AGF Management Limited (AGFB) Earnings Call Transcript & Summary

All right. Good morning, everyone. Thanks for joining our latest market update webcast. With me is Kevin McCreadie, AGF's CEO and Chief Investment Officer; and AGF Portfolio Manager, Mike Archibald. I'm David Patt, Editor of the AGF prospective block. Before we begin, I've got to go through our administrative items related to our virtual event platform as always. Today's presentation will last no longer than 60 minutes. Those joining us live can submit questions any time during the presentation by opening the Q&A icon found along the side of the presentation screen. Questions will be addressed near the end of the webcast. Additional resources for this session can be accessed in your attendee hub at the top of the page under the Resources tab. And then finally, please note, CE credits may be available for members of our Canadian audience. Okay. For those of you that tune in regularly, you'll know that every quarter, we run through our asset allocation committee's latest quarterly update. So without further ado, I'll hand it over to Kevin to summarize this quarter's changes. Over to you, Kevin.

Yes. Thanks, David. The way we're looking at the world right now, we're just kind of neutral in our equity bet underway fixed. Within the equity bet, you could see -- if you go back one slide, we continue like the U.S. and Japan. And again, we're underweight Canada, Europe and Asia Ex-Japan for reasons that we'll talk about probably related to more as you think about where a recession will appear first. If you look to the fixed income slide, we are still underway for getting closer. We remain very underweight rate sensitive. So as you think about a world where rates are now higher for longer, and the bond market may demand more in terms of yield to buy that supply continue to be underweight there. And obviously, overweight high yield where we think when you're starting to approach coupons that are near 10% and yet economies in the U.S., particularly which are resilient, which make most of that market, pretty good opportunity. And then neutral on the emerging markets, given the back up in the U.S. dollar. If you flip to the next slide. You could see from an alternative cash button, a cash which now yields well north of 5%, most places in the world, it gives us a nice hedge plus the alternative bucket on equities to manage through some of the volatility that we're going to see some in the near term.

Okay. Great, Kevin. Let's provide a little bit of context for the update. And maybe the question for you is when you think of the backdrop for equity markets. Let's start with equity markets first. When you think of the backdrop now versus the past quarter, what has changed in your mind, if anything?

Yes. If you remember at the end of June, we have a really strong push on equity markets, right? Things have gotten a little hotter. You had central bankers all around the world saying, "Hey, we're not done yet, right?" And again, this was in the backdrop of a very strong late push on Q2 on equities, right? Now it is sitting here in the fall. And I'd say it almost as if every central bankers got the same playbook. We may be at the level that is restrictive. The argument should no longer be how high, it should be how long. And we're watching the data, very closely. So and I think the markets are starting to say, hey, maybe they're starting to believe you're seeing fixed income again, have a very volatile backdrop over this quarter and again, starting to recognize that maybe this idea that rate cuts are anywhere near us is a little bit further out than people thought. So I'd say those are the 2 big changes, which is this belief finally that maybe central bankers need to be listened to versus what we thought earlier in the year or the market thought earlier in the year, which is that they should be cutting, right? That seems a bit longer, now because the strength of these economies has been okay.

And then, Mike, let's bring you into the conversation and maybe just a thought from you in terms of what's changed over the past quarter, particularly in equity markets?

Sure. I guess from my lens, and I agree with what Kevin had said there, the thing that's changed probably the most is just the trajectory of where earnings growth is. So as we look back to the first half of the year, earnings growth was negative for the first couple of quarters. We're really now at the point in time where we're going to start to tip probably just slightly into positive territory. So we've kind of lapped over the challenging periods that have occurred in the last 12 months and now we're starting to look like we might be heading back into a period of actual earnings growth and I think we're going to have to -- as Kevin said, we going to have to recalibrate to a number of things, growth for the fourth quarter looks like a hockey stick, it's almost double digits. I don't think that's quite likely. In 2024 and 2025 earnings estimates are both up about 12%, 13% for the year. And so when we think about the macro backdrop and what's been going on, that doesn't seem very likely to me, but nonetheless, I think there is some level of positivity that we can take away from earnings starting to move back higher. I think the other main thing, and I guess we'll probably talk about it as we go through the call today is just the change in the geopolitical environment that's going on. And I think that introduces a whole host of tail risks, if you want to call it that, to what's happening in broader equities, what's happening in fixed income and what's happening in currencies. And so I think those things are going to continue to, in certain parts of the market, put a lot of pressure in other parts of the market, probably be a bit of a tailwind, and we'll talk about that. And then I guess the last point I'll just echo is what Kevin said. I mean we sat here, I was on this call, I think, 6 months ago and yields had moved up quite a bit. With bond yields are now at 2007 levels. Interest rates are at yield levels that we haven't seen for many people in 15 years. And I know the economy has been relatively resilient, but that pressure is still likely to come for the consumer. It's still likely to come for businesses, and it's probably going to have an impact on equity markets. So those are the things that have changed. I think some of those are happening at a little bit slower pace than maybe I would have thought. I thought some of those things would have happened a bit quicker. It hasn't but I do think it's still probably likely to have an impact here as we move into the end of '23 and into 2024.

