Regarding interest rates, Ed stated uncertainty in the short term but predicted a need for rate cuts in a couple of years when the economy slows down. David expressed concerns about deflationary forces driven by global debt and aging demographics, with less concern about sticky inflation. Both agreed that rates will come down quickly in about two years. Ed also highlighted the significance of popular demand for fiscal consolidation, given rising interest rates and high debt levels, which could lead to public pressure for fiscal reforms. They agreed that there is still uncertainty in hos the Federal reserve and the Bank of Canada will behave given mixed signals and uncertainty in the US and Canadian economies, and the desire to retain credibility in inflation fighting.
In the second half of the interview, Ed and David discussed portfolio positioning in the wake of a poor september performance in the stock market.
David noted the lack of breadth in equity market performance, even during the market’s better days. He pointed out that the S&P 500 equal weight index lagged significantly, suggesting it was a classic bear market rally. He shared his belief that both Canada and the US are heading into a recession, with the expectation that inflation will drop more than anticipated. David favored duration and found treasury bonds appealing.
Ed echoed David’s sentiment on the attractiveness of duration in investments. He also highlighted a correlation between real interest rates and the stock market, emphasizing that bonds currently appear undervalued while stocks seem expensive. Ed pointed out that buying bonds now could potentially yield capital gains if interest rates decline.
David concluded by mentioning that the equity risk premium is below 100 basis points, an unusual situation that could indicate that the stock market is overvalued, bonds are undervalued, or a combination of both factors is at play.