“Slug it out one inch at a time, day by day. At the end of the day – if you live long enough – most people get what they deserve.” – Charlie Munger
Note that the contents of this memo are all my thoughts, and not the views of RBC Dominion Securities. As well, no part of this content was AI-assisted or created.
[YOU CAN LISTEN TO THE ABBREIVATED PODCAST VERSION OF THIS NOTE HERE]
Friends & Partners,
While at one of the events I participated in last month, someone introduced themselves to me and was interested in my wealth management business. He proceeded to inquire into my thoughts and outlook on things in this tumultuous environment. He went on to tell me his one ‘very wealthy friend just sold his entire portfolio’ after it took a bit of a hit on one of the volatile October days. There is certainly reason to be worried and cautious on multiple fronts – but I noted that one should really be in a position to never worry about money. Money is the worst thing in the world to worry about – there are much better things to worry about than money. And if you structure your portfolio and your life in the correct way, you will never have to worry about it. Sure, it was a bit of a plug for what we do at Chapman Private Wealth Group, but I believe it to be entirely true. We all want to sleep well at night, and have ‘enough’, whatever that means to you.
Source: Unknown
We do our best to make sense of all the noise and data points out there (hence this monthly Partner Memo), but this quote I read somewhere recently may sum things up the best: “The market doesn’t owe us clarity. (My) job is not to know the future with certainty, but to navigate the uncertainty with discipline.”
The markets unrelenting push higher certainly has many scratching their heads. There is significant bifurcation in the markets under the surface however. This bifurcation into “haves” and “have-nots” and divergence in valuation creates inefficiencies in both equity and credit – companies that are treated with excessive complacency vs many of the rest. This is most obviously in the US markets, where the Magnificent 7 continues to drive index performance while the rest of the “S&P 493” remain somewhat lackluster. Companies with “AI” in the ticker or story trade at meaningful premiums, while those without trade at discounted levels, while the fervour in unprofitable and meme stocks continues unabated – so far. Fundamentals will matter again at some point, you can mark my words…
What's driving US equity market performance? It isn't profits.
(average price return (12/31/2024 to 9/30/2025)
Source: Canoe
Investors are generally not rewarding fundamentals in the US market currently. The allure of future profits are enthralling, creating an environment driven by hope and momentum rather than earnings and returns on investment. Narrative-driven markets have one distinct problem: strong stories inherently compromise sound decision-making. We may have seen this movie before somewhere?...
This type of market dispersion doesn’t last forever, and fundamentals reassert themselves. The timing? Who knows… you can’t time the market. I have noted Howard Mark’s quote on this front multiple times: “you can’t predict, but you can prepare”. We remain astute and aware that this market is fragile under the surface. Concentration in non-profitable growth can work powerfully in one direction – until it doesn’t. Markets go up on escalators, and down on elevators.
So, currently the bears and cautious voices point to a wall of worry, including sticky inflation, a cooling labour market, a climbing deficit, elevated valuations, a possible AI bubble, tariff/trade uncertainty, a government shutdown, and all of the other geopolitical tensions that abound globally today.
On the other hand, bulls make a case for a continued market ascent backed by momentum, rising GDP, sustained earnings growth, strong consumer spending, the start of a Fed rate-cutting cycle, rapidly advancing technologies (e.g., AI), deregulation & stimulus from the “One Big Beautiful Bill” and $8 trillion sitting in cash/money market funds as future fuel. As well, seasonality matters and the fourth quarter is, historically, the best quarter of the year.
As always, both make a strong case, which I dive into in detail further in this month’s Partner Memo. This is also why one shouldn’t be “all in” or “all out” of the market – getting the timing right on that call may happen once or twice, but no one will make that call correctly with consistency and repeatability. So we position accordingly.
Other Interesting Things To Highlight
A big thank you to On the Bay magazine for inviting me to take part in their holiday season article - it was a new experience and a blast. I was the certainly the least cool of the otherwise esteemed group!
I was honoured to again be the presenting sponsor of the second annual Escarpment Corridor Alliance Annual Summit, which took place at Osler Bluff Ski Club on October 24th. The event was oversubscribed with 325 attendees, and highlighted a day of learning about Nature Corridors, how they are necessary for the longevity of the Niagara Escarpment of South Georgian Bay, its people and the economy that sustains it all.
Following our last exclusive Family Office event in April that focused on how to assess and diligence alternative managers, we shifted gears for another event that focused on tackling some of the more difficult topics when dealing with investment managers. The event was titled ‘Managing Your Managers’. It was a packed house that included the leading family offices in the country. It included an expert panel that shared actionable insights on navigating the complexities that arise after capital has been deployed, and we heard from leading and notable fund founders.