Yes. Let me touch on something, David, that Mike just said. It's the bond market, right? When you look at what's causing the equity market volatility, it is the bond market. And you look at a day like today just for -- take a snapshot, arguably, the geopolitical events overnight are troubling, right? These events over the last few weeks, very troubling, right? In terms of what it means potentially for oil for a greater involvement of different players. You would have gotten up this morning and said, "Hey, people are going to flock into bonds, that would have been the thing, right?" the safe haven asset. The 2-year from yesterday morning was [ 5.11 ], it's [ 5.23 ] this morning. It is backed up significantly. The 10-year which yesterday morning was [ 4.75 ], is now [ 4.92 ]. So these are vicious backups, right? That's people saying, "I need to get paid more to take on fixed income from here." And that is this idea that maybe people think rates are going higher. Certainly, the bond market is going to do the Fed's work for them a little bit. Think about most things in life, they work off of the 10-year. Mortgages work off of a 10-year, corporate bond buyers work off of the 10-year. So as you push these yields higher, it makes it harder for everyone to borrow. And so you're starting to again, the Fed doesn't need to raise short rates as long as this curve keeps going like this, it's going to take a fair amount of restrictiveness in the play here.

Okay. Let's -- let's put it back to something you talked about, Mike and that was earnings growth. And we're sort of in the midst of U.S. earnings season right now. I believe the U.S. banks have all reported and I think a lot of the big tech will report next week. Any surprises in terms of what you've seen so far from earnings season? Mike, I'll start with you first, and then Kevin maybe some thoughts on that as well.

Yes. So it's a bit early. As you mentioned, David, I think we've got, call it, 30 or so S&P 500 companies that have reported, and it's heavily skewed towards financials, as you note. I guess I would just say a couple of things. The bar for financials is so low right now, just given the fact that there's very limited earnings growth. Loan growth has been really sharply decelerating just given the move that we've seen in rates and just how stressed I think or I should say stress, but how much debt some of the consumers globally already have. So earnings for the banks have actually come in better than expected. We haven't seen a real uptick in credit. But as we've been talking about internally for a couple of months now, the consumer looks pretty stressed here, right? They've done a lot of work. Their excess savings are probably being depleted. We've seen that on a couple of calls from some of the major banks. We heard the same thing again out of Morgan Stanley this morning, and that stock was off sharply today, 7.5%. So I think the consumer, we've talked about the resiliency that the consumers had, and that's still showing up in some of the retail sales data that we're seeing. But we got to be getting close to the tail end of that. And so I think the spending patterns of that we've seen in 2022 and 2023 are going to change dramatically as we move into 2024. If we flip the script and start thinking about technology, which has been the real driver and the leader of the S&P 500 returns this year with the Magnificent Seven, those numbers are actually still going to be pretty good from a growth perspective. So you're going to have high single-digits, low double-digits out of most of those companies. The question just is, is that going to be enough to sustain the valuations that those businesses trade at? And so I don't have an answer for that question. Certainly, we're seeing a lot more volatility in those names in the last week or 2, and they have corrected a little bit from the highs that we saw in the market in July but the narrowness of the S&P 500 this year is still being exhibited with those companies really driving the -- you could call it, 14% return for the S&P and the equal weighted index of the 500 companies is actually negative on the year. So it's a very, very big divergence. I think we get Netflix and Tesla tonight and then you get the other big guys all next week. So we should get a better idea from those names. I would just say, I think the AI hype in a number of these names has probably been fairly well priced, and I'm not sure regardless of what the numbers look like for this quarter, whether or not you're going to be able any upward revisions to those companies. So I wouldn't say I'm negative on that part of the market, but I would just say I'm cautious until we kind of get better feel for what the valuation multiples look like? And then I guess the last point I'll just make here is the economically -- other economically sensitive parts of the market, so I think consumer discretionary and think industrials, those stocks have held up remarkably well so far this year. If there is a slowdown in the economy, you're going to start to see it there first. So think about engineering construction companies, thinking about United Rentals of the world, those types of names. Those are businesses where you should start to see a pullback in operating activity and so we're going to continue to watch those names closely to see if that's what happens.

can I just add to that to what Mike said? We're really, really early in the earnings season, David, right? We know that this Q3 based on the data that we've seen so far, the GDP data is going to be strong. It could be a 4 to 5 kind of percent -- kind of number in the U.S., very different than Europe, which is flat to negative, Canada, flat to negative, right? And that's being driven by a bunch of things. That's going to be hard to repeat in Q4 of some of the headwinds and weaknesses. if you look at the banks that have reported, these are the big guys. It's the JPMorgan's, BofAs, the Citis, right? They have multiline businesses, fee income, they do trading income. They actually lend very little to -- to the average middle market and commercial real estate player. You'll get a better feel of earnings of banks when you get to next week. We're the regional guys in the U.S. who have to pay up to keep their depositors. The cost of therefore, keeping a depositor in their seat has gone up dramatically with this higher yield. When someone could reach out to -- in the case of the U.S., go to T-bill and get 5.5%, right? That puts pressure on a bank to keep raising rates. I'd say you're going to have a very different tale of the banking systems health come next week. So far, when you read through BofA, which I think is really the one to look at for the health of the consumer. And the same with Citibank. A lot of depositors, right, a lot of borrowers, a lot of credit cards. Credit card charge-offs are starting to look like Q4 '19. The low end of the consumer has kind of blown through their excess savings. And yes, even though retail sales were strong yesterday in the U.S., it seemed to be driven by a couple of one-offs Labor Day week and back-to-school buying, but the low end seems like it's really hurting. And it's really being driven maybe by the upper end of the economy. I'd say the second point in earnings, we've gotten some staple companies come in and when I looked at today, Mike and I were talking earlier in the call. You're seeing these guys report 7% earnings growth, right? It's all price. 7%, Procter & Gamble is what I'm referring to today, 7% in terms of profit growth, 7% in terms of price, volumes down. So that too comes to an end, you just can't keep doing that, especially as inflation starts to cool. So I'd say, I would [indiscernible] read a lot, to Mike's point, in the first couple of weeks here because the real economy is one that's going to start to report starting tonight and into next week and will get some feel for it. Probably my last comment on the big 7 thing that Mike talked about, the Magnificent Seven or whatever. They kind of into the average person in the street, they become the new staple. They feel uncertain about all the stuff in the Middle East. They feel uncertain in the spring about the banking system with Silicon Valley Bank. Everyone is talking about a great recession, the most talked about recession of all time. They know what Apple does. They don't know how to value Apple. They know that they make phones and airpods, et cetera. They know what Microsoft does. So people crowd into the things they know. Where those things go from here is probably they kind of run flat to the market. They don't have to go down a lot. But the big boost that they had in the first half of the year is probably behind them. So that would be what Mike's point about the equal weight, which is negative. That's where the participation needs to be. Those average stocks have to start picking up, and that would happen when they start to see that economic growth will recover from, again, some of these headwinds that we're about to talk about.

Let me ask you just to follow up on that, Kevin. So you -- this Magnificent Seven, so they're acting kind of like defensive stocks, but do they exhibit any characteristics of a defensive stock now?

Yes. Here's the thing. This is different. I tell people this all the time. This is not 1999. Valuation maybe yes. But these are companies with good cash flows. They have real earnings. They just -- it's about how much you want to pay for them and what those growth rates, as Mike said, will be in the future. We've pulled forward a lot of things related to AI, by the way. When you can't get some of these chips, guess what happens, you over order. So -- and the chip guys they don't want to disappoint any of their customers so they allocate it. They give everyone less than they ordered. So if you know you're going to get less than you order, what do you do? You'll order more. And so a lot of that's been pulled forward. A lot of people know that China, for instance, was going to ban some of the stuff. A lot of that's been pulled forward. So again, this is not about where the good companies are bad. They're actually really good quality companies that have just gotten probably well ahead of themselves because people have flocked into them because I know what Google does, they know what Microsoft does. They know what Apple does, right? So they have become a little bit more [ staple-like ] for people than they would have been in the past. It's not so much as AI-driven maybe as it may be. I know what they are, and I'll flock into them.

Yes. And I may add 2 quick things here, David. I think just also almost all of those companies refinance their balance sheets, pre interest rates going up. So they have rock solid balance sheets. They do have some debt, but it's but it's funded at 2% or less for a long period of time. So that helps. And they are huge, huge cash flow machines. So in an environment of uncertainty, cash flow is king, and these companies have a lot of it. They generate a huge amount of cash every quarter. Other point I was just going to make is some of the more leading-edge parts of the economy, so think about airlines, think about hotels, those -- those businesses have recently started to provide much different outlook than they were providing 1 to 2 quarters ago. So the airlines, in particular, they've taken a lot of prices. If you fly anywhere, you're paying a lot in every seat in the plane is full. They've started to give a little bit less rosy guidance here for the next 3 to 6 months. And so that, I think, is part of the leading edge of what we're trying to pay attention to to figure out is the consumer fully tapped out? I'm not saying that they necessarily are, but I think there's probably going to be a bit of a change to the spending patterns that we've seen for the last, call it, 12 to 18 months?

On that front, Mike and Kevin, you can weigh in on this, too. But I'm just curious, it's more of a process question in terms of earnings season. So you have the results, obviously, that come out, but it's also the guidance side of it. Where do you hold -- what do you consider as more valuable to what you do? Or is it sort of a balance? Is it even? How do you approach that dynamic?

Both matter. So we use some factors to screen for both in most portfolios across AGF. So you're trying to figure out, like is earnings growth coming in on the reported quarter at the level that you expected? Really when guidance matters is when it's significantly different than consensus, okay? So most of our models here in the funds at IRON and a number of the other funds that are on AGF. We'll use some level of forward growth estimate, and that's going to be based upon generally, the consensus estimates for that particular business. If those change dramatically based upon management guidance and that happens quite often around quarterly earning season, then obviously, the market will usually pay more attention to that, either positively if there's a guide up has happened this morning with a couple of companies, Abbott Labs being a good example of that or negatively if there's a big guide down. So there's no sort of one size fits all answer this question, David. I think we pay a lot of attention to make sure that the business is reporting numbers that we expected them to report, but also particularly around this time of the year because you're starting to get close to the end of 2023. And now more folks are focusing on 2024 and what those estimates are going to look like and businesses are starting to talk about 2024. So probably this time of the year is really when you're starting to focus more of your attention on the outlook, but certainly look at both.

