Hedging AI hype with a pair trade, and where to find Canadian defence exposure
A risk-conscious pair trade can preserve S&P upside while shorting AI hype. Plus, Canadian defence names such as MDA and Calian offer domestic exposure as geopolitics reshape markets.
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By Torontoer Staff
This Market Factors column outlines a risk-conscious pair trade designed to keep exposure to U.S. equities while positioning against an overhyped AI investment cycle. It also highlights Canadian defence stocks that may benefit from rising geopolitical tensions and shifting defence budgets.
The trade aims to limit downside from concentrations in AI leaders without giving up broad market upside. The defence section focuses on domestic companies with tangible contract opportunities and consolidation potential.
Keeping upside, fading AI
Salesforce has scaled back some AI initiatives after ambitious staffing moves and product delays, a reminder that early AI deployments struggle with complex or numerous directives. The company is down 14.3 per cent year to date, while Atlassian, HubSpot and Twilio have fallen sharply, and some buy-side strategists are questioning software exposure even at materially lower prices.
Hardware and semiconductor names remain strong, with Micron up more than 27 per cent year to date, but scepticism about the AI investment narrative is growing. AI products that attract users are not reliably translating into revenue, making parts of the sector vulnerable to repricing.
Many buysiders see no reasons to own software no matter how cheap or beaten down the stocks get.
Jordan Klein, Mizuho Securities, quoted by Bloomberg
The pair trade I am tracking shorts the market-cap-weighted S&P 500, via the Vanguard S&P 500 ETF (VFV-T), and uses proceeds to buy the Invesco S&P 500 Equal Weight ETF (EQL-T). The equal-weight approach reduces the influence of hyperscalers and semiconductor equipment makers by giving each S&P constituent the same weight.
If the AI leaders fall, a market-cap-weighted index will be dragged lower, while an equal-weight benchmark should retain exposure to broader U.S. equity gains. That makes the strategy a hedge that can still capture market upside, with less reliance on a narrow group of high-flying names.
AI stocks were simultaneously underhyped and overvalued.
Tracy Alloway, Odd Lots podcast
This framing helps explain the trade. AI may transform industries, but monetization remains difficult and uneven, creating an environment where targeted hedges may be more prudent than outright long positions in the most hyped names.
Canada has defence stocks too
RBC Capital Markets hosted a Canadian aerospace and defence conference that showcased domestic opportunities tied to chronic geopolitical tensions. The discussion highlighted areas such as precision navigation, drone-versus-drone systems, faster supply chains and hypersonic capabilities.
MDA has been invited to bid on U.S. missile-defence work and sees meaningful merger and acquisition prospects in Europe and the United States. RBC analysts estimated roughly US$20-billion in tangible opportunities for the company, which would support growth through contracts and strategic deals.
Analysts at the conference pointed to relatively undiscovered Canadian plays. Engineering firm Calian, where defence accounts for about 65 per cent of revenue, and audio-visual infrastructure specialist Evertz were mentioned as domestic technology names with defence exposure and potential upside as budgets expand.
Relatively undiscovered defence investment plays in the Canadian tech ecosystem.
Ken Herbert, RBC Capital Markets analyst
Investors looking for a pro-Canadian way to access defence spending can consider these smaller-cap names, while weighing contract concentration, procurement timelines and geopolitical risk. Defence work tends to be lumpy and long dated, making patience and selectivity important.
Diversions: a new multipolar world
A recent Atlantic feature by Robert Kagan argues the post-Second World War liberal order is fragmenting, with implications for defence spending and alliance dynamics. In his view, a more multipolar world will prompt rearmament in Europe and Asia, and a looser alignment of U.S. policy and traditional partners.
Mr. Kagan suggests that higher defence budgets and regional self-reliance will be central to national strategies, even if those moves reduce the degree of U.S. security integration that characterised the last eight decades. The shift raises the prospect of more competitive, and possibly more unstable, international relations.
Even the most well-managed multipolar orders were significantly more brutal and prone to war than the world that Americans have known these past 80 years.
Robert Kagan, The Atlantic
For investors this geopolitical reorientation increases the odds that defence budgets and procurement cycles will be supportive for contractors, though country-specific politics and procurement risk will matter when evaluating individual stocks.
Quick hits
- Active management tends to outperform in down or highly choppy markets, making stock selection more valuable if volatility rises.
- Luxury goods valuations are mixed, with some names downgraded on valuation grounds and a few upgraded after underperformance.
- Scotiabank forecasts a continued bull market in natural gas, citing new LNG facilities, data-centre demand, cold weather and fewer working rigs.
The pair trade discussed here is intended as a tactical hedge, not a long-term market call. Similarly, Canadian defence stocks offer thematic exposure but require careful assessment of contract pipelines and execution risk.
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