VISION 2026: Markets in motion: A CIO outlook for 2026 - Andrew Marchese

Andrew Marchese: [00:00:00] Thank you, everyone. Good afternoon and good morning to those of you watching on the West Coast. We have 40 minutes, I've been told, and we've got a lot of stuff to go through. I'm going to build on some of the things that you may have seen in Denise Chisholm's previous presentation. Denise is great, she's always got a lot of data. Her opinions and viewpoints are well-substantiated with fact. I'm going to add a few slides to all of this and try to give you what I think is a pretty decent outlook as we look forward into 2026 and beyond. We're going to keep it as always, we're going to focus on corporate profits, we're going to focus on the valuation of risk assets and talk a lot about liquidity and interest rates. There's a lot going on in the geopolitical context that I'm sure a lot of you have questions about and how much should we actually be paying attention to any of this stuff. Lastly, outside of equities and fixed income we got hard assets, namely like gold and silver and other things going crazy. We're going to tackle all of that.

[00:01:12] For those of you who have heard me speak before, one of the things I've been working with is we're living in a world that changed materially. It really changed materially after the global financial crisis. When we were starting to get back to more of a normal world, the conventional world that preceded it for a century before that, COVID hit. The pandemic induced a change in the financial largesse that exists in the world. I think, unfortunately, or fortunately, depending on your viewpoint, that was a momentous event that's going to change a lot of things going forward. It affects a lot how we're going to value risk assets going forward. The playbook that we used to use to talk about economic cycles and investment cycles, what leads, what lags, how we think about the typical playbook, I think has actually been obliterated. That makes it challenging on active management. We need to be more opportunistic, we need to be faster, generally speaking, and we have to represent our investments with higher conviction in order to be successful.

[00:02:36] The world we're living in right now is going to be dominated by secular themes, some of which we've been talking about today already, AI, changes geopolitically that are inducing gross spending in defence, suppression of inflation right now that Denise talked about but possibly building debt and a future inflation problem going out some years. We're going to have to tackle those things. All the while there's still an economic cycle bubbling beneath the surface. In North America what we're starting to see is signs of actually early cycle behaviour. As it pertains to investing we're going to talk about secular themes that you should be using as your core that will continue to be monitored, increased, decreased as is appropriate, and then adding things tactically from a cyclical perspective.

[00:03:37] As we sit here today the corporate profit backdrop in North America is very strong. Looking at the S&P 500 Wall Street estimates are for about 13 to 14% earnings growth in both this year and next. It's a pretty healthy backdrop. All the while it's really becoming more diffuse, and I'm going to talk a little bit about this. The profit outlook because of margin improvement and a little bit more incremental demand we're seeing in both the manufacturing and service-based economies. That's a bullish backdrop. All the while if we look at credit spreads, equity risk premiums, P/E multiples, all that kind of stuff, valuations aren't great but I don't think they're an impediment to actually risk assets going higher. In totality, the backdrop for investing in risk assets I would call is, I wouldn't say neither bullish nor bearish, I would say it's actually very constructive. Until one of those things changes we have a backdrop that we should be pursuing in some way, shape, or form risk.

[00:04:50] I'm going to show you some graphs to kind of substantiate that. As always, a discussion in investing would be incomplete if we didn't talk about risks. The greatest risks that I see right now are kind of two-fold. One is the unabashed profit generation stream that we've seen out of hyperscalers and the commensurate spending in CapEx around AI. The AI theme in reality and practicality touches far more than what I think the average investor really perceives. Any disruption in that profit engine and subsequent CapEx spending cycle can actually have very significant deleterious effects, not only on the company specifically in question related to AI but a lot of spillover industries and sectors. We'll talk a little bit about that.

[00:05:44] The other thing I think we need to really think about, Denise mentioned this a little bit as a disinflationary backdrop but longer term I find it hard to believe with the amount of money that's been printed globally and the balance sheets of some countries out there that at some point inflation will be a problem. It's not a 2026 problem, it may not even be a 2027 problem but it's something to look out for on the horizon, mid-horizon if you will, the market generally does a really good job of sniffing that out in advance. One of the things that we're going to have to pay attention to from the fixed income market, particularly if the US Federal Reserve goes into a further easing environment, is the behaviour of the long end of the curve and the potential for quantitative easing this year to reemerge.

