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.

Welcome to this month's episode for the Monthly Partner Memo. My name is Jack Taylor and I am Paul's associate wealth advisor. I'm a certified financial planner by designation, commonly known as a CFP, which means that I get to help clients implement strategies to achieve their financial goals.

I'm also excited about a new special podcast series related to things you wish your younger self knew. It's going to help create a fundamental understanding of personal finance for all Canadians of all life stages, whether you're a student, early, mid late career, you just retired, or you're enjoying your later retirement years.

And we'll explore different topics and strategies each episode to fully round out your knowledge. I'm planning to make it as principles-based as possible so that it will be relevant for a very long time, and hopefully be a helpful resource for you and your family to be able to share with.

Now let's get back to Paul's August of 2025 Partner Memo. And a quick note. These are Paul's words. And so when I speak in the first person, I'm of course referring to Paul. And here's the quote to start off from philosopher Arthur Schopenhauer.

Quote, "Talent hits a target no one else can hit. Genius hits a target no one else can see." We are supposed to be in the dog days of summer. Even though I'm writing this month's Partner Memo from the cottage at 5:00 AM watching the sun rise, things don't feel as quiet out there as one would hope for this time of year.

The headlines are never ending. Tariffs, geopolitics, broader, macro, and geopolitical uncertainty, meme stock fever once again, markets at all time highs that keep chugging higher. I will hit the Send button on this early on August 1. And a lot can change in a few hours, it seems.

August 1 is the formal tariff deadline set by Trump, and while Trump has stated no further extensions will be granted, the administration has so far shown a reluctance to follow through on policies that have generated adverse market reactions.

A major concern these days for most of us is information overload. We have too much evidence on any topic we choose to the point that you can find convincing reasons to believe pretty much anything. Then confirmation bias takes over and people feel sure whatever they want to happen is going to happen.

But the worst part may be that those who desire a certain outcome tend to cluster together, convincing each other this thing they want will occur, but our views and desires don't define the future. This is where we separate the signal from the noise, and it's becoming increasingly more difficult to do.

The right approach is simple, but difficult to admit that we don't know the future, recognizing many possibilities is key, including the possibility that you don't know what you don't know. Then examine all the scenarios and assign probabilities to each one and assess accordingly, including the ability to adapt if things change.

This is having process and analysis, which is easier said than done well, especially in these times of short attention spans and decision making. So what's going on in the markets anyway? They continue to track higher, almost daily it seems.

In effect, the market has taken a show me stance to all of the potential negatives still lurking in the macroeconomic periphery. It's entirely possible that tariffs, which are going to be much larger than expected regardless of where they settle, may create an inflation spike. And this evidence that's starting to happen already.

But the market's view of that is so show me. Similarly, it's entirely possible that tariffs and policy whiplash, which are worse than most expected, could combine with still higher interest rates to slow economic growth.

And there's some evidence that's starting to happen already. But again, the market's view of this risk is so show me. On tariffs, Trump on the administration appears serious about maintaining high tariffs on trading partners, including a potential 15% tariff on the European Union, which was floated on Friday.

And tariffs currently stated levels would not be good for US or global growth. But the market's view of this risk is so show me. Admittedly, while economic growth has moderated from levels at the start of 2025, it has stabilized over the past few months.

And so far, neither tariff threats nor policy uncertainty are causing a material downgrade in economic growth. But we may not have felt the effects of the negative noise out there quite yet. Economic resilience so far is not an all clear on recession risks, even though stocks are acting as though they are.

The bottom line is that facts on the ground have remained positive so far, better than expected economic growth, stronger than expected earnings, relatively stable inflation, and anticipation of lower interest rates.

Those positives have helped investors ignore risks looming on the periphery and adopt this show me attitude towards them. And that is why stocks are at highs. But this show me attitude is also reaching historic extremes.

The S&P 500 is trading more than 23 times the 2025 earnings per share of $265, and more than 21 times 2026 earnings per share of $298. Those are historically very high and unsustainable valuations.

