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Mike Miranda:
Welcome to Beyond the Portfolio, the podcast where we take you inside the thinking that shapes today's markets and tomorrow's opportunities. I'm Mike Miranda. Today is December 15th and we're continuing our 2026 Outlook series, a third of our four special episodes where we're exploring what's ahead across the investment landscape. Our first two episodes covered private markets and alternatives and fixed income. Today we dive into the equity market landscape, and in early January, we will wrap up with our long-term capital market assumptions and the key themes for 2026. We have a crowded panel today, one CIO and two strategists harnessing the power of BMO across two countries and a variety of market perspectives.
Welcome back, BMO Wealth U.S. Chief Investment Officer, Dan Phillips, Brent Joyce, Chief Investment Strategist for Canada, and Carol Schleif, Chief Market Strategist. I know all three of you have been working feverishly together crafting your thoughts for 2026, so let's get started. Let's start with Dan, so we have a backdrop to work from. Dan, you work off of a scenario framework and your base case calls for equity market momentum to continue while respecting that markets may face some valuation headwinds. Walk us through your base case scenario.
Dan Phillips:
Yeah, sure, Mike, and glad to be here with all of you guys today. So when we think about the markets, we first start with the macro side of things and we go through growth inflation and monetary policy specifically. Starting with growth, we do think that the expansion can continue. We think it'll be somewhat modest, although we do believe that the economy, the U.S. economy can outpace the current 2% consensus expectation, maybe coming in around between 2.5 and 3. And reasons for this are, one, the consumer, which has brought some worry to the markets, given the fact that the hiring pace has slowed. And in some areas, it appears as though the consumer might be a little bit stretched. But in the first quarter of the new year, they will be getting a record amount of tax refunds to the tune of about $520 billion, which is an increase of about 40% over last year, thanks to some of the provisions within the tax bill that was passed earlier this year.
In addition to that, we think the investment will continue not only in things like data centers, but more broadly, also thanks to the tax bill, which gives 100% R&D expensing. And so there could be some more reshoring, for instance, and some other general construction. We could really use some housing, for instance, as well. So we think that side of the GDP equation will be supportive as well.
And then finally, we are finally at the part of the Trump agenda where you get some of the more market-friendly stuff. We're going into a midterm this year. And specifically other than some of the stuff that I've mentioned on the regulation side of things, we might see some deregulation, which can help the markets and the economy as well.
On the inflation side of things, we sit at a pretty steady rate of inflation. It just happens to be above the Fed's 2% target, but has maintained, at least on the core PCE, which is the inflation metric the Fed looks at most below 3%, and it has been below three and really in a tight range between call it 2.5 and 3% for the last 2 years. So steady inflation, price stability as is the Fed mandate, albeit not at their 2% level. I think we need to think about the 2% level as more of a floor in this new environment versus if you think back to the post-financial crisis period, it was more of a ceiling. And so inflation steady, but still a little bit elevated.
On the monetary policy side of things, of course, we will get a new Fed share announcement sometime soon. Whoever is picked, they will probably be on the easing side of the hawkish-dovish spectrum. And for us, we think that we could get three rate cuts next year, and in a really good case, four, which would be sort of in every other meeting type of pace for the Fed. This compares to the Fed, which right now says, at least according to their dot plot, only one cut and the market's thinking two, maybe three cuts. So we do think that there may be room for the Fed to move a little bit more than what is priced in. And that is predicated on our inflation view where we, as I said, believe that we'll keep that below 3%. If it goes above 3%, then all bets are off. I think the Fed would need to address the inflation a little bit more than their full employment mandate.
And then finally, getting into the markets quickly based on that macro outlook, we do see equities with a 10% type earnings growth this year. We think that will eat into some of the multiples. Right now, the valuation multiples are a little bit elevated in this environment. That said, last year, as much as the markets have gone up so far this year, I should say, we did not really see a lot of multiple expansion because the markets gained just a bit more than the earnings gained in 2025. And so the multiples were pretty steady, but they are a little bit elevated. And we think that in this year we may, again, eat into those multiples a little bit through earnings growth. And so overall, we would expect somewhere around an 8 to 9% type return on the equity markets using the S&P 500 as the proxy. Credit markets, spreads are very tight, and so we're underweight there, but that is good for equities as long as the credit markets continue to function so well.