[00:06:35] Lastly, it's really about a change in the world order. Whether you want to talk about leader imperialism, countries looking more inward, potentially shrinking in total available markets due to trade, this, to me, we can all deal with. It's less of a risk in my mind. It needs to be monitored ... the reason it needs to be monitored, none of us can actually forecast this with any degree of conviction or accuracy. On the surface I'm not overly concerned about any of it but given the personalities at play, the way things can either improve or deteriorate at the drop of a hat, obviously, it's something you can't take your eye off. We'll talk about that as well.

[00:07:22] As always, these are the four pillars of investing. We're going to spend a lot of time on each of them, probably equal time on each of them and we're going to bounce between them and see how they interact with each other to paint a picture, as I said. I think the backdrop for investing in risk assets is quite constructive but there are a few things to note in that overall theme. The first place to start with at a very high level is the financial conditions that exist in the United States, given it's the economic superpower of the world. What you see before you here on this graph is a horizontal line at 100. Any time this graph, that line, is above 100 financial conditions are somewhat restrictive. When it's below 100 it's very accommodative. Accommodative is good for business, it's good for corporate profits. You can see where we are right now, far below the 100 line and potentially heading lower.

[00:08:26] You can see, dating back to 1995, is that when you're heading lower it's generally a good place to invest in, generally speaking, in risk assets. All the while, though, with that aggression and optimism that comes with good times you potentially sow the seeds of something that will stop this entire cycle. Call your attention to the period just after 1998, interest rates started going up, all the while we were building a bubble in Nasdaq and, generally speaking, telecom equipment CapEx. The period of time became very restrictive, Treasury yields went higher, the US dollar got stronger, credit got worse, and it snuffs out a cycle. But as you see right here Treasury yields are accommodative, potentially going lower in the US, credit is tight, or accommodative, spreads aren't as tight as they possibly could be so they could tighten up from this point forward, and the US dollar, nobody in the US wants a strong USD. I don't care what the headlines say. They will work in best efforts to try to get the US dollar down, 80% of the globe actually benefits with a weaker US dollar.

[00:09:47] There's been a lot of conjecture over the last few days on that front. I would anticipate further interest rate cuts to come in the US later on this year, not because they necessarily need them but because they can do it. If that happens the Federal Reserve is the last bank in the world that has embarked on its rate-cutting cycle. Most of the developed world has already gone through it. Bank of Canada, as we know, is far ahead of the US. In fact, today, they went on hold. The underbelly of a typical economic cycle usually follows this. I talked about big secular themes forming the backdrop of big investment ideas that we've kind of been embracing for the last 5 to 10 years but all the while countries, economies go through a cycle.

[00:10:41] Starting on the far left-hand side of the graph, you have the early phase coming out of a contraction or a slowdown area. You go through the mid-cycle. Interest rates typically go up at that point, slow down the economy and then go through the late portion of the cycle and you either kind of skip a recession and go right back to early, or you go into a recession. You can see where all the countries fall on this chart right now. What's very interesting, if you rewind the clock about 18 months, 18 to 24 months, all these dots for these regions and countries were almost sitting on top of each other. We've kind of spread out. What's very interesting, though, is even though we've seen a prolonged late cycle behaviour in the United States, even in the UK, what's really happening is there's green shoots of early cycle-like behaviour. It would not shock me that if I came back to this stage in six months' time if the US area of this curve actually showed up more in the early cycle.

[00:11:46] This is very telling because while it's an economic kind of schematic the stock market historically follows a pattern around what stocks lead in the early, mid, late cycle and during contraction. What's also very interesting in the market, particularly that of the US, is that traditional early cycle stocks ex-financials, think about restaurants, autos, housing, transportation stocks, and they're all fairly correlated to the tune of about 70%, have not participated in the market rally that we've seen over the last 12, 18 months. Their profits, largely speaking, have still been negatively revised. Now, in all those areas of the market I talked about there may be tariff concerns or real practicality around the impact of tariffs. US housing has its affordability issues. In transports we've seen about eight consecutive quarters of negative earnings revisions by Wall Street but the stock's valuations are now starting to price that in. Any bit of good news should be met with optimism. Those stocks are directly beneficiaries of further interest rate cuts.

[00:13:05] It's one place to look for our active managers, areas of the market that haven't yet participated that could potentially participate, while other parts of the market have actually moved and on a relative basis are pricier. It's one thing to just keep in mind here. This chart shouldn't look as dispersed as it is. My conclusion on this is that we're living in a world where you're getting simultaneously both late cycle signals and early cycle signals. We as investors have to be more attuned to the idiosyncratic profit outlook for the companies that we're thinking about investing in and at the same time being very quick to capitalize on the availability of cheap prices. I think if we do all that work then we're going to continue to add value for our unit holders.

