“The pessimist sees difficulty in every opportunity. The optimist sees opportunity in every difficulty." – Winston Churchill
“A pessimist complains about the noise when opportunity knocks." – Oscar Wilde
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 also now listen to this month’s abbreviated podcast version HERE.
Friends & Partners,
Many of you are coming back from the summer doldrums, and September marks the return to school and many back to their respective job roles. Things will ramp up for fall, and on the market side, research analysts/strategists and economists will be busy firing up the printing presses to try and capture some of your mindshare. So I will keep it as brief as I can this month, and hit you with the important and notable items to consider.
Hopefully it was a restful summer for you, though markets certainly didn’t get much of a break this summer. Even though there was lots of noise among the headlines, optimism still reigns for the most part. This month’s opening quotes are poignant – it is difficult to find much ‘value’ out there in these hopeful markets, but opportunity is always present, we simply have to dig a bit harder to find it.
Investing has something of a Hippocratic Oath to it: Firstly, try not to lose money – that is, protect capital. A good way not to lose money is to not buy overpriced stuff. Not so easy when everything is running higher like a scolded cat... Remember, the time to leave the party is when the first beer bottle gets thrown against the wall.
What makes a good investor? I recorded an interesting short podcast on this very subject, you can listen to that HERE. 5 attributes of a good investor trader are: experience, intelligence (to a point), emotional fitness, introspection and patience.
Experience is a big one. Here's an interesting tidbit – anyone under the age of 40 had no experience with the financial crisis in the markets whatsoever. Someone who graduated from college in 2008 was 22, and today they’re 40. 40 year olds are senior folks in finance, Managing Directors at banks, and running funds. They haven’t seen sustained volatility for weeks on end (a VIX over 80), and 10% intraday moves. Or equity markets go down 20% in a single week. There is an interesting Wall Street Journal article recently noting that “there has been a generational change among investors. Fewer remember calamities such as the dot-com downturn or even the financial crisis. Instead, the current crop of young investors have known mostly blue skies since they opened their first brokerage accounts.” The 2010s were pretty quiet, relatively speaking.
The money is made in the waiting. There is a saying: trading takes up 1% of your time. Research takes up 9% of your time. The other 90% is waiting. Warren Buffett was the best waiter in history – and that turned out pretty well for him.
The earnings yield of the S&P 500 is the current earnings of the companies of the index divided by the price of the index. The “real earnings yield” takes that number and subtracts the inflation rate as priced in the market. We want this number to be as high as possible. But, by this measure, we have as low an earnings yield as we have had in thirty years. This is not because earnings are low (quite the contrary) or inflation expectations are high – it is because prices are high across a number of geographies, sectors and indicators. Act accordingly.
I have this conversation with my wife all the time – there is the decision around optionality in everything we do. Every. Single. Thing. Every decision, personal or professional, is ultimately an assessment of the reward versus the risk. There are situations where you can risk a little to make a lot. And ones where you are risking a lot to make a little. Or worse. I want to get you thinking about optionality in all your activities (including investing), which is another way of saying risk/reward.
Gains in markets over the past few years have stretched the bounds of what most investors would call reasonable valuations in the tech space, which has pulled up the S&P500 with it, and recently we’ve seen certain AI-darling stocks trade at extreme valuations (like 200x+ forward earnings!?). Combine this with an economic and inflation outlook that is sputtering – perhaps things will continue to move forward without issue, but we have to note points like that of Mark Zandi of Moody’s Analytics who has warned that the economy is at serious risk of recession: “Consumer spending has flatlined, construction and manufacturing are contracting, and employment is set to fall. And with inflation on the rise, it is tough for the Fed to come to the rescue.” He went on to cite the weak employment picture, tariff headwinds, and the immigration crackdown not helping.
But things aren’t all bad by any means, and there is always opportunity! And there is today, too. Just in different places than in past years. Things will continue to improve over time, and markets will move with them in the long run. On this point, resist the ‘doomsday’ predictions – a picture is worth 1000 words, and this 15 second graphic tells it all HERE.
Overall, the economy is in decent health and continues to power though potential challenges so far. However, macroeconomic outcomes are impossible to predict as we know: for investors, it remains a case of prioritizing a well-constructed institutional portfolio, with a focus on risk management, capital preservation and solid diversification across stocks, bonds and selected alternatives.
Other Interesting Things To Highlight
Our family managed to get a few days away in August for a quick trip to NYC to see the sights, some shows, eat good food and catch up with some old friends. I have spent a lot of time working in NYC in my institutional days covering global hedge funds – it is the center of the finance universe without question, and I feel that the core of my skillset was forged in that experience.
I am proud to again be the presenting sponsor of the second annual Escarpment Corridor Alliance Annual Summit, taking place at Osler Bluff Ski Club on October 24th. This is a very important concern, and the Summit highlights 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. Purchase your ticket HERE
My Friend’s House provides shelter, crisis support and advocates for equity for women and children in the South Georgian Bay area experiencing gender-based violence and abuse. In 2024/25, 42 women and 27 children accessed the shelter, they received 3894 crisis calls (1468 information and support calls), 119 women accessed transitional support, and 83 children and Youth accessed individual and group counselling. This is an important initiative for the community.
