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.

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This is capital insights, a podcast from the Chapman Private Wealth group. Here's Paul Chapman.

Welcome to this month's episode for the monthly partner memo. My name is Jack Taylor, and I am a certified financial planner and associate wealth advisor at the Chapman Private Wealth Group. During this episode, we will review Paul's September 1st of 2025 partner memo. Quick note, these are Paul's words.

And so when I speak in the first person, I am of course referring to Paul. Here's a quote from Winston Churchill. "The pessimist sees difficulty in every opportunity. The optimist sees opportunity in every difficulty", end quote. And another quote by Oscar Wilde, quote, "a pessimist complains about the noise when opportunity knocks", end quote.

Friends and 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 the 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 of not losing money is to not buy overpriced stuff.

Not so easy when everything is running higher, like a scalded 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 it here, and the link is on our website. Five 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, for example, or equity markets that go down 20% in a single week. There is an interesting Wall Street Journal article recently noting that, quote, "There has been a generational change among investors. Fewer remember calamities such as the dotcom 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", end quote.

The 2010s were pretty quiet, relatively speaking, and there's a good image about the new generation of, quote, "buy the dip investors propping up the market". 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, and 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 30 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. So 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, whether 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 taking a lot of risk to make a little. I want to get you thinking about optionality in all of 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&P 500 with it. And recently, we've seen certain AI darling stocks trade at extreme valuations, like 200 times or more 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 a serious risk of recession. Quote, "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", end quote.

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 the 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 a thousand words, and this 15-second graphic tells it all, and the link is on our website. Overall, the economy is in decent health and continues to power through 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. Moving on to a subtopic. Considering the headwinds, I noted in the opening section that there are multiple headwinds in the markets and the economy.

Let's go through the most relevant ones together. Valuations are undeniably high in both stocks and bonds. The very low real earnings yield matched with a high price to earnings multiple piles on with the quite high price-to-book ratio of the S&P. This is the highest ever today at 5.3 times, and it was 5.1 times 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 versus 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.

Valuations matter, and we have some good charts that show the S&P 500 price-to-book value ratios over time, as well as the 12 month forward price to earnings ratio for the S&P 500 index on our website by Bloomberg. Investor complacency abounds and speculative behavior is back with a vengeance in certain areas of the market.

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 US has yet to feel the brunt of the tariff impact as well. Further upward price pressure 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 1970s experience, and there's a good graph on the website that shows 2020 inflation versus the 1970s inflation overlaid with each other. Additional macroeconomic headwinds include a stretched, low-income consumer as the US 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 homeowners wealthy on paper, this wealth is locked up and may not support the consumption the US economy relies on. Elevated national debts, 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 US companies, based on market capitalization, now make up 40% of the S&P 500 total value at an all time high.

The top five largest US companies, again, based on market cap, now account for 25% of the S&P 500 total value, more than 10% above the long-term average of 14% since 1990. NVIDIA alone accounts for 8% of the entire S&P 500 index. 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 of the index. The top 10 S&P 500 stocks trade at an average price to earnings ratio of 26 times the 2025 earnings, versus 20 times 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 exposure, and we've done this for our clients.

This could be an S&P equal weight as this has outperformed the S&P cap weight during easing cycles. And this is a good graph to support this on the website. And moving to another subtopic, 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, whether 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 realized. To put it into context, earnings for Q2 ended up being $35 billion 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 part of the markets 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, high-quality composition, and more asset light than 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 six months.

The resumption of Fed easing is seen by many as an argument to look through potential activity softness. Historically, though, the restart of Fed easing has driven equity consolidation for a while, with the uptrend resumed after four to five months. And there's some good graphs that support this on our website. In the six instances since the '80s when the Fed restarted easing after to pause, the S&P 500 index was down every single time in the month following the cut and would show a positive performance further down the line.

Thanks so much for listening. As always, if you want to contact us to review any topic in greater detail or request a podcast topic, please feel free to reach out to us via email at chapmanwealth@rbc.com, or through our website, www.chapmanprivatewealth.ca. You'll also be able to find our monthly partner memos and helpful articles and resources on our website. Have a great month.