Upcoming Events
I am honoured to be on a panel presenting at an upcoming alternative asset manager forum in Toronto. McMillan LLP is proud to partner with Capoeira Partners in a series showcasing perspectives from emerging alternative asset managers, allocators and thought leaders. Topics will include best practices in building and scaling an asset management business, the advantages of allocating to smaller, specialized managers, how to best position a strategy within a broader portfolio context, and insights from allocators on how managers can differentiate themselves and attract capital. It will be held Nov 19 at 4pm-630pm at McMillan’s offices 181 Bay Street, register HERE.
I am inviting clients and partners to a Toronto open house event hosted by Harrison Healthcare. I don’t have a professional affiliation with them – just a belief that their offering is useful to many of us looking for personalized executive healthcare, and they are redefining ongoing care to be more personalized, comprehensive, and service-oriented, providing exceptional care and peace of mind.
Harrison promises seamless navigation of healthcare services and fosters a trusted relationship with a team of experts committed to your health. As a client, you’ll have year-round access to their full team of Nurses, Dietitians, Exercise Physiologists, Mental Health Navigators, Genetic Counsellors, and Care Coordinators — working together with your Harrison Family Physician to support your health goals. Harrison offers seamless navigation of referrals, on-site diagnostics, and a 24/7 after-hours solution for urgent care needs.
Join us for an evening of connection, discovery, and innovation with Harrison Healthcare: Wednesday, November 12 at 5:00–7:30 PM. 16th Floor – 2 St. Clair Ave West, Toronto
RSVP: harrisonhealthcare.ca/Toronto-Open-House
They will extend our clients a discount if they look to move forward in working with them. Looking forward to seeing some of you there.
A.I. Will Change The World, But Beware The Hype*
The hype and hysteria around AI is amazing – and the narrative is pushing that sector to new levels. Are we in an AI bubble? It’s always obviously afterwards, and surprisingly difficult during the bubble – but my response would be ‘likely’.
It will certainly change the world, but adoption timing remains unclear, as does future profitability versus mind boggling capital outlays being made today. If we are in a bubble, no one knows the timing of a collapse – the music can play longer than we would expect.
There are hallmarks reminiscent of the tech boom and bust – one of which is the worrying trend of major AI players making ‘circular’ deals to pay each other to fund growth, or the appearance of growth.
In the end, you have to actually sell the product. That update and related profitability is the key question. So far, it’s a borderline dud – but it’s early days. The pace of AI adoption is starting to slow, which casts doubt about the enormous productivity gains forecast by AI cheerleaders. It’s not because AI doesn’t work, but rather that companies need time to adjust their business processes in response to the introduction of a revolutionary technology, which takes time. So, again, time will tell. So far, this is narrative and expectations.
While the growth of consumer subscriptions for OpenAI’s products has been impressive, the adoption of AI by enterprises has been much more mixed. According to MIT researchers, 95% of enterprise pilot AI projects are scrapped without any return on the investment. A recent Bloomberg report cited research from Stanford and Harvard that some AI applications are actually counter productive to productivity because the outputs amount to “workslop”.
It is unclear whether the vast amount of capital being deployed into AI will end up being allocated well. Bain estimated a couple months ago that $2 trillion in revenues by 2030 are needed to justify the planned capital expenditures, with all the announcements since, that estimate should be higher now. According to the Wall Street Journal, that $2 trillion figure is more than five times the total global subscription software market today, while Morgan Stanley estimated that AI products generated $45 billion in revenue in 2024. Oof.
I noted in the opening section that we may have seen this movie before. AI’s capital expenditure spree is a bit reminiscent of major technological advancements like the build out of fiber to handle internet traffic in the late 1990 and early 2000s. If this proves to be the case, the aftermath for markets may be ugly.
Vitaliy Katsenelson has some interesting summary thoughts on why to remain cautious on this theme when it comes to the investment side:
- Bubbles don’t form from thin air. They arise from stories that contain both truth and hype.
- Predicting winners in technology revolutions is nearly impossible. People sound confident, but nobody truly knows.
- The AI companies are in a race for survival. Each must keep competitors from gaining an advantage. But their individually rational choices may collectively produce tremendous overcapacity.
- Growing debt in the AI ecosystem is making it more fragile and sensitive to external events.
- It is also problematic that so much capital is going to buy rapidly depreciating hardware.
The next issue for all of this is the amount of sheer power it will all require. Hence the hype around data centers.
