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. [MUSIC PLAYING] This is Capital Insights, a podcast from the Chapman Private Wealth group. Here's Paul Chapman. Welcome to this month's podcast for the monthly partner memo. It's going to be 1st of June 2025. It's certainly been an eventful year so far. So we start off with an abbreviated version of the monthly memo and the quote is from Warren Buffett, who hung up his skates after 94 years on this Earth and a very long career and a net worth of over $150 billion. One of his famous lines is, "We don't have to be smarter than the rest. We have to be more disciplined than the rest." So I think that's really inspiring and timely. And I've been doing this long enough, almost 30 years, that I've seen many things that pass for conventional wisdom that stop working at some point. And if you get enough gray hair in this business, you've seen a few cycles. Interestingly, many people only survive half of one cycle, which is usually the first half, which is less instructive than the back half. And I would argue that the front half of today's cycle started around the end of the financial crisis, so around 2009. And we're at the halfway point around 2022, and that's where I think things have changed. It can be very stressful and unsettling when markets go haywire, like we've seen again this year, especially in April. But we've certainly experienced panic periods prior. We've seen this movie before. It changes a bit every time, but it certainly rhymes, especially the human emotion side of it. So while we can't prevent others from making emotion driven decisions, we can remain disciplined and grounded and process-driven, which is the key. And I said this in an earlier podcast, I think our second podcast, that investing isn't actually about earning the highest returns, believe it or not. It's actually about the risk taken to achieve that return. And so the behavior matters, and I cited that I'm a pilot and investing can be a bit like flying, which is hours and hours of boredom punctuated by moments of sheer terror. 2025 is shaping up to be a pretty interesting year so far. It's been all over the road, and it's a quagmire of moving parts, and US tariffs is the main driver of that. The tariff story is all over the map, and even though as we record this, a day after the Court of International Trade ruling that the Trump administration's use of the International Emergency Economic Powers Act to impose the reciprocal tariffs on the trading partners or as an overreach, but that will certainly be fought. And that story, the tariff story isn't over. They're here to stay at some level, but the size and speed of implementation is still to be determined, but it's certainly not zero. So I'm still relatively cautious in a lot of ways. And one reason for the caution is the market seems to be looking past the tariff noise for the most part and acting like concrete deals, or most of them are imminent or complete. While we've only seen modest progress on trade frameworks and very few actual deals which are quite complex and often involve thousands of products. So there's a good chance we see more market volatility moving forward, I think, around this subject. So that remains to be seen, and I think we're still in the early innings of any impacts being caused by these tariffs. But overall in the US economy, things remain OK. Number one strong earnings from key companies have made Q1 earnings growth pretty solid. Two, oil prices have declined pretty significantly since the end of March and OPEC signaled an increase in production, which helps dampen the concerns around inflation and cash flow for consumers. And then three, a modest rebound in some economic figures such as the ISM services index and steady jobs reports and things like that. The economy is still strong so far, but we're not returning to the economic system of old, I don't think. I think we're in a new environment somewhat. Trump plans on raising significant revenue through the tariffs, and the only question is the speed of their implementation, I think, and the levels. But what are the cost implications of reshoring entire industries? And that's not clear. We don't know, but the numbers won't be de minimis. From all this weakness is bound to leak into the economy in the coming months, I think, to a point. Valuations, especially in the US in stocks are pretty stretched and treasury yields haven't been staying low. They don't appear to be on a downward trajectory. They've been creeping upwards even if the fed and the central banks lower the overnight rates a bit from here. So rising yields as many know don't help stock valuations unfortunately. So now that equity markets have recovered most of their April drawdowns anyway, it feels like many across the retail world, so to speak, the investing public have significant public equity exposure and they don't realize necessarily how much risk they're actually taking. So 40% to 50% pullbacks in the market are usually about a once in a decade event. And it's not even likely, it's more of a certainty, believe it or not. So you can be somewhat positioned and prepared for that, but investors in the last while seem to have been conditioned to expect that central banks will be there to bail them out, and they buy the dip, which seems to work every time into perpetuity, they assume, but only time will tell. So to sum that up, implementing some defense and defensive growth and some hedges, so to speak, are the name of the game today in my view. Defense and hedges are insurance in a form, which is funny because people have insurance on all their house, their car, their life, but not really on their portfolio, which makes ultimately their life more pro-cyclical, meaning the higher highs, lower the lows across the board, which includes your portfolio because they're tied to markets which are tied to the economy, which is tied to your job and your well-being overall. So we want to smooth at least part of that ride so our clients can sleep at night and preserve capital and ultimately meet their goals at the end of the day, whatever the day throws at them. So now we'll get into a couple of the subsections of the note that we'll go through fairly quickly, but the first one is entitled. There's lots of reason to remain cautious and defensive, which I touched on in the opening section, but a few more data points to put some meat on that bone is that there's a fair bit of complacency out there still. Valuations are high as I noted, sentiment is optimistic again, and animal spirits abound. On the tariff front, there's a consensus on Wall Street that the US economy can withstand a 10% to 