Jason Del VicarioA Comment -- General Comments From an ExpertA CommentaryCOMMENTSep 24, 2018

Going back 2 weeks ago, Chairman Warsh talked about a more laissez-faire approach to how the Fed is going to handle interest rates. That is, let's stop intervening in the markets and see what happens. Following that press conference, it would appear there's been a loss of confidence in the Fed's ability to manage inflation. They've been putting out small fires along the way, with Scott Bessent on the weekend talking about keeping the cost of the US deficit under control and interest rates down. It's all linked to inflation expectations.

When we look at what the market's pricing on inflation, the long-term outlooks are very benign. We have what's going on in the Middle East impacting oil prices -- spiking one day and down the next, war on/war off. It's causing a lot of anxiety. Equities don't care whatsoever about that, as they're high on earnings and AI. But at some point they might, and then we'll see multiple compression.

If we look at where long-term interest rates were coming out of the dot-com bubble, and before we got into the era of 0% Fed policy and negative interest rates all over the world, the US 30-year traded between a low of 4-4.25% and a high of around 6%. That's probably the trading range for 30-year yields, slightly less for 10-year yields, and we need to get used to it for decades to come. Unless there's some kind of revelation in the US Congress as to how to balance the budget ;)

He understands very well Israel's message to the world:  We are not going back to a world where Hamas and Hezbollah are threatening Israel. Until that happens, the IRGC has to stop funding them and Iran has to recognize Israel's right to exist. Under the current regime, that's impossible. So the war will keep going.

For political reasons, Trump doesn't want too much noise between now and the midterm elections. He'll downplay it and talk about peace and deals. Once the midterms are over (one way or the other), the conflict will escalate.

He gets asked this a lot. Not a whole lot, is the answer ;)

One of his favourite areas right now is medical marijuana. Very cheap, with very high potential of banking reform in the US (that's been an ongoing narrative for a couple of years now). Good for a trade, don't put a lot of $$ in (1-2% position at most). Very speculative.

When you think of rising interest rates, long bonds are cheap. But you need to have the view that the economy's going to fall off a cliff. If it does, $$ will come out of equities and go into long bonds. Duration is a great asset class when the economy is unstable and weak. Could be a 2027 story, and that would be one of his favourite asset classes right now.

If you asked him whether there's the potential in the next year for a strong rally in energy names again, he'd be onboard with that for a trade.

But if you're look at 5- or 10-year holds, you have to be insane. Oil prices are going lower. Once this issue in the Middle East is cleaned up (and he thinks it will be), we have a lot more friendly oil coming to the world and OPEC is starting to break apart. There will be very little pricing power. With the recent correction, the war trade is a good one on the bullish side. If you're playing a long-term hold, you have to be a seller on strength.

Bubble?
Everyone's asking him whether the current market's in a bubble. There are elements of a bubble -- you can see it in some of the sentiment readings. Some recent reading are at all-time highs in terms of institutional excitement over equities. Other surveys show not so much. There's no definitive tell for when it's a bubble.

Let's look at margin. The first chart shows how much leverage people are using in their trading accounts. (Banks have to keep these stats and report them to the government.) Margin debt is at all-time highs. Traders are using more options than ever before. ETFs that have 2x exposure. These are all bubble-like characteristics of euphoria.

But to say that this is the top, or this is the day before it all falls apart, nobody can tell you that. A topping process takes forever.

The thing that's different now from the past, is that earnings are really driving things. Earnings for the S&P for this last quarter were expected to be around $83. As earnings have come in, that number's going to be $100. Now, a large concentration of that is in just a handful of stocks. Earnings expectations for the next couple of quarters keep rising. As long as earnings expectations keep rising, and as reporting comes in as good or better, markets will keep going higher (regardless of all the other things that we're worried about). Whether geopolitics or inflation or rising interest rates, the market just doesn't care at the moment.

Where have earnings surprises come from? This quarter, we had a 30% upside surprise. AMZN and GOOG, for the most part, made up a huge part of the earnings surprise. Compared to previous quarters, these numbers cross almost all sectors. So the trend is broadening. The catalyst has been the "one, big, beautiful bill" and tax incentives.

