TRANSKRIPTIO 🔗
WEBVTT
00:00:03.759 --> 00:00:08.960
Welcome back to Fourth Lane's Off the Charts podcast, where every two weeks we cover three market headlines that matter.
00:00:09.119 --> 00:00:10.800
I'm Andrew Sarner, Portfolio Manager.
00:00:11.039 --> 00:00:13.119
And I'm Vanessa Huey, senior client advisor.
00:00:13.439 --> 00:00:17.920
Three big things to cover this week rate hikes, midterms, and pockets of pain.
00:00:18.160 --> 00:00:24.960
So, Andrew, the Fed held rates steady last week while the Bank of Canada raised rates for the first time in over three years.
00:00:25.120 --> 00:00:28.800
What's driving these decisions and where do interest rates go from here?
00:00:29.120 --> 00:00:41.200
Number one, the big thing that both the Canadian Central Bank and the Fed are going to be looking for is inflation, and they don't want to see inflation get back out of control like it did back in 2022.
00:00:41.359 --> 00:00:45.119
We are seeing signs that inflation is beginning to re-accelerate.
00:00:45.280 --> 00:00:48.799
Core PC has re-inflected upwards.
00:00:49.039 --> 00:00:54.159
For the purpose of this discussion, let's consider US and Canadian inflation to be similar.
00:00:54.399 --> 00:01:00.320
There are going to be nuances around the edges, but more or less in the globalized world, they're going to be driven by similar factors.
00:01:00.399 --> 00:01:02.399
So there are two big things driving inflation.
00:01:02.479 --> 00:01:04.959
It's going to be energy and AI supply chains.
00:01:05.120 --> 00:01:20.000
On the energy side, really being driven by Iran, and there's not enough energy and rising energy prices flow through, not only directly to that inflation number, but secondly, there are derivative impacts such as transportation prices across the economy.
00:01:20.079 --> 00:01:24.560
And then AI supply chains, there's just so much demand that supply can't keep up.
00:01:24.799 --> 00:01:29.599
But this is really isolated and shouldn't be impacting other parts of the economy.
00:01:29.760 --> 00:01:32.000
So I come at it from a logical perspective.
00:01:32.159 --> 00:01:36.159
Raising rates isn't going to produce more energy or reopen the straits.
00:01:36.480 --> 00:01:45.280
So from a practical perspective, I don't really get the attempt to raise rates in order to stop inflation in this instance.
00:01:45.519 --> 00:01:46.000
I get it.
00:01:46.159 --> 00:01:53.280
Maybe you could kill demand that is going to slow consumption, that will make energy prices less impactful.
00:01:53.439 --> 00:02:00.159
But still, at least the initial wave, it doesn't really matter unless you're seeing derivative impacts like wages begin to spiral.
00:02:00.239 --> 00:02:01.120
Then I get it.
00:02:01.359 --> 00:02:04.560
I think the Fed raised just for credibility purposes.
00:02:04.719 --> 00:02:06.799
The market sort of pushed them up against the wall.
00:02:06.959 --> 00:02:11.120
And in order to not be seen as a lame duck, the Fed decide to hike.
00:02:11.280 --> 00:02:15.520
It didn't really matter, but I think it really comes down to those credibility purposes.
00:02:15.759 --> 00:02:17.199
This week we saw them hold.
00:02:17.360 --> 00:02:19.039
They were a little less hawkish.
00:02:19.199 --> 00:02:26.639
And I don't think there's really a reason to be overly hawkish because we're starting to see the first signs that AI investment might be beginning to slow.
00:02:26.719 --> 00:02:29.759
And you know, that was the major bright spot of the economy.
00:02:29.919 --> 00:02:31.360
So I think it makes sense.
00:02:31.520 --> 00:02:36.319
And this is what the Fed really echoed that they're going to wait for more data to come out.
00:02:36.479 --> 00:02:40.080
Now turning our attention to Canada, this one I really don't get.
00:02:40.319 --> 00:02:43.439
So we have headline inflation that is slightly above target.
00:02:43.599 --> 00:02:44.719
I think it's 3.2%.
00:02:45.120 --> 00:02:50.319
Measures of core inflation are directly in line within the range at 2%.
00:02:50.879 --> 00:02:53.039
It's not like the economy is overly strong.
00:02:53.199 --> 00:02:57.360
The consensus is really 1% real GDP growth in 2026.
00:02:57.439 --> 00:02:59.599
And then you have a labor market shedding jobs.
00:02:59.759 --> 00:03:09.280
So any of the reasons why you would historically want to hike prices, such as a very tight job market and the economy running too hot, they just don't exist.
