Transcript

This podcast is intended for audiences who reside in the province of Ontario. The products, services, and securities referred to in this podcast regarding RBC Dominion Securities Inc, as permitted, are only available in Canada and other jurisdictions where they may be legally offered for sale. The information presented and discussed should not be construed as an offer by RBC Dominion Securities Inc to sell specific securities and/or services in any jurisdiction outside of Canada. All opinions and views expressed by the speakers are not representative of the views and opinions of RBC Dominion Securities Inc. All information and opinions provided in this podcast are in good faith, but without legal responsibility. This is Capital Insights, a podcast from the Chapman Private Wealth Group. Here's Paul Chapman. Welcome to May's version of the partner memo. Lots going on in April, so there's lots to talk about. And I started off this month with a quote, as I do every month. And this one is a Swedish proverb that says, "in calm water, every ship has a good captain." And that was never more true, in my opinion, in markets prior to today's. So we've got lots of interesting things happening in April, and it highlights that quote that I mentioned in spades. There's lots to talk about, and probably the most amount of time I've put in any partner memo. There's so many things going on and so many things to think about. I would encourage you to read as much as you can. There should be lots for everybody in there. Let's start with the obvious one, and that's Trump, which hasn't had the smoothest execution I've ever seen considering the US turnaround, and suddenly punched most of their allies in the face. Also, I'm not sure that the American view of the "America First" slogan includes the attempt to repatriate all the lost employment to poor countries and textile sweatshops and mind numbing assembly lines, but that remains to be seen. But I'm not here to pontificate what's right or wrong. I usually just aim to decipher the facts as they're given and give an unbiased view of the implications moving forward. But I will note that it doesn't appear that things are going quite as well for the countries ripping off the US and trade deals as they are for the US, who supposedly been getting ripped off. If you look at the GDP per capita over the years, as we all know, Canada has been pretty weak on that side of things. And the US has been a very strong as it's been with that growth since 1990 or before. So it's not like anybody's participating in global wealth creation any better than the US has. Perhaps the Trump administration will finally conclude that maybe it's actually been getting a good deal out of being nice to their allies, but that remains to be seen. But the good news in all of this is that given what has happened in the markets, Trump still cares about the markets. Obviously, he stepped back his rhetoric around tariffs as interest rates were moving up on him in the bond market. But he wants interest rates to be dropping over time, given there's a mountain of US debt that needs to be refinanced in the next few years. And he's using clearly tariffs for negotiation purposes to a point. The challenge for investors is that Trump has a power to resolve many of these issues if he chooses, but we just don't when he's going to use that. And while the 90-day pause on higher reciprocal tariffs is a welcome reprieve, it's certainly not the end of the story. So we expect to see continued noise in stocks, bonds, treasuries, and currencies. So I've been touting for some time pretty strongly that we're in a different environment than we've been in the past 10 to 15 years. And the investment landscape will be different moving forward and continue to evolve away from that environment. And I have two relevant quotes I'd like to note on that front, and then would ask you to think about it through that. Do you still think we're in the same place we were prior? So the first one is from Luke Ellis, who is the CEO of Man Group. But he says, quote, "The 2010's will go down in history as the easiest environment asset owners have ever seen. You could just buy anything. It didn't matter what you bought. The more you bought, the better it was. When you look at volatility adjusted returns of bonds, stocks, tech stocks, anything, they ended up being around the same thing. You just had to buy a lot of them. On a risk-adjusted basis, buying anything worked. Any time there was a dip in the price, you just bought more of it. And when you look back in history, I think that's a unique environment." End quote. And the other one is buy another asset manager Philip Toews. And he said, quote, "investors diligently prepare portfolios based on the last 30 years of market behavior while remaining unaware of the potential for the return of devastating patterns that occurred outside of their working lifetime. With changes in the geopolitical and economic landscape occurring today on a scale we haven't seen in decades, it may be wise for investors to study history beyond the recent past in order to truly understand ramifications." End quote. So the world of finance, markets, and banking is ultimately about trust. And once the trust is broken, it's very difficult to rebuild. So if Trump ripped up a deal that he himself negotiated, why should anyone assume that he will honor the next deal? Trump's a binary negotiator. He's not one to make many concessions given American position of power here. All countries agree to Trump's terms, to some degree. I think they will. But just look at Canada. Our trust in the US has made us largely dependent on them to purchase our products, oil, et cetera, minerals, even going as far as to refuse a pipeline to get our oil abroad and instead just selling it to the US at a heavy and persistent discount. So I think the good news from all this is that in time, whether that's a few months or a year or so or more, the majority of this noise will be behind us. But it's going to be a bumpy ride along the way and hard to hang on for many people, which reinforces the old adage that when it comes time to buy won't want to. I guess a positive is that outside of Canada, many countries will be following their lead and lower their