Transcript

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This is Capital Insights, a podcast from the Chapman Private Wealth Group. Here's Paul Chapman.

Welcome to the July version of the podcast of the Partner Memo. Certainly lots going on this summer. And I started by asking the question or posing the question, did you think we'd be back to all time highs within a few months if I had asked you for your thoughts in the midst of the Trump-induced tariff nightmare back in early April? I think many would say definitely, it's a surprise.

But the point is many fall victim to the allure of market timing, often at times when it's most foolish to do so. God forbid you'd sell at the bottom and then be chasing it all the way back up. But it's human nature thinking that things which are not foreseeable are foreseeable. And when that goes astray, one gets stuck in the doom loop of regret.

The desire to believe one can see that which they cannot see or solve for is innate in all of us I think to a point. Nothing is more humbling or breaks down this tragic flaw than the markets, that's for sure. But this experience once again highlights the benefit of thoughtfully investing in a well-positioned portfolio construct. And while we are tactical here at our business, in our portfolios, we're not trying to time events.

Investing legend Howard Marks once said there's only one way to describe most investors. Trend followers. Superior investors are the exact opposite. Superior investing, as I hope I've convinced you by now, requires second level thinking. A way of thinking that's different from that of others. More complex and more insightful.

Some take little to no risk, which usually means losing money to inflation over time, which is fine if that makes you sleep at night. And then there are other people who take too much risk, which usually ends in incomprehensible demoralization. The answer is to take the, quote unquote, right amount of risk, whatever that may be.

The Holy Grail is in making a solid return for an appropriate amount of risk, which includes minimizing the noise and the downside capture. The point is to target risk rather than returns, which I've discussed at length recently in a number of memos and other podcasts and written work.

Many do it backward to this though and aim to get a return and take more risks than they should to get there. Every concern and worry for investors when it comes to markets is always changing. Know this time will usually not be different. All that's different is what the particular uncertainty is. There will always be a worry or two and uncertainty along the way.

The most recent issue we contended with was Iran and most investment styles. This is just noise for that and won't really affect the portfolio in the long run. Geopolitical noise often doesn't over the long term. But it is human nature ingrained in us since the dawn of time to look at every event and decide whether it is food or fear. We're emotional animals in the end.

It's difficult to fight this instinct because the noise is just so much fun, which is a problem when you're addicted to negative headlines, and there's a growing gambling mentality in the markets, which I suspect will come home to roost for some investors in due course.

To escape the noise embedded in the economic and investment signal, you need calm voices who can pull you out of the emotional trap and refocus you on the big picture and what's really important. And this is a role that I aim to fill. And I have many that I consult with to turn to maintain that calm as well.

This year so far is a wonderful example of this. Our clients are in all weather portfolios, diversified across a number of best in class strategies, and geographies, and managers, and it felt very little noise in their portfolios while capturing solid gains along the way. Strategies that spread risk across assets are outperforming by near historic margins this year, which is a shift from the concentrated bets and indexing in recent years that has worked well. I expect this isn't over either.

No question that uncertainty abounds. Even US central banker heads are uncertain, admitting that projecting interest rate policy is only a guess at this point. They note that, quote, we haven't been through a situation like this, and I think we have to be humble about our ability to forecast it, end quote. Looking under the hood in the US, the weakest and most cyclical part of the economy is housing, which has been quite weak.

Employment has been showing signs of stalling as initial jobless claims rose recently pretty sharply, though they're at levels still holding within a historical range. In real time, indicators of employment are also weakening. But on the other hand, the American consumer has been pretty resilient, and credit card surveys are showing that resiliency and same store sales of general merchandise in the US is growing steadily.

The risk here is that consumer spending can be attributed to households potentially frontrunning the tariff increases, so time will tell there. Consumer sentiment readings have been crappy as well but are improving as of late, . And the hard data in the coming months will tell the true story. So it's still a bit of a wait and see approach.

Tariffs are here to stay for sure. Just the question will be the level. And they'll be a drag on the economy at best and could incite inflation if and when businesses pass through this cost. Uncertainty around US tariff remains, but a worst case scenario has largely been ruled out as progress toward more trade deals seems to be being made.

Economic growth in Canada and the US should also likely slow but not stop, and any rise in inflation should likely prove temporary, which means stocks can perform OK against this backdrop if policy, earnings, and investor sentiment all cooperate.