I am proud to be the presenting sponsor for My Friend’s House and their events in 2025, and they are hosting a wonderful evening of art & entertainment Saturday, September 20th at Side Launch Brewery in Collingwood. The inaugural HeART of Red Gala will showcase artists and their work from all different mediums in an effort to raise much needed funds for the Southern Georgian Bay women's shelter. Get your tickets HERE
Considering The Headwinds…*
I noted in the opening section that there are multiple headwind in markets, and the economy. Let’s go thru the most relevant ones.
Valuations are undeniably high, in both stocks and bonds. The very low real earnings yield, matched with a high price/earnings multiple, piles on with the quite high price-to-book ratio of the S&P (highest ever today at 5.3x; and it was 5.1x in March of 2000). Is price-to-book a great valuation indicator? Not necessarily – capital intensities have changed significantly and profit margins are higher than in years past, the index composition is evolving, and tangible vs. intangible asset weightings are as well. But it is a data point along several other data points that point to the same theme of expensive asset prices. Valuation matters!
Source: Bloomberg
Investor complacency abounds, and speculative behaviour is back with a vengeance in certain areas of the markets. Goldman's Speculative Trading Indicator sits at an 88th percentile ranking, with data going back to 1990.
Stocks have arguably become divorced from economic expectations:
Low-inflation regimes in Europe and Canada are generally positive, but are now at risk given the non-finality of trade tensions and the potential for greater domestic inflationary bouts from any retaliatory measures. The U.S. has yet to feel to brunt of the tariff impact as well, further upward price pressures in upcoming prints may add to inflation risks, which combined with below-average GDP growth, raises the risk of a stagflationary environment. Not a good outlook.
With inflation seemingly creeping up again, will we encounter a second wave? Perhaps a repeat of the 1970’s experience?
Additional macroeconomic headwinds include:
- A stretched low-income consumer, as the U.S. economy bifurcates into a relatively small cohort of very wealthy individuals and an inflation-pressured regular consumer. While an increase in real estate values may make home-owners wealthy “on paper,” this wealth is locked up and may not support the consumption the U.S. economy relies on.
- Elevated national debt as a result of consistent reliance on budget deficits, even in healthy economic environments, including a $1.8 trillion deficit in 2024. This leads to an increasing interest bill that diverts government spending away from more productive uses.
- Increased global competition, as other nations rapidly modernize and attempt to catch up with American technology superiority.
Market concentration (in the US) is also a significant risk. The big tech names are driving the US index – passive investing has worked well until this year, and it’s breaking down perhaps because it isn’t so diversified any longer.
- The top 10 largest U.S. companies, based on market capitalization, now make up ~40% of the S&P 500’s total value, an all-time high.
- The top 5 largest U.S. companies, again based on market cap, now account for ~25% of the S&P 500’s total value, more than 10% above the long-term average of 14% since 1990.
- NVDA alone accounts for ~8% of the entire S&P 500, a record high level of concentration for one stock in the broad market index (which actually holds just over 500 names).
- 70% of the S&P 500’s positive “economic profit” (which is essentially the net source of increasing shareholder value in the S&P 500) is generated by the top 10 largest names in the index.
- The top 10 S&P 500 stocks trade at an average Price-to-Earnings Ratio of 26X (2025 earnings) vs. 20X for the “rest of the market.”
The fact that 2% of the S&P 500 Index’s holdings account for 40% of the 500-company index’s total market-capitalization value is not only a statistic that is attention grabbing, but it’s one that should be concerning because this bull market is now more dependent on the continuation of the rally-supporting AI narrative than ever before. This has become an underappreciated downside risk to this market, which has become dependent on the performance of only a handful of mega-cap tech names trading at optimistic valuations.
So, we may want to consider changing our US equity exposures (and we have for our clients)… S&P Equal Weight has outperformed S&P Cap Weight during easing cycles:
There Are Many Positives To Keep In Mind*
I always have to remind readers (and myself) that markets climb the wall of worry over time, and will be well ahead of any ‘turn’ in news and sentiment (positive or negative). So far, earnings are still strong, and Q2 reporting just ended with resilience. Better than expected, and much more broad-based than many realize. To put it into context, earnings for Q2 ended up being $35bn stronger than had been expected at the start of the quarter! 10 out of 11 sectors saw 70% or more of companies beat earnings expectations. Concentrations remain unhealthy, and valuations for parts of the market remain concerning, but operating performance remains more diversified than many investors appreciate.
The US markets may be expensive, but there is some justification for this – lower leverage than most periods, higher quality composition, and more ‘asset lite’ than ever before:
As I keep harping on valuations, that’s not necessarily the case outside of the US, or even within the US! As I noted in the opening section, opportunities are out there…
As interest rates continue to decrease, this has historically been positive for stocks. Equities historically tended to show a mixed performance as Fed resumes easing, but would rebound after 6 months. The resumption of Fed easing is seen by many as an argument to look through potential activity softness. Historically, though, the re-start of Fed easing has driven equity consolidation for a while, with the uptrend resumed after 4-5 months:
In the 6 instances since the 80’s when the Fed restarted easing after a pause, the S&P 500 was down every single time in the month following the cut, and would show a positive performance further down the line:
