Jordan Wong - Portfolio Specialist

Marcello Montanari, CFA - Managing Director & Senior Portfolio Manager, North American Equities

Robert Cavallo, CFA - Managing Director & Senior Portfolio Manager, North American Equities

Jordan Wong: Hi everyone. Welcome back to our monthly web series, Tech Talk. My name is Jordan Wong, and of course as always, I'm joined by Marcello Montanari and Rob Cavallo, both managing directors and senior portfolio managers on the RBC GAM North American Equity Team, both responsible for products like RBC Life Science and Technology Fund and RBC Global Technology Fund. Welcome back, gentlemen. It's good to see you.

Marcello Montanari: Good to see you too.

Rob Cavallo: Thanks.

Jordan Wong: Excellent. Well, as folks who watch this know, we get together monthly and of course we use this time to talk about all things going on across the technology and health care space. We're only about six weeks into 2026. The S&P is, let's call it flat to slightly down. There have been some headwinds within technology worth noting, the sector itself is down only about 4%. Healthcare sitting kind of flat on the year. But when we look under the hood, there's been a ton of price action, particularly within segments of the technology sector. So, I do want to touch on some of those things and maybe we can start off with, big shocker, software businesses. Marcello, we talked about this a little bit in our last episode in January, but in the few weeks that have passed, we've seen another pretty massive leg down in those businesses and so it’s great opportunity to circle back on the state of software. Maybe I could just ask you to give us your thoughts again, sort of a State of the Union address for these businesses. It'd be great to know how you're thinking through all this prevailing negative sentiment, and to the extent possible, any thoughts around changes across your portfolios as a result of all the price action that we've seen in the last few weeks.

Marcello Montanari: There's a lot going on for sure. So, clearly we're in a moment of some pretty significant fear. If we think about it, AI as an investment theme, I think is kind of probably generally misunderstood from the bulk of the investment community. Of course, there's people who are all over this and specialists who really understand this. But when you have a lot of people who don't truly understand what's going on here, it's easy to develop fear when something isn't well understood. So, we're now in a situation where there's a lot of fear.

This kind of started in the summer when we started seeing certain software companies - the market was a little bit more discerning - it was basically saying, for example, if something like Adobe, which typically has a very probabilistic statistical type of outcome because you're creating images and things like that, you can easily say, well I don't like that image, but I like this one. It's easy to see if there's errors in images and things like that, I'm just using this as a broad example. Those type of businesses were perceived as being a little bit more at risk. So you started seeing them fall off and start to trade down, and there's been kind of this cascading effect where it's been one kind of cohort of software companies after another.

And I think the most recent fear that's caused this, and it's almost kind of like, how many times can the market discount the same narrative over and over again? Because we kind of just keep seeing this cascading effect on effectively, quite often the same story. So what kind of really triggered it was the coding tools that came out of Anthropic, the Opus 4.5, which I think we may have spoken about last time.

Jordan Wong: We did. Yeah.

Marcello Montanari: Most recently, now we got the Opus 4.6 which kind of ratcheted up a bit. And then OpenAI came out with Codex 5.3 which my understanding is that actually I'm pretty sure that 5.3 is actually built on or trained off of the new Nvidia Blackwell chips. This is like the first inkling we're getting of the capabilities of stuff trained on those chips and it's quite impressive.

There's basically been this narrative that's gone around that basically LLMs, the models, basically destroy existing software business models, or at the very least they truncate the opportunities. So, we're taking a cohort of companies which were viewed as being very high return, very high value, therefore trading at some typically higher multiples than the general market, to something that should be feared. I mean I'm not going to claim that I understand all of this because there's a lot of moving parts here, but it's easy to get really nervous and put the entire software space into the “this is too hard for me to figure out and I just want to get out.” So you get a buyer strike at the same time as people are selling it, and then you've got the passive components like ETFs and stuff, they're selling, and therefore the plan sponsors for some ETFs might have to do pro rata selling across the board, which leads to this indiscriminate selling now where the market's no longer discerning one group of software companies versus another one.

Because there are software companies that are actually are clear beneficiaries of this, like all of the data infrastructure companies, be it Datadog, be it Databricks which is private, but Snowflake and MongoDB and even Palantir (which is massively valued), has come down a lot and it's become completely indiscriminate now. So within all this, now you start to get opportunities. And so how do we treat this? In the funds, it’s kind of two ways. We're basically making sure that we understand the true risks underlying each software company and each software package that's there, and what the outlook will be if they can actually incorporate agentic elements into their products and therefore at some point reaccelerate their business, versus things that are truly challenged. The first place to start on that is to really understand the competitive moat that different software packages have around them.

I always use this example because it's the extreme. The extreme is like SAP and their core product, S4HANA, an ERP system that is a strategic asset for all companies that actually use it -it drives the entire business. It has immense amounts of hooks into internal systems, external systems, the domain knowledge that's involved in putting that together, the amount of people that keep it running. That's one extreme and you can see how that would be more resilient than something that might just be a point solution. So, we're going through and we're doing a full analysis of the software product. Intuitively, we already know all that, but we're kind of redoubling our efforts just to make sure. And so, we're picking the names we think that when this thing does bottom out - I'm not saying that's happening anytime soon - I think this has probably got a little bit more run, but when it does bottom out, we'll be there ready to pick away at names.

