmas season anything from China or APAC anywhere. It's much more complicated than that. I think what we're looking to see is, what are the timelines for some sort of implementation of a tariff structure? Because it's probably going to happen, you know, whether that's a 10, 20% tariff, we don't know. It would probably be not out of line with what we're seeing in other areas of the economy.

You know, semiconductors are interesting because the actual raw chip coming into the United States is very minimal. It's really part of finished goods. So, like, how are we really going to account for this on a component basis within things like iPhones, computers and same thing from a pharma perspective. Are we going to do it based on existing drugs, just new drugs? Bottom line, what I'm hearing is -- and this is coming from a number of like senior management of pharma companies -- that you need to show commitment over a long period of time that you're going to build and invest more into the United States. And it's a game right now of who could put out the bigger press release numbers of what their commitment is over the next five to 10 years.

So, you have companies like Johnson and Johnson for instance saying, “Over the next five years, we're going to build enough capacity so all of our new innovative drugs will be mostly manufactured in the U.S. for the U.S.” I think that's what you're going to see. I’m looking for phased in timeline structure. What's that going to look like? Because if it's just one hard date within the next year, it's going to be challenging and you're going to see numbers for both semiconductors and pharma come down because of that.

So hopefully calmer heads will prevail. The things we're hearing is that that's the road we're going down but clearly, we need to get some more information as it relates to Section 232 probably very, very soon, maybe even before this next webcast gets sent out to the folks out there.

Just to follow up on the most favoured nation policy. Basically, this is an executive order that the United States should not pay more for their drugs than any other basket of developed market economies out there. Think of the biggest EU countries, Canada, etc. This again, it's a very complex issue because the U.S. has a different system in terms of how you look at gross pricing and net pricing versus most other markets where you just look at net pricing. So, the actual disparity is much less than the headlines that you'll see but it's still meaningful.

Importantly, last week we got a bit of an update. Four points from a Trump executive order as it relates to most favoured nation that actually looks more positive for the drug space. It looks like it might be just for Medicaid, not Medicare, which is the bigger spending component of the system, and it might just be in new drugs and not in all drugs. And there's some potential levers there that actually might be positive in terms of changing the model in being able to go more direct to consumer.

So, net, I actually think the executive order we saw was better than expectations and hopefully starts to be a bit of a relief overhang for the group because clearly the uncertainty around the pricing model has weighed on these stocks for many years and especially the last six months since Trump took office for his second term here. So, I'll maybe stop there just in the interest of time.

Jordan Wong

No, that’s great. Really appreciate that.

Maybe pivoting, I do want to talk about earnings. Particularly, we saw some pretty strong earnings results across the Mag 7 cohort, notably Microsoft and Meta. So maybe just talk to us about those two stocks and some of the key takeaways that you took from the latest round of earnings.

Marcello Montanari

Okay. So yeah, both companies put up some really strong numbers and across the board we've seen some pretty good numbers from a lot of the tech space.
But you know, for Microsoft it's all about Azure. Although, the rest of the business was firing on all cylinders, Azure is basically their cloud computing platform. Their growth was just phenomenal. Basically, the last quarter surprised us when it came in at around 35% YoY growth and this quarter came in at 39[%]. And so, there was some pent-up demand.

If you recall six to 12 months ago, Microsoft was talking about how they were having some capacity issues and that was hindering some of the growth there. But you know those capacity issues have since been rectified and we're starting to see all the growth come through here and a lot of it is driven by AI.

So, you know, in a market that's fixated on the AI theme, to get the company that, as far as in the infrastructure space- short of being a semiconductor company- for a company in the infrastructure space that does a lot of work in applications, these are the type of things we want to see moving forward and positively. Basically, it delivered really well, just great results there. And you know, all these names have some fears around them; look at the capex that's being deployed into all of this, is there ever going to be a return? So, when you see these types of numbers come out and this type of growth, it just kind of calms the fears, that yes, there is in fact a return on investment.

On top of that, in terms of a lot of the infrastructure stuff that Microsoft does, everything looked pretty pristine and pretty strong. And on top of that, the Copilot element of the business is starting to gather some strength and starting to show some positive results. If we were moving back six months ago, there was a lot of excitement about Copilot, but the prevailing view was it's good, but it's not totally there yet. Anyway, that's starting to improve and the narrative around that is getting a lot better.

In terms of Meta, just again, blowout numbers. Meta is one of the main companies that actually benefits internally from machine learning and AI. And it's showing up in just about every single metric that's used to follow Meta.