And then finally on the interest rate side of things, we think that rates can stay fairly range bound. If we're right on policy and if we're right on inflation, then that would be a downward pressure on rates as the Fed cuts in the backend of the curve starts to price that. And then on the upside, the fact that inflation still is a little bit elevated, the fact that markets are a little bit worried about inflation as well as the debt load will pressure rates up. So our expectation is that we'll be kind of caught between those 2 forces and that interest rate such as the 10-year treasury, for instance, will probably stick in a band around the current 4 to 4.25.
Mike Miranda:
All right, thanks, Dan. That's very, very helpful. And I think the scenario framework that you outlined is very useful to think about the markets. Brent, you work with explicit North American price targets. What are those and what's your view on valuation? And are these considerations unique to the Canadian equity markets?
Brent Joyce:
Thanks, Mike. Great to join everyone. Yeah, we too are constructive on North American equity markets, and we have Canada and the U.S. as our most favored across the globe. Similarly, we've got percentage earnings growth in the mid-teens across most global markets, and I am allowing for some downward wiggle room on valuations. But that still drives equity market gains similar to what Dan was talking about in the high single to low double digits. So specifically, consensus earnings for the S&P 500, 14%. We think there could be some upward surprise to that, but we have the multiple contracting from current 27 times down to 24, and that drives a price target of 7,400, which is a little over 8% from December 12th's close.
For the Canadian market, the TSX, it's a slightly rosier outlook. There's better expectations for EPS growth. Valuations don't need to contract as much, and notably, the dividend is chunkier here in Canada. So earnings growth of almost 16%, the multiple here is 20 times, and we're going to bring that down to 18 times, and that's a 34,000 for the Canadian equity market. So it's also an 8% return, but as for considerations that are unique to the Canadian equity market, we add that dividend yield, which is twice what it is for the S&P 500. So we're 2.6 versus 1.3. And we're bullish on the Canadian dollar, which for Canadians means knocking down some of those S&P 500 returns. When we think more broadly about valuations, as I noted, these price targets do account for some downward slide, and that's, I'd say, a bit more conservative view than some of the others that are out in the marketplace. But I think our experience tells us that when sentiment is running high, asset valuations are priced for a lot of good news, and that does leave less of a margin for error in the event of any disappointment.
Now, we're not expecting disappointment, but we need to respect the fact that the expectations for performance are pretty high. We've described it across sectors as downsize for some areas, right size for other areas, and then actually upsize for a few. And so the downsize would be things that are AI and AI adjacent, information technology, communication services. For Canadians here, it would be the gold sector and maybe some other parts of global markets. There's a risk that share prices of some of these companies are either ahead of where fundamentals can go in the short term, or at a minimum, you don't extrapolate the current trajectory out into perpetuity. Importantly, this is not the entire subset of these businesses. Many continue to present great opportunities, and I'm encouraged with the market movements here in November and December, they point to some good investor discipline.
On the right size, this is a big chunk of the market, both in North America and globally, and it's really just a story where we need earnings to continue to grow, to continue to deliver on share price advance. And that should be reasonable given the positive backdrop that Dan's outlined and that I agree with. And so share price appreciation remains positive, but not at the same pace as we may have experienced this year or in prior years. Globally, these sectors would be financials, industrials, consumer discretionary. The bottom line is good things are happening in these businesses. Their share prices have correctly reflected that so far, and we would expect to see more of this, and that's very normal behavior for stocks.