Citi published a thorough research report in October which concluded that OpenAI will have to spend over $1 trillion to deliver its promised computing power in the next 5 years. The amount of energy they will need to deploy is equal to 250 gigawatts of computing capacity (by 2033), which would cost at current prices over $12.5 trillion (this is 40% of the total annual GDP of the entire American economy by the way). For this $1 trillion of capital expenditures that OpenAI has committed to, they are optimistically estimated to have $163 billion of revenue by 2030!. Putting that into perspective: If they devoted 100% of revenue to capital expenditures, with no money left for anything, they would be about $837 billion short of paying for their commitments. So, they have no intention of paying for all this from actual revenues, they assume that the capital markets will pick up the tab. One analyst called it a “fake it until you make it” strategy.
The bottom line is that you need a lot of things to line up and go right for all of this to pan out well. It’s possible that it does. It’s possible that it doesn’t.
The music is still playing – so far. But let’s hope it doesn’t follow the tech boom and bust. Because the stakes are much larger today: a market correction of the same magnitude as the dotcom crash could wipe out over $20 trillion in wealth for American households, equivalent to 70% of American GDP in 2024. This is several times larger than the losses incurred during the crash of the early 2000s.
Reasons To Remain Vigilant – The Cautious Data Points*
As you can see, I’m certainly aware of the risks that abound.
Many are fearful of current valuations, and for good reason. While valuations tell us little about where the market might go over the short term, over the long run valuation can be a dependable predictor of forward returns. Canadian valuations are elevated, but not crazy. Same goes for international stocks. But the S&P 500 forward P/E ratio has hung around 23x recently, and that’s steep. The implication for longer term returns isn’t pretty.
Source: Oaktree
Retail investors appear to be all-in, and mostly in the Magnificent Seven/AI names given the narrow leadership in the markets currently:
And retail buying is getting frothy, as evidenced by recent ‘buy the dip’ activity in options markets on recent pullbacks:
And from the looks of leverage being employed in the markets, it’s certainly hard to argue any excesses at all have been addressed by the central bank. The ratio of margin debt to money supply is higher than at any time except February and March 2000, which was the peak of the dotcom bubble:
All this while small business owners are highly uncertain – NFIB surveys are useful inasmuch as small businesses have little bargaining power and they are therefore sensitive barometers of the economy. Elevated levels of uncertainty pose a headwind to growth, as businesses will be hesitant to invest and hire during such periods:
In addition, private credit is becoming a source of investor anxiety. In the wake of the collapse of subprime auto lender Tricolor Holdings, followed by the bankruptcy of auto-parts supplier First Brands, JPMorgan Chase CEO Jamie Dimon’s warning about cockroaches in the financia system: “My antenna goes up when things like that happen. And I probably shouldn’t say this, but when you see one cockroach, there are probably more… Everyone should be forewarned on this.” Even before Dimon’s “cockroaches” comment, the BoA Global Fund Manager Survey showed respondents were increasingly concerned about private equity and private credit as a source of systemic credit risk. This is one spot where I disagree with general sentiment – private credit in itself shouldn’t pose systemic risk in my view, but can certainly cause a lot of noise around sentiment as we’ve seen.
On this topic, I tend to agree with Blackstone’s CEO Steve Schwarzman who noted last week that “despite all these positive developments over the past several weeks, there's been a significant external focus on the implications of certain credit defaults in the market. These events have been erroneously linked to the traditional private credit market as a result of misunderstandings and misinformation. Importantly, the defaults and focus. Resulted from bank led and bank syndicated credits. Not private credit. Moreover, these situations are widely believed to involve the fraudulent pledging of the same collateral to multiple parties. The traditional private credit model is characterized by direct or in the context of a long term hold strategy with due diligence performed by sophisticated institutional managers and rigorously negotiated documentation. For Blackstone, our 150 billion plus direct lending platform is comprised of over 95% senior secured debt with low loan to value ratios of less than 50% on average, meaning there is significant borrower capital subordinate to our positions in nearly all cases from companies backed by financial sponsors or public companies, and. In the private investment grade area. We've concentrated our activities in multi dollar markets where Blackstone is often a leading player, including data centers, energy infrastructure and real estate. With our loans secured by underlying assets of excellent quality. Our long term, highly disciplined approach to investing in credit is the foundation of the strong results we've produced in this area. As with every business at the firm. Our non-investment grade private credit strategies have generated 10% returns annually, net of all fees. Since inception. Nearly 20 years ago. In direct lending specifically. We've experienced annual realized losses of only one tenth of 1%, including through the global financial crisis. And our investment grade focused private credit platform in Bgci has experienced zero realized losses to date. Of course, as the cycle progresses, it's reasonable to assume we'll see some increases in defaults, but we believe our structural advantages will continue to produce superior results”.