Yes. I would argue we're at this inflection point. And to Mike's point, David, which is this quarter reflects -- your stock has moved into this quarter. When you report will basically be assessment of the facts. Where we are all now thinking about -- and to Mike's point, this inflection point of higher rates. Finally, the consumer is starting to weaken, much higher 10-year yields, which is where the average company borrows, right? It's going to be about what you say about this future as we get closer to the end of these rate hikes. So the -- so let's assume hypothetically, if you made your earnings and they were just in line and your revenues were just in line, your stock is probably flat to down a little bit because you moved into the quarter. If you basically say that things are weakening around in the future, they're going to discount that quickly and take that down. So I think we're at one of those kind of inflection points because we're getting kind of a change in terms of the economic environment under us. We -- Mike talked a lot about the big tech guys being able to borrow and have literally made fortresses out of their balance sheet. And some of these guys aren't going to borrow for years and they've locked in at 2% and 3%, and they produce a ton of cash. You got to Remember, the average company in the Middle Market America, which drives the economy in Canada doesn't borrow in the bond market. They're borrowing the credit system through a bank, private credit market, they're paying 10%, 8%, 9%, 10%, right? Those are real pain points. So very different experience when we go into 2024 for these very, very large companies versus smaller companies in the middle market companies that don't borrow in the bond market. So I'd say you're at this inflection point from earnings where -- we've had this big push on rates. We've been talking about the softening 18 months into these rate hikes now almost 20 months. This is where you start to see things. And that's why I say this quarter, the guidance is probably more important than what you actually report.

Yes. And one last one, I'll just make on that, like margins have been so resilient, right? And we've seen that. That's -- obviously, price has been very good and top line has been moving up, and that's largely because company has been able to pass price through to end consumer regardless of the industry that you're in. So margins have been very, very resilient. There's a lot of things happening in the environment right now that could bring that into question. So if inflation starts to roll over, obviously, you have to take that in price. And as the commodities have moved up on these geopolitical issues, that starts to eat into the expense side as well. And so I think those are things that we're really watching closely. I've been surprised at how resilient margins have been particularly for many companies in the industrial and consumer space. It remains to be seen if this is a quarter that starts to bite or if we kind of glide through here again.

Okay. Let's talk about geopolitics a little bit more in depth. Mike, you mentioned -- that you mentioned at the start of the call. How concerned are both of you with what's happened over the last week with respect to Israel's declaration of war on Hamas and what kind of implications does that have potentially for what you guys are trying to do day to day?

Yes. I mean, obviously, David goes without saying, terrorist attack with this magnitude is just a horrific, barbaric, right? It's never good for any society. When it draws into this geopolitical arena of a broadening engagement, particularly with this idea that you can bring Iran into this, which brings the U.S. potentially into this, what does that mean? You saw this morning, Iran asking for a boycott of Israel oil, Israel just to put some commentary around this is only about 330,000 barrels -- 330,000 barrels in terms of its needs. Most of that is being -- it can be met with other players in the region, but it's the prospect of this kind of stuff, which, right, if you are worried about inflation and the idea we've already seen a push on energy. It's probably been the best performing sector Mike, since probably second quarter, right, because prices have gone up, right? If you put another $10 on this, oil goes to almost $100. What does that do to gasoline prices? What does that do to a pension consumer? So geopolitics, what goes on there for getting the tragic loss of lives of innocent people now on both sides. It's really going to be around the impact it will have on commodities supply chain. So let's assume you block the Strait of Hormuz, right? You don't have to do anything else, but Iran decides he will not let ships through, that brings U.S. carriers into action. The price of oil keeps again, pushing higher, which means the consumer, again, who has to make choices. If your paycheck isn't going up, and it cost you $1 more per gallon, you have to drive to work, guess what? You have to put food on the table, put gas in your car. You're not spending on other things. You will slow these economies down rather quickly. So there is sensitivity to the geopolitics of what it does to a, the underlying commodes, but 2, consumer confidence. People start to worry about this stuff. They don't buy things.

Yes. And I would add 2 points to that. I think as we bring in more participants into the geopolitical arenas, the possibility for miscalculation, I think by one or more of them goes up dramatically. That's really what worries me the most. If something very, very unexpected happens here. And then there's -- it's very difficult to forecast those things. But that's probably why you're seeing a move in gold prices that you've seen recently. They bounced call it, around about $100 because there is a bit of a fear premium that the market is buying. So that's number one. I think the volatility and Kevin touched on this in commodity prices is -- has the potential to be very inflationary just at a point in time when inflation is starting to roll down in most of the developed markets in the world, particularly here in North America, and that may change the path of what happens with interest rates going forward. So there's a lot of steps that have -- we have to kind of cross through or stairs. We've got to climb before we get to some of those things. But I'd just say that they are inflationary. And I think the biggest point I would echo is that these are going to be dampeners on the growth outlook for the global economy going forward, right? Oil prices go up, if they tip into triple digits here or potentially even higher, depending on with Saudi Arabia and Russia decided to do with their output, that becomes an instantaneous tax on everyone and that hurts Q4 and 2024 growth significantly, and that will require repricing in all assets.