dependence on the US. In my experience, diversification gets talked about but rarely implemented well. So thankfully, in our portfolios, we've been underweight American stocks since well before the noise started in April, which has been positive for our clients. The market noise is unnerving, but the holy grail lies in positioning well for one's risk appetite and preserving capital during volatile times. The natural reaction for many is to react and sell and attempt to avoid further losses. Any investor who's worth their salt, I would say, knows that short-term time in the market is a fool's errand, and the chart that I include in the note shows why. But essentially, what it's saying is, of the best 50 days in the market over the last 30 years, half of them occurred during a bear market, like we've seen in April. So you get those fast whipsaw moves. If one would have missed just the 10 best days over that period, returns decline over that period by over 50%. Missing the top 20 cost investors 73% of their return in top 30 days, 80%, and so on. Higher long-term returns can only be achieved with both good and bad markets. You can't have one without the other. And you're not going to time one without the other as well, or the other, I should say. This isn't to say that portfolios shouldn't be actively managed and tactically positioned and capital preserved during volatile periods, but it's a reminder about timing the market is not what you want to do. You have to spend time in the market and let compounding do its work. While it might be tempting to precisely time market peaks to sell at the top, and troughs to try to re-enter at the bottom, the probability of doing so across multiple cycles is very low, if not impossible. The more suitable approach is to stay disciplined and invested, which can help keep investors on the trajectory towards achieving their financial objectives. For those that commit to a plan, less anxiety awaits and goals get planned for and they get achieved. So I'm going to go through the subsections of the note now in terms of just touching on the moving parts there. There are some interesting things. So the first one is entitled, what is Trump's endgame anyway? Making sense of all of this and a focus on the bigger picture. So I'd start by saying when there's political noise, like I said before, we don't opine on why that is. We just want to assess it and therefore the implications for markets and the portfolios. But these are unique times, and the issues are largely man made, i.e. Trump. And we need to try to understand what the drivers are and what the end goal is here, potentially, as random as some of it may seem. And this could inform where the puck may be going. I find that few are opining on a quote unquote, "better solution" in terms of Trump's playbook here, and where he potentially could be going and where he should be going. But I included a link to a podcast and/or YouTube video by Ezra Klein and Tom Friedman who discuss it. It's a bit long, but it's one of the best listens I've had. And I think to sum it up, they would argue that to many, including Trump, are focusing on the China of 2015, not the China of 2025. And that's because China takes a long view, a lot longer than the four years that Trump will be around for. And they have an authoritarian system which is tightly controlled by the Chinese Communist Party. They're likely better prepared to absorb a period of political and economic pain than the US. So there are moving parts around all this, not just with China, but with tariffs around the world forced on them by Trump. And details are changing every day. But I thought there's a hedge fund out of the US called Greenlight Capital. And they put together a note, and I'll highlight some of the high-level points that they make from it. The first one is the administration is a disruptive entity. It's not upsetting the apple cart necessarily. It's about upsetting all of the apple carts at the same time, their go-fast and break things people, which is a very high-risk strategy. But it may turn out that going fast and breaking things is not the greatest idea when it comes to geopolitics and the global economy. The present foreign relations strategy is called America first, but given all the moving parts, it could create America solo in the end if everybody turns on them, which could be the case. The goal appears to be for them to use tariffs to raise revenue for the country and establish barriers that will create economic incentives to produce in the United States rather than abroad. While this re-industrialization may be well-meaning, there are serious problems with this thinking. First, a trade deficit doesn't mean that we are being ripped off. The US buys goods in the other country gets money. The US gets the benefit of enjoying the goods. It's not that different from going into a deli and buying a sandwich. You get the sandwich, the deli gets your money. You get to do with it whatever you need to. Nobody's getting ripped off. Secondly on that, while there seems to be nostalgia for manufacturing and jobs related to that, it's not clear that having workers in poorer countries in the US knit their socks and make their T-shirts, et cetera, they have migrated to a service economy in the US and have nearly full employment. There are things they could do to ease the pain, starting with dramatic improvements in educating their children. But there are better solutions than trying to bring back low-value-add manufacturing jobs. And then it goes back to the point of trust. These continually shifting demands from Trump and the administration, and possible alienation of their allies, is causing a loss of trust. And a reserve currency that the US dollar is requires a sense of trust. Not to mention that if Trump engineers a recession from all this, even with interest rates going down-- if you look at history as a guide, then inducing a recession causes a negative impact to the budget. And the US is in a sticky situation with that one, because the negative impact of budget deficit widening during a recession far outweighs the positive impact from a decline in rates. So that's food for thought for the administration and why we could see things change. The next section is just about American