00:03:09.439 --> 00:03:14.319
So with inflation already within range, I don't see the need to hike.
00:03:14.400 --> 00:03:21.759
So this is only going to further weaken the Canadian economy, especially in the cross areas, would be those rate-sensitive sectors like real estate.
00:03:21.840 --> 00:03:26.080
So deals were already not penciling, they're only going to further not pencil.
00:03:26.240 --> 00:03:30.479
And in terms of just even residential sales, it's going to be slower.
00:03:30.639 --> 00:03:39.759
You have that impact to consumption because if you just think of a regular household, if they're floating rate, they're going to be now paying more to their mortgage that they could be spending in the economy.
00:03:39.919 --> 00:03:47.680
And the only real benefit I see to hiking it, and this is really the only argument you can make, is it strengthens CAD.
00:03:48.240 --> 00:03:54.159
But I would rather see an economy firing on all cylinders before we considered hikes.
00:03:54.319 --> 00:03:55.439
So we'll see.
00:03:55.599 --> 00:03:57.919
I think it's a mistake, but I get it.
00:03:58.000 --> 00:03:59.759
They're trying to catch up to the U.S.
00:04:00.000 --> 00:04:02.000
still doesn't make much sense.
00:04:03.680 --> 00:04:05.919
For a second topic, we know the U.S.
00:04:06.000 --> 00:04:08.479
midterm elections are taking place this week.
00:04:08.719 --> 00:04:14.960
Andrew, what are the potential implications for financial markets and what should investors be watching most closely?
00:04:15.360 -->
Load full transcript
00:04:18.879
Yeah, Trump is one of the most unpopular presidents in U.S.
00:04:18.959 --> 00:04:19.360
history.
00:04:36.240 --> 00:04:45.040
The thing I would take with a grain of salt is just the other week, we saw a very big surprise in Brazil with Lula winning.
00:04:45.199 --> 00:04:49.199
When Trump ran against Hillary, we saw pollsters be very wrong.
00:04:49.360 --> 00:04:53.360
The last presidential election, pollsters were really wrong.
00:04:53.519 --> 00:05:03.759
So maybe we should be thinking about the fact that these polls prior to the actual election, there is a larger error than we think.
00:05:03.920 --> 00:05:06.720
So there is a chance we could get an outcome out of nowhere.
00:05:06.879 --> 00:05:08.560
I just want people to think about that.
00:05:08.720 --> 00:05:11.360
But historically, any outcome is good for markets.
00:05:11.600 --> 00:05:14.720
The market doesn't necessarily have a huge preference.
00:05:14.800 --> 00:05:22.399
We can get into the nuances, but it's really the uncertainty being removed from markets that the market tends to celebrate, uh, celebrate.
00:05:22.639 --> 00:05:26.800
You look back at other midterm years, and markets tend to bottom around now.
00:05:27.040 --> 00:05:32.720
So this suggests that maybe it's time for investors to shrug off the negative headlines and get long.
00:05:33.279 --> 00:05:35.279
But here are the two things I'm worried about.
00:05:35.439 --> 00:05:37.519
Number one, Iran escalation.
00:05:37.600 --> 00:05:44.879
So the midterms were acting as a deterrent for the current administration to escalate it even further.
00:05:45.040 --> 00:05:53.680
They didn't want voters or even polite glads to be able to latch on to the Republicans are bombing Iran again, a war no one wants.
00:05:53.839 --> 00:06:02.319
And then on top of that, the Iranians, the Chinese, the Russians had every incentive to sort of escalate before to push Trump out.
00:06:02.560 --> 00:06:06.800
The one thing I do know is the status quo isn't really working.
00:06:06.959 --> 00:06:20.079
If we remain with the status quo where there is no deal, I can tell you oil prices are going to probably$150 because the world is short oil in this current structure and there needs to be change.
00:06:20.240 --> 00:06:24.560
So that occurs probably either via peace deal or via regime change.
00:06:24.800 --> 00:06:34.000
Nonetheless, this is a big overhang for Marcus that all of a sudden the one deterrent that the administration had to not escalate is gone.
00:06:34.160 --> 00:06:39.120
So I would think if there was going to be action, we see it in the next couple of weeks.
00:06:39.360 --> 00:06:45.920
Obviously, if they decide to re-escalate, yeah, it was probably not going to be good for oil prices or the market.
00:06:46.160 --> 00:07:00.639
Secondly, the other tail risk or potential tail risk, I don't even know if it's a tail risk or not, it could actually be good for markets, would be if Democrats come to power, they
could become very hawkish on data centers, which could slow development.
