Hello and welcome to The Download. I'm your host, Dave Richardson, and we are joined by a very special guest today. We often get portfolio managers on, economists, portfolio engineers. They work in their specialized area. I thought for today, because we're going to do a quick update on a couple of key themes that are playing out in the market, we get our jack of all trades. Someone who can cover the whole ground. Oh, you're nodding your head. You're in agreement. You are the everything man. That's Eric Savoie. Eric, welcome.

Thanks for having me.

We've had Eric on many times before, a very popular guest. And again, he can run the gamut. Eric, we're looking at markets that are still sitting in around all-time highs, but we've had another escalation in the war, a little bit of a back off this this past weekend. We have seen yields really kick up, and that's always a concern. And then the question is, is that related to the war, or is that something bigger happening behind the scenes around debt levels and the amount of supply of debt that's coming to market, not just from the government space but also from the other big theme, which is artificial intelligence and what's going on there. Of course, huge run-ups in some of these stocks over the last several years, particularly the semiconductor stocks leading the way early this year. And we just thought we'd check in with you this morning and get an idea of what your thoughts are in these areas. So why don't we start with yields? As we're recording this right now on Monday morning, July 27th, we’re sitting at about 4.65% on the US 10-year. We were sitting around just under 4.40% a couple of weeks ago, or maybe even less than 2 weeks ago. The 2-year is kicking up well above 4.3%. So, we've seen the whole curve shift up. And how are you looking at that and thinking about that with respect to everything that you're involved in directing strategy for bonds, stocks, etc.?

Sure. Yeah, you rightfully captured that there's a lot going on, no shortage of excitement in financial markets lately, that's for sure. You touched on it, the two key themes driving major market volatility over the last several months and pretty much all year. One is the war. It's really this on-off nature of the war. You have talks of a ceasefire, and of course then they go back to attacking each other again. And so that back and forth causes all sorts of volatility. And there's the war on trade, as I would describe it, where you get a pickup in oil prices. And then of course that naturally feeds into higher inflation expectations and causes a backup in bond yields as we've seen in the last several weeks. And then also causes a bit of a headwind for equity markets, although the equity market has been especially resilient through this entire period. There's been a lot of volatility beneath the surface, but the overall index levels, as far as equity markets are concerned, have been relatively stable. For fixed income in particular, we've been looking at a range on the US 10-year between 4.40 and 4.80% on the upper end. The backup that we've seen, we touched 4.71% last week. To us, that starts to reflect better risk-reward as if you think about it from an investor standpoint, the higher the yield gets, the more return potential is being offered to investors that are willing to invest in those fixed income instruments. And so we feel, if anything, more constructive about the bond market as yields have backed up. And part of the reason for that— of course there's always a wide variety of scenarios around that base case view and things are fluctuating on a day-to-day basis— but our base case view is that the effects from the war are largely or likely to be temporary. So we do get this flare-up. But if you think 6, 12 months down the road, it's likely that this war sees a resolution. Day-to-day that feeling changes a lot, but really that's our base case assumption. Inflation expectations, if that is the case and we are right on that, oil prices are likely to subside or moderate or stabilize in the $80 range, maybe the high $70 range, and inflation expectations likely moderate. As a result, you get less of this fear or talk about potential rate hikes by central banks. And if that's the case and you get more validation by the central banks that there's not really a need to hike monetary policy in this environment, then we can see the scope for bond yields to retrace on the back of all of that. And so that's where we're sitting in our view on fixed income. As the yields go up, we become a little bit more interested in the long end of the curve, if that makes sense.

We had Sarah Riopelle on. By the way, if you want to listen to previous episodes, please follow us wherever you get your podcasts. You can also subscribe to watch us on YouTube. So Eric, I always like to get your perspective. Sarah Riopelle was on and in her portfolio, she's been taking advantage of what you talk about, this range-bound yield curve. On this podcast, we tend to talk about the US 10-year and where it's moving, and that idea that it's been moving between 4.80 and 4.40%. We had some other ranges earlier where it was more 4.70-4.20, but we seem to be 4.80-4.40 right now. And you can make a little bit of money just trading that by taking a portion of your portfolio, and when yields start to bump up towards 4.80%, throw a little bit in bonds, and then when we get down towards that 4.40% mark, you pull out, and that's something that you've been doing and you think is probably a decent idea for those who have a tactical portion in their portfolio.