On the upsize, there's been a talk about a rally and everything. That's just plainly not true. We do have some sectors that have lagged, and thinking about some of these that have been less loved over the past three years and that are levered to this further improvement in the global economic backdrop. I would say in our order of preference, healthcare because of its valuations, energy, consumer staples, and real estate are all ones that we want to keep an eye on. And so I guess the bottom line is that an upsize growth scenario does provide benefits to all parts of the equity market, but different sectors have moved to varying degrees to reflect that scenario so far.
Mike Miranda:
Thanks, Brent. That's very, very helpful, not only to affirm our overall thesis on the broader macro and broader market backdrop, but also to dig a little deeper and think about where there are specific sector opportunities. So thanks for that. Carol, let's bring you into the conversation. I haven't put these two on the spot with are we in a bubble question, but what can we say to investors who harbor those concerns? Because I know you and I who speak to clients very often, this is on their mind. What thoughts do you have there?
Carol Schleif:
First off, thanks for having me and letting me join the party. And second off, thanks for putting me on the spot. But yes, there has been an awful lot of talk around bubble, and it actually takes two forms. It seems like for clients, there's the markets in general, given the fact that it looks like we're slated for a third year in a row, strong double-digit gains. And then there's also the fears about bubble as it relates to AI spending and what's gone on there. And so let's address the first one first, but let's level set because markets in general spend the bulk of their time in an uptrend. Going out, it depends on whether you look at 1 year, 3 year, 5 years, 10 years, but anywhere from 75 to 80, 90% of the time, markets tend to trend up. And a lot of times investors forget that and we get anchored.
It's human nature to expect after things have been good for a very long period of time to see some sort of pullback. And behavioral scientists also tell us that as humans, we feel the downturns much more acutely than we enjoy the upturns. And so that leaves us sort of on edge, particularly after markets have been trending up as long as it seems like they have and have been as resilient as they have. But just because they're old in calendar terms doesn't mean that we're necessarily due for a pullback. And so it's important to remember and to really follow the fundamentals, and both Dan and Brent have laid out a lot of really constructive fundamentals going on for the markets in general. And I think a lot of times investors, especially in the near term here, are under-counting what a framework shift we've seen, particularly in the U.S. in terms of the current administration really leaning into putting policies and reducing regulations and doing a lot of things in place to encourage and basically coax a lot of animal spirits out of hiding, if you will.
I saw one stat go by earlier this morning that talked about globally, M&A is up, mergers and acquisitions are up close to 40% this year and should clock more than $4.5 trillion worth of mergers and acquisitions. And you don't have that sort of activity go on when people are really fearful about the way things turn out. A bubble as it relates in general, there's a lot of fears. There's been a lot of analogies drawn to, is this like the late '90s technology bubble that we had, tech 1.0, if you will. And having lived through that bubble, managed money for clients through that entire buildup to that bubble and prior ones, this one has very few hallmarks that mirror that one.
So it's important to remember back then what drove a lot of markets and a lot of valuations is you had a significant number of companies, particularly in the technology industry that were going public. Many of them had no earnings. A big chunk of them even had no revenues back then, and there were different valuation metrics being used. What's driven current markets is not only the constructive framework that we've had, but it's also the new technologies, the shift that's happening there, the spending that's happening not only on artificial intelligence, but also on things like robotics, electronic vehicles, autonomous vehicles, lots of other things driving and cloud, all sorts of things that are driving spending and constructive shifts in what's going on. And the spending is happening from companies that are very large, very significant cashflow businesses.
And so it's very much supportive of what's going on and realistic. And it's also important to remember that a lot of the spending that's happening is happening from companies not only that have solid earnings and revenues and other cashflowing businesses, but have very clean and pristine balance sheets. And the vast majority of the spending that's gone on to date has happened there. So the play out of these things is very different than it has been in prior cycles. And given everything else constructive going on in the business environment, there's good solid fundamental underpinnings.
