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

No doubt that money's rotating. If you look at the quality of the rally in the last few months, the stocks that are going up the most are the ones that were the most heavily shorted. And that's not a high-quality factor.

Earnings are coming in and broadening out a little bit, but still largely concentrated in the leadup from the AI investment.

We're on the eve of a recession here in Canada, yet the TSX is at all-time highs. Hard to justify those 2 things. Depending on what kind of investor you are dictates how aggressive you want to be in moving your money around. It also depends whether your investments are in taxable or registered accounts. All those things are factors in what you do to protect your portfolio.

In this high-valuation era we've been in for some time now, he loves the buffer-style ETFs. They allow you to continue to participate on the upside (if there is upside). But they give you a good degree of protection during a market pullback. BMO has a number that trade in the US, and other providers are coming out with them. Great for people worried about valuations and a recession.

Another method is to put $$ into covered call ETFs -- boost the yield in your portfolio with something like ZPAY. It gives you a much higher income component as a guarantee into your return versus the price volatility of an overvalued equity marketplace.

Could also consider shifting assets into bonds. If we do get a recession, government bond yield will come down. A  lot of that's already reflected in Canada, but we have yet to see it reflected in the US Treasury market. So US Treasury long-duration bonds could be attractive.

But none of these measures are buy-and-hold. You have to be very active in your portfolio when shifting things around, if you're going to worry about a recession and try to time the market. It's the hardest thing to do, even for professionals; he's been doing it for ~40 years now, and hasn't figured out the secret sauce yet ;)

Likes the natural gas space a lot, there's an abundance in NA. It's one of the most efficient ways to generate energy in a less dirty way than burning coal, for example. Likes it as a transitionary, carbon-based fuel to power the world. The world's going to need a lot more energy what with AI and the electrification of the world in the coming decades. Nat gas will be a big part of that.

He wishes the Canadian government had invested better over the last decade so that we could distribute our nat gas resources to somebody other than the US, as the US is becoming increasingly difficult to deal with on trade.

Cockroaches in the Credit Market

Last week during JPM's earnings call, Jamie Dimon used that phrase when referring to some of the fraud that was recently in the auto loan space. There's always been fraud in markets. When he talked about cockroaches, he said that when there's one there's usually many. A lot of the private credit managers spoke up and said that there might be cockroaches in Dimon's neighbourhood, but not in theirs.

At the end of the business cycle everything seems great and wonderful, with markets at all-time highs. Larry brought along some ETF charts to follow along with and see when you need to really worry.

The first chart shows the total return of the high-yield bond ETF, HYG-N. The chart goes back to before the great financial crisis. That same chart also depicts the total return of VTI, the Vanguard ETF that represents the entire US stock market. You can see great gains there. But during the period of recession (whether the GFC or the very brief recession during Covid), you can see the shock to credit markets.

A second, related chart shows a white line representing the yield spread of high-yield (junk) bonds over their government equivalents. When that line rises significantly, it's correlated with weakness in equities. About a year before the GFC, that spread in high-yield bonds started to rise. Based on where it is today, we don't have that same sense of credit risk that we saw back in that period.

So, what does that mean? During Trump's tariff upset in April, the white line jumped towards 5%. So that's 5% above the yield of a government bond. Going back to pre-GFC, it was 15-20%; during Covid, it went north of 10%. So we're nowhere near that level of worry in credit markets. Dimon's comment might be a little bit premature.

He's also brought along a table from Moody's, which shows the average default rate annually all the way from AAA down to non-performing, C-rated bonds. If you add up all the junk bonds (BB, B, and all the C's), it's a little less than 9%. Once a company defaults, the recovery rate is ~40% (so if you lent them $1, you get 40 cents back). When you do the math, on average you could lose about 4-5% in junk bond investments.

One last chart, BIZD, represents the private credit markets. It's at a very important inflection point here. If that line breaks, it's telling you something.

Market Update:
The Canadian economy gained more jobs than expected in September as the unemployment rate stayed unchanged at 7.1%, raising questions about the timing of the next rate cut. In addition, the Prime Minister Mark Carney brushed off calls to retaliate against the U.S. over tariffs on some Canadian exports, saying the two were in talks to figure things out. The Canadian dollar was 71.20 cents USD. The U.S. S&P 500 ended the week up 0.5%, while the TSX was down 0.7%.