15% tariffs. That remains to be seen, but I think Trump is not necessarily going to back down across the board, that's for sure. On the economic front, there are soft data, data points, deteriorating hard data usually lags soft data. And in that case, the market may be in that interim period, that's analogous to the Bear Stearns time after their bankruptcy and the market recovery took some time. And in February 2020, just before COVID, the market recovery when coronavirus was known, but investors hadn't fully realized the magnitude of the effect. Valuations are fairly steep, as I've noted. And then finally, over the long term, starting points of excessive pessimism set the stage for healthy returns, and that's not where we are today, it's opposite. It's pretty excessively optimistic, which usually paves the way for limited returns. But this relationship brings to mind the guiding principles of Howard Marks, which is one of the most legendary investors of all time. And his points are it's not what you buy, it's what you pay that counts. Good investing doesn't come from buying good things, but from buying things well. He also says there's quote unquote, "no assets so good that it can't become overpriced and thus dangerous. There are few assets that are so bad that they can't get cheap enough to be a bargain." And so the riskiest thing in the world is the belief that there's no risk. So those are all very good points from him. But after a record 15 year run, the US stock market might be poised for a prolonged period of underwhelming performance based on things we've seen historically and where it's trading today. So I've written ad nauseam. I think that the investing landscape will look very different moving forward, and we have to position accordingly, which doesn't mean there won't be opportunities, but the returns won't be from where we've seen them in the last while, I don't think. But I notice that one doesn't want to cut off their nose to spite your face. That is the title of the next section, and it's more about behavioral finance. So doing well with your money has little to do with your intelligence, and most to do with your behavior. So I spoke on this subject a fair bit in the last couple of podcasts and noted that success in investing isn't always due to creating the perfect portfolio, but rather more to do with what you don't do, especially during times of volatility. So bull markets often drive individual investors into thinking they're brilliant stock pickers, just like bear market scare many to sell quality investments. But an excellent point from Bill Gates. He once said that "success is a lousy teacher, as it seduces smart people into thinking they can't lose." So we should know anyway that you can't and won't time the market consistently. That's pretty much a set rule, I would say. And the only reason most investors underperform is because they let their emotions drive their investment decisions, especially when times get tough. And so underperformance is driven by behavior, which is basically a proven fact. And I include a really interesting chart that shows the average equity market investor versus where stocks have returned. And there's about a 4% gap between those two numbers, and you can guess which side the investors are on, on that. Bonds is even worse, and even in balanced funds and growth funds and various asset allocations, the average investor is usually about 5% behind where they should be. And that's simply because they're selling at the wrong time and buying at the wrong time. The final section in this note this month is just I always want to highlight the positive data points because there's always reason to remain optimistic. The market climbs the wall of worry, but certainly the market's been moody. A month ago the outlook for the economy was that we'd see stagflation and the outlook for stocks was boarding on a lost decade, similar to what we might have seen in 2001 to 2009, where you really didn't gain a lot in stocks over time. But man, that's changed, people are optimistic again. But you have to remember that markets don't wait for smooth roads, they're always forward looking and they don't react to the world as it is. They respond to where it'll go next. The acceleration there is often pretty quick coming out of the bottom, and the early part of the rebound is often the sharpest, and you sure saw that in April. The turns always happen before they're obvious in nearly every cycle. Stocks are recovering before the economic data shows improvement. And I think the most recent example of that was COVID. Things still felt pretty bad when the market started going higher, and it never stopped going higher for a few years. So there are certain bullish arguments today which can make sense I think. The first one is that if global tariffs land around 10% that won't be enough to derail the US economy, it's probably not enough to derail consumer spending because the companies will probably eat some of the increase in tariffs, generally speaking. So the consumer might not actually feel that much at the end of the day. And that 10% tariff regime, if it happens, would give businesses clarity to continue with their corporate planning because a lot of people are frozen in their tracks right now. Bullish 0.2 is inflation will not rise that much and the fed will end up cutting rates. Inflation statistics could remain low enough to keep the fed on track I think, and they could cut multiple times this year, as could the Bank of Canada which supports the economy. And bullish 0.3 is that valuations might not be as bad as they seem. The S&P 500 right now is almost 22 times forward earnings, but that forward earnings number will turn to 2026 numbers soon, usually around mid-summer. And at this point, analysts are expecting about $290 a share of earnings. So using those figures, S&P 500 might be trading closer to around 20 times, which is not cheap but not crazy overvalued. And finally, it's notable that there's a lot of capital on the sidelines. There's $7 trillion on the sidelines. So 7 and 1/4 to be exact. Just a few years ago, that was 5 trillion, even five or six years ago, it was only three trillion. So it's going up very significantly. So the bottom line there is markets don't wait for green lights. They start moving when the road is just less blocked, not necessarily completely clear. So recoveries begin when the confidence is still low. And history shows that the strongest gains come well before conditions feel safe. So I would note tariffs are a headline, not necessarily a halt. And policy noise may detour the market but shouldn't derail it. So staying on the road matters.