That's right. So we actually have been tactically trading around those ranges ourselves within the Select portfolios. As yields get closer to that 4.40% range, we're more inclined to lighten up on our fixed income exposure. Not in a big way but just making minor adjustments as we see fit as that risk-reward becomes a little bit less appealing as yields get lower. And then just a couple weeks ago, as yields were starting to back up again, we figured it was appropriate to put some of that back into fixed income as that risk-reward improved. And so, we like bonds more at that 4.60 to 4.80%, and a little bit less as we get closer to 4.40%. The other thing I should have mentioned earlier, in terms of the inflation expectations, on the one hand you have the war which is impacting inflation pressures. Then the other piece is AI and all the spending around it. Our long-term view on AI is that it's likely to have a disinflationary impulse on the economy as you get more productivity and cost of things start to come down as things become more efficient. But there's a sequencing to that because early on, as companies are big into this buildout and investing hundreds of billions of dollars in developing data centers, and that's leading to increased cost for memory chips and all sorts of things that go into the AI ecosystem, that's causing a little bit of an upward inflationary bump on the beginning. And so that's feeding a little bit into the fixed income market as well. But it's another one of those pressures that we expect to ultimately subside over the medium to longer term.

So, Eric, that would suggest that if we're range-bound— we'll come back to the US 10-year Treasury, because it's so easy to find that yield for anyone listening or watching the podcast— at some point, we're going to break out of that range. Based on what you're saying, it seems like your view would be that we're more likely to break below the 4.40% than above the 4.80%, but that's not without some risk. This is still one that we've got a lot of things to have play out. You'd want to draw a line in the sand and say, yeah, we're going down below that.

In the near term, anything is possible, and so you could have a clustering of risks that all flare up at the same time, which certainly could push yields higher in the near term, but according to our models, something like a fair value or an equilibrium level for the 10-year yield, at least according to how we model it, is in the mid to high 3% range. So that's what we see as being the anchor point. Of course, that's more of a medium- to long-term assumption, and we can always deviate very far away from that midpoint in the fixed income market as well as the equity market. And so there's a possibility if we get an escalation of the war, if we get some more fear around government deficits ballooning to extraordinarily higher levels than they already are. And then the government spending, the further the war drags on, of course, the more spending is involved with that. And that could also be upward pressure on bond yields. So there's no question there is a scenario in which we do get a spike, maybe short-term in yields. But in our view, that would be just an even better opportunity to potentially add to fixed income positions if we do get higher yields, if we were to break out. And we wouldn't expect those higher levels of yields to be sustained. At least that's our current thinking. It's always subject to change.

And that's a great place to transition to stocks, because if you were to have that breakout to the upside, that would have an impact on stocks. And then that takes one of the other things that's providing air to this economy— or helium, I guess, if you do the balloon thing— is the idea that the wealth effect is enormous when stocks have moved forward as far as they have. But I really like the idea— and I was hoping you would get to this, and sure enough, you delivered, as always— that sequencing is critical. You've got all this stuff going on in AI, and we're going to get into that in a second. That would be one thing, but then you layer this war in and how much of an impact it can have on oil prices. We've seen oil go from $65 to $120, back down basically to $65, then up close to $100, now back into the mid-$80s. That's a lot of bouncing around. And if that wasn't happening in the background you might sit there and go, okay, well, we've got this AI halo effect that we're going to get in terms of reducing costs, creating efficiency, improving productivity, which we're already seeing. And that's likely going to be a nice smooth ride. And we might sit back and let that play out if risks of inflation, risk of higher oil prices, risk of an extended war, risk of higher interest rates wasn't kicking around in the background. And then you have to say, okay, in the sequence of things, as these companies are spending hundreds of billions of dollars investing in infrastructure with the hope that somewhere down the line they're going to get a return for it— ah, well, I might be pretty comfortable sitting and waiting for that and pretty confident. But then, when all this other stuff's going on in the background, that makes me a little bit more nervous. And then that creates volatility there too.

