A Comment -- General Comments From an Expert (A Commentary)

Shorting is not for everybody. It's risky. Shares can be dragged up with an overall market move. He avoids shorting.

He's looking for earnings growth and a broadening out of it. We've had a very narrow and strong leadership by a handful of tech names (the Mag 7). For this bull market to sustain itself, it's really important for earnings to broaden out beyond those names. What will largely set the tone in the coming weeks is AI and what its related companies tell us about going forward.

We'll hear from banks to start off earnings season, as we typically do. There we have rising interest rates and a steepening yield curve, and the banks will provide some insight into that situation.

The market's swinging quite dramatically here and, for him, that speaks to the narrowness of the market. There's uncertainty. If we do get some bad forward guidance on earnings, that won't be good for the market.

True. There's a saying that "a rising tide lifts all boats". You want that broader participation. There are an awful lot of companies that just aren't making any, or any significant, money. When you look at the topline (revenues) versus the bottom line (earnings), you're seeing earnings growth expectations of 10-12%. But we're seeing nominal GDP of 4%. It's getting ever more difficult to reconcile what economic growth will deliver and what earnings will be.

When it's more concentrated that tells you that if those companies miss, look out below. It becomes a higher-risk market when earnings aren't broad.

That's it. The market went from pricing in a dramatic amount of rate-cutting six months ago, to virtually pricing out the entire rate cut path. Now the Fed still thinks it's going to cut rates a couple of times, but the market is now down to 1 rate cut for 2025.

Import prices will be lower with a stronger US dollar, sure. But that's a small part of the pie compared to labour costs, healthcare costs, and everything else related to supply/demand that's driving inflation. Domestic inflation is driving prices higher, and has little to do with exports.

Trump incorporating tariffs is a concern. It makes it far more difficult for the Fed to add stimulus until we actually see more economic weakness. Right now, the economy and labour markets are still ticking along. 

Weakness in the equity market is a much-needed correction at this point. If 18x PE is normal, we're trading at 24x. Is it egregious? No. But it's on the very high end of the range. It's open to risk with a narrowly led market, instead of broad participation to growth and earnings.

These ETFs give you exposure to an index such as the S&P 500, but then there's an embedded put strategy for protection. You'd buy 10-15% protection on the downside, and then sell a call to pay for that. A no-cost structure of protection. Limits upside, but protects the degree of downside risk.

Loves them right here, right now. It's for those who want to and need to stay invested in equities for growth in the long run, but who are nervous about the markets.

If you need it in 2 years for a deposit, you don't want to put that $$ at risk. You need to put it in an instrument that will be there for sure in 2 years. While the S&P 500 isn't going away, it's possible (not predicting) that it could be down 50% in 2 years. In this situation, capital preservation is far more important than maximum growth.

Look at the buffer ETFs, as they have less downside risk and still some upside potential. He's also seen commercials for private mortgage investment corps, generating 7-9% yields; in a registered account there'd be no tax consequences. He'd go with that, as even the buffer ETFs are capped around 10%.

Earnings Growth and 2025

Warren Buffett was a student of Benjamin Graham, who wrote a seminal book on value investing. In the short run, the market is a voting machine. In the long run, it's a weighing machine. This means that in the short run, markets can get irrational, emotional, and swing up and down. In the long run, fundamentals matter and markets will track those long-term, fundamental trends.

To get a handle on short-term swings, Citigroup puts out the Economic Surprise Index. They compare the consensus for a particular economic indicator with the actual number, and whether it's a positive or negative surprise. Whether we're beating expectations or not tends to have an impact on markets.

When interest rates started to come down, the S&P 500 trend channel accelerated. Interest rates started to come down in 2024, until very recently where we're back at 5% again. Financial conditions are getting easier, which is what usually happens when interest rates fall and stocks do well.

But in the last couple of months, financial conditions have started to tighten. Both stocks and bonds are starting to work against the trend. If we start to see the 30-year break above 5% and hold, that spells to him tighter financial conditions and further weakness to come. What do we need to happen to get there?

Enter earnings season. In 2022, consensus expectations were for $260 of earnings for 2024. At the end of 2024, it now looks as though the number will be $242. The market typically, though not always, overestimates what earnings are going to be. 

The consensus for 2025 is $272, which is more than 10% earnings growth. We're in a 4-5% nominal GDP market, so it would be difficult to generate that 10% growth unless things are firing on all cylinders. Looking at 2026, consensus is adding another 10% earnings growth on top of that. Markets are priced for perfection. Unless the news and outlook are both very, very good, expect people to sell into rallies during earnings season and expect financial conditions to tighten up a bit more.

What is the P/E Ratio?

The price-to-earnings ratio, or otherwise known as the “P/E” ratio, is a financial metric commonly used to measure how expensive a stock is compared to its earnings. The ratio can be rephrased as the amount that an investor is willing to pay for every $1 of earnings for a specific company. The ratio involves two components; the first is the ‘P’ portion, which is the current price per share of the stock, and the second is the ‘E’ portion, which is the Earnings Per Share (EPS) of the stock. For example: if Stock A has a current price per share of $30, and an EPS of $1, then the P/E ratio is 30X (calculated as: $30 Price / $1 EPS = 30X P/E). To maintain a stable P/E ratio over time, the price must appreciate at the exact same rate as the earnings per share. For instance, for the P/E to remain at 30X in the next year, if the share price increases by 10% from $30 to $33, then the EPS must also increase by 10% from $1 to $1.1 (calculated as $33 Price / $1.1 EPS = 30X P/E).
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We're burning off and will burn off more optimism. There are always uncertainties in the world, but optimism is high and so are valuations. A new US president is coming in and the US government carries a massive deficit of 6% of GDP, nearly twice of Canada's, while their interest rates are rising and potential trade wars. Meanwhile, Biden is further constricting the further transfer of chips to China--is this sound policy for America long term is a big question. Does this pile up on big companies like Nvidia and Apple, the latter of which does a lot of business in China and could face retaliatory measure by the Chinese government? Doesn't know, but possibly. Overall, investors are too optimistic as there are many risks around. Be cautious about most markets, including the U.S. The Russell 2000 is -10%, for example, so we are burning off excess, but there's more to come.

Fair to say that the US and China are in a technological war. The war the US restricts China's access to chips, then the more China will build its own chips. The US can have superior chips for a while, but when China catches up, look out. It will be a powerful competitor to the US. Chip-making is cyclical. The US blocking such access may have good intentions, but could harm the US long term.

He buys the homebuilders only a recession when they're beaten up, below book value and things are really bad. The bulls say that demographics and concerns over immigration fuel housing demand. However, it looks like interest rates will be higher for longer, so affordability becomes a major issue. The new president's policies could be inflationary.

Yes, simply because we have two major events occurring over the next couple of weeks, with the major one being Trump. The other is a Canadian election coming up. So he's holding off until he sees policies coming out, as it's just too volatile right now.

Nevertheless, overall he remains quite bullish on the US. Virtually all of his positions are in the US, no reason to change that.

Has put virtually no new money in Canada, due to the ruling Canadian government for the last several years. We've lurched from one crisis to another in terms of deficit, housing, and inflation. Tax structure is not conducive to foreign capital coming in, and it takes decades to get anything approved. Capital gains tax in the US is much more favourable for startups.

He had held Canadian banks for quite some time, but then got out when the TD money laundering fiasco started. A change in government might be an opportunity to invest in Canada, but he wants to wait until the dust settles a bit.