Okay. And then -- maybe we can just talk a little bit about we're still dealing with as investors, the Ukraine war as well. And I'm just wondering the combination of what's going on today, if that just kind of multiplies the concern a little bit from your perspective, Kevin?

Yes. I mean we've talked a lot about this with Greg Valliere and others on this call over the last year. The world is a dangerous place more dangerous that it's been a long time. Ukraine issue is not resolved, if anything, you would argue that their offensive is met into a standstill. You're heading into its place with the winter. And at the same time, if you look at what's going on in the U.S., u.S. politics, the House of Representatives is a mess. There's another vote for trying to find a speaker today. Nothing is getting done. And one of the issues that you saw with the last speaker was support for Ukraine. So when you have these fiscal deficits running up around the world because of all the support governments had to do for COVID to keep their economies flow. People are looking and saying, how much more can we afford when we have these issues at home? And so the fact that Ukraine hasn't made great strides in here, you could be bogged down. And all of a sudden, they have become Page 2 story on the geopolitical front to what's going on in the Middle East. If you're in Europe, though, you're paying a lot of attention to it, right? You get a cold winter here, gas prices start to pick back up. You look at inflation rate just this morning in the U.K. We're seeing inflation in Canada trend now below 4% on a core basis. In the U.K., we're still in a number that's in the 6s -- gets core. Headlines still in the 6s. And so that's energy, it's food, it's a lot of things. So while, again, we don't talk about it. It's -- Ukraine is getting to a place where this bogging down of things and especially when it comes to the U.S. and other governments, you're going to have to sit there and say, how much more can we afford to do here. It may force some changes there. So I'd say you put them all together, you're dealing with a lot right now. Let me just touch on the geopolitical with regards to the U.S. Congress. Greg is not on today, but his pieces in the last couple of mornings have been pretty good about this. if you basically don't have a speaker of the house, you can't pass these bills through. The latest will be to try to tie and build, giving $100 billion to both the Ukraine and Israel at once. But nothing is getting through. And so there is some concern there. The longer this goes on, you're facing now probably another government shutdown in early November. None of this will be good for both of those fronts in the geopolitical side.

Okay. heavy stuff, guys. Let's lighten it up a little bit, but relative to what we've talked about, I'm going to ask for a big prediction from you and this is regarding the equity market. So obviously, we rally this year a little bit, and I'll talk about the S&P 500. Curious to know when you think we might reach a new all-time high on the S&P 500? Mike, I'll start with you and then Kevin, after that.

Sure. Good question, David. I wish I had the crystal ball. Look, I think markets are going to continue to be volatile. I guess if you were to peg me to a particular time, I'm going to say this second half of next year. I think we're going to be in a period of volatility, there's going to be an adjustment factor that still needs to happen to both earnings and to consumer spending and that's going to have an effect on the valuation multiple that you're going to want to pay for those earnings streams. I would also just say, I think you're going to have a little bit more uncertainty around this market as you get towards November of next year, which is the U.S. election. And typically, after that outcome, you generally see a pretty good rally in stock. So I don't want this to be construes me saying that next year is going to be a negative year. Stocks are going to go down a lot. I don't think that's the case. I just think we're probably in a bit of a sideways tape here. You're going to have to be good at stock picking and maybe you want to have a little bit of extra cash here over the foreseeable future. But if I had to get pinned down to a particular time, David, I'd say, maybe it's late in the fourth quarter of next year after we get through the election, and we're starting to figure out what the new run rate of proper economic growth is with interest rates at these high levels.

Yes. I mean I guess for me, David, it's not too dissimilar to Mike. I think we're -- there is some seasonality that plays in the markets. We know that late November ended December typically is a pretty good time. We're in the tough cash right here for markets. Could you see a drawdown from here if you're looking at markets of 3% to 4%? Possibly, but it's going to be very volatile. If you see the bond market start to change, in other words, rates start to drop which means either signaling from central banks that maybe they truly are done. None of them have a probability of raising rates here at this next meeting. And the Bank of Canada, which meets next week is maybe 15% chance of an increase, highly unlikely they go. Even the U.S. Fed, which has been talking about the fact they may have a little bit more to do, less than 10% for November. Even the Bank of England this morning, which began with a hotter CPI number, probably around 10%. So again, if you get some relief, if you get through these 3 events in ECB, you may get a rally in bonds. People may start to believe that it's no longer about how high, right? We may react to high and it's about how long, which is a different story. That may give you some relief with that seasonality if bond rates can drop here. [ Sadly, ] if they keep backing up here, I'd say that the equity market is going to be in a tough place. I think the next leg for this market will be when you actually start to cut rates. That's going to tell you that, yes, things are probably gone too far. We've weakened things enough. Economies are actually starting to slow to a recession, maybe even in a recession. The risk is that central bankers stand on the sidelines with their arms crossed as the recession unfolds because they're still looking at inflation as being too high because we've conditioned equity markets over the last 20 years that every time you get weakness, the Feds -- any central bank is going to cut rates to bail you out. It just may take them longer to do the bailout this time. So that may cause some indigestion in the first part of next year. But I agree with Mike, I think we get to new highs later in the year. Because once you cut rates, what are you trying to do, you're trying to make it affordable for people to borrow money to buy things, to spur demand, demand drives profits, you're generating profit growth, you're hiring people back. They're getting wage increases again. They're going out and buying sunglasses and jeans and you started the machine over. That sets up a new leg for the market. So again, seasonally, you could have a little bit of a tough patch in the next few weeks. You could see a pop toward the end of the year. And then it gets kind of this, when do we cut rates kind of thinking comes into play. And we made disappoint because at the first batch of weakness, we just may not do it. But I'd suggest later in the year next year, we'd probably move to a new part of the cycle as you start to cut rates.