We're now living in a period of compressed growth expectations brought to you by a new paradigm of government spending and government indebtedness. This will lead to lower GDP figures than in the past, structurally worse than it's been for probably decades. So it's no secret that by almost every single valuation metric as well, stocks and broad indices are expensive, and investors need to temper their return expectations out there, which I'll touch on shortly. I dug into later in the note. So we have to focus on selectivity.

There will continue to be value out there but in different places and where it's been. This won't be a good environment for passive investing, I don't think. Something I've been saying for a while. The fact of the matter is that sideways markets have always followed secular bull markets. And if 2009 to 2021 wasn't a bull market, then I don't know what one is.

So having implemented some defense and defensive growth and some hedges has all served our clients very well this year, and risk remains the name of the game in my view. We want to achieve a decent return with lower risk and smooth the ride out, so our clients can sleep at night, preserve capital, and meet their goals at the end of the day.

A smoother ride in life is worth the effort because we're emotional animals, and we feel losses more than gains. So let's minimize that noise along the ride. And I included an interesting little chart that shows that basically, losses are felt a lot more than gains, as we know.

So in terms of the subsections, there's only a couple this month, and the first one is the list of reasons to remain cautious and defensive. There's always a long list on that side, but you have to balance it with the positives. But let's start with the negatives, and one of the big ones is the remains a significant amount of complacency out there. The S&P 500 is retesting all time highs. And this is amidst an increasingly complacent investor base.

Doug Kass, who's a legend and runs a well-known hedge fund named Seabreeze Partners, just noted really succinctly what the uncertainties are that investors face, and I'll just run through them quickly. He says we face the highest geopolitical risk in many decades that won't be resolved quickly. We face the largest level of social and political risks in the US since the Vietnam War.

We face the greatest chance of inflation, he calls it, which is slowing economic growth and sticky inflation since the '70s. We face the biggest threat that the US dollar and capital markets in the US will no longer be a safe haven in modern history. We face the greatest debt load and deficit ever, and neither party or in Canada, I would add, seem to favor any fiscal discipline whatsoever. We face the largest capital spending spree in history on AI through-- well, however, that return on investment is still far from certain, and the market's definitely pretty optimistic on that front.

I would add that tariff and trade policies into that mix, not just in the US but globally. And US consumers, as I noted, aren't feeling great. The consumer sentiment index, Michigan index was stuck at one of its worst readings on record for two months in the spring after dropping 30% in first four months of 2025. So over 80 years of this survey, it dropped this large and this fast has almost always predicted a recession.

Investors are pretty all in on stocks. We're at the highest allocation ever by a pretty good margin outside of the tech boom, which it's higher than that even was. And finally, valuations, as everyone knows, is the elephant in the room. And if you look at a holistic measure of long term equity valuations across the globe, it sits at it's 85th percentile, going back over a century.

Non-US markets are cheaper, however. So that's an area of potential attractiveness I think. And I show a chart that highlights that in the US with the price to forward earnings ratio where it is, it's consistent with 10-year returns of close to 0, with the optimistic case being low single digit returns. So I think that's just showing that passive investing isn't going to really work. We're going to have to dig for some returns.

So I'll look to the positives though to close out the note. There are always positives to consider, especially knowing that most of the time, the market looks over the precipice of worries and headwinds. And the big one, as I noted, was valuations, which is a concern for longer term returns and not a great timing tool. But current valuations might not be as much of a headwind to these returns as you could assume if we look at history.

Barclays did some good work on this, noted that while average returns decreased as valuations rose from 10 to over 20 times, earnings returns actually improved as that PE went over 22 times up to about 24. We're at around 22 now. So they think this is because the market typically traded at these levels for sustained periods in the aftermath of V-shaped recoveries, like 1998 and 2020.

So assuming earnings don't get hit, you could still see upward trending markets from here, which I think is probably a decent base case, but there will be potential potholes along the way. And the whole sell America theme came and went pretty quickly. There were fears that foreigners were dumping US treasuries and the US dollar. So that's probably overblown. If you look out on a chart I included, foreigners remain the largest holder in the US treasury market. Their share of the total has technically been in steady decline for years. It actually peaked in 2008.

And since then, foreign holdings have more than doubled, and debt held by the public has nearly quintupled, which means demand for treasuries has broadened out over the past decade as well. So it doesn't look like there's any particular cohort tanking the US market anytime soon. But as I've written at length and I'll write again next month, the US has significant amounts of debt that will come home to roost, I think, at some point, but we'll get into that again further in next month's note and podcast. Thank you.