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

Mixed American job numbers today would have made no difference to the US Fed's decision last week. The numbers are benign. The US is on a jobs strike--managers won't make hiring or firing decision until they see greater clarity of the economy, sectors, and industries. We're not in stagflation; the economy is still growing, but inflation is a risk. We got a rate cut, but the market was surprised by the dovish tone--and the market didn't react well, which is telling. The market is supposed to like a dovish Fed. If rates go down for the wrong reason, it could create other problems, namely higher inflation.

The thing to focus on is something Chairman Powell said last week in his press conference when asked about the state of the labour market in the US. He said while the US economy has been generating an average of 40k jobs in the last 6 months, the FOMC believes that this number is being overstated by up to 60k jobs a month. That would imply that for the last 6 months, on average, the US economy has been losing 20k jobs per month.

Some market participants are looking at that and saying that the Fed needs to be more aggressive in cutting rates. Yet others say, wow, if we're starting to lose jobs that means weak economic performance and it isn't good for equity multiples. 

For him, that's the debate going forward. Can we muddle through in a Goldilocks fashion? The US administration wants to run the US economy hotter to keep the stock market more robust in a midterm election year. So 2026 is shaping up to be a very interesting dynamic.

When we look at what's priced into the market, we're essentially looking at one more rate cut, maybe two, between now and the end of next year. Markets are already starting to price in rate hikes based on that. 
 
What that tells him is that they're really worried about inflation. The Fed really has to be very delicate in its assessment and balancing those 2 risks of jobs and inflation in 2026. Larry wishes he had a crystal ball that made it clear, but that's where his focus will be.

It started with the supply-side shock from Covid, which is now largely over. But we're entering a world of less globalization, which means fewer efficiencies, and higher costs.

The question is whether the new dynamic of AI is going to raise productivity enough to completely offset any of the inflationary pressures? History tells us that technology and innovation are very disinflationary. So there's the camp that believes we shouldn't worry about inflation, and the camp that believes we should. That second camp is looking at the massive amount of government debt in the world that's going to get very expensive if inflation comes unanchored.

The unofficial new voting member of the Federal Reserve in 2026 and beyond (aka The White House) does care what the stock market does. He thinks there's going to be some influence. We heard from Kevin Hassett over the weekend in the news media that he would be open to listening to suggestions from The White House, though wouldn't necessarily do what The White House said in terms of monetary policy because it's a multi-member voting system.

There's a new dynamic in the FOMC that we haven't seen for decades.

When you buy an ETF in Canada for a foreign market, whether hedged or not hedged, the cost of hedging is very real. On an ETF for the US, there's still withholding tax and other tax issues that happen in the background. Not a lot of tax efficiency in terms of which way you go.

The question is:  Do you want that foreign currency exposure or not? His rule of thumb (probably for the next couple of years) is that if the CAD is 70 cents or lower, you want to make sure that the foreign currency is hedged. Fair value for the Canadian dollar is probably a lot closer to 80 cents (or $1.25 in trading terms). When we're at that point, that's perhaps when you'd seek the USD exposure. He doesn't think we'll get much beyond 74-75 cents anytime in the next 12 months. If we do, then he'll change his view on where we're heading in the short run.

There was a pretty dramatic shift that happened during the recent Canadian employment report recently. If we see another strong report, that could push the CAD to being quite a bit stronger.

Global X has a suite of ETFs that are executed by way of a total return swap. Those are the most tax-efficient. There is a slight extra cost to them, but on an after-tax basis it's your best bet for exposure to foreign markets. 

The real benefit to a Canadian is the Canadian dividend tax credit -- those only come from Canadian corporations. So if you're buying exposure to a foreign security, even though it trades in Toronto (for example, S&P 500 or MSCI EAFE), those dividends are not treated tax-efficiently but are treated as income.

For income seekers, he's recommended ZWU with its covered call exposure. You get a big percentage of that return coming by way of capital gain, which is your most efficient way of paying tax.

Planning  for 2026

Fed Chair Powell talked about how he thinks the US is losing jobs. Tomorrow's jobs report should be pretty interesting.

Post-FOMC last week, and post the most recent BOC meeting and Canadian employment numbers, is related to the first chart he's brought along. It shows implied current overnight rates based on how the futures market is trading. We can see that it's pricing in 2 more rate cuts (with the potential of 2.5) to the middle of 2027, but then starting to price in a bit of a tightening pattern after that.