Yeah, for sure. So there's two things happening. The war certainly is something that's injecting fear among investors. It's that uncertainty of we don't know what's going to happen. Is this a big deal or not? But as we've seen this play out— it's been going on for several months now— we can say with a fair degree of confidence that the impact to the broader global economy is relatively limited. Certainly, there are different pockets where it has a bigger impact than others, but overall we don't see the war sending economies into recession. In terms of it being a fear mechanism for the market, certainly as yields go up, the way I see it— I think it's Warren Buffett who said this— the interest rate or the yield really is like the gravity on the economy or the stock market. You can think of it, as the yields go up, that makes everything a little bit heavier for the stock market. In technical terms, it should reduce the normal valuation that investors are willing to pay for stocks. But in the background, the valuation is one thing, or the fear that investors may feel as headlines of the war fluctuate. The other big thing is that the earnings situation fundamentally for the S&P is incredibly strong. It's probably the strongest that I've ever seen, particularly outside of a post-recession recovery. Their earnings are expected to grow 29% in the S&P this year. To put that into context, I don't think we've ever seen that level of growth expected except for when you're coming out of a recession. And so this phase of the cycle is fairly unique in that we didn't have a recession and we're just having this earnings boom that's happening due to all these big AI players spending hundreds of billions and over the course of years, trillions of dollars, developing their AI capabilities. Now, it's causing some very interesting dynamics within the equity market because there's different pockets of winners and losers. There are the spenders. All the hyperscalers are spending all of this capital. And then you've got this other cohort of companies, which I would call the AI suppliers— those are the ones that are producing the chips, the memory and all of that stuff that goes into building the data centers— and so you can almost see it as a transfer of capital from the hyperscalers to the AI suppliers. So you've got this very interesting situation where earnings especially are booming for these semiconductor stocks. And this is why we've seen the semiconductor index triple over the last year. You've had some incredible growth in that space. And the question for investors now at this point, is how durable is that? Because this presents a risk where, if you were to extrapolate the current trend of earnings for the semiconductor stocks into perpetuity into the future, there's a risk that earnings growth may not persist indefinitely. If this is just a 2-, 3-, or 5-year build-out phase of investment that's expected and then the hyperscalers say, well, okay, now we've built our data centers, that's done, we don't need to invest that tremendous amount of capital anymore, that could potentially be a negative scenario for the semiconductors. So there's a lot happening. And this is what I said earlier, how there's lots of volatility beneath the surface. You're seeing so much rotation of capital between different groups of stocks as the market digests who will be the winners and losers in this AI theme. But at the index level, the S&P or some of these other markets has just been incredibly stable. And there's different indicators you can look at that measure intra-market volatility versus overall market volatility. Those lines have completely diverged where the internal stock market volatility is very high, but the overall index level volatility is actually quite subdued, which is actually quite fascinating to look at.

And this has all been happening really all the way post-COVID where you've had these massive bull markets and pretty significant bear markets across almost every sector. As you just walk through time, there's always one sector that's getting hammered and another sector that's flying high. And it's just the big concern that you have a bear market or a significant shift from a secular bull market to a secular bear market and you'd expect everything to fall at once, but we just haven't seen that. It's just this constant rotation, as you say, capital moving all around in what would be the most efficient markets we've ever had in history. Maybe we don't hit all of the 100% score on the efficient market hypothesis, but at least they're more efficient than they've ever been, and so it seems like capital's finding its way around. Again, if I'm just sitting in a market, I'm doing pretty well as long as I've got a diversified portfolio.

Yeah, and actually to that point, if you were to focus on the S&P, it has been going a little bit sideways in the last several months, but the S&P Equal Weight Index, which just gives an equal weight to each of the 500 stocks in the index, has actually been steadily climbing. I believe it made a new all-time high this morning. And so, the breadth to the market has actually been quite good, even though you see this rotation going on beneath the surface. And I think part of what's happening there might be that even though we debate and there's a lot of headlines about the spending from the AI companies and then the AI suppliers and how all that's working out, really one of the bigger themes is that AI overall stands to benefit the entire economy, all the companies in the S&P. So every company can take advantage of the tools that will boost productivity and help companies be a lot more efficient and help boost their profit margin. If you think of it that way, in an optimistic scenario, AI stands to be quite beneficial for the overall earnings pool for the S&P, not just the tech sector specifically.

I think that's really important, your point around the equal weight S&P. We went through an unusual period where you had a highly concentrated market which favored the index itself. Well, actually, why don't I let you do it? We brought you on as the smart person on this podcast. What's the difference between the S&P 500 index as you would see it reflected on TV every day, or when you look at it on whatever website you track, and the equal-weight S&P 500?

The standard S&P 500 index that's widely quoted is a market capitalization weighted index. So the bigger companies have a bigger weight in the index. NVIDIA, Google, Microsoft, all those big companies actually take up a massive share of the weight in the index and dominate the movements of the overall index move on a day-to-day basis. If you have a big move in NVIDIA, for example, that will have an outsized impact on the overall index. The equal weight, in contrast, assigns every company 1/500th of its weight in the index. So every stock has an equal weight. Whether it's an ultra-mega cap or one of the smaller large caps, they're all represented the same. The reason why it's interesting to look at the two of those is that the S&P cap weighted version does have a lot more concentration. Its movement will be dominated by the Mag 7, for example, which is about 30% of that index. And so they will have a really big impact on the overall move. And the equal weight tends to be a better measure, in our view, of the broad-based equity market or the performance of the average stock rather than being concentrated. And it's important. Sorry, go on.