At the same time, in this business, you're always going to make mistakes. We're looking at names and said, this particular name, I made a mistake there. But the good thing is that the whole sector is down, I can swap from what I believe is a mistake into something that's being unfairly punished. So, we get the switch opportunity in the meantime. We've been doing some of that, a little bit of switching here and there. Keeping some powder dry to basically pick some stuff up when we feel more comfortable. If I was to use an example, you know, we've sold some Adobe in the past, some Nutanix, some Workday; and yesterday on Shopify, stellar quarter - clearly a beneficiary. Without a doubt a beneficiary. The market just freaked out that the margins are going to be a little bit lower going forward just because they're reinvesting to take advantage of a whole slew of products that they're rolling out. So, we kind of look at that and say, probably they're going to be a winner longer term, so maybe, place a little bit more of a bet over there while we've taken money from other places. I hope that that's helpful.

Jordan Wong: No, that's excellent. This current environment certainly is uncomfortable, but volatility inevitably does create opportunity within markets. Very quickly, while software is getting beat down, memory, on the other hand, has soared. Just quickly walk us through kind of what's fuelling all the price momentum within the memory businesses. You know, we're looking at stocks like SanDisk up over 150%, Western Digital close to 100% already, on the year.

Rob Cavallo: Yep, for sure. I'd like to throw this one quick stat on the software side just to drive home how indiscriminate it's been. JP Morgan has this basket of what they claim are AI resilient software stocks, and you can maybe nitpick about a name or two - but for the most part they seem fair. AI resilient stocks have outperformed software by like 6% or 7% as of earlier this week, but it's still down 30% relative to the market. So just to Marcello's point, it's just sell everything, we don't even want to think about it. We're at that point of the trade it seems like.

To your question on what's driving memory, what we've seen is just massive shortages and the market has realized that for probably (at the very least) for the next almost 18 months, probably well into 2027, we're in a massive shortage of both major types of memory. DRAM which is sort of the more longer, storage based type memory, as well as NAND, which is more the quick flash memory. Both are important components into the data centre and the whole AI trade. The DRAM side a bit more because these are chips that are basically sitting side by side on the actual system with the GPUs and whatnot. So the Microns of the world, Samsung, SK Hynix in Asia, these names - they're well sold out into next year and that shortage is not going to decline anytime soon. What this is doing is not only driving pricing for AI memory to heightened levels, but just even commodity memory. Prices are up, 70%, 80%, 100% sequentially. There's just not enough of this in capacity and that's really what's driven this trade. We can argue that maybe it's gone a little bit too far in one way. And if you believe in the memory demand like the chip guys, like Nvidia, the Broadcoms, the AMDs – they are probably not reflecting that same trade. There might be some tactical element there but it's really the shortages, just for simplicity, that’s driven the memory upside.

Jordan Wong: Not a good time to build your own PC right now?

Rob Cavallo: Not unless you're willing to pay hand over fist.

Jordan Wong: That's very helpful, thank you both. Rob, I'll stick with you and maybe we'll pivot and talk a little bit about healthcare. There's been a lot of noise in the obesity market so far in 2026. Maybe you could discuss your thoughts around the launch of the new oral drug from Novo, the pending Lilly oral launch, as well as pricing dynamics and what exactly all the noise around these digital pharmacies means.

Rob Cavallo: Yeah, for sure. At the start of the year, we had the launch of Novo Nordisk Oral Wegovy, so their oral obesity medication. It has well exceeded expectations. The script growth has just been phenomenal, which is good for Novo. It's also good for Lilly because beginning of April, Lilly's oral drug is likely to be approved and it'll be on the market soon after that. Oral is this big opportunity, and an opportunity where Lilly is going to probably beat expectations based on what's kind of priced into the stock today. So that's great.

What happened though is kind of building on this momentum. One of the online digital pharmacies, Hims, announced last week announced that they're going to come out with a copycat oral Wegovy, oral Novo Nordisk drug, and offer it at a fraction of the cost. I think it was $49 for the first month and $99 thereafter. Anyway, somewhere in the $500 price for six months purchased up front, which would be a discount to Novo’s kind of $150 per month pricing. We were very lucky, Novo Nordisk management actually happened to be in our office for a meeting the day this was announced. Just great balance on our end. So, we really were able to pick their brain.

Clearly, our view coming out of it was that this was illegal. The way these pharmacies work is last year, or two years ago, they were able to offer the injectable drug because those drugs were in a shortage. By law, when there's a shortage, these pharmacies are able to compound their own medications and offer it. Those shortages rolled off a year ago. They're still selling it, which they shouldn't be. The oral drug never had any shortages and Hims was really pushing the envelope here legally. We were sort of proven right in our view, and the very next day after this announcement, the FDA basically came out, they didn't call them out specifically, but basically said, we're not going to allow these copycat drugs to be able to basically come out and compete against authorized drugs that are not in shortages, and basically shut this program down. It did create a lot of noise going to the Super Bowl where the GLP1s kind of dominated the commercials in the U.S. from what I understand. But that's it, it’s basically a strong oral launch and these digital pharmacies, Hims specifically, really trying to piggyback off of it. That's being shut down, and it's really setting up an opportunity for both Novo Nordisk and Lilly to have upside to numbers on the oral drug launch this year.