exceptionalism, a term that's being used recently. And is that at risk? And the short answer is essentially it is, yes. All of this drama is inflicting damage on the idea that American economic exceptionalism is top of the world, which has been a major tailwind on US assets for years. But what that means in plain English is the US economy is more resilient and innovative in the world than others, and US markets are the most liquid, transparent, and well-run in the world. There's been no competitors over years, even though China is arguably growing just based on size. But they're not there yet. American economic exceptionalism in practice makes the US dollar the reserve currency of the world, which gives it massive power globally. And the US treasuries are the biggest global risk-free asset. It's the fuel that feeds investors insatiable demand for US treasuries, and allows the US economy to feel virtually no ill effects of its deteriorating financial condition, because there's always more buyers of this debt. No other country in the world has enjoyed this privilege. But at the heart of it is the unwavering rule of law and rock solid structure of the US government. And finally, on that point, the rest of the world is very overweight, US stocks and treasuries. So it's something that might rightsize over the next number of years. The next section is entitled, "Assets are not acting as they normally do in times of trouble." And here's why. I wrote about this because usually when there's a flight to safety, meaning people buy bonds, safe bonds, when stocks are getting crushed, the US dollar usually finds strength as well as capital flows to the safe haven assets during turbulent times, which hasn't been the case. We've seen weak stocks, weak US dollar, and weak Treasury bonds. There are a few reasons for this. Trump is mainly breaking the playbook, which is upsetting most countries and investors across the globe. Safe-haven bonds and treasuries should be acting well, but they're not, or they haven't been, because he had foreign dumping of treasuries and retaliation to the tariffs to a point anyway. You'd had inflation fears come up because of tariffs-induced inflation over time. There's been profit taking on all assets. So everything goes down when markets get quite stressed. The US national debt is not pretty, which is not good for bonds. And there is something called the basis trade that was unwinding, which is a little bit complicated, but it's essentially a trade that was put on by hedge funds. And as part of that trade, they buy a lot of treasuries. And that trade unwound somewhat, which caused treasuries to sell off. So there's noise about the US dollar, as I've noted, losing its reserve currency status potentially. That hasn't happening in the near term, but its dominance has been taking a hit in the near term, for sure. So we'll see how that falls out. The second last section is entitled, "is the economy falling off a cliff?" This is more focused on the US economy, but the short answer is not so far. So despite warnings of stagflation and surging recession worries, economic data has so far stayed pretty resilient. Over the last three months, a pretty wide gap has created between investor and consumer sentiment and actual hard economic data. Most major sentiment readings have plunged because the expectation is that trade volatility and policy chaos will create an economic slowdown at best, and at worst, stagflation or recession. But the hard economic data hasn't shown any significant deterioration yet, despite these warnings. While most of the data is still from March, the trade war escalated during that month and the policy uncertainty began in February. So we're starting to see some of this come through now. But have to remember that the economy in the US has twice, in the past five years, defied expectations and stayed resilient through both COVID and the interest rate surge of 2022, which in both cases, analysts and pundits predicted a loss of momentum and potentially a recession, which both times the US economy proved more resilient than expected. But that's something to watch closely because that'll be the next shoe to drop, I would expect. So the final section is just entitled, "interestingly enough, should I prepare to panic?" Which is a funny line that a trader I used to work with used to say. Market noise could persist for days or weeks or months, and no one really knows what the future holds. And I would be hesitant to listen to anyone who convinces you with authority that they do. But we'll try our best to lay out what potentially could be coming down the line. And we know where we are today. And we want to prepare and position accordingly. Economic impact, we have to remember, is different from market impact. We don't yet how things will unfold on the economic front. There are just too many unknowns and variables. What I can tell you is that markets began recovering after COVID lockdowns and the most violent 30-day sell off in a generation, which also featured the three worst market return days since Black Monday, over a 10-day period. But within weeks and months, the COVID news started to improve, but the market improved much more quickly ahead of that time. Same with Black Monday in 1987. It was down 22% in one day, and the market was actually up that year like it was in COVID. So there's just too many factors to make market action predictable by any point. But the one predictable thing, I think, is the foolishness of trying to predict the differentiation more is in how we prepare. So we have to remember that a lot of investors fixate on short-term risks and engulf themselves with headlines that portray an image of maximum discomfort. We want to focus on the now, and we feel like we have control in the now. But historically, the odds of experiencing a positive return drastically increases with longer holding periods. So patience remains your greatest asset when it comes to investing. And you can see that even if you just hold TSX stocks, so the Canadian stock market, which isn't a recommended portfolio, but just for illustration purposes. You've actually haven't lost money in any five year rolling period since 1977 or longer, five years or longer. So it just goes to show patience is a virtue