I was going to say that that big concentration was almost unprecedented in the levels that it got to. And then that becomes very difficult, and you start to hear people say, well, you can't beat the index. Except that when it shifts all the way over to an extreme and you've got that concentration, that's often when the equal weight takes over. And the equal weight's been winning for quite some time now. And it's when the equal weight is doing better— and you can validate it— that's when I want to give my money to a Stu Kedwell, a Scott Lysakowski, a Sarah Riopelle, a Phil Langham, all the people that we have as guests on this podcast, people who really are great stock pickers and bond pickers. And that's where they can really have a heyday versus when it's just one tiny, small portion of the market that's winning and it keeps on winning. It's hard to hold your nose on some of those individual stocks in a portfolio.

Yeah, that's exactly right. I would characterize this market as exactly being a stock picker's market. If you have good stock picking ability, this is exactly the environment for that where you have very high inter-market volatility and very low overall market volatility is where you can really make those moves on the swings within the index. And then the other thing I would point out on concentration— we talked about the S&P being highly concentrated— it’s emerging markets. We haven't talked about that but emerging markets are even more concentrated right now. Particularly the Korean equity market where just 2 stocks make up about 50% of the index weight. The Korean stock market is one of those, and it has tripled or quadrupled over the last 12 to 18 months, something like that. Just been extremely explosive growth in that index tied to mostly the growth in semiconductor stocks. So that's an area where we've been a little bit more cautious because the run-up that we've seen has been so extreme. And so within our portfolios, actually, we have neutralized our exposure to emerging markets from an overweight position before to take advantage or to just take profits on some of that extreme run that we've seen.

Yeah. Again, it's not just, as you say, an individual stock concentration, although I guess the Korean story is that story as you shared. But you can go to some individual markets that have high exposure to a certain area like the Canadian market, to gold, for example. Gold has corrected significantly from its high earlier this year. Although you haven't seen a ton of it in the actual index, it has had an impact on returns in Canada. And then of course, South Korea is the classic example right now. You're seeing how that effect can reverberate through the economy when you have people— and we talk a lot about this on the podcast, Eric; I know you're a regular listener too— about the speculating or even gambling impulses of a lot of investors right now. This is one of the things that we try to emphasize on this show is the idea that the way to go, there's no get-rich-quick scheme. Investing is a disciplined process that takes time. And if you follow the right strategies, and we talk about them all the time here— diversification, regular investing, dollar cost averaging, on and on— that's where you'll ultimately win and succeed. And again, it's boring, but we do know it works if you follow that process over the long term.

Yeah, it's like the old adage, time in the market beats timing the market. And it is true because over the last year, there's just been so much volatility. And if you tried to time things, you could easily be spooked by some of these fears. All of a sudden, Trump changes his mind, the market goes back up. It's quite surprising. Last year was another one of those years where if you told me at the beginning of the year, all the risks that investors would have faced, and then you made a prediction on what the market would have returned that year, I think it would have been hard pressed to imagine that stock markets delivered double-digit gains. But here we are again. So far this year, most markets are sitting at double-digit gains year to date despite a lot of the headwinds that we've seen. So it's just another one of those examples where you could easily construct a bearish case, but stocks just have this remarkable ability to continue to rise. We never know for sure if that will continue, but odds are, if you look at the very long-term track record of the stock market and all the recessions and bear markets occurred in the past. And after every bear market and every recession, you get a recovery and a subsequent bull market. That's testament to just show the resilience of the stock market, the economy, and the human's ability to overcome very difficult challenges. If you are looking at the long term, I think you need to be an optimist. Being pessimistic can work, but usually only in the short term. And so, if my money's on the line and I could choose being optimistic or pessimistic, I'll choose optimistic every single time.

Like you were sharing earlier, the profit growth you're seeing, despite all of these challenges, just shows you how well business owners, businesses, their employees, they employ that technology, they use that human ingenuity and they find a way to grow their profits. And if they grow their profits, their stock is going to go up over the long term. And you want to be a part of that as an investor, not a speculator or a gambler. Eric Savoie, thank you so much. That was awesome. Thanks for agreeing to come on. He came on short notice too, so I always appreciate that. But I know you're always ready to go. And once again, you were fantastic. So thanks, Eric, and have a great week.

Thanks for having me. Always a pleasure.