And one final point I would make is to Brent's point about there's a lot more breadth to what's happened in the markets. And we saw it in the most recent aggregate. When you aggregate S&P 500 earnings for the most recent quarter, you had the top line growth of over 8% and bottom line being the earnings growth of over 13%, which means companies are running themselves very astutely. They're paying a lot of attention to those margins that they're trying to maintain. And margins are close to all time highs where they have been since coming out of the pandemic. And it was broad-based. You had 9 or 10 of 11 sectors that were participating in those double-digit earnings or the increases in 4 or 5 that were double-digit, solid double-digit increases. So it's more broadspread than is perceived.
Mike Miranda:
All right. Thanks, Carol. Appreciate that because I know that is a concern and we do hear it a lot from clients, and especially given the wonderful returns that we've had in equity markets the last three years. I appreciate you providing some insights there on valuations and that bubble concern. Dan, let's go back to you. You obviously outlined your base case scenario at the [inaudible 00:17:29], which I think is helpful for us to think about equity returns. Are there a choice between bad and worse in your other scenarios? Maybe give us a framework for the downside risk and the upside risk.
Dan Phillips:
Yeah, definitely. So I would characterize it as a choice between bad and potentially down the road eventually worse. And I'll explain what I mean by that. Let's start with the bad scenario for next year. So as we talked about in our base case, we believe that the Fed has perhaps three, maybe four rate cuts in them next year. And in our base case, along with the growing economy, that's actually quite positive. But there's a big caveat here in that, one, these rate cuts need to be appropriate for the economic environment and need to be messaged appropriately. And what I mean by this is first, appropriate for the economy. If the Fed, because of a desire to cut rates, ignores inflation, which is fairly steady right now, albeit as we mentioned, a bit above their target. If that inflation number starts to creep towards or above 3%, and yet, they being the Fed, insists on cutting, the markets won't like that. And the backend of the curve, think the 10-year treasury yield, for instance, would probably actually move higher, and that could make for difficult times in equity markets.
And then on the messaging appropriately, if the message from the Fed comes off as too political, the independence of the Fed will be questioned and the markets will similarly be somewhat wary even if the Fed is cutting rates. The decision that President Trump has right now, which seems to be between the two Kevins, Kevin Hassett, Kevin Warsh is the big one. The markets seem to much prefer Kevin Warsh who has been in the Fed, has a little bit more of that Fed understanding than Kevin Hassett, who has been mostly close to Trump over his last, call it, decade, both in the first administration and the second administration, and therefore the markets perhaps view him as potentially a little bit more politically swayed. So that'll give us some indications on this risk case, this downside risk case, if it should happen.
Our upside risk case, the one that I called potentially eventually worse is what we would describe as asset inflation, or you could call it the makings of a bubble. If we get the rate cuts that we expect and the economy continues to grow and the AI story continues to be on pace, the markets have a tendency and investors specifically to get a little bit too exuberant, and we could see actually markets inflect higher from here. If you look at today's markets, and by that I mean specifically since 2022, the lows of '22, which funny enough occurred right on September 30th of 2022 to today, the markets are up about 100%. If you look at the dot com era and during its 5 years of pretty much 20% gains per year at least, the markets at this point were up about 125%.
And then they went on in 1998 and 1999 to tack on 2 more years of above 20% returns. And you could really see an inflection upwards in the S&P 500 at that point, which is one real indication of a bubble. If you see the markets, the line graph start to inflect outside of what was the trend, that of course is a good signal that you may be in a bubble. And so for this upside risk case, we may see something like that where we see the markets actually start to accelerate higher because those who are on the sidelines feel left out, the expectation that AI can do no wrong, and we could see really nice market returns.
Now, as I said, this could be eventually worse because of what happens to bubbles. They generally pop. And so while there would be a nice upside for 2026, we would have to be very careful that it isn't in fact a bubble. There are reasons, as Carol mentioned, not to believe that we're certainly in a bubble now or we'll move into a bubble. One being, of course, the much better profitability of the high-flying tech companies today, which have profit margins of around 20%, which is quite impressive given the size of these companies and also the earnings growth that they're showing given the size of these companies. And if you compare that 20% profit margins to the dot com era, the profit margins back then were closer to 5%. Valuations back then actually were a little bit lower in those high-flying tech companies than in say, for instance, the Magnificent Seven today.