Come 2027, we may have a new (Democratic) Congress and potential gridlock. It might be time to worry at some point. But for the next couple of quarters, we can keep going higher.

In spite of a lot of geopolitical headwinds for the last 4 months or so, optimism has been pervasive. We got a fresh burst of it in August with both the S&P 500 and the TSX surging to record highs. Both those indices are up over 7% since he was last on the show 2 months ago. 

This is all concurrent with the release of Q2 earnings, and they're phenomenal. In Canada, earnings are up 15% compared to the same period last year. More than 30% in the US.

The enthusiasm is well validated by fundamentals.

There is that. They also say that the first casualty of war is the truth, and that's certainly been the case from both sides in this conflict. Yes, it appears that investors are shrugging off the war, perhaps hopeful that it will end.

As it relates directly to the economy and corporate earnings, markets do seem to be shrugging off high oil prices (down from peaks, but elevated from a year ago). Higher oil means higher inflation, which has implications for monetary policy. Markets are settling into an expectation that rates will, at best, stay steady through the remainder of the year.

There's a tug-of-war being set up between interest rates and inflation. The score is on the tape; earnings are winning.

Interestingly, the Magnificent 7 are no longer so magnificent. The group is up ~2% from 2 months ago, which trails the S&P 500 (which itself trails the equally weighted S&P 500). Seeing a broadening out of investor interest.

After 4 years of this capital spending arms race, we're starting to see trickle-down benefits flowing broadly into the mainstream economy. The most rabid enthusiasm is still in semiconductors, hyperscalers and memory, but we're starting to see some of the benefits of AI usage trickle down to garden-variety businesses.

Nothing has been sleepy about this summer, or this year in general. Feels as though we're on a constant seesaw. War on/off? Interest rates down/up? Economy weakening/strengthening? If US jobs numbers are weakening that might be a good thing, as perhaps interest rates won't go up. 

And now we're also in the middle of earnings season, so we're seeing a lot of volatility because of that.

Mostly positive. Her focus isn't really in the AI-tech space, so she can't comment on some of the negative earnings today. When you're trading at really high valuations, you're priced to perfection. Even a small revision to estimates, or a small miss, results in a large stock price move. Energy stocks have been pretty good with oil prices higher. 

In general, pretty volatile. Yesterday, all the pipelines that she loves and cherishes were down. Why? Was it because SHOP was up 20%? Because oil prices were up? So hard to tell in this type of market what's causing the moves.

The best thing for her sanity and client portfolios is to look through the short-term noise and focus on the long term.

Preservation of capital is the most important thing for her clients. This actually makes it very difficult to invest in this type of environment, since market valuations are elevated. Even the boring stuff that her firm owns might be trading at 20-year highs.

The other thing to focus on is dividend income. If you're collecting 4-5% in the form of dividends, then regardless if the market is up, down or sideways, you're still getting income year in and year out. Stock price only matters when you're looking to sell. Her firm wants to own names for 5, 10, 20 years. Look through short-term volatility, and use weakness as a buying opportunity.

For new clients, they're sitting on too much cash really. With valuations elevated, it's hard to find decent places to invest. For example, it's been hard to buy Canadian banks this year.

For clients already invested, dividends that aren't withdrawn have been put into money market funds. This provides dry powder to deploy if there's a correction.

With the SHEL takeover of ARX, international players are starting to look at Canada. We have a low-risk jurisdiction and access to Asia. Because SHEL has a stake in LNG Canada, we're going to see expansion there.

Right now, we have too much production and not enough places to put it. But we're working on it.

She's stronger on gas than oil at the moment because of power demand. We're going to need baseload energy (data centres and reindustrialization back to NA), and though renewables will have a role, the rest will have to come from natural gas or nuclear. 

Hard to look at any of the banks trading at 20-year-high valuations when we have a weakening economy. Something has to give, and she thinks it'll come off the bank stocks. Capital markets and wealth management have been the real drivers. People look at banks as bellwethers for the economy; if the banks are doing well, the economy must be doing well. She doesn't feel that way.

At the end of the day, they'll do well because of their oligopoly position. Underlying businesses are OK. She's just not comfortable buying at these valuations. If we get a correction to our economy, the banks will be the first ones hit.