Whether it's daily active users, whether it's the amount of time spent on Instagram video or on reels, you name it, every single metric is heading in the right direction. And then there's pricing and monetization, and all of that is working out. And Meta, within its digital advertising products, it's got a product called Advantage Plus. What Advantage Plus does is, it basically automates the entire digital advertising process for small and mid sized businesses. Well, for any business really. But it really benefits small and mid sized businesses more than anyone else.

And Meta’s of the view and Google's the same because they have performance max, very similar. So, you just basically give them an amount and they say, “what's the return you want on this?” And they deliver it. And now you're starting to put generative AI tools in front that can create campaigns on the fly. So, the entire process, from creatives all the way to the output and the return on ad spend is being automated which gives us small and mid sized businesses quite a boost going forward. And we could maybe even argue that we saw some benefits of that in Shopify's results this morning. So, all this is kind of coming full circle. Again, we're starting to see the fruits of all the spending that's going on in this space and it's showing up positively and that helps basically allay some of the fears in terms of returns.

And then to just delve briefly into Google for a minute. We saw the same thing. Very strong results in their Google cloud where it accelerated as well. So, the entire cloud computing which is being driven in large measure these days with AI is all moving in the right direction. So that just kind of adds fuel to the fire here.

I just want to mention that in all cases, all these companies basically raise capex again. And the market, for the most part, just shrugged it off and said, okay, we're seeing the benefits of the top line, so we're okay with you spending extra money here. And that's the mood of the market right now, but that could change tomorrow, you never know. But at the moment it's like, if we're seeing results at the top line, we view this as being fuel instead of something else.

Jordan Wong
No, that’s great. Thank you, Marcello.

Rob, I want to talk a bit about healthcare. As I mentioned earlier, it's been a rollercoaster year for the sector and so maybe you could just give us an update on your thoughts, views and outlook and any positioning changes that have taken place in the Life Science and Technology Fund since the beginning of the year.

Rob Cavallo
Yeah, so definitely been a roller coaster. It actually had been leading the market, it was, I believe, the best performing sector in the market up until one week or so past Liberation Day.

I think you know, as the market bottomed on April 8th/9th, healthcare’s relative performance topped, and I think the biggest issue has been a trigger back or rotation back to risk on broadly across the market. And healthcare has helped fuel that trade along with some other defensive areas.

It hasn't helped that the rest of the economy, and the rest of the market got their tariff medicine in and around that time and the thinking then as we talked about with tariffs, MFN, that overhang was still to come and again, it was another reason to kind of be shy of the group and look for other opportunities elsewhere in the market.

Importantly, I think as you get past the next maybe month or so, and we get resolution around both the most favorite nation policy and some of the tariff implications for pharma as we discussed earlier in the podcast, I think the clouds will start to clear for healthcare and there are reasons to get optimistic. Valuations, the sectors trade at a 30% discount to the broader market for better earnings growth in 2025 and 2026. M&A probably poised to accelerate again once we get past this uncertainty period. Key subsectors in the group have gone through rolling recessions over the past two to three years. So, areas like tools, health insurers, more recently. And I think tools definitely were in the early innings of the recovery insurers. As we get to the latter part of this year and potentially into next year, there's recovery there. There are reasons to be optimistic on the pharma side. There are some key high profile trial readouts coming that again could get investors excited to be back in the group.

And so, we do think there's opportunities and we've been underweight through this period, but we've more recently started to add back some weight. “SMIDCAP” biotech, so small and mid cap biotech, has been an area we've added a little bit of weight to. Also, within large cap pharma, just some defensive characteristics as we get to a bit more of a challenging seasonal period for the market more broadly. So, names like Johnson and Johnson and AstraZeneca in the UK.

The other notable thing is we've fully exited hospitals. We have been adding back some of the tool’s names, as I said, as they emerge from some of the recessionary issues they felt. So that's kind of broadly how we've been thinking and repositioning within the group. But hopefully its set up for a better second half than we've seen the first half to date.

Jordan Wong
And Rob, maybe I could ask you to comment quickly. We saw some GLP1 news come out last week. Subsequently, we saw Novo Nordisk share prices fall quite a bit. Now, Novo is not a US name, so it's not in your benchmark, but maybe just brief us on what took place last week and if there are any concerns going forward on a name like Eli, which also operates in the GLP1 space.

Rob Cavallo
Yeah. You mentioned its not in our benchmark but it's a name we have owned from time to time over the years so very familiar with it and could see opportunities again on this reset, although we think it's still a bit too early here.

I think the Novo issues were probably more Novo specific versus a read on the market. But you know, it's August 6th, Eli Lilly will be reporting tomorrow so we'll have a better view after that. But I think it's a bit more Novo Nordisk. I think it's important to say one, they announced their new CEO, and they reset numbers coincidentally with this. So, there's maybe an element of kitchen sinking numbers for the new CEO as he takes his seat.