Okay. Great. Thanks for humoring me with that -- with those -- that answer. And of course, forecasting is always a bit of a mug's game, but it sounds like there's a grind ahead for investors.

The answer to that, David, you never put a date with a number. You give one or the other.

That's right. Okay. Let's get to some questions from those that are tuned in today. Here's one on the U.S. yield curve. So here it is, Kevin, maybe you first, and then Mike, if you want to weigh in, the U.S. yield curve has been flattening. Is that a surprise even though you have talked about the bond market today already?

Yes. What we're seeing is something called a bear steepener. The curve has gotten steeper, meaning less inverted, right? We were probably inverted, meaning a 2-year yield was higher than the 10-year by something like north of 150-odd basis points, probably 6 months ago. Today, that has that inversion. The 2-year is only about 30-odd basis points higher. Normally, that happens, right, is because the 10-year comes down to meet the 2-year, okay? I'm sorry, the 2-year comes down to meet the 10-year. What's happened here is the opposite. The 2 years kind of hung around and the 10-year has climbed toward it, right? And we've seen this a couple of times in history. And that's a reflection of this. Maybe I need to get paid to own bonds that the thing we call that term premium. There is uncertainty in the future, right? So maybe these higher rates for longer, right? So -- and maybe I do believe these central banks that may be where the 2-year yield is at [ 5.25% ] where short rates have to go. But maybe I need to get paid something more in the future to own longer rates. One of the things I had talked to a lot of advisers last year, a lot of firms were out there pushing these long-duration products meaning they're going to -- long duration assets or bonds are going to rally as you get into this weakness. And that has shown up. The damage has been done on the long end here by people expecting that to happen. What you're seeing happen is these longer end rates starting to climb. So the curve has flattened out. We're -- and again, it's because the inflation has been stickier, central banks have been more stubborn, and they're telling you they're going to be there on hold for longer. So I'd say what we've seen is bear steepener. I would say, let's call it market off guard, but given the backdrop of inflation, probably makes sense.

Yes. And we've had, I think, this view internally, our fixed income team is -- just there's an enormous amount of supply of paper that's had to come forward this year just given where budget deficits are in the U.S., and that's certainly put upward pressure on yields as well. I mean, again, the debt levels in the U.S. are just incredible at the current time. So that's certainly also played a bit of a role in this to, David.

Okay. Next question here is what would the ideal portfolio mix look like today considering what's expected over the next 12 months? And then follow-up to that. Also, what are some talking points we should be having with clients that have been suffering through this last 22 months? So maybe the first question, I don't know if that [indiscernible] asset allocation a little bit, but...

Yes, it does. I would not be afraid of a 60-40 portfolio at these levels, okay? When you had yields going back in the middle of COVID, a 10-year treasury was 50 basis points, right? It's a small change in the price of that bond wiped out the coupon, okay? Up in here now, when you're looking at parts of the curve at north of 5%, you can have a couple more hikes and bond prices can go down. There's still enough coupon to keep you out of a negative return scenario, okay? If you believe these recessions are going to be moderate, which we currently believe when they occur, and defaults are going to be low and things like high yield, which is a much higher actually quality index today given the fact that some of the largest borrowers are energy companies, which are a pretty good balance sheets right now. Things like high yield near 10% are probably good things like emerging market debts start to look attractive in that low kind of 10% to 12% kind of range. Things like private credit look pretty good. So you don't need to own sovereign bonds, you can package a bunch of yields and make up your [ 40 ] to give you enough coupon to keep you out of it. And then you start to move into next year where you actually see the weakness, and you probably want to be overweight that [ 60 ] a little bit, right, which is the equity side to pick up because the average stock -- to Mike's point earlier, don't forget that's the average stock if you equated and gave Amazon the same way as everything else in Microsoft the same way as everything else, is negative year-to-date. So they will start to participate off of those levels, and that's probably where you want to make that shift somewhere into next year. So I would not fear the 60-40 at all.