Jordan Wong: That's helpful, thank you. As we wrap up the episode, quickly I'd like to touch on how the market responded quite interestingly as a result of some of the leading cloud operators most recent earnings. In fact, the market seemed a little bit bothered by the amount of CapEx increases that we've seen across this group. Marcello, maybe I can start off with you. Anything that you saw or witnessed, or picked up on, from the most recent earnings period that is maybe altering your view on any of these businesses or any businesses related to these cloud operators.

Marcello Montanari: Well I'm going to lump Meta in with this because they're one of the big spenders. Because you're focusing in on the CapEx, I think what I would key in is that, yeah, the numbers are big. The opportunity is at least they believe and we believe as well, that this is going to be a long-term secular growth area. What we saw though is like a bifurcating, because there's two companies that show incredible results coming out of this. So Meta is actually generating higher revenues. They're all generating higher revenues, but Meta and Google have used machine learning and AI to basically improve all of their ad complex, the ad targeting and all of that. All the tools that they've built around this, the generative AI portion where you can create ads on the fly is starting to take off, and the returns on ad spend is improving as well. That’s highly visible, we can see these two companies are getting great returns out of all of this. So, we’re kind of okay with them spending the money.

When they were making announcements like Meta had a great response with stock response and Google did as well, but they’ve both kind of come off since then. Microsoft on the other hand, the expectations going to the quarter were very high. In fact, management was talking about 37% growth in Azure, but the street was like really kind of at 40% and they came in at 39%. So, they beat management guidance, they beat sell-side consensus, but they just came in shy. The company said, if you were to believe them, that they had to use a lot of resources internally because they have R&D departments and they're building some of their own models and they're doing other things, and they said they had to take some of this capacity and turn it inwards for their own operations.

They said they could have easily been into the 40% growth if they were selling completely to external customers. But the market didn't want to hear anything of that. Then on top of that in their core software business like M365, there was a little bit of weakness there. Not material weakness, but anyway, high expectations, and then the high capital spending just didn't hit the same way it did for Meta and Google - which were just showing outsized revenue growth.

Then for Amazon it was kind of almost the same situation. But all of these companies, Meta basically uses its capacity for its own uses, but all of these companies have immense amounts of capacity coming on over the next 12 to 24 months. We've talked about that quite a bit. We're expecting to see an acceleration in all of these businesses. The atmosphere right now is very negative around everything, So that's kind of where we are right now. We think that the prospects here are still very sunny over the long term. So, we're still happy to be here.

Jordan Wong: That's great. Rob, any anything from your end to add?

Rob Cavallo: The only thing I would add is that given the level of increase in CapEx, questions are going to start to creep in about, what kind of growth or is it a decline in spend that you can expect into 2027? How is that going to filter through on the chip side? I think it's too early. I don't think it's fair to build in that these are declines. But when you start to see the types of stock reactions that you saw, it's bit more heightened alert that if we were to see a quarter or two quarters where maybe the returns start to hold steady as opposed to expand, it'll start to kind of question the 2027 spending outlook. It’s too early for that, but when you factor in that with the point that these companies are now going to be spending almost all of their free cash flow to fund this, just leaves a little bit less room for what the CapEx budget might look like going forward. It’s still too early, but something that’s kind of brought that a bit more top of mind than it was pre results, and what that’s going to mean for the semiconductor names.

Marcello Montanari: Those are good points. I just want to add one thing. Having done this as long as I have, one thing I’ve observed over the years is, and we’ve probably talked about it in the past, the market has trouble when it comes to spending, and it always depends on what the overall mood of the market is. But there’s a difference between fuel and weight. Fuel is like we’re going to spend money to basically fuel this business and grow it, versus weight, which is we’re spending money because, whatever, competitive challenges are getting tougher, and we need to protect it, stuff like that. Most of the spending here is fuel that these companies are spending to grow their businesses, but the market is in the mood of treating it all like, “this is weight. Will there be a return?” We could have put these same results in a different market atmosphere and gotten a totally different answer or response, I would think.

Jordan Wong: That’s excellent, guys. Thank you. That’s all that I had for today’s episode. There is, of course, so much going on. So, if there’s anything you think we missed or should touch on, I’ll hand it back over to you.

Rob: I think that’s probably a good place to end for today.

Marcello Montanari: Yeah, I think we might be overtime here already.

Jordan Wong: Well, the good news is we’ll be back in about three or four weeks, and I’m sure there will be plenty to talk about then. So thank you guys, as always.

For those interested, if you’d like to learn more about products like RBC Life Science and Technology Fund or RBC Global Technology Fund, we do encourage you to visit our website, www.rbcgam.com

All right, thanks everyone, we’ll talk to you soon. Cheers.