So there's reasons to believe that certainly we're not in that bubble yet, but in our upside risk case scenario, we could see something that looks more like a bubble, which of course would be upside in the time that it's on the right side of the bubble being formed, but then the other side would be notably worse. So those are our two risk case scenarios, upside and downside. We have them evenly balanced. They have 25% probabilities on both with our base case at 50. And so overall, if you look at our current positioning tactically and portfolios, we are overweight risk, but just by a little bit. We have some "dry powder" if we do see a market pullback, for instance. And so we do definitely take those risk or the base and risk case scenarios into our thinking.
Mike Miranda:
Brent, do you line with Dan on these other two scenarios? What do they mean for Canadian investors or perhaps more broadly non-U.S. investors?
Brent Joyce:
Yeah, thinking more about an upside scenario that's not tied to the AI theme, really. If you think about stimulus in China, stimulus in Europe, defense spending across all the NATO countries, in addition to the backdrop, maybe productivity that continues to expand outside the U.S. whether that's from AI innovation or otherwise. And you just go to a good old-fashioned global cyclical growth upturn or even just a mild surprise on growth, then non-U.S. markets are typically more highly levered to that kind of a scenario. They've got higher exposure to the cyclical sectors versus the secular growth themes that are in AI and technology, and maybe to some extent, healthcare that are the big chunky sectors in the S&P 500.
So for non-U.S. markets, valuations have moved from below their long run average to slightly above it, so they're not as cheap as they used to be, but they're not as expensive as the S&P 500, nor would you expect them to be. Earnings growth for international developed markets, it's around 12%, and that's the highest level in 3 years, so that's notable. Earnings growth expectations for emerging markets, they top the list at 17%. Now, it's important to remember these are pretty, EM in particular, historically pretty volatile markets, and we would generally see these as satellite positions and for more risk tolerant investors.
But the other piece of this is should the AI theme stall, then non-U.S. equity markets are less exposed on a name-by-name basis in those stock markets. But I think the risk off sentiment that that's likely to spark doesn't mean that there would be no volatility outside of the U.S.
Mike Miranda:
That's helpful. Thank you, Brent. So Carol, let's go back to the media maybe a bit. And you were talking about bubble before. What other misnomers populate the media that are missing the point or that we need to put into context here for our listeners?
Carol Schleif:
Yeah, I think they relate to a number of different things. One of them is all the machinations over valuations, and I know they're full. I would push back because the argument over valuations sometimes forget the fact that we have morphed the economy, particularly in the U.S. from a more industrialized economy that predominated through up till the early to mid '90s, and that margins when you are a more services-based, knowledge-based society have drifted substantially higher. And so with margins higher, the tenor and tone of business shifting, having valuations, the media knee jerks quite often to everything being overvalued. And it all depends on what you're looking at. And it also forgets to look at the denominator, which means the fact that earnings have grown substantially as both Brent and Dan have alluded to, and that impacts earnings especially and valuations, especially looking forward.
Another thing that gets discussed quite frequently is the consumer, will they spend, won't they spend? And the one thing that gets ignored is the consumer can be counted on to spend through thick and thin. They might spend a little more or a little less, but when you look at the very long-term trendlines, consumers very seldom, if ever, pull back on their spending. And so having consumers be a reliable source of support for the U.S. economy, we are at the point in the U.S. where the consumer and consumption is something like close to 70% of the U.S. economy, and the upper deciles of consumption happen pretty reliably. And they're driven much more so by market valuations and housing valuations than they are by employment status, although employment status is important too. So many of the things that the media hand wrings about, they forget the nuance in it.