And if we think about them in the context of the greater shakeup to the global trading system in nearly 50 years, it seems quite rich. It has also bred a sense of complacency in investors. It is entirely possible that these elevated tariff rates don't cause inflation or slow growth, but it's very uncertain and the aggressive nature with which markets have assumed it won't happen should give us some pause as long-term investors.

Some investors have taken speculating to a new level. JP Morgan notes that, quote, the latest bout of extreme crowding currently in the hundredth percentile is in high beta stocks, and this spans both riskier low value alongside speculative growth plays.

Another thing being overlooked in this complacency, I find, is the fact that 10 companies now account for 40% of the US stock index, and that tech adjacent companies now comprise over 50% of the index. The inverse reality of this is that defensives have historically been 30% to 40% of the S&P 500, and are now sitting barely at 15%.

So not only is the risk on much higher than has historically been the case, but the stabilizers of the index are not what they once were in that index. Having implemented some defensive growth and some hedges has served our clients very well this year, and remains the name of the game in my view.

We want to protect capital first and foremost, achieve decent returns with lower risk and smooth the ride 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.

We are emotional animals and we feel losses more than gains, so let's minimize those on the ride. Reasons to worry complacency speculation and valuations. Investor complacency towards a myriad of risks out there.

Combined with rather aggressive behavior in the markets is an ugly combination in today's environment. As an example of aggressive behavior, it is notable that meme stock trading has taken off again and many are doing it on leverage.

The New York Stock Exchange margin debt increased 18.5% over two months ending June 30. As investors utilize broker leverage to buy equities, this is the fastest rate of investors re leveraging to buy US equities since late 1999 and mid 2007, and we know how those periods ended.

And note this one. The Goldman Sachs nonprofitable tech index is up over 60% from the April lows. I'd like to call unprofitable tech crap. This is Ponzi-like element to it. You buy it for the hope of higher prices, not for the cash flows.

Along with equity valuations making new highs, so has equity speculation. Quote, "The latest bout of extreme crowding, currently in the 100th percentile is in high beta stocks." And this spans both riskier, low-value alongside speculative growth plays, notes JP Morgan.

Despite market optimism, not all is good under the hood using data from Equifax. Next, Davis Research highlights that credit cards, student loans, and auto loan delinquency rates in the US have climbed above 12%, 7 and 1/2, and 5% respectively.

In other words, we are potentially entering a credit delinquency cycle at a time when credit spreads. This is the yield compensation demanded by investors for the risk of default remains near record heights.

Valuations are clearly at high levels in the US. And The Financial Times noted that forward returns are challenged from here. Quote, "Just because investors have never before realized positive 10-year real returns when investing at Cape above 37.3 times doesn't mean they can't. This time, may be different." End quote.

Speaking of complacency, recession expectations have dropped again, oddly enough. Finally, here's an interesting take on all that capital that is sitting on the sidelines with the implication that it's ready to buy more stocks. Quote, "Many market commentators think of money market fund balances as capital that will migrate to stocks at some point. Dry powder for a rally.

But history shows this only happens when short-term rates decline. With the Fed on hold for now and only expected to cut rates modestly this year, 50 or maybe 75 basis points, it is hard to see this sideline capital getting into the game anytime soon." End quote from Datatrek.

The outlook of potential stagflation below average growth and higher than expected inflation is a plausible scenario from here. The economic resilience we've seen of late could be a mirage attribute to the combination of tariff front running as a response to tariff announcement volatility and uncertainty.

Many expect that the full effects of tariffs on inflation and growth will start to be seen in the third quarter of 2025 and continue into next year. Time will tell. We do know that the threat of tariffs and uncertainty it has caused has affected corporate behavior and consumers as well as they're seeing the highest tariffs rates since 1911.

Tariff revenue only began to rise in April, as it has been steadily increasing since then. We may begin to see the preliminary effects in July to September time frame for companies, which would then be reflected in the third quarter earnings.