00:07:00.800 --> 00:07:08.639
Now, from a US perspective, I think it's important that if you were leading the AI race, you want to stay ahead in that AI race.
00:07:08.800 --> 00:07:14.879
So if they block data center development, this could allow other countries such as China to catch up.
00:07:15.040 --> 00:07:25.439
It's just a politically popular topic to latch on to because there's broad fear about AI job displacement and we see negative headlines week after week.
00:07:25.680 --> 00:07:27.600
So it would make the US weaker.
00:07:27.680 --> 00:07:43.519
But you know what actually could be a good thing for stock prices of the hyperscalers because all of a sudden they don't have to be concerned about overspending, which would allow them to monetize some of their investments and give the market more certainty that they're actually going to make money from this.
00:07:43.759 --> 00:07:51.040
You would see the AI CapEx beneficiaries suffer, but look, that's eventually going to happen.
00:07:51.199 --> 00:07:54.319
So these companies would be like the chipmakers and stuff like that.
00:07:54.399 --> 00:07:58.720
And if the hyperscalers are spending less money building out data centers, this would fall off.
00:07:58.959 --> 00:08:04.800
Yes, the US has some exposure to this, but the hyperscalers are the big portion of the US index.
00:08:04.959 --> 00:08:12.000
And then from a user perspective, an AI CapEx overbuilt is actually probably a good thing for users.
00:08:12.160 --> 00:08:17.199
It means that there was too much compute built and consumers get abundant cheap AI.
00:08:17.279 --> 00:08:20.639
And this is like what happened in the dot-com rollout.
00:08:20.800 --> 00:08:22.560
Everyone got access to the internet.
00:08:22.879 --> 00:08:29.759
And then the other analogy, investors are beginning to contrast the AI build out to is the shale build out.
00:08:30.000 --> 00:08:49.039
So some of the cash flow projections for the hyperscalers are reminding investors about the shale overbuild, which was very bad for energy producer stock prices, but it was great for the broader economy and consumers of that cheap natural gas.
00:08:49.200 --> 00:08:54.559
So while it could be bad for stock prices, it could ultimately be good for the consumer.
00:08:54.720 --> 00:09:04.000
But if things change from the current trajectory, I think there's probably just some tail risk that exists because we don't know exactly how things are going to play out.
00:09:06.320 --> 00:09:15.519
For our last topic, the SP 500 fell less than 1% last week, but that headline number masked a lot of what was happening beneath the surface.
00:09:15.840 --> 00:09:18.240
Andrew, what's the real story across markets?
00:09:18.720 --> 00:09:22.000
As I wrote about last week, I think there's many pockets of pain.
00:09:22.159 --> 00:09:27.840
It's actually been extremely frustrating that at the index level, everything has looked totally okay.
00:09:28.080 --> 00:09:36.320
And the reason why this is happening is the top 10 companies in the US make up such a large portion of the S P 500.
00:09:36.480 --> 00:09:37.679
It's almost 40%.
00:09:38.240 --> 00:09:50.000
So what that means is depending on how these 10 companies are going to do, that's really going to dictate how the market is performing, even if the other 490 companies are selling off beneath the surface.
00:09:50.159 --> 00:10:00.559
So this is what we've sort of noticed the past couple weeks is that you actually have the technology sector down and every other single sector up.
00:10:00.799 --> 00:10:07.279
And the index, the SP 500, would be down, but from a breath perspective, the majority of companies were up.
00:10:07.440 --> 00:10:18.240
So that signifies to me that looking at the SP 500 performance is not necessarily indicative of what is actually happening in financial markets or the broader economy.
00:10:18.399 --> 00:10:21.120
It's really looking at SP 500 performance.
00:10:21.200 --> 00:10:23.440
It's what are these 10 companies doing?
00:10:23.759 --> 00:10:28.480
So with that being said, there's actually been a ton of pain under the surface.
00:10:28.559 --> 00:10:32.960
So last week, a handful of companies were down over 20%.
00:10:33.759 --> 00:10:39.919
ServiceNow was down, I think it was like 25 to 35% in just a single week.
00:10:40.159 --> 00:10:45.039
Earlier this year, we saw AI CapEx beneficiaries suffering the same fate.
00:10:45.200 --> 00:10:47.440
And this really hurt the hedge fund complex.
00:10:47.600 --> 00:10:52.240
So according to Goldman, long short managers were down 3.3% last month.
00:10:52.480 --> 00:10:55.519
Tech focused managers were down 12% last month.
00:10:55.600 --> 00:10:58.559
And reminder, these managers are supposed to be hedged.