A third category would relate to hyper focus on the Fed and what the Fed is doing. It's important and the Fed is psychologically important for the direction in markets, but substantially less of the lending happens through the formal banking system and a lot more happens through other avenues of credit, either directly from pension funds and large institutional managers or through private credit, through alternative sources of funding and cashflow from businesses. So while the Fed is important psychologically, they're a lot less important than the blow-by-blow that the media often gives them about Fed independence is very important. But who's going to vote which way, is their dissension at the meetings and things like that gets a lot more time than most markets pay attention to because when push comes to shove, investors go back and look at how companies are performing. They've been very discerning in the way they've treated stocks even in the same industry this year and very careful.
And so following the fundamentals for companies either through the Fed's Beige Book, which is a very interesting way, it's a periodic look of what's happening on the front lines in each of the Fed districts. And that's an important read on things and listening to companies and what they say about how they're performing is also a very important read on things.
And wrapping it all up, I think there's a tendency for the media to make it either or, all or none, black or white. And it's important as investors to realize that there's a lot of nuance underneath all of these things. And so when you hear a headline that might make your heart skip a beat, it's important to take a breath, take a step back and think through what's actually really going on and that there's frequently a bigger, broader story than the media can convey.
Mike Miranda:
Oh, that's great, Carol. I appreciate those insights on the media for sure. So let's wrap this up maybe with a one sentence from each of you. What is the biggest risk you see in 2026? Brett, you go ahead.
Brent Joyce:
Yeah, the risk of being a little esoteric, I'd say bond yields rising for any other reason than good economic growth or even inflation. And so that gets to this concept of term premium and that relates to supply and demand dynamics in the bond market. And then we're talking sovereign yields here and a little bit towards credit sentiment. And so this could be homegrown in the U.S. which would be the most troubling. But the bond market's a global space and rising UK and Japanese bond yields, we're keeping an eye on, and they could certainly spark some angst.
Mike Miranda:
Thank you. Carol, how about from your perspective?
Carol Schleif:
From my perspective, the biggest risk would be I do expect to see another really solid up year, but perhaps with more volatility, especially as we psychologically broaden out the trade from being just AI-focused to a much broader participation or understanding that there are more companies participating. And the concerning thing would be if that volatility strikes early in the year and it scares people out such that they're sitting on the sidelines and don't have the opportunity to stay invested, I worry about volatility and psyches, if you will.
Mike Miranda:
All right. Thanks, Carol. Dan, last views from you.
Dan Phillips:
Yeah, I think the risk I'm focused on is that Trump picks the wrong Kevin. The markets have clearly shown their preference for Kevin Warsh. I think they'll be a little bit concerned if it's Kevin Hassett. And then I think we're all really in trouble if it ends up being Kevin McCallister of Home Alone fame because Trump once met him in the Plaza Hotel lobby.
Mike Miranda:
Fantastic. All right. Well, those are very insightful, great risks that you both or all three of you rather identify. Fantastic discussion. I want to thank you, Dan, Brent, and Carol for your thoughtful insights on what we're seeing for North America and the global markets next year. As we heard today, our experts are optimistic on the global outlook and economic and capital market prospects for the coming year. The backdrop, as you heard, is supported by solid fundamentals in economic growth, earnings, monetary, and fiscal policy. But as you heard, that optimism comes with a serving of realism as valuations in some areas require a deft hand. Summing it all up, three quarters of our scenarios fall in the good to better camp.
Be sure to watch out for the final installation of our special Beyond the Portfolio 2026 Outlook series in early January. That will cover our long-term capital market assumptions and key themes for the coming year. To you, our clients, we offer heartfelt thanks for your faith and trust in us, allowing us the privilege of working on your behalf. Our responsibility to you is always front of mind. And so this time of year, I just want to offer a special best wishes for 2026. I'm Mike Miranda. Thanks for listening, and we'll see you next time as we continue exploring the insights that shape portfolios, markets, and the world beyond the portfolio. Thank you for listening to Beyond the Portfolio. You could follow us on Apple Podcasts, Spotify, or your favorite podcast app. Until next time, I'm Mike Miranda.
Speaker 5:
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