Andrew MoffsA Comment -- General Comments From an ExpertA CommentaryCOMMENTJan 28, 2021

It doesn't change his expectations for a second rate hike there. There are a number of things contributing to it. Defence spending is quite high, as is AI infrastructure spending. Plus the dislocation in energy markets. It's been hard to get inflation under control.  

The problem the Fed's facing right now is that inflation's been above their core target for more than 5 years. So the new Fed chairman is taking a harder line.

If you look at the futures curves, it looks as though we could have a second rate hike later this year. But it's a dynamic environment, and things can change quickly.

Yes. Fear seems to keep growing daily because of uncertainty. For example, how will the midterm elections play out? 

One thing that gets glossed over is the fixed income market in the US. Foreign countries own US treasuries. If US trade with those countries goes down, their ability to hold those securities goes down as well. Japan's bond market is internally sources, while the US has a bigger reliance on foreign investors. 

The uncertainty negatively impacts the rate outlook.

What you're looking for on valuation doesn't change. But your return expectations do. In Canada and the US you get very concentrated markets, and with those come pockets of overvaluation.

Important to have a disciplined process and rebalance. In Canada, the only things flying high right now are financials and energy. In the US, it's the tech names. A lot of sectors are still really down on their luck, and you can find some good opportunities.

He finds this sector puzzling right now. (He started his career as a bank analyst, and has been around them his whole career.) The valuations today are not seen very often; about 20-30% above 5-year averages. EPS growth in same range. Not sure if it's because money has flowed out of the US and into Canada? Pretty sure it doesn't have to do solely with growth outlooks for the banks.

Very shareholder-friendly. Great dividends (though yields have come down as valuations have gone up). Buying back lots of shares. Rising rates pose a challenge, making the valuation of Canadian banks a bit vulnerable.

If you own, consider rebalancing a little bit to free up some capital. Don't exit entirely. To allocate new capital, just wait.

Tough to know, and tough to time it. He finds it easier to recognize value and be patient enough to wait. With fund flows so fast these days, things can rerate in just one quarter. If you wait too long, you can miss your opportunity. So he tends to get in once he sees the value.

The price you pay dictates your return. If you get in at a good price, you can get earnings growth and multiple expansion for a great total return.

The deal between the US and Russia for diesel is a drop in the bucket and will have little impact. What's interesting is the US seems to have relaxed the sanctions against Russia, but now faces US bi-partisan pushback. He'd be surprised if this deal goes through, considering many Republicans oppose it. He doesn't see an end to to the US-Iran war. Iran has leverage and will string out this war for as long as they can to gain even more leverage. He's amazed that some believe that oil prices will fall after the U.S. midterm elections. In Canada, Alberta's premier first proposed the TransMountain extension a year ago, but nothing has been done so far. Carney isn't moving at breathtaking speed, as promised.

It's been underway since late August, but more evident in the TSX than in the S&P 500 (which is being narrowly held up by a narrow group of names).

The TSX is actually down roughly 5% off its late-August peak. Difficult to pinpoint any one reason. It's a broad-based selloff, a stealthy bear market.

Number one would be high oil prices, more problematic in the US than in Canada (given our heavier weighting in energy names). Inflation. Interest rates. Bond yields at 20-year highs.

Another shoe dropped this morning with the Canadian jobs report, massive job losses in September.

We're seeing anxiety around tech, and we're certainly not in the early innings of the AI story. Seeing more and more concerns about AI. 

Will the colossal spending generate returns commensurate with their cost? The other things people are getting increasingly anxious about are guardrails, governance, and potential regulation around AI. It cries out for a globally coordinated approach. With globalization fracturing by the day, that's not happening.

All that angst is hitting the market.

As for earnings, tech earnings are going like gangbusters in the States. Yet there are jitters. Yesterday saw an erroneous news release about OpenAI's revenue being overestimated, and then retracted. That caused a big selloff in the tech complex yesterday.

A good way to summarize it is that there are a lot of "nervous hands" on these tech stocks.

Those are the 2 big ones. Long bonds in the US, and now globally, have started to blow out. Bonds at 2-decade highs are causing some jitters. He was at a dinner last week, and the talk was all about how can both rates and markets keep moving higher? So that's the #1 focus for investors.

Oil keeps getting pushed out. The war in Iran signals that it's winding down, and then it ramps back up. 

Definitely a bit of investor fatigue out there the higher these two numbers go. It puts a lid on certain sectors of the market.

We're just 1-2 years into the enterprise adoption of AI -- big corporations that have entrenched IT systems starting to use AI for productivity. Have also seen deflation on the token cost (actual cost to run an AI model). Output is also much higher quality.

Seeing some deflation, particularly if you look at employment and wages. Very slow wage growth in the midst of cyclical factors (inflation, data centres, oil) that are pushing inflation. Structural inflationary forces on the other hand (wage growth, shelter, and housing), are starting to slow down. That supports a more moderate inflation outlook.

Not sure how much of a factor US midterms will be. Movement towards the Democrats might handcuff the Republicans on some parts of their agenda. It won't really change anything over the next 2 years, broadly speaking.

It really comes back to inflation and the price of oil. The last time we saw long bonds act the way they are now, we did eventually see some stress in the US banking sector. There's a very supportive movement to lower capital and reserve levels across the financial system in the Western world, so the stress might not appear. But as a rule of thumb, rates can go only so high before something in the financial system starts to bend, if not break.

So we might see some more volatility. Until we don't. ;)

All manias die. This is a mania, and a whopper. We haven't cleared the system of the last spate of mania that was the massive government spending through Covid, which people took and bought extremely aggressive stocks. Then the Fed tightened credit in 2022, and those people got slaughtered.

Usually when people get hit like that, if it doesn't last too long (just a year as opposed to 2-3), their memories aren't very good. So people have come back.

This particular mania is following on all the excitement of meme trades and growth stocks. Now here we are with a very justifiable investment boom in AI. But when everyone wants something, that's the time to stay away.