00:10:58.799 --> 00:11:03.440
Earlier in the year, we saw even generalist hedge funds get involved in the AI trade.
00:11:03.519 --> 00:11:11.039
And it was a cheap, easy way to get outperformance over the index if you could latch onto some of these high flyers.
00:11:11.120 --> 00:11:14.799
But we're now seeing that work in reverse and hurt some hedge funds.
00:11:15.120 --> 00:11:17.600
Active management is just such a difficult game.
00:11:17.919 --> 00:11:24.159
Last month, it wasn't tech, it was biotech getting annihilated and it still hasn't recovered.
00:11:24.399 --> 00:11:29.919
And then over the past two weeks, what we've seen is credit and converse getting hurt.
00:11:30.080 --> 00:11:39.360
So Bloomberg last week had a headline about a$35 billion credit hedge fund called a Rini that was down 26% year today.
00:11:39.759 --> 00:11:41.200
I saw a chart this morning.
00:11:41.440 --> 00:11:46.080
European triple Cs now have a yield to maturity of over 20%.
00:11:46.639 --> 00:11:53.120
Now there's some idiosyncratic events going on there, but still looking at that broad index over 20%.
00:11:53.840 -->
00:11:57.360
That's extremely high and signifying extreme amounts of pain.
00:11:57.600 --> 00:12:04.480
We spoke to some of our managers last week and they were hearing about pods being liquidated at the multistrats.
00:12:04.639 --> 00:12:13.039
So what is happening in this instance is these multistrats, how they're able to deliver these returns is they run extremely tight risk limits.
00:12:13.200 --> 00:12:19.440
So if you're a portfolio manager there, you draw down 5%, they just say your job is gone, you're done.
00:12:19.600 --> 00:12:22.399
There's no second chances in a lot of these instances.
00:12:22.480 --> 00:12:23.679
It's just like you're done.
00:12:23.919 --> 00:12:31.840
When that happens, the multistrat takes over the portfolio and they just sell at whatever cost to limit risk.
00:12:32.159 --> 00:12:40.080
Now, the issue, we've seen this happen a few times in various instances in public markets, but public equity markets are more liquid.
00:12:40.240 --> 00:12:45.600
The issue with credit markets is there's no liquidity and there's no natural next buyer.
00:12:45.759 --> 00:12:48.240
It takes time for that liquidity to return to market.
00:12:48.320 --> 00:12:57.840
And I think that's what we're seeing in credit markets right now is this technical selling is you know what you have a couple four sellers that are pushing the market lower and there's just no buyer there.
00:12:58.000 --> 00:13:02.399
So the market goes lower and lower, forcing other people to be liquidated.
00:13:02.639 --> 00:13:05.679
This tends to be an interesting buying opportunity.
00:13:05.919 --> 00:13:14.080
So that would be one of my investment takeaways in this situation is things aren't selling off for fundamental reasons in some of these instances.
00:13:14.240 --> 00:13:18.799
There's going to be pockets of opportunity where, for technical reasons, things are selling off.
00:13:18.879 --> 00:13:20.879
And that tends to be a reason to buy.
00:13:21.200 --> 00:13:23.279
Converts also look interesting.
00:13:23.440 --> 00:13:30.320
They were looking quite rich, but due to for sellers, that market valuations have normalized.
00:13:30.559 --> 00:13:34.799
And then lastly, just as I mentioned before, investing is hard.
00:13:34.879 --> 00:13:44.080
So it's frustrating to see it looks like very calm waters at the index level, but under the surface, there's actually a decent amount of pain.
00:13:44.240 --> 00:13:49.679
And that index is going to continue to be driven by what is happening with the hyperscalers.
00:13:49.759 --> 00:13:55.759
And while things look okay right now, and at the index level, there aren't any issues.
00:13:55.919 --> 00:13:59.759
I think investors should be thinking about just how much binary risk.
00:14:00.000 --> 00:14:04.639
Because if you see these pockets of the market blowing up, the index has been immune.
00:14:04.799 --> 00:14:15.679
But there will come a day where it's the AI and hyperscalers that are taking it on the chin, and index investors won't be too happy when that happens if they're very concentrated.
00:14:18.399 --> 00:14:23.519
So to summarize, Fed held rates steady and the Bank of Canada hiked.
00:14:23.759 --> 00:14:27.600
In our perspective, though, the Canadian rate hike didn't make much sense.
00:14:27.840 --> 00:14:33.279
Secondly, we have a catalyst this week for equity investors with midterm elections taking place.
00:14:33.519 --> 00:14:41.679
And finally, the S P 500 only being down 1% is doing a poor job of describing what is happening across equity and credit markets.