Yes. Totally agree with where Kevin is at right now. I think being overweight fixed income makes tons of sense at these levels. And on the equity sleeve, which is what I do, I would say you probably want to be geared in the near term a little bit more towards larger cap stocks just as the uncertainty reigns supreme, particularly on the macro side and with respect to earnings, as you said, though, when that shift occurs, you're going to see a big move into early cyclicals that will tend to be small caps, things that will work much better as the interest rate cycle starts to go from up to down. And that will be in point in time when you're probably going to want to shift your portfolio allocation a little bit. So too early for that right now. But certainly, as we get through to maybe the middle of next year into the third quarter of next year, that will make a little bit more sense.

The other thing I'd say, David, too, for the first time in a long, long time. In 2-plus more decades, cash, if you're really concerned about the short term actually offers you again the ability to hide out and get paid something, especially if you believe inflation continues to climb down a bit.

Okay. And maybe the second part of that question, just are there any kind of simple touch points? If you're talking to somebody, just a little talking points about how people can kind of deal with it?

[ Might be everything ] for all advisers today and people talking to clients is we're closer to the end of this part of the phase, right, which is don't get caught up in whether it's one more hike or 2, right? The damage has done, and we know this is a lag between 18 and 20 months from where we were at the end of the fall, 2 years ago, where we were near 0, now we're up where we are, right, highest levels of rates since probably 2006, right? And I would remember to tell people that the levels of things in 2006 actually look very similar. The 10-year bond in 2006 before the great financial crisis was 4.6%. Inflation was running at 3%, the multiple on the market was about 17x. All of that's kind of where we are. And so I'd say -- and that was a pretty good backdrop, right? So it's not the level of things it's how quickly we got there, and we're going through this adjustment process. And so we haven't been in a cycle like this in quite some time. And I'd say the second thing is I don't believe -- we haven't talked about this. This is probably a discussion for 2024 but people do ask me, are we going back to 0 interest rates, and I would tell you no. Another sound bite for people is, we're going to live in a world with a yield curve where you have to pay to borrow money. We're -- and that's okay. it will mean economic growth may look different, right? Returns on project financing that you may do have to look different. So the world will be a little bit different, a little slower. It doesn't mean it has to be negative. So don't caution this volatility in this year. It's the adjustment year. It doesn't mean that we can't have a decent equity market off the backdrop of things at these levels.

Yes, I'll just add to that, David, I think, obviously, 2022 for fixed income investors was one of the worst ever 50 years, let's call it. And even the drawdown we've seen this year, it hasn't been great, obviously, but it certainly hasn't been as bad as last year. I would say to Kevin's point, we're getting closer to the end of that. And so your returns on the fixed income side of your portfolio should start to look better for here. Equities, as we talked about, have been very, very narrow. And so you've had to be in the right places that's typically been large liquid names. I would just say my forecast kind of over the medium-term horizon is just given where debt levels are and valuations, you're probably going to see a lower 5-year return for equities than we've seen in the past. But that certainly still doesn't mean you're not going to earn anything on those. I think it's just going to be probably a little bit lower of a run rate. So understand that certainly, clients have been pressured, obviously, on the return side of their portfolio and then certainly on the inflation side with respect to their bill. So it has been certainly a tough period of time. I would just echo Kevin's point like I know it's hard, we're getting close to the end of it, and things are going to get better. I think if we look out 24 months from now.

There's one more shift the markets have to make, David? Right now bad -- a good economic news is bad for markets. It's bad for the bond market if economic data is too hot. That means they fear higher rates or longer. It's bad for the equity market, which fears those higher rates. There's a point in time when we shifted bad economic news, which is now good for markets, right, bad economic news, markets are rewarding and synergies, maybe these guys can stop raising rates. The equity market responds as well, the bond market rallies. There's going to be a point in time where bad economic news is actually bad, right? Bonds will rally and equities will sell off, right? And that's probably the transition point that we have to look for too, right? And that means we're moving to the end of this thing, right, where things are softening to a point where we can start to remove the restrictions that we've put in place.

Okay. A couple more questions here. Maybe I'll ask this one first. And I'll direct it to Mike because obviously, you're an expert on the Canadian equity market side of things. So just a quick question, thoughts on Canadian stocks, just generally speaking, where we're at and where we might be going with them?

Yes. The TSX has been a very trendless market this year. It's trading fairly narrow range up to the top and back down to the bottom, and we've just kind of been bouncing around up and down, up and down all year. There hasn't been a lot of direction in the market. So I would say a couple of things that are going to be important here going forward. We remain quite constructive on the commodity complex at the moment, energy in particular. So I do think oil prices don't even need to really go much higher from here as long as they can kind of stay in this let's call it, 75 to 100 range, which I don't think is a heroic ask just given the supply and demand fundamentals and what's going on from a geopolitical perspective, energy companies are going to continue to earn an enormous amount of money. So let's call that around 20% of the index, which I think has pretty good prospects on a go-forward basis. I think the materials space probably can do relatively well. That's going to be more correlated to what goes on in the broader economy, and there may be a little bit of volatility as we kind of reset expectations here, but that's part of the portfolio -- or excuse me, part of the market should lead out of the -- when rates start to get cut. And then of course financials and that's really the big wild card here, okay? So I don't want to go down talking about Canadian housing too much here, but banks are struggling right now. They're finding it difficult to have good credits to lend to. And obviously, the mortgage portfolios are going to continue to come up for renewal here, call it, 20% of homes on fixed -- or excuse me, 20% of fixed rate mortgages need to get refinanced every year. So there could be a bit of a challenge to financials in the near term. But valuations for those particular sectors, particularly banks are getting near really, really blow down levels where if you have a say, a 3-year time horizon. Dividend yields are very, very attractive. Valuations are cheap. And yes, you'd have to live through a bit of uncertainty here with respect to what growth looks like going forward. But I think over kind of a medium term, you'll do quite well. So energy is certainly the market momentum leader right now. That would be an area of the market that I would continue to focus on in the next 3 to 6 months. And as we get through to kind of the peak in macro, if you want to call it that, when rates start to level out and possibly come down, Canada is a very early cyclical market and should do quite well.