He believes this type of thinking is completely out to lunch. Let's look at the S&P 500 analysts' top-down consensus, and there are 24 of those analysts. They think the year-end target for the S&P for 2026 is around 7489 with about 9.7% index growth. Earnings growth is estimated at 12.6%. 

Those strategists are saying that the economy's going to do really well next year, earnings growth is going to be great, and we're going to have another good year for equities. But that really doesn't support what the market's pricing in terms of Fed policy. If we get that kind of earnings momentum and the S&P is strong, then we're not going to see any more rate cuts. In fact, the next series of cuts will be when the US economy starts to falter.

Equity markets and messages from bond markets are telling us different things now. We can look at the bottom-up aggregation consensus on a graph, which takes the 503 members of the S&P index and rolls up analyst targets by their weight in the index. It comes up with a target of 7938. 

Historically, we've never hit those targets. So don't use them as your targets. But again, those numbers are telling you that analysts are very optimistic. Not really what the Fed funds futures are pricing in, in Larry's mind.

As we look to 2026, we have some challenges. Valuations in public equities are just not compelling right now, yet markets keep going up. He's been advocating a rebalancing of portfolios to maintain market exposure, but to shift to investment strategies that will generate more income. Private equity and private credit markets are good places to be, while still delivering on your long-term rate of return (and higher than the rate of inflation). Remember that timing the market is extremely difficult.

Next year will be challenging from an investment perspective. He's seeing a lot of things that don't add up, which tells him that something very different is likely to happen next year. He only wishes he could tell you what it will be ;)

Not a bubble in the sense that there are real products with a real economy, unlike the late 1990s. But there will be a washout and a cleansing, because there always is when things get a little frothy. We just can't time it with any precision.

Bonds are at tight levels suggesting a risk-on environment or confidence in the credit market which is good for equity markets. Concerns are not showing up in the equity markets. A lot of people are invested in S&P ETF's and many don't realize they're paying 25 times this year's expected earnings, the highest valuation since the dot-com bubble. However the market can stay expensive for a few years and a trigger is needed to start the selling. Once started the market can fall off a lot faster than people expect so most get caught in it.

Not sure what's driving it. The Fed decision is out of the way and there are 2 weeks left in the year. We should be coasting, but that doesn't appear to be the case. 

We've had mixed results from ORCL and AVGO, and anything around AI and AI capex is hyper-sensitized right now.  Investors may also have been waiting for that last Fed catalyst, and now that there's nothing left in the year they're trimming positions. Who knows?

Whatever it is, it doesn't really matter to his firm. Though down today, the TSX remains strong and is down much less than the NASDAQ and the S&P 500.

Looking back on this year, it's been crazy. It feels like four years instead of one :)  This time last year we weren't even talking about tariffs in a major way, and now it's part of everyday discourse. Even if we'd known that, we wouldn't have expected markets to behave the way they have. We probably wouldn't have expected the TSX to be up as much as it is.

It's been a surprisingly strong year. And that's why you stay invested. You don't know when things are going to perform or not perform, so you have to stay the course no matter what.

He has concerns. Many of those are because a lot of this looks like and rhymes with a lot of things that have happened previously. He's a student of history, so he uses the past to make decisions about the future.

The other thing that's concerning is how big an influence this space has on the broader market. If we have a problem here, it will be systemic. Concern is really starting to be seen around the bond market. Companies have done a lot of borrowing, and capex continues to inflect upwards from already-elevated levels which now must be financed with more debt than equity. That's where the rubber's going to hit the road, and we're going to have to start seeing some cashflows from all this investment.

His team hasn't really changed positioning much in the last couple of years. They were early into the themes of electrification and demand for electricity. AI has pushed that further than they would have thought. So there is some concern that if the data centre buildout proves not to be quite as broad as people are thinking, that disappointment will be seen in many stocks. But it's going to hit the hyperscalers even more.

He's not necessarily counting on the demand from AI. He's counting on steady demand from near-shoring and re-shoring, climate change, migration, warmer temperatures increasing demand for cooling. Data centres are on top of that.

His firm is pretty happy with how they're positioned. What they'd like to see is a broader mean reversion (aka a pullback) to get some more $$ invested. Right now holding about 10% in cash, and would like to get that down to 2-5% (especially with interest rates dropping).