[00:14:00] As I was saying, my belief is that the US Federal Reserve will continue to cut interest rates at some point during this year. This chart asks the question, well, can they? Now, the way to read this chart dating back to 1983, the gold line is the natural rate of interest, the interest rate at which growth and inflation are balanced off. When interest rates are above the gold line you're living in a restrictive monetary world. You can see that when you live in a restricted monetary world for some point, it's hard to see here but there are shades of vertical lines that are kind of like a rose colour or a red colour, those would be recessions. If you live in that area for too long you're going to induce a recession. The early '80s, you can see here the early '90s were emblematic of that.

[00:14:53] Now, we're sitting right on that line. I've got to believe there's a lot of reasons for the Federal Reserve, and it's been talked about at length in the media and I think the Trump administration has made it patently clear, is they want lower interest rates. As I mentioned earlier, they want a weaker dollar. That's good for growth. I would anticipate that this line then, the blue line that kind of moves around the gold line, will descend into more of a accommodative stance. Going back to the first slide, financial conditions in the US should actually improve if this turns out to be true. This is important because lower interest rates, a more accommodative business environment, financial conditions improving to the tune of a weaker US dollar, lower Treasury yields, better credit, it's all good for growth, profits and it's all good for valuation. It lowers your discount rate effectively.

[00:15:58] All the while we're talking about a cycle where we could get more stimulative but in the backdrop we've had a huge amount of money printing, basically dating back to 1987, and we've done very little to take money out of the whole system. The chart on the left basically shows you in a global central bank context all the interest rate cuts that have taken place since about 2001. Very few opportunities to actually take the capital out. We lived through 2022 when inflation perked up cyclically but in the grand scheme of things we never took a lot out. The amount of money that was injected into the system due to COVID was 4x that of the global financial crisis. If you just kind of think on that a bit this is what we're kind of dealing with. When money is abundant it does funny things to prices of all assets because you're effectively pushed out on the risk curve.

[00:16:58] The question we get often is, well, are stocks generally expensive? I would say they're not cheap but they haven't hit an alarm area that I would be concerned about. One of the refutes to that argument would be the chart on the right. People look at the price-to-book ratio of the S&P 500 and quickly say, looks a lot like it did at the apex of the dot-com bubble. A few things going on with the chart on the right that I think makes that conclusion erroneous. One, the constituency of the S&P 500 is far different today than what it was back then. Two, the businesses are better, generally yielding higher ROEs. The revenue and earnings stream are also more durable. If you have a higher ROE to work with you should, by definition, have a higher price-to-book to value it off of. The businesses that made up the S&P 500 back in 1999 were far more capital intensive with far more cyclical ROEs.

[00:18:11] While you'd like to see something lower from a starting point to invest in I think in part it actually does make a lot of sense. Needless to say, though, it's something that we should also monitor through other valuation metrics. One of the things to kind of further get some grip and conviction about valuation is to look at the equity risk premium, which is simply the earnings yield minus the 10-year yield. If you follow the dark blue line here on this chart, kind of starts at around zero or just above zero, goes up to north of six in around 2011 or so, and it's now right back down to zero, it would tell you that, well, we're probably more on the expensive side, that the equity risk premium shouldn't be this low. It got really low, actually negative, meaning fixed income is riskier than equities back in the late '90s.

[00:19:07] The way I would kind of reconcile this in my mind, though, it all goes back to money supply and therefore credit and the VIX, which are actually tied at the hip, is probably a better measure to say, will the equity risk premium kind of back up? Right now, as you see from the chart in kind of the top left, spreads are kind of low, not as low as we've seen them. If we do get more stimulus in the system, monetary, we know we're already getting fiscal in the US and that should manifest itself in real economic data starting this half of 2026. I would say it's actually durable but as with all valuation metrics when you start to get a little on the expensive side and stretched you always have to worry about the snapback. Valuation is never a catalyst for any mean reversion. It just tells you how far you can mean revert when the right ingredients in the recipe shows up for that mean reversion. Right now, I think it's mostly okay.

