Hello, and welcome to the Download. I'm your host, Dave Richardson, and it is Stu’s Day. But really Wednesday. We should really just say that every day is Stu’s days. Isn't that what we came down to? Every day is Stu’s Day. So it doesn't matter, really, when we record this, it's Stu’s ays anyways.

That's right, Dave. Everyday Stu’s day. Hopefully, in my head it is, but I don't think in too many people's heads it is.

That's right. It's always 05:00 somewhere. It's Stu’s days every day. Before we head into the winter, I wanted to get an update on your leaf raking. I imagine you have a similar level of meticulousness around your leaf raking. Or have you cut down all the trees in your yard so there's no leaves falling down.

Got to give the leaves some credit this year, they were persistent. They just did not want to fall. And it really took this last blast to knock some of those brave leaves off the tree. So there's still a bit of work to be done. But that was different this year.

But do you get every single leaf, or you accept that Mother Nature is going to leave a little bit of them lying around on your yard somewhere?

A handful, but I like to get at it. I do some, but I do have some help, too, I have to admit. But we like to keep it clean.

Okay, this is where I might have trouble being your neighbor because I'm not quite as precise. I've got somebody like you who lives close to me, and he kind of gives me the side eye because he gets his lawn perfect, and he sees my pile, and he thinks that's blowing over onto his lawn, and I know he doesn't like it. It almost makes me want to not be that precise. But you give some of your neighbors just the odd look because they're not as clean as you.

Yeah, I kind of get it one way or the other. The thing you don't want is you don't want to leave the leaves, and then you get all these maple trees the next year or what have you, like the little trees spurting up, and that can be troublesome.

Yeah. You know who's responsible for that? The squirrels. They're burying stuff. Okay, so let's get back because there's a lot of stuff going on. It's kind of nice. A lot of the things that we've been talking about in terms of thinking the way things would play out, really, this month have started to play out. And of course, three weeks or four weeks is not a trend, but certainly we've seen interest rates come down significantly if you look across the yield curve. And we've been particularly focused on the yield curve in the US, the Federal Reserve— not to dismiss Canada, but we're largely tracking relative to them. They move rates down; ours come down as well. And then are we a little bit lower? A little bit higher? Lately we've been a little bit lower for a lot of different reasons that we'll probably talk to Eric about the next time we have him on. But the way rates have come down, what are you seeing as that yield curve? Is it saying anything to you, Stu? Are you looking at it in a particular way?

The one difference in the way that the yield curve has moved in the last month is, as you say, rates have come down, but the yield curve has lost slope. It has been negatively sloped. And the last time it lost slope, it was because both interest rates were rising. This time it's because both are falling, but the short-term interest rates are falling a little bit faster, which is the market's way of trying to sniff out, will central banks eventually ease? And the reason that's interesting is that from a long-term standpoint— and we talk every week—, but these cycles take time to play out. So inflation peaks and a year later, interest rates peak, and a year later after that, earnings often bottom. And generally speaking, that still seems to be not a bad game plan to be thinking about. So the question this time, normally the last phase when earnings bottom is when the yield curve goes from a negative slope to a positive slope, because short-term interest rates move below longer-term interest rates as the central banks eventually start to reliquify the market. And that's often in response to a bit of a slowdown. And when we look at a variety of data, the economy is still in pretty good shape, but if you squint and look at unemployment in a certain way and this and the other way, it looks a little bit slower. And that's been the big change in the way that the yield curves slope. We've had two moves where it went less inverted, but this second move is a little bit different. And we got to give that some thought.

In what way is it different, Stu?

Just because it suggests a little bit more of a slowdown. The average stock has not performed very well. And I think the average stock has sniffed this out a little bit and worried about it more than maybe the headline indices would suggest. As we move into the next three or four months, every analyst is running all sorts of scenarios on their stocks, and we try and understand the good, the bad, the different, you name it. When interest rates come down, you have support to valuation. So as long as there's nothing catastrophic, all of a sudden, you've got this valuation support, which allows me to look across the valley, but occasionally I still have to figure out exactly how earnings are going to reset. And that's something that can cause some volatility. The question this time around will be, has the world slowed enough? We talked about the United States a lot, which has been pretty good, but China, Canada, other areas, maybe they've slowed enough. We've seen some of that earnings decline, but whatever's going to come on the earnings front is likely to come in the next three or four months. And then the average stock, as I say before, is definitely priced for that a bit more than the market as a whole, which can be positive for owning the average stock over the whole market. And that's kind of where we're getting to right now.

Let me just go back though, and just make sure. Because we've got tons of new listeners. We were looking at the ratings the other day. It's fantastic. People like listening to you in particular. Some negative comments about me, but we'll leave those. My mother supplements with positive comments. But the idea of this valuation floor as rates come down, so what that's basically saying is as long as earnings stay where they are, rates have come down, so those earnings are worth more. So then, even if earnings just stay where they are or go down just a little bit, you've got some support at this level of the market. So the stocks can stay valued at this level because those rates have come down. And when you're discounting back future earnings, this is what we do, they discount at a lower rate and that provides you that support. And then now you're trying to figure out because what you're saying is economies are slowing down. Very clearly there's lots of things that are showing that several countries in Europe are in technical recessions; Canada is in a technical recession. So now the question is, how much do earnings fall? And do they fall enough to take us below this valuation floor that you're talking about?

That's right. And also, how people feel and think as earnings decline. Because the two legs of the stool are earnings and the price that you pay for them. So when earnings are really good and people feel really good about them, they often pay a very high price for a very rosy consensus. And ironically, that's the risky time as an investor. Other times you pay a compressed multiple for depressed earnings and that's what feels the worst. But it's the best time to be an investor because you then have two sources of upside. Today, the valuation of the average stock is around average. There's a valuation of a handful of stocks that's above average, but the average valuation of the average stock is around average. So then what do I think about earnings? Well, if they're still deteriorating, but my mindset is that they're going to get better, then that affects how I might pay for that stock versus they're deteriorating and getting worse. If that's my mindset, then that's far worse. I would say, right now, with today, you have average valuations, you have some concerns around the economy slowing, but because inflation is dropping, there's now a bit more confidence that the central banks have the tools available to them should the economy slow. Before we were worried that the economy is going to be very robust, inflation is going to be high, they're not going to be any assistance when things slow down. Now you get that shift. That's a big difference for the average stock. The headline of the index is still a bit more of a robust valuation, but if we look across a wide swath of companies that might pay dividends, have good balance sheets, that's been the dynamic that's changed in the last month or so. And it's too early to say that it's totally confirmed that the average stock is about to perform better, but there's certainly some of the early evidence. The ingredients for that to take place are coming into fold.

Stu, I'm just thinking of what you're explaining here and how you have to parse between different stocks, the ones that have performed very well, that are expensive, broader market, pretty fairly valued, where interest rates are going. This sounds to me like a period of time, say, like over the next six to twelve months, where your expertise in managing a portfolio as a professional investment manager has a little bit more value than other times in the cycle. Is that fair? I know you're always adding value, but is this one where you're particularly able to just get your portfolio positioned for the next economic cycle after we go through a slowdown? And that's where you can really set things up for a nice run on the other side?

Well, I hope so. You mentioned squirrels in your backyard, and one of my favorite sayings is a blind squirrel finds the odd acorn. So taking everything with a grain of salt, when the average stock does better than the index, that is a better time for active management. And a couple of things that take place in this environment is you can debate more stocks or less stocks, but quite often you want to put money to work when stocks are still volatile. When stocks are down, you're trying to feed some money in. But again, that period of time when the average stock does a little bit better, that can be better for active management. Going back, 2022 was a great year, and that's when the average stock trounced the stock market. That's when the economy was doing better. This year has been tougher because it's been a narrower market, and if you haven't owned six or seven names, you've had a different experience. Going into next year, if we can have this last period of angst around earnings, some stability on valuation that does set the table for the average stock a bit better than maybe it has been set before.

And then what we're going to have to watch as investors, if we're looking at indices, is that these bigger stocks that have been going higher and have higher valuations, if they're underperforming now the broader market, but because they've got these big weights, they represent more of the overall market, you can actually have the market doing pretty well, but when you look at the major indices like the S&P 500, maybe not so much the Dow but the Nasdaq, you're getting great performance across the board. But the index isn't going anywhere because the bigger stocks just aren't doing as well.

Yeah, that's right. You could have a portfolio— I like dividend stocks, but yes, you could have a portfolio of stocks paying you pretty handsome dividend yields growing their dividends modestly, not seeing a whole lot of activity in headline index movements, but still getting reasonable returns from your portfolio.

And I think, that’s a pretty good environment for someone like you. We're going to have Dan Chornous on next week and he's just written a paper primarily around asset allocation, but also just talking about some of the things in the economic backdrop. We're seeing rates coming down, we expect rates to fall next year and he's talking about the relative risk return of bonds versus stocks and he's kind of suggesting that right now bonds look quite attractive. But if we take a look at the next six to twelve months and you say earnings are going to bottom out twelve months from now, are we still likely going to be in a period where we see a significant amount of volatility in stocks again as they're determining good news one day, bad news another, and see how they're going to play out over the next six or eight months?

Yeah. In the next little while, because the coupon on bonds has improved so much— notwithstanding, rates have come down in the last month— but generally speaking, you have an attractive coupon, and we think interest rates have peaked or are in the process of falling. So there's a period of time here where that looks pretty attractive while we totally sort out earnings. But the baton will pass. And it will pass from fixed income back to equity as we have confidence that valuation can hold, and we have confidence that earnings are in the process of bottoming. And we discussed that at length when we talked about the current environment.

Yeah. And the market's going to look out over the valley, as you're saying. What's your nose line?

The long nose of the stock market sniffs out. You always want to be thinking, where will things be six to twelve months from now?

Yeah. It's still a bit of an uncertain time around equity markets, the stock market. But you want to be very careful because once it starts to move, it moves fast. And being there early is important to get the returns that you need out of stocks through an entire positive economic cycle and positive market cycle. So you want to be careful not to be left behind. And this is where, when we're out talking to clients right now, maybe if I've got a lump sum of money to dump into the stock market, I'm not dumping it in wholesale. I might use a different approach.

I was just going to say, you're teeing me up for dollar cost averaging.

There we go. Everyone, take a sip out there. Take a sip of your coffee.

When is it not a good time for dollar cost averaging? But yeah, this is the right type of environment.

Great. Well, Stu, that was fabulous. Lots of acorns in that one. I should go back and say, I'd love to have you as a neighbor. You would be a fabulous neighbor. I would probably tidy up a little bit more than I do, but I'd love to have you on the street. But I'm more suburban. You're more of an urban guy. So we'll get into that as we move forward, too. That's a big difference.

Great. Well, thanks as always, Dave.

Okay, talk to you next week, Stu.