And so we get back to stretched valuations. In the DotCom bubble, the S&P 500 market cap versus GDP was 125%. It has rocketed much higher lately. Prior to COVID, the S&P 500 market cap to GDP was 125%, but it’s now almost 200% - an increase of the same 75% that we experienced in the DotCom bubble.
And this looks even worse when you factor in inflation:
Source: Bloomberg
Inflation remains stubborn, so don’t expect it to tank any time soon:
Finally, this is a bit confusing – I’m not sure if this is positive or negative for the outlook. But few seem ‘happy’. There was a time when strong equity markets made people celebrate, but that doesn’t seem to be the norm anymore. The University of Michigan Consumer Sentiment captures consumer attitudes towards personal finances, general business conditions, and market conditions. This survey has historically tracked well directionally with the S&P 500. The puzzling aspect is that, with markets up so much, why is consumer sentiment worse than during the depths of the financial crisis?
But As Always, The Market Can Climb The Wall Of Worry And Focus On These Positives*
The market has so far cast aside the doubters (which it always does over the long-term – pessimists get creamed over time…).
We are entering the positive fall/winter seasonal period, and the rally should continue show signs of broadening. The prospect of easy financial conditions leading to a 2026 consumer rebound should help support the fuel for continued strength in markets.
Everything is far from perfect, but the slowing labour market is giving the Fed (and Bank of Canada) continued incentive to ease. This is despite the stubborn inflation data, which is unable to drop to the target range (near 2%). The current narrative of this market is that tariffs are less than feared as a driver of inflation, and the labour market weakness has gained the focus in Central Bank policy deliberations.
This is causing bond yields to drop. Dropping bond yields should continue to be a strong tailwind to equity valuations.
Today’s version of the Tech run up isn't the same as 2000. Earnings didn't follow price in the dotcom era. Earnings this time around also went parabolic with price. Different this time, unless consensus estimates turn out to be completely wrong. Possible.
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Source: Morgan Stanley
Key credit indicators are turning more positive. Default rates for high yield debt and loans appear to have peaked, along with delinquency rates for auto loans and credit cards:
On high valuations, BofA makes a good point: Today’s valuation multiple doesn’t compare to prior cycles (see chart below): “While the S&P 500 screens as statistically expensive on most valuation metrics we track, comparing today’s multiple to prior cycles is apples to oranges, in our view, given the mix shift within the index. The S&P 500 has shifted from low-margin, asset- and labour-intensive industries (70% manufacturing in 1980) to high-margin, innovation-oriented industries (50% of the index today)."
Seasonally, we are heading into a strong period historically. Generally, the final quarter of the year is traditionally strong due to: 1) Year-end bonuses, raises and gifts provide extra investable assets to flow into the market, 2) Holiday shopping generates more economic activity and leads to better sentiment and 3) Active fund managers tend to sell losers and buy winners to spice up shareholder account statements (known as “window dressing”), which adds momentum to market-leading stocks. There are always cases for and against a continuation of the rally, but seasonality matters and the fourth quarter is, historically, the best quarter of the year.
Finally, expect more liquidity in the system soon – DON’T FIGHT THE FED. The current quantitative tightening (“QT”) program is likely to end in the coming months. When the Fed ends QT, it will continue to reduce its holdings of mortgage-backed securities and use the proceeds to purchase U.S. Treasuries to keep the overall balance sheet flat; so back to quantitative easing (“QE”), despite a decent (albeit bipolar) economy (rich people spending money and AI-driven capex). The shift back to QE amongst fiscal and current deficits of roughly 6.5% each should have positive implications for liquidity and equities. Powell noted that “the outlook for employment and inflation does not appear to have changed much since our September meeting four weeks ago,” which implies that we will see interest rates head lower from here.
Selling in times of heightened uncertainty is generally the best way to ensure heavy losses, as it often rhymes with selling low and missing the rebound. More importantly, one should keep in mind that the only certainty is that there will always be uncertainty, as it is the price to pay for capital appreciation in the long run. And – need we add – it isn’t in the media’s best interest to report the latest news with nuance and historical perspective; better to let fear and pessimism easily set in. However, the chart on the right should act as a reminder that letting emotions take over is a good recipe for short-term gain, but long-term pain.
Source: NBF