[00:20:13] The corporate profit backdrop is also very okay. On the left we have the MSCI ACWI ex US and looking at the earnings growth over the next 12 months and beyond. Same is true on the right for the US Market. We've broken out the Mag-7 and we've also broken out the  ex 493. On the S&P 500, I mentioned probably about 13 to 14% earnings growth forecasted, a little bit better than that for the Mag-7. On the MSCI ACWI ex-US you're sitting at around 11. EAFE is about 8 to 9%. All a very favourable backdrop. Last year rest of the world kind of outperformed off of better valuation to growth metrics. Think about a PEG ratio, so P/E to growth basis. All in all this is the stuff to watch. This is what we spend the lion's share of our time thinking about. If this is bar for corporate profits what will drive the market higher is probably coming in and above that. If the market were to go lower it would start with this. In other words, earnings expectations and estimates would be too high and we'd have to negatively revise. This is the starting point.

[00:21:31] The starting point actually looks pretty good going out. With an accommodative backdrop from a liquidity and monetary perspective we would expect a more diffuse CapEx cycle, see more investment coming from other industries and sectors. That were all to come to fruition it would allow you to have greater confidence about these numbers coming to fruition. It's where we spend the lion's share of our time from an active management perspective. I keep talking about money supply because I think it's the overarching theme that pushes people and investors out on the risk curve. The blue bars down below on this chart demonstrate the money coming into the system when it falls below the zero line or taking money out of the system. As I said before, this is a snapshot in time from 2015 but if you rewind the clock to the global financial crisis, and even before that, it paints a very, very different and kind of overwhelming picture.

[00:22:39] As long as the money supply grows investors get pushed out in the risk curve and we must take on a more kind of detailed and thoughtful approach to valuing risk assets and also valuing them against each other. We saw this in a microcosm right kind of in the second half of 2020 into 2021. COVID hit, risk assets got obliterated, vaccine showed up shortly thereafter, monetary supply and response was immediate, and all risk assets got bid up, whether you're talking about equities, hard assets, jewellery, art, speculation, everything kind of worked. To compare and contrast asset classes against each other I think is going to be a very poignant exercise for all investors going forward because I don't see how you attack this in a meaningful way over the next five years. The supply will continue to build. We have to use that as our starting point and almost like this is the ground we're playing on. This is what we have to get comfortable with.

[00:23:52] From that perspective I think you're going to have to have different arguments about how you think about the price of different asset classes. The asset class in question, if my slide will move, there we go, that most of you are thinking about that directly participates in this is gold. Now, in our team there's been a number of us who have actually been bullish on gold for a while but if you were to corner me and say, would you thought bullion would be at $5,300 an ounce today, if you asked me that question about 12 months ago I would probably say no. Not that I forecast a price, I can tell you all the points why you should be bullish on gold but it directly goes to this. I think the point being, I've talked about a migration in talking about the digital world that pulls on the demand for hard assets but also the monetary world has created this as well.

[00:24:55] The old 60/40 balanced portfolio, and I think Jurrien Timmer has talked about this a bit, might be outdated and the need to have 20% of that portfolio generally coming at the expense of fixed income, in some way, shape, or form exposed to hard assets, whether that's gold in part, land, industrial commodities, probably makes sense to some degree. The problem with the money supply is, and the debt we've built, you don't have to deal with that today but you will have to do with that at some point in the future. Bullion is some way, shape or form an insurance policy on that. M2 money supply growing, US imperialism or countries turning inward with a lot of US Treasuries need an offset. If you're concerned about the US and you're a big holder of US debt you need something to offset it. That's it.

[00:25:58] Global central banks will probably continue to top up their reserves with bullion and diversify at the same time, which in some way, shape or form, even if it's small, probably necessitates some selling of US Treasuries, particularly if geopolitical events and tensions run a little bit higher. That's going to play a lot of havoc with the currency markets. Gold, at the end of the day is not a commodity, it's a currency. Don't ask me to explain silver, I can't. It's an industrial commodity as best I can tell that it's not behaving like anything I've ever seen. I've been doing this for 28 years. If you guys got the answer, please tell me, I'd love to be informed. Gold makes sense to me in a lot of ways. The other ones that make sense to be are land. It's very easy. If the world's turning more inward land, by definition, becomes more valuable because you have to feed your own people, you have to defend your own people, so on and so forth. A 60/40 portfolio should be moving to a 60/20/20 portfolio.