Okay. Here's a question. And I have a feeling you guys are probably just -- Kevin, and particularly, maybe you may want to take this in a different direction than just answering the question itself. But the question is with everybody flocking to a high 1-year GIC or guaranteed investment certificate, couldn't make sense to invest in longer terms now. So maybe if you can answer that question, but also I think there's a bit of a debate about GICs versus just a bond fund. So maybe you want to discuss that, too, in the pros and cons to that.

Yes, as I said earlier, last year was the wrong year for people to try to go out and buy these longer-duration assets, right? Because we knew that central banks weren't done and we knew the markets hadn't adjusted to decide do that they were going to be longer. That adjustment has taken place. As I've said, the steepener that we've seen more than 30 basis points. Hard to see rates going much higher. The 10-year could go higher. But again, as I've said in my earlier comments, small changes in price aren't going to wipe out the coupon from here. So I'd say you can probably safely start to play into bonds now. And let's assume that basically, as I said, bad news start to be treated as bad news. The equity market is going to go down, the bond market is going to go up. Your bonds are going to do well to hedge your equities. That's not going to be the case with GIC. So again, the ability to move into bond products here versus a diversified bond product here versus GIC is probably the right time. You can hold a little bit of cash right now, but what will happen is as central banks start to cut rates, the banks are going to cut a lot faster, too. And so you're going to have rates go down when you go to refi or that matures at a much lower rate than what you have today and you're going to have missed that roll down in bonds as they start to cut rates, the bond market does quite well. So I'd say it's an okay pivot here versus where that my comments would have been a year ago.

All right. So we're getting close to time. So maybe I'll just give you guys a platform for some final thoughts and then we'll call it today. So Mike, I'll start with you and then we'll get Kevin to close to.

Yes. I guess I would just echo a lot of what I've said already. I think there's -- we're in very uncertain times here and volatility is going to be a key piece of happens in all asset classes for, let's call it, the next 6 months, at least, I think, in my mind. Earnings growth is going to be from my lens is the most important thing that we need to get recalibrated here for equities. What does that earnings stream look like for the broader S&P 500 and then on a sector-by-sector basis is going to be important. We probably will get a clearer picture of that as we get into next year, possibly the end of Q1, we should start to get a better sense on what the appropriate multiple is and where we are with respect to the macro environment. And I think Kevin has talked about it a couple of times and certainly a lot internally, we are very, very near the end of the rate hiking cycle quite likely, and that will require a different set of thinking and allocation as we get into the rate-cutting cycle. And so those are still probably a couple of quarters out here at least. But once that happens, you're going to want to shift your portfolio a little bit, and then we're continuing to watch for some signposts along the way to give us some confidence that we're getting closer to that. Inflation will be obviously one of the keys and obviously, a little bit better environment for general macro overall.

Yes. I guess for me that we're going to have some volatility ahead, David. We're going to have some headwinds around some of the data coming up. You're going to have a GDP print in the U.S., which is going to look very, very strong. It could be 4% or 5% GDP growth. Don't think about repeating that in Q4, things will start to slow down. And the consumer in the U.S. is about to start paying down a lot of the student debts again which they haven't had, you have this political uncertainty around the house, a potential budget shutdown. And the issues geopolitically, as we talk all way on confidence, and at the same time, we also see from what the banks have reported in the big 1, Citi and BofA that things are slowing in terms of credit, credit charge-offs and other things. So again, prepared to make this idea of volatility, but we are closer to the end. It doesn't mean we're going to have a negative market here in the end of the year. It's probably a sideways with a lot of volatility, but start to think about how you want to position for 2024 because I think that's really -- if we get that part of the portfolio, right, which is when they start to cut, I think that's where, again, most investors see a recession and they panic and the reality is the equity markets don't care about a recession. They move in front of it. Short term volatility, I think long-term opportunity.

Okay. Great stuff, guys. That brings our discussion to a close. Thank you, as always, to everyone tuning in today on behalf of Kevin and Mike, we appreciate your time and support and look forward to sharing our insights with you again next month. Before you go, please make sure to click the ad session button in your attendee hub to register for our upcoming market update events, including our next installment taking place on November 15. To complete your CE credits today, please complete the survey available to the right of your screen or at the top of the home page in your attendee hub. And please note, you may only submit answers for your survey once. However, you may have the opportunity to go back and edit responses, if needed. Have a great day, everybody.