Two, Novo Nordisk, you know, look at the script data, they have been losing share to Eli Lilly so it's not a complete surprise.

Three, there are these things called compounding pharmacies, so like “hims” and “hers” would probably be the one of the more better-known ones. They're making their own Ozempic, so they make slight tweaks, and they can basically call it Ozempic, and they've been more in the crosshairs of this than Eli Lilly. Novo Nordisk was probably also being a bit more optimistic about how some of the compounding stuff goes away for various reasons, that are probably another podcast topic, but they are probably a bit more optimistic around how they guided around that.

I think the net of it is, this is probably more Novo Nordisk. I still think that Eli Lilly is set up “beat and raise,” especially on their obesity and their GLP1 portfolio more broadly. So, hopefully that answers your question, but I think again more Novo Nordisk than a market issue.

Jordan Wong
That's really helpful, thank you.

Now, Marcello, maybe we'll end the episode off talking a little bit about cybersecurity. It's a theme within your funds. Palo Alto, in particular, has been a long standing holding in your portfolios. We've seen a number of large deals in the cybersecurity front this year, Google Wiz and more recently, Palo Alto's $25 billion announcement to acquire Cyberark. So maybe just talk to us about these deals, your thoughts on the space and your outlook going forward.

Marcello Montanari
Well, we're still very positive on the cybersecurity space. The threat environment just keeps getting broader and broader, which means you need more and more cybersecurity solutions to combat what's going on here.

It's funny, you mentioned Wiz as well. In the case of Google buying Wiz and Palo Alto buying Cyberark, in both cases, those are the largest acquisitions ever made by those companies by a large measure. And the prices paid are quite attractive as well. Although Wiz went for a much higher valuation than Cyberark.

As far as Palo Alto is concerned, they're basically using a playbook that's been used in a lot of software space, which is basically to provide a platform. And to provide a platform you need to have multiple elements. And because there's so many different elements within cybersecurity, Palo Alto is trying to go to its client base. Their go to market approach is, we can be the one stop shop to provide everything. And provided that each of the components is at least good enough, they believe that their customer base will sign up for that. So that's basically a pretty major trend that we've seen in software for many, many decades, let's call it.

But on top of that, what's really hot right now is identity management. And I've seen reports that basically 80% of cybersecurity issues have something to do with either a failure or some sort of vulnerability in terms of the identity management and the ability of people to access things that they're probably not supposed to and things like that.

So that's where Cyberark sits. They sit on identity. And that's why Palo Alto went for big acquisition rather than the usual small tuck in that they would normally do. Just because this particular market segment has a lot more growth in front of it, but it's gotten to the point where it's got a critical mass already. So, I guess it was Palo Alto's view that might as well go for one of the leaders in the space that already has a market and then fold that into our platform.

And the thinking there is obviously that by adding this very important component to the platform they already have, which is quite powerful in and of itself, that it'll basically jumpstart the entire business and re-accelerate growth for the entire platform and for every component with it.

So that's basically the thinking that’s going on there. And we think that longer term this is the right move for them, and it'll ultimately pay dividends.

As far as Google's concerned with Wiz, acquiring Wiz was really more about just becoming more appealing to enterprise customers for the Google Cloud platform. And so, Google Cloud is the third largest. You got AWS, Azure and then Google Cloud is the smallest one. And Google doesn't have the kind of the enterprise “chops” as we'll say that Azure does. Like when it comes to Azure, Microsoft is number one. Every single IT manager has Microsoft on their Rolodex, if I use that old term, whereas Google doesn't have that kind of mind share within enterprise. So going after Wiz, which has a great customer base, it was viewed as a way of strengthening the appeal to enterprise customers. And on top of that, Wiz is what they call multi cloud. So, it can serve multiple clouds at the same time. And Google is just viewing this as a way to become more attractive to enterprise customers and then use the existing customer base to cross sell and eventually, in due time, take more customers from some of the competitors.

So, I think that's a different approach than Palo Alto, which is just trying to become a platform, Google is more about just making their own Google Cloud platform more appealing. And I think I'll leave it there.

Jordan Wong
That's great, thank you. Thank you, guys, so much. That is all I had on the agenda for today's episode, so maybe we'll wrap things up here.

As always, I want to thank you guys for making the time to speak with me, and for those of you watching, if you do want to learn more about strategies like the RBC Life Science and Technology Fund or the RBC Global Technology Fund, we do encourage you to visit our website at rbcgam.com Thanks again and looking forward to linking up again next month.

Marcello Montanari
Thank you.

Rob Cavallo
Thanks, a lot.