Webinar Replay: Q3 '26 Asset Allocation Viewpoints

July 28, 2026

Sébastien Page, Rick de los Reyes, Christina Noonan (moderator)

Christina Noonan

Hello, everyone, and thank you for joining us for this quarter's Asset Allocation Viewpoints webcast, Powering What's Next, brought to you by T. Rowe Price's Multi-Asset Division. I'm Christina Noonan, a portfolio manager within Multi-Asset, and I'll be your host for today's discussion. It's been another fascinating quarter for investors. AI investment continues to drive strong earnings and market leadership, yet geopolitical tensions, inflation concerns, and the evolving energy landscape continue to challenge the outlook.

Today, we'll discuss how those forces are shaping our tactical views and where we're finding opportunities.

OK, so let's introduce today's panel. With me as always is Sébastien Page, who you may recognize from Bloomberg, CNBC, and LinkedIn. He is the chief investment officer and now the co-head of Global Investments. He is also the cochair of the Asset Allocation Committee (AAC), responsible for tactical investment decisions, and the author of Beyond Diversification and the Psychology of Leadership. Great to have you with us, Sébastien.

Sébastien Page

Thank you, Christina. As usual, I'm fired up, but especially fired up because we have Rick de los Reyes today. He's always compelling. He's a great writer. Now, you won't read his writing today, but he's also a great communicator, so I'm looking forward to it.

Christina Noonan

I'm excited. All right, so we're joined by our special guest, Rick de los Reyes, head of commodities and portfolio manager within the Global Equity Division. Rick's investment experience began in 1997, and he has been with T. Rowe Price since 2006. His experience also includes being a portfolio manager for the global metals and mining sector strategy within the Multi-Asset Division. Rick is also a member of the Asset Allocation Committee. And with nearly three decades of experience analyzing global energy and commodity markets, Rick is the perfect person to help us understand how today's geopolitical developments are affecting energy prices, inflation, and ultimately investment opportunities across all markets. So thank you for joining us today, Rick.

Rick de los Reyes

Thanks for having me.

Christina Noonan

So we have a lot to cover today from the latest Asset Allocation Committee discussions to energy markets, inflation, earnings, and what that all means for portfolio positioning. And we want this to be interactive. So please continue sending us your questions throughout. And we also keep an eye out for a few polls along the way. So let's jump in.

So Sébastien, over the past few months, the broad themes of inflation, geopolitical tensions and AI infrastructure build-out have remained largely the same, but a lot has shifted under the surface. The AAC recently met. What are maybe the top three factors in that discussion?

Sébastien Page

Top three. I can only choose three, right? So, OK, let me do three. Earnings, momentum, and AI. I'll leave inflation for Rick for another question. Earnings, momentum, and AI.

On earnings, it's fascinating how price momentum has stumbled. The momentum in July has basically crashed, but earnings momentum continues. So you have a little bit of a break between earnings momentum continuing and price momentum crashing. And this is price momentum specifically in semis and in specific parts of the AI supply chain. But let's talk about earnings momentum and how robust it's been. Let's go back to the beginning of the year. The forecast for the first quarter was that earnings would grow year over year compared to the same quarter the year prior by 13%. In the end, Christina, after the quarter was done and we reported on everything, earnings grew 27%. Remember, the expectation going in was that we would grow 13%. Now we're in Q2. We're reporting in Q2. The expectation going into Q2 at the beginning of the quarter was that earnings would grow 19%. By the way, these are big numbers, OK? 19%. And we're tracking at 26%. And breadth is improving too, with the 493, ex the Mag 7, tracking for Q2 at plus 23%. Earnings momentum is phenomenal. It's part of the reason why the Asset Allocation Committee has modestly added to stocks.

Second theme is momentum. There's a story, Christina— I don't know if you've heard this, I don't know if you've heard this, Rick. It's the story of a finance professor who's walking in the parking lot with one of her students. And there's a $20 bill on the sidewalk. And the student goes, “Hey, professor, here's a $20 bill.” And the professor, who's an efficient market theorist, says, “It can't be a real $20 bill because if it were, someone would have picked it up already.” And the reason why I tell that story, we've heard it before, but the reason why I bring it back, is that momentum, according to efficient markets, should not work. You should not be able to make money just by looking at the stocks that are doing well and buying them. And in fact, over time, it's proven that it doesn't make a lot of money. It makes a little bit, there's different versions of it, but it's not a highly profitable strategy.

Let's do a thought experiment, though. Imagine that every month you build a strategy that simply ranks the S&P 500 stocks based on their trailing one-year performance, past returns, what has just happened over the last 12 months, and you just pick the top 10 performing stocks. The following month, you do the same. Very simple momentum strategy.

My finance professor would say, “This will not work. Markets are efficient. This is not a true $20 bill. If it were, someone would have picked it up already.” Well, up until the end of June, if you had just picked the top 10 performing S&P stocks every month, you would have outperformed before fees. Because I didn't run the fees and the transaction costs, this is just an experiment. You would have outperformed the S&P 500 by 40% annualized, 40% per year. This is the biggest momentum rally that we've had over a three-year period in 25 years. Interestingly though, and we know a lot of this is driven by semis and by earnings too. Interestingly, that trade last time I updated it recently is down 20% in July.

So people may – go ahead, Rick.

Rick de los Reyes

It's more today, I was going to say.

Sébastien Page

It's down more today as we record this. We know a lot of people watch this live. It's down even more today.

So comparisons to the dot-com bubble to me are inappropriate, but interesting. They're not really good comparisons, but they're interesting. If I look at this return, chasing dumb momentum, just pick the top 10 performing stocks. If I look at that strategy, and I look at which stocks are in that basket right now, and I compare it to the same strategy if you'd done this at the peak of the dot-com bubble, I get hugely different fundamentals. The current momentum basket’s profit margins are 12 times higher, their ROE is eight times higher, the price to cash flow is less than a third of the peak of the dot-com bubble.

So some will say, are we having a bubble in earnings? And maybe Rick, we can discuss this, but these are not relevant comparisons. My point about momentum, you can go long momentum, you can underweight it, you can try to hedge it, but it's hard to ignore it as a trade currently in the market. And let's remember that the Nasdaq went up 300% in three years after Alan Greenspan said “irrational exuberance” for the first time in 1996.

Third theme is AI. Will the capex cycle slow down? Or, as we're discussing in the Asset Allocation Committee, what could derail the capex cycle? I think personally the capex cycle will continue. The forecast is $3 trillion of spending over the next three years, and the demand for the end product of AI is incredibly high and growing still in a quasi-vertical way. 1 billion users on ChatGPT. Claude is just gaining rapid, accelerating adoption inside the

enterprises. We're deploying it, we're using it. So across our investment platform, we are long certain AI bottlenecks. But what we're learning, and especially with today, with the momentum crashing, it's not just the GPUs, it's not just the semis. The AI bottlenecks are expanding everywhere. So cooling equipment, memory, networking, aerospace, gas turbine, electrical infrastructure. Even small-cap companies can rally if they produce something that becomes part of the supply chain in building a data center.

So my view, and it's not necessarily a broad consensus on the Asset Allocation Committee, but probably the majority view is that the AI theme in terms of its build-out is sustainable, $3 trillion of spending in three years. And every time we get updates on these estimates, they're not going down, they're going up.

Christina Noonan

And we'll certainly talk more about the AI build-out next and very impressive rally. And this has all been with a war going on. So we're happy you're here, Rick, to help us break it down. So it's interesting that we haven't seen a stronger reaction in oil prices. So curious your thoughts on that and how the current situation in the Middle East factors into your longer-term views.

Rick de los Reyes

Thanks for the question. And I think it's good to distinguish between short term and long term right there because I think in the short term, clearly, it's been disruptive, right? I mean, you shut down the Strait of Hormuz, that was 20% of the world's oil supply. Clearly, that's going to have an impact. We originally had the oil price shoot up to above $120 a barrel. Since then, it's been kind of on and off, right? We've had periods where the Strait is open. Not long ago, actually, we had almost restored sort of normal shipments. Keep in mind, you don't even have to restore shipments all the way back because you do have pipeline capacity that's been opened in Saudi Arabia and UAE that's made up some of the difference. So, you know, it's definitely been disruptive.

I think when you ask, you know, why hasn't the price gone up even more, I think part of it is because we do have some supply getting through. I think the other thing to keep in mind is that even though oil kind of gets all the attention, I think it's really important also to pay attention to refined products. And that's something that doesn't get as much headlines.

But if you look at crack spreads— now, crack spreads are the difference between the price of taking oil and turning it into gasoline or diesel. Crack spreads have gone up and have stayed up. And so there's been no reprieve there. And I think that's a function of the amount of refining capacity that's been shut in in the Middle East, the amount of refining capacity that's been damaged in the Middle East. And Russia-Ukraine plays a factor there as well. The Ukrainians have become much more aggressive about damaging Russian refineries. And so we have seen a lot more refining capacity come off. And so I think the real potential

for damage here to the economy is actually more probably on the refined product side than it is on oil at this point. That's the short term.

Now, I would say, if we're talking about the long term, my concern is almost the opposite. My concern is that coming out of this, assuming that we get an end to the war in the Middle East, assuming that the Strait of Hormuz opens, if we can get an end to hostilities in Russia and Ukraine as well, you eventually come out of this with oil supply actually being higher than it was prewar, right? We've seen how OPEC is increasingly starting to lose relevance. The UAE has already dropped out of OPEC. Iraq has threatened to drop out of OPEC. It is really getting to the point that most of these Middle East producers just want to produce as much as they can. Any supply discipline that we had in the Middle East prior to the war, I think, is less after the war. So you actually probably end up seeing more production eventually than you saw before. Add to that Venezuela, which we know the United States really wants to increase production coming out of Venezuela, restoring that to what it was historically, which was much higher than it is today. We're getting increased production out of some other places too. Canada is increasing production, is increasing egress out to the West Coast. The U.S. is trying to increase production.

And so you potentially get to a scenario where you actually have more supply than you had before the war, but your demand potentially is less. And that's the other thing that I think we have to keep a really close eye on is demand and how much demand destruction has resulted from this whole incident from countries around the world saying, maybe I just don't want to be dependent upon the Middle East for oil as much as I was. And so I'm either going to try to produce more domestically, do what I can, or I'm just going to try to decrease my consumption.

And the country I would keep your eye on the most here is China. The amount of apparent demand decline in China during this incident here in the Middle East has been very large. I mean, 4 to 5 million barrels a day out of a 100 million barrel global market is actually a very significant amount of apparent demand decline in China. Now, that apparent demand can decline for two reasons. One can be because you've just got a ton of inventory, and so you're running down your inventory so you're not buying. Or it could be because your actual demand is lower, right? They're just shifting more to EVs or more trucks using liquefied natural gas instead of oil. I mean, there's different ways that it can happen. We don't know the extent of the Chinese inventories. We don't know how much they've drawn down. We don't know how much they might have left. It's really going to take until after the war is over and things start getting back to normal that we will find out how much of that decline in apparent demand is actually a decline in real demand as well. And if you've got even 1 or 2 million barrels of decline in real demand from China, that's a significant demand decline for a market that, as I just said, potentially has even more supply.

So while we have all this disruption in the short term, and that's clearly keeping prices somewhat elevated, I think we could actually see a worse supply-demand situation after the war is over.

Sébastien Page

Rick, if let's say the war is over, the war is over in two or three months, how long does it take for the world to become oversupplied in oil?

Rick de los Reyes

I think the supply side can probably bounce back pretty quickly. And we saw that when the Strait of Hormuz was briefly open. Actually, the shipments bounced back pretty quickly. I think the demand side is more of an interesting timing issue because your demand coming out of the war, your apparent demand is likely to be higher because everybody's going to want to restock their inventories. So you think about the U.S. and the Strategic Petroleum Reserve. We've brought that down significantly. Clearly, the administration is going to want to increase that once they're able to. And I think other countries around the world are going to want to have more strategic reserves as well, just to protect themselves in case anything like this happens in the future. So I think your apparent demand will be high for a while. But once that inventory restocking is over and we go back to what is a normal steady state demand, and like I said, potentially supply is higher, then that's when you would see probably prices potentially go to a lower level than they were even before the war. And so that's probably sometime in 2027 if we were to resolve this soon.

Christina Noonan

It's very disruptive in the near term, but potentially higher supply over the long term. Want to stay in the current environment. What about gold? We're getting some questions from the audience. It started to act as a hedge but would love your thoughts on what's happening with gold.

Rick de los Reyes

I think gold is reacting far more to the trend in real interest rates, which is somewhat of a function of oil and of the war as well. But it's really a function of real interest rates.

Historically, gold trades inversely with real interest rates. So when real interest rates go higher, the price of gold goes lower and vice versa. What has happened ever since we got this new chairman of the Fed is I think he knows that it is in his best interest to sound hawkish early on. He wants to establish his credibility. He's going to try to sound hawkish. Whether he follows through on that or not is yet to be seen. I have my doubts about whether he'll actually follow through on that. I guess we'll find out tomorrow, at least a little bit more. Probably dangerous to even be talking about this the day before a Fed meeting. I think as soon as he came on as new chairman and started sounding hawkish, you saw interest rates start to go up a little bit.

In addition to that, you do have the impact of the war and the impact on oil. When oil goes up, oil and inflation tend to go hand in hand. When oil goes up, inflation goes up, interest rates go up. What I think is really happening to gold and the reason we've seen the pullback is that fear of higher real interest rates. We'll see what happens tomorrow. I think if the Fed comes off more dovish than expected tomorrow, you'll probably see the gold price actually rally. And I do think the longer-term trend for gold in terms of protecting you against currency debasement and whatnot, I think that's still intact. Our debt and deficits aren't getting any smaller. If anything, they probably get bigger as a result of the war. So I think thinking of gold long term as a hedge against that, I think is still the right call. I just think we're going through a bit of a phase right now where the concern is higher real interest rates and that's what's negatively impacting gold.

Christina Noonan

Makes sense. So that leads nicely into our first audience poll. So while oil prices have come back from their highs, inflation remains front of mind for many investors. So please answer our poll. What is the biggest risk to inflation over the next year? Oil prices, tariffs, labor (so wages and services), or food. So please let us know your thoughts. And as we hear from the audience, we'll also hear from Sébastien. So can you let us know how you are feeling about the inflation backdrop and positioning?

Sébastien Page

I'm peeking at the poll responses before I give my answer so I can be agreeable with our audience. But all joking aside, it's oil prices that's coming up. I don't think that's surprising. The thing with the Strait of Hormuz being closed again or near closed, would you say it's closed?

Rick de los Reyes

It's pretty closed right now.

Sébastien Page

It's pretty closed. Is that the reserves are much lower than they were when this first happened. So that worries me just mathematically in the short run. I agree with your distinction between short-run inflation pressure and long run, maybe we even end up with an oil glut. But in the short run, we just printed 3.5% on the headline CPI. The month-over-month print was soft, but that was driven by declining energy prices. And now they're going the other way. But what's interesting to me is that the inflation swaps, which aren't perfect, but they somewhat represent how investors price inflation when they trade derivatives. This basically represents a one-year forecast that's, quote, unquote, implied by the markets. They're at 2% for one year. That doesn't seem right to me. And the inflation breakevens, too, if you prefer to look at inflation breakevens, they're at 2%. So it's not just is inflation going to go back up to very high levels. I think it could go back up—not to 9% like we had—but it could go back up meaningfully in the short run.

It's also about what's the market pricing in? 2%? Maybe, maybe not. The surveys give you higher numbers, but that's an important question. If you're going to manage a portfolio, you probably want to, as I've said before, hedge the inflation risk at least for the next six months. Rick is on the Asset Allocation Committee and we discussed that a lot. And if I remember, your votes were in favor for now to continue to hedge that risk.

Rick de los Reyes

No, I definitely think that that's the correct call. And I would also say what I just said about oil is really specific to oil. I think there's a lot of other commodities out there that are going to continue to see tightening supply and demand. And so I think the use of commodities as an inflation hedge is still going to be a good one, even in a situation where the oil price has flattished down.

Sébastien Page

But to me, also, there's pent-up inflation in other areas. So fertilizer gets into the cost of food and then there's food inflation, freight, and insurance and just moving stuff around gets into the cost of manufacturing and then that creates inflation. This is the interesting part about inflation. So much of what we do in financial markets is difficult to predict, but there are easier-to-predict lagged effects with inflation that you can see coming from a mile away and there are some of those. And in general, you do have demand. The economy is doing fine, at least in the short run. And so you're left with the decision to hedge or not to hedge inflation risk. I would err on the side of hedging. At least think about it that way in the short run.

Christina Noonan

So hedging inflation risk. And we talked a little bit about the Fed meeting tomorrow have come out pretty hawkish. But we know they also look through the headline inflation, the higher energy price, oil prices. How do you think the Fed and Warsh are thinking about this? Or how should they be thinking about this?

Sébastien Page

I mean, I could maybe rephrase the question is, and I don't know, Rick, what you think, but is the question basically, do we think that the Fed is going to think this is—I'm going to drop the word transitory. Are they going to use that word again? I don't know. What do you think? Because that would be the argument for kind of ignoring those pressures, because those pressures are quite obvious right now.

Rick de los Reyes

And I think a lot of it really does depend upon the direction of these hostilities in the Middle East, because we saw a lot of those really. The inflation number that came out for June that was lower than expected, that was when all of a sudden we had the Strait open for a bit, oil prices came down. I think if we can get the oil price back down, then inflation ends up being pretty benign, and that takes a lot of pressure off the Fed, right? And so, as I kind of said before, I think Warsh has every reason to want to sound hawkish coming out of the gate. I think he wants to have that credibility.

But was he really hired to go raise rates? I don't think so, right? I think he wants to avoid raising rates if he can. And so it's really just going to depend on seeing that trend in inflation coming down. So we can see the trend continue to come down, even though it's not at target level yet. My guess is they try to avoid raising rates unless it reaccelerates. And a lot of that, like I said, actually depends on the war.

Sébastien Page

Yeah, look, I've made the point before, maybe even in this webcast, that inflation is potentially on a collision course with Fed policy. I still think that's possible. One way to look at this pressure between Fed policy and inflation is to look at the two-year yield compared to the fed funds rate. And the two-year yield is at 4.3% and the fed funds rate is at 3.7%. That gap is pretty wide. Historically, the Fed actually follows the two-year. The two-year is the leading indicator of the Fed. Now, we know all these relationships are circular. It's like in Excel, when you have a circular reference. A lot of the Fed watching markets, markets watching the Fed, a lot of this is going on. But watch that pressure point. If you're out there, if you're an advisor and your clients are asking, is there pressure here on the Fed? One good way to answer the question is look at the two-year and look at where the fed fund rate is. And the wider that gap, the more pressure there is.

Christina Noonan

And it is interesting how quickly we went from chance of cuts to hikes now.

Sébastien Page

And the market took it in stride.

Christina Noonan

Yes. And so, Rick, I want to come back to you. So say we are at peak inflation, maybe peak rates. Where does that leave you from a risk-taking perspective? And maybe what indicators are you looking at in the current environment?

Rick de los Reyes

Look, like I said, I think a lot of this still does come back and depend on the war. If we can get that to come down, then I think you probably have seen peak oil prices, the 120 that we got to earlier in the year. I think you have seen then probably peak inflation and then potentially peak rates as well, right?

Obviously, a lot can change. But that would be the direction if things can continue to move toward a path of peace. In that scenario, then I would say you actually want to start looking at parts of the market that have been neglected, the interest rate-sensitive parts of the market. Those are the areas that have been most hit.

Gold we already talked about, right? Gold has pulled back as a direct result of rising real interest rates and fear that interest rates are going to continue to rise even further. So, I would think gold having pulled back from $5,500 to around $4,000 starts to look like an interesting place to be adding if you think that we can stop seeing the increase in interest rates. I think there's some other interesting opportunities on the industrial metal side in construction materials.

I was just in Vancouver last week, actually, and met with some of the Canadian timber companies. If you're looking for deep value in the market, that is a great place to go. These stocks trade for a fraction of their book value. They've been in a depressed market for years now because lumber prices have been terrible. They've also suffered from tariffs. But there's been a tremendous amount of capacity that's come out of that industry. And so when demand does eventually return, I think it's a bit of a coiled spring, right? The supply is not going to be there to meet it because so much capacity has been shut down, much of it permanently, that you're not going to be able to get a supply response when lumber demand finally comes back. So if we were ever to get to the point that we were building 1.5 million homes a year in the U.S. like we used to, instead of building 1.1 or 1.2 [million], whatever we're building now, then that's the kind of market that I think you want to look at if you're thinking things are going to be peaceful and interest rates can start to calm down a little bit, mortgage rates can get down a little bit. I remind everyone, we actually had just gotten to a five-handle on the 30-year mortgage in the U.S. when the bomb started dropping in Iran. So we were on our way there, and it lasted about a day. Then the bomb started dropping and interest rates immediately went back up and mortgages went back up. But so you can see that in an environment more of peace and with declining inflation, we could get back to a lower mortgage rate and we could actually start to get a bit of a construction cycle.

Sébastien Page

OK. He's sounding bullish. I think that's like if you take an 18-month horizon, say, that's encouraging.

Rick de los Reyes

I think that's right. I mean, I think, I mean... Like I said, a lot is depending upon things playing out the right way. But if we can go back to a world of peace and all of a sudden, like I said, the oil price ends up going down because we get a big supply response postwar, then all of a sudden you're in an environment of lower inflation, but still very strong growth. I mean,

that's a Goldilocks scenario. That gets back to kind of the ‘90s analogy you were talking about with Alan Greenspan. I mean, it ends up looking like this was just kind of a midcycle correction in what is otherwise still a massive growth cycle ahead of us due to AI and data center build-out and whatnot. And if we can do that, maintain that strong growth while inflation is actually still reasonably controlled, that's, I think, very bullish.

Christina Noonan

So a lot contingent on getting to the other side of the war. And so it's interesting, while inflation and rates have dominated the macro conversation, investors are continuing to reward companies heavily investing in AI. So we have another audience poll. What will be the biggest bottleneck to AI over the next five years? So electricity, so power needs for data centers, chips and infrastructure, capital spending, and the scrutiny that has come along with hyperscalers continuing to spend, as well as consumer demand. So please respond to the poll. Let us know what you think the biggest bottleneck will be over the next five years.

And so Sébastien, one of the themes you touched on earlier was AI investment as one of the strongest supports for earnings and markets. It's one of the things that the AAC had been looking for has been this broadening of markets, but a lot of that has been contingent on AI build-out. Can you talk about broadly your views on AI and where you see the future going from here?

Sébastien Page

AI is such a great topic because everybody lives it. We all interact with it and we all have opinions on it. But looking at the survey, I'm surprised there's 9%, 10% of the responses on low customer demand. That surprises me. I think that demand is even just starting in a way in our own company, how we implement it. But who knows? And then the point about electricity availability is interesting as well. I wonder what, Rick, you're going to want to say about this. But let me just answer the question.

First, AI is changing the way we work. At our company, for example, we're scratching the surface. The technology keeps improving and delighting users. None of the major players are willing to concede that they won't have the best model. We call it the intelligence frontier. So one of our portfolio managers in equities likes to say, this is game theory. Winner takes all. They're facing each other, and they want to have the best absolute LLM. That means more investment. That means the race continues. Financing remains readily available. And you see this. This is like the least of the concerns in the survey. And that makes sense. Of course, Oracle's debt spreads have gone up, but Alphabet, Amazon, Microsoft have borrowing costs 20, 50 basis points lower than average investment-grade company. And leverage ratios for these companies, yes, they're borrowing. Yes, they're borrowing big amounts. But the leverage ratios are about half of the investment-grade universe. So the hyperscalers’ desire to spend is not slowing any time soon. Any time soon, I'm going to say, is not slowing for the next 12 months. Seems like the survey agrees.

To be clear, earnings growth has been so impressive that it may not be sustainable, as we were talking about earlier. The market, though, seems to be pricing in the fact that the earnings growth is not necessarily sustainable. If you look at the spread on the price/earnings ratio for semis versus the price/earnings ratio for the market, it's very wide, and semis' price/earnings ratio is depressed. So the market is expecting that those earnings are not sustainable. The price/earnings ratio on the Russell 1000 Growth is 21. It was at 30 recent peaks. So the earnings opportunity is migrating to bottlenecks. As we've said, the game is to be long AI bottlenecks.

Compute demand still exceeds supply, but value is clearly broadening. I mentioned earlier, all these things, power, cooling, memory, networking, aerospace, gas turbine, electrical infrastructure. What's interesting is on the small-cap side. Some companies, as I mentioned earlier, can participate here.

Beyond that, I will say about AI that we're starting to see margin improvements by AI adopters. Now, this has to be the next leg of the trade. If you follow the bottleneck, if you follow the AI trade, at some point, the benefits have to translate to the AI adopters. If I scan our research platform, you know our analysts at T. Rowe Price proprietary research publish 10,000 research notes a year? We have one of the top five research platforms in the world, and I will argue the most integrated research platform in terms of how the pieces move together. We also do, as a research platform, 4,000 CEO-level meetings, all proprietary research. That's how you build an edge in an investment business, is broad investment in proprietary research.

So if I scan— this was a shameless plug for investment capabilities. But the point I wanted to make is I have the ability now with AI to scan our research notes. And I can go, of everything that's been published live over the last two weeks on our platform, what do you see around this theme? It's fascinating for someone who's got an asset allocation background to get micro bottom-up input from stock analysts, what they see in those 4,000 CEO meetings a year. And what I see is that the stories about AI adoption, building efficiency, are company specific. They're just starting.

Again, I'll use the term scratching the surface on AI-driven margin expansion for adopters, and of course, margin destruction for businesses that are being disrupted. AI is an expanding theme from GPUs to—and that trade is not working well right now—to other bottlenecks along the data center, the supply chain, and then to adopters.

I was going on Bloomberg TV recently, and as usual, I sent my notes to the producers and kind of half-jokingly, I was talking about how the AI trade continues and moves along the supply chain and ultimately to adopters. And I wrote in my notes, “’to infinity and beyond’, as Buzz Lightyear said.” And I got on the air. Jonathan Ferro, of course, has this big quote: “from Sébastien Page, to infinity and beyond!” So the lesson is, be careful what you put in your notes. They might put it in bold font in a live national audience.

Christina Noonan

It would have made a good webcast title. And yeah, this week, hyperscaler earnings will be very telling. It's interesting that our audience doesn't think lack of capital spending will be the biggest bottleneck. But certainly, we'll see this week. So that brings us to what a huge part the power and energy complex has been in AI. It started out largely as a technology story and has quickly shifted into the energy markets. Would love to hear your thoughts on that, Rick, and what it means for the future of energy too.

Rick de los Reyes

Absolutely. Very happy to hear that our audience thinks electricity is the big bottleneck because that's what I do for a living. So certainly happy to see the enthusiasm for that. It's really fascinating to see what's happening because we went through a good 15-to-20-year period in the U.S. where electricity demand was basically flat, right? And obviously GDP was growing during all that, but our energy efficiency kept increasing during that period, right? Everybody was switching to energy-efficient appliances, things like that. And so we were able to keep electricity demand largely flat for kind of the last 15 to 20 years.

And with AI data centers, that changes everything, right? All of a sudden now we're actually having growth in demand, and nobody was prepared for that. Nobody's been building new capacity. Nobody was prepared for that.

And so the question is, how do we meet that demand? And that's a big question that the hyperscalers have been having to tackle as they try to build new data centers is, how am I going to power this? And you can go through, kind of by process of elimination, the way that we generate electricity in this country to figure out how to do it, right? Coal is clearly not something that people want to do, right? I mean, existing coal-fired power capacity will probably be around maybe longer than we thought, but nobody's going to build new ones. I think renewables like wind and solar definitely can be part of the solution, but they can't be the entire solution because you do still largely have an intermittency problem where wind works when the wind is blowing, solar works when the sun is shining. And although some of the battery storage technology is improving, it's certainly not something that that most hyperscalers are going to be completely dependent upon. So it might be part of the solution, but not all of the solution. Natural gas, we have abundantly, certainly here in the U.S., and so that we would want to use. I'd say the biggest bottleneck there is the infrastructure part of it, trying to get a gas turbine right now. If you want to get a gas turbine to build a gas-powered power plant, call GE Vernova. They'll put you on the list for five or six years from now, because that's how backed up they are. Then you get to nuclear, right? Nuclear, once again, very interesting. I think particularly with the advent of SMRs, which are the small modular reactors. These are kind of the mini nuclear reactors that many companies are developing right now that can be produced more economically than the large-scale nuclear reactors. That could potentially be part of the solution as well, though I'd say there's also going to be a time lag. Certainly, if you want to build a large nuclear reactor, that can take a decade. The smaller ones, we'll see. If they start to work, we've got some that are scheduled to come online in 2028, 2029. We'll see how that goes. That could eventually be part of the solution as well.

I think in the end, it's really going to just kind of take everything, right? And we're even seeing a lot of new technologies coming out, new geothermal technologies, new battery storage technologies, lots of different efforts to try to kind of feed this beast of power demand that's coming from it.

Sébastien Page

Rick, do you have thoughts on fusion? Is it science fiction?

Rick de los Reyes

I can tell you. There's not a lot in the publicly traded markets that we can do in fusion right now. There are private companies, and we do look at these private companies. We meet with these private companies every now and then. They seem very optimistic. I think is it possible to do? The answer to that seems to be yes. Is it possible to do economically at scale? I think a lot of that is the question that still needs to be answered. And so we follow these private companies. We're obviously very interested in what they're doing, but it's not an area that we're invested in just yet.

Sébastien Page

And just a thought experiment, Rick, not a prediction, not an investment view, just a thought experiment. If fusion starts working at scale, what happens to the rest of the energy markets?

Rick de los Reyes

Yeah, if it starts working at scale and economically, and it can basically price out any other form of energy, then yeah, then it was going to end up taking a whole lot of share, right? And you're looking at a very different energy complex. But I think I will probably be retired before that happens. And so we'll continue to follow the companies and we will track them and see how they're doing. But I think getting to the point that they're actually going to be able to deploy at scale and replace other forms of energy is a long ways away.

And I think everyone knows that, which is why we've seen even the moves that the Trump administration has made on nuclear. There was an executive order mandating that we quadruple the nuclear power in this country by 2050, I think was the deadline. And to do that, you would need to build a large-scale nuclear reactor, multiple of them, like every year between now and then, more than we've ever built in the past, right? And so It would take a significant effort to reach that goal if we are going to reach it. We're seeing more companies trying to build out more gas turbine capacity, things like that, just efforts to try to boost the supply of other types of energy. I think if we thought the fusion was going to happen anytime soon, we probably wouldn't be doing that.

Christina Noonan

So yeah, so energy needs, huge challenge going forward, all hands on deck. So I want to take a quick step back. We talked about AAC has moved modestly overweight equities, still have inflation hedges on and now small-caps. So a trade that we put on, I think mid last year, successful trade small-caps. This may surprise some people have been up more than 40% over the past year. So Sébastien, can you talk about the small-cap trade and if it still has legs from here?

Sébastien Page

So we had a strategy meeting recently, and a small-cap portfolio manager started talking about what he called a golden screw. And I couldn't understand. I think, Rick, you were in that meeting. He said the golden screw. And what he was talking about was the golden component, like a small part of the supply chain that's in limited supply that's provided maybe by one company. Maybe they have a monopoly, and they build that little screw that goes into the bigger thing, and that becomes the golden screw because those companies then just go vertical. So he was explaining that as an example of how small and mid-cap companies can participate in the supply chain, to use a quantitative term, in a highly nonlinear way, in a highly explosive way.

So the Committee has been long small- and mid-caps in the U.S. for quite a while. Small companies have this opportunity to participate in the AI supply chain and benefit from adoption. Look, rates have been relatively stable. They're up the last few weeks, but we have had 175 bps of cuts in the short end already. From a long-term perspective, relative valuation is still favorable. If you look at profitable, higher quality small-caps, the S&P 600, it's still in the bottom 30% of its valuation range, despite that massive rally. Still in the bottom of its valuation range, bottom 30% relative to large-cap by long-term historical standards. You continue to see earnings growth converging.

And ultimately, I think Rick and I are both agreeing on this. The economy is doing fine. The economy, the economic surprises, whatever your favorite index of economic surprises, they're trending up, year to date. So this is all favorable for small-cap plus domestic. A lot of policy. The tariffs are back. I guess we didn't talk about it today. But those policies that favor domestic production ultimately are good for small-cap companies.

Christina Noonan

So I want to come back to something we talked about. So we talked about the constraints on energy for AI, but now I want to pivot also constraints on critical minerals and rare earths, an area of commodities that we haven't touched on yet. They were in the headlines last year, another area that your team has been constructive on. Can you talk about what you're seeing there?

Rick de los Reyes

Yeah, happy to. And speaking of the momentum unwind, I mean, the critical mineral stocks have definitely suffered from that. So many of these stocks are down 20, 30% just here in the month of July. So I think it does probably create an interesting opportunity because I don't think the story there has ended, right? I think there was a lot of excitement, particularly last year when the U.S. government announced kind of this landmark deal with MP Materials, which is a rare earths company in the U.S. And as part of that deal, they set price floors and provide financing and a Department of Defense contract. I think that sort of government support, particularly in rare earths, is not over. We've seen some other moves since then. We've seen the U.S. supporting USA Rare Earths and its acquisition of a rare earth battery company in Germany. There's been other moves as well. I don't think that's over. We are in discussions with these companies.

I think there's discussions happening at all levels, at the Department of War, at the Department of Energy and the Department of Commerce are all involved. And I think what everybody recognizes is that we do not want to be dependent upon anyone else if we can. I think the U.S. would like to be self-sufficient if it can, but at least not be dependent on non-Western countries, when it comes to critical minerals that we need. And rare earths is the one that gets all the attention, but I actually don't think it's going to stop there either, right?

I think uranium is going to be one. We've already talked about nuclear and the Trump administration's ambitions on building nuclear power. The U.S. produces something like 1% of the world's uranium, right? And so I think trying to support that industry. I think things like tungsten and antimony, which are things that are not household things that we talk about all the time, but those are very important for defense. And so I think we're going to see more government deals.

Sébastien Page

What is antimony?

Rick de los Reyes

It's a hardening agent. It's used in bullets, right? And so it's something that's very important. Tungsten as well. It's actually the second hardest element on Earth after diamonds. And so they're used in missiles. They're used in bullets and things like that. And so it's very important for defense. Tungsten, very similar to rare earths, a very large percentage, something like 80-90% of it comes from China.

And so there's a very strong desire to make sure that we have built up a Western supply chain, even if it's not U.S., at least countries that are friendly to the U.S. And I think you're going to continue to see a lot of government support and financing deals to make sure that happens. And so I think they've been probably distracted because they have a war going on. But I think, once again, if we can get that behind us, I think they probably start focusing again on some of these types of issues, such as critical minerals and securing supply chains. And you'll start to see more announcements along the lines of what you've seen already with a couple of rare earth companies.

Christina Noonan

So one theme that has emerged from today's discussion is how intertwined all of these forces are. So AI, energy, inflation, geopolitics, all kind of moving together, not independent forces. So Sébastien, as you put all of that together, I guess what is one investment theme that you think the market may not be fully appreciating today?

Sébastien Page

Based on what I said earlier with the inflation swap at 2%, with the breakeven at 2%, I'll pick that one. We hedge inflation risk. Treasuries still play a role in the portfolio, but it's diminished. Treasuries are not as good a hedge when you get inflation shocks. In the Asset Allocation Committee, we hold energy stocks, metals, cash, TIPS, hedged equity, different ways of protecting against inflation risk.

As I said earlier, inflation is likely to be on a collision course with Fed policy with the two-year yield at 4.3% and the target rate at 3.75%. This indicates pressure on the Fed to raise rates.

So to wrap it up, I'll tell you an anecdote that happened to me at our investor conference in Nashville a few months ago. I decided to come earlier and I was presenting the next day. I got in the elevator on floor two, two people got in and they were holding mugs. This was like early afternoon. So apparently Nashville is a fun place, kind of like Vegas, like they were having fun and they look at me. And one person, one lady, says, “We've been thrown out of the pool.” And then the other one says, “Well, you know, T. Rowe Price has reserved the whole conference area for their client conference and they even reserved the pool for their reception.” So I'm in the elevator there and she looks at me and she goes, “T. Rowe Price,” and she's visibly angry, “Do you know them?” And my answer was, “T. Rowe who?”

So this is an anecdote. Talk about, something I love to talk about, which is elevator pitches. How do you describe something, a concept, in an elevator where you have two floors to make your point? And I'll tell you how we're thinking in the Asset Allocation Committee as a pithy elevator pitch: stay diversified, stay invested, and hedge inflation risk.

Christina Noonan

Well said. And so on that hedging inflation risk, Rick, you've shared a lot of great insights with us on commodities. So say our viewers, investors, are looking to increase their exposure to commodities. What would you say the best way to do that would be?

Rick de los Reyes

Yeah, I mean, as Sébastien said, we really hedge inflation risk a lot through commodities. I think that is the best way to do it. I think if you look at the different choices that you have in ways of investing in commodities, I think commodity futures are probably not a great idea, particularly for people who don't know how to trade those. I mean, if you look at futures, they trade in different time periods and along a curve. Your typical commodity future trades in contango, which means the future price is higher than the spot price. And as a result, every time you roll that future, you lose a little bit of money, right? You're always kind of selling low and buying high. That's a really hard way to make money.

And so what we choose instead is really to focus on commodity equities. And what I would tell people, too, is really focus on the upstream commodity equities, right? Try to focus on oil and gas companies, mining companies, agriculture companies, companies that actually have the resource in the ground, because that's where I think the scarcity is going to be, right? I think the scarcity is going to be with the resources that you can. If it's not already there, you can't put it there, right? So if you're worried about inflation, if you're worried about resource nationalism, if you're worried about resource scarcity, if you're worried about the electricity and power demand from AI and from data centers, which we know you are because we saw it on the survey, then I would definitely focus on those upstream natural resources. And that's what we really try to do in our strategy.

Christina Noonan

Upstream natural resources, helpful advice. Great note to end on. Thank you.

And so this concludes this quarter's Asset Allocation Viewpoints webcast, Powering What's Next. Thank you to Sébastien and Rick for sharing their insights and thank you to everyone who joined us today. Thanks again for spending part of your day with us and look forward to seeing you next quarter.

202607-5632670

Investment Risks

Active investing may have higher costs than passive investing and may underperform the broad market or passive peers with similar objectives. Each persons investing situation and circumstances differ. Investors should take all considerations into account before investing.

International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. The risks of international investing are heightened for investments in emerging market and frontier market countries. Emerging and frontier market countries tend to have economic structures that are less diverse and mature, and political systems that are less stable, than those of developed market countries.

Commodities are subject to increased risks such as higher price volatility, geopolitical and other risks. Commodity prices can be subject to extreme volatility and significant price swings.

TIPS In periods of no or low inflation, other types of bonds, such as US Treasury Bonds, may perform better than Treasury Inflation Protected Securities (TIPS).

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Glossary of Terms

A basis point (or bps) is equal to 0.01% or 0.0001. It is used to describe changes in percentages or interest rates.

Bullish is used when describing market sentiment; a bullish investor generally expects prices to rise; a bearish investor generally expects prices to fall.

Capex (capital expenditure) refers to a company’s spending in long-term assets such as property, technology, or equipment.

Consumer Price Index (CPI) measures the monthly average change in prices paid by urban consumers for a market basket of consumer goods and services.

Fed funds rate, or the Federal funds rate, is the interest rate at which banks and credit unions lend excess reserve balances to other banks overnight.

Gross Domestic Product (GDP) is a measure of total market value of goods and services produced within a country during a set time period.

Graphics processing unit (GPU) is a computer chip used in graphics rendering.

A hyperscaler is a company, often a technology or cloud services provider, that operates cloud infrastructure platforms.

An inflation swap is a type of contract between two parties that enables one party to transfer inflation risk to the other. One party will pay fixed payments and the other will make payments based on the floating rate on an inflation index. A floating rate will change based on market conditions.

A Large Language Model (LLM) is an AI system trained on a data, able to generate code based on instructions in a natural language.

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Rare earths are certain chemical elements found in the Earth’s crust, typically not found in a concentrated form. They are used in high-tech applications.

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