This may be the reason why the economy appears to be resilient so far. Again, time will tell here and we'll know shortly. The reality is tariffs are not going away as they are needed to offset the growing deficits in the US.

The nonpartisan Congressional Budget Office warned that the big beautiful bill-- this is the OBBB act, will add 3.4 trillion to US deficits. This is a major issue and overhang in the US. And that leads us back to the US debt issue-- something I've written about at length over the last couple of years.

The US debt situation requires raising revenue, as well as spending cuts. The US can't simply grow their way out of this problem as they have in the past. All of the debt options are bad, and they won't seriously address the problem until a crisis forces them to.

The crisis hasn't come yet, but it will. We are establishing the conditions for one right now. Unfortunately, we have grown too comfortable with uncertainty. You've likely heard the phrase, "Minsky Moment" which refers to the ideas of economist Hyman Minsky, who studied financial crises.

Minsky found crises occur when a long period of stability prevents investors from seeing risks that are in hindsight, usually obvious. Governments and markets and investors can be complacent longer than you can bet against them.

We are in an era of complacency. You should check out the charts that we have on the website in the Monthly Partner Memo. It helps to give a good idea for the data points that Paul likes to show. The graphs on the website show the US debt, which is Federal versus everything else except blanks.

From 2008 forward, Federal debt rose while the other categories fell or stayed flat. John Mauldin notes that they've slowly transferred debts that would once have stayed in private hands to the Federal government's balance sheet, or to the quasi Federal lending agencies.

The various post 2008 bailout loan guarantee/quantitative easing programs changed the way they borrow. The assorted COVID programs changed it even more. They transferred a lot of risk from the private sector to the government.

They're still accumulating unsustainable levels of debt, but they are shifting them out of the private economy to the government. This creates an illusion of solvency. Businesses and households seem to be in a good shape, because so much debt has left their shoulders and moved to Washington, but as taxpayers, they're still ultimately responsible for it.

Intentionally or not, they've put their debt out of sight, out of mind. This lets them keep merely spending and investing in ways they probably wouldn't if they knew how much debt they really had. The Federal pot is someone else's problem. Complacency will continue until it doesn't. Then we may see a Minsky moment.

But remember there are many positives to highlight as well. The positives have won the day so far in the last few months, even in the face of significant uncertainty. This highlights the importance of assessing all aspects of the markets objectively and implementing process around that.

There are significant risks and headwinds out there, but we also have to remember that staying on the sidelines while you are waiting for the end of the world, which could be a long way off, is not a good investment strategy.

Remember, there is $7 trillion in cash on the sidelines still, which can serve as fuel and defense in the markets. The overall investment outlook has improved since early 2025 across a number of fronts.

Tariff visibility, tax and deregulation visibility. Fed outlook likely more dovish moving forward from here. Economic policy, uncertainty is receding, which at a high level, is an overall positive without question. Corporate earnings have been strong and the outlook is good as well on that front.

Don't fear investing at Career highs. It happens by definition at all times. JP Morgan notes that, quote, "While some investors may not feel comfortable buying when markets at highs, history shows there is little difference between future returns following a new all time high and future returns following any other day when the market has not registered a new high.

Since 1950, the S&P 500 has delivered strong returns in the forward one, three, and five-year periods from a new all time high. The reason is, at the end of the day, an all time high is just like any other trading day, and investors are best served by viewing them all through the same lens. Don't let fear of all time highs keep you on the sidelines. Rather, stay invested and diversified and maintain a long-term perspective." end quote.

Keeping things in perspective, if we assess the equal weighted S&P 500 index, we're cheaper than where we were before COVID, even after having endured multiple black swan events. And you should check out the images that we have on the website and graphs that help just to give context to all the data points that Paul shares in this memo.

As always, if you want to contact us to review any topic or data point in greater detail, even request a podcast topic, please feel free to contact us via email, that's chapmanwealth@rbc.com or through our website, chapmanprivatewealth.ca. You'll also be able to find our monthly Partner Memos and helpful articles that we create on our website. Take care.