[00:27:11] To conclude I just wanted to touch a little bit on the AI theme. For those of you who have heard me talk before, AI is a page one story. It's been a page one story for a while. It's important. Somebody said this morning it's the biggest technological revolution we've ever seen and will probably benefit mankind in ways we can't fully appreciate to the upside. I agree with that statement but it has a way of pulling on things, namely in the hard asset world, that I don't think enough people are actually talking about. Whether it's copper or other industrial materials these assets are actually undervalued on a relative basis. Somebody told me once a long time ago, you make more money finding a story that goes from page 16 of the newspaper to page 1 than you make investing on stories that are on page 1. Technology has a way of increasing demand for hard assets. As I said earlier, monetary stimulus, while we hopefully raise GDP, not only in the US but globally, with more stimulus there's a limit to that.

[00:28:28] It actually is an insurance policy against things going wrong, both from a monetary perspective and a geopolitical perspective. Back in Liberation Day I got an email from my boss who was actually overseas at the time and he just wanted to know, he was being out of the office, how things are looking in the market and what are you thinking and all of these things. One of the things I talked about at that time was if you looked at what the Trump administration was first proposing, very mercantilist-like economic beliefs. I think the effective tariff rate that we talked about on April 2nd of last year was somewhere in the neighbourhood, depending on how you do your math, 27% to 30%. We're nowhere close to that today. Things have been watered down and/or delayed.

[00:29:19] What I wrote in the email, what was very telling, when you institute these types of economic policies, and if you go back to the late 1800s in US history the US annexed the Hawaiian Islands, they built a fortress from a shipping lane perspective around the Philippines, went into Guam, I said, that conjecture is not going to go away. Now, we could debate how effective that type of geopolitical behaviour will be in the 21st century but if it doesn't go away the demand for natural resources naturally goes up. What's in the ground, both proven and probable, is probably more important than what's being produced The way that we think about maybe a conventional oil and gas company or a conventional copper, zinc or nickel miner, we always would value on a profit stream basis and we would always take a conservative approach to what's actually in the ground.

[00:30:22] Given this backdrop there is the potential for speculation to occur, and where you believe there is a large body of reserves in one of those commodities that I talked about, that actually is priced earlier. It's one thing to think about. Again, going back to the idea of not tactical but a strategic allocation in an otherwise balanced portfolio. One thing I'll kind of conclude with is all of this behaviour in this world we're living in where I said the conventional cycles have kind of been obliterated, you have smaller economic cycles with smaller amplitude of both growth and contraction occurring but the overarching themes about AI investing, potentially hard asset investing, that are going to take over from an investment vehicle perspective, you all have a lot of choices.

[00:31:20] One of the things that's gone on with the money supply is also a ton of financial engineering. We have more ETFs, more mutual funds than we do securities out there. You can create products in any way, shape or form that you want. I tell you this for the purposes of saying, if you are constructing a 60/20/20 portfolio, or based on your client needs a 60/40 portfolio or some derivation thereof, what is going to be vitally important is to understand the correlations of what you hold in your portfolio. If we are dealing with both secular forces and underlying cyclical forces and living in a world where financial largesse is right there in front of us the likelihood of correlations occurring between assets naturally goes up. It is imperative for you to understand why the securities that you hold or the asset classes you hold are behaving the way they are.

[00:32:23] We've noted that internally at our shop, talking amongst the PMs and whatnot, that price behaviour of certain securities which were previously never correlated are increasingly correlated. Part of that is because industries are changing. Technology companies are becoming financial companies. Utility companies are being thought more as growth engines as opposed to traditional utilities. Some of that's incurring. The other thing that's also driving it is financial engineering. You can go out and express a certain thematic investment approach that you want to very easily. That will cause distortions in price. The other thing that's happening with all this money sloshing around in the system is price gets arbitraged away very quickly. Some people may say, well, that means you've got to act and trade a lot. Actually, you have to do the opposite of that.

[00:33:22] The trading can happen in terms of overshoots and undershoots on price. It's very important to have a mid to long term outlook for your investments and not react to the day-to-day gyrations of price because in this environment, it's my belief that the single day volatility of prices, particularly for equities, will only rise. You, in concert with your clients need to have a very firm understanding of, one, the correlations that exist in an otherwise balanced portfolio  and, two, your outlook, the length of your outlook and how you perceive success. Again, going back to absolute returns. Ultimately, what you're trying to do is give yourself a glide path. When risk does tend to rise in the system pare back risk. When it looks more favourable add, I would say, somewhat aggressively. That's going to be more important than anything else going on underneath the surface. With that I will conclude my statements. Thank you very much for your time and attention and I'm going to turn it over to Darren Lekkerkerker. Thank you.