It was a mixed week of greens and reds. Consumer staples rose 3.3%, while consumer discretionary and materials gained 1.5% and 1.2%, respectively. Industrials edged up by 0.1%. On the other hand, energy slid by 5.6%, while technology and financials gave up 1.1%, each. Real estate ended the week down slightly, 0.2%. 
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TSX is largely gold, so that's what's driving the bus. It's the only sector outperforming the index this year, and it's outperforming by so much that it's raised the average of everything else.

Under the surface, the infrastructure stocks they own are doing pretty well. So he's happy with where things stand.

We're in some sort of changing of the world order. US government taking positions in private companies. Ongoing trade war which escalates and de-escalates day by day. A lot of that is filtering into gold. His firm is a bystander in  this. They own a bit, but not a lot. 

He's been watching the dichotomy between gold and Bitcoin. Bitcoin is supposed to be digital gold and better because it's portable and costs less to store. But it's not performing the same way gold is. That tells him that adoption isn't there yet. As well, when the person on the street is chatting about gold, that's a warning sign of bubble-like behaviour.

The changes we're seeing in the US treasury market and in many countries makes it hard to tell exactly how assets should be valued. Assets are valued relative to each other. A year ago, gold was clearly undervalued relative to other assets, and now that's changed.

You can make logical arguments both that there's room to run higher, as well as that we're overheated here and due for a pullback.

Some investors like the entertainment and streaming segments, but his firm doesn't find those areas durable enough for their clients. That world just moves too fast for them.

Just this morning, he had a discussion with a client who's retiring at the end of this year. She's 58 and has worked for the same company for 30 years. It's not as though she's retiring with a massive portfolio, but it's enough for her to live off of. This portfolio has to take her to, say, 98 years old. That's 40 years. She needs something that's very durable and will last that length of time. Produce income for her to spend, protect the downside, and provide some upside if there are worries about inflation or currency debasement.

Interestingly, whole Canadian energy space has been pretty resilient. Gradually people are returning to Canada on the basis of our lower decline rates, better prospects for transporting oil out of the country, and a government that might support further investment. Good case to be made that oil prices could rally from here. 

In 2026, you'll really want to watch drilling plans for US shale drillers. If they're not drilling, that could set the stage for a pretty good environment in Canada.

He's underweight, and has been for some time. His portfolio position on banks is ~15%, compared to 20-25% of the index. It's not a market-timing call, but more of a long-term structural call. Better places to put $$. For individual clients, he doesn't mind selling some bank stocks to fund expenses. Otherwise, he's happy to hold and collect the dividends. 

All of them are quite rich, he's not buying right now. And we're still not at peak reset for Canadian home mortgages, which will be end of this year and into next. He'll be watching that.

Investing 101: Lump-Sum vs. Cash Flows

Time is money, and money is time. One of the founding principles of investing is that cash upfront is almost always better than spread out over a period of time. To achieve the same ending amount, less money is required if it is provided in full upfront than spread out over time. To demonstrate this, we show below that $10,000 upfront grows to ~$25,000 in 12 years, growing at an annual rate of 8%. Conversely, an investor would require 12 payments of $1,225 ($14,700 total) earning 8% annually to have $25,000 by the end of 12 year period. Therefore, $10,000 upfront growing at 8% achieves the same ending goal as $14,700 spread out over 12 years.
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It's been the same themes all year long. If you look at the core sector leadership groups, it's been financials, industrials, and materials really driving the bus. Materials have been exceedingly strong.

There's been continued hedging in portfolios against inflation. Inflation is sticky. While the Fed is now cutting rates, it probably increases the longer-run chances for inflation. You can see that in the long-term treasury bonds.

The TSX is benefiting because the sector makeup in our market is a more inflation-oriented index.

The problem with market-cap-weighted indices is that they can become exceedingly overweight certain sectors. 

So if you look at the S&P, it's underperforming almost all global markets YTD. It's a very growthy index, and some of the sectors that are really working are very small pieces of the S&P. For instance, materials make up ~3%. Whereas in the TSX, the materials sector is a much larger piece (in the teens). 

In a market right now that's uncorrelated, it means that there are haves and have-nots. For active portfolio managers, it means there's an opportunity to add value.

From 2007-2024, the all-world index (ex-US) had almost no return. Whether you were looking at Europe, South America, or Asia. Japan had 33 years of no return.

But in the last 18 months, international equities are outperforming the US. Part of that has to do with ~31-32% of the all-world index being financials, and financials have been very steady. Materials is a much larger piece of the global index. There are also a lot of great industrial companies. 

International investors wound up very focused in the US because it was the only game in town. But now their markets and their currencies are doing a little better, and so we're seeing capital rotate back to international stocks.