Hello, and welcome to The Download. I'm your host, Dave Richardson, and it is Stu's Days on the Prairie, because I'm in Regina, Saskatchewan, Stu. Where are you today?

I'm sitting in the homestead. I'm in my office.

And it's a beautiful office. I know in our world, you certainly aren't judged by the beauty of your office. It's purely functional by design.

Functional and messy. Messy is a sign of progress.

So, Stu, I can't let this go in the week where we had one of the biggest events in the history of the world, apparently, which was the eclipse that happened on Monday. Are you a big eclipse guy?

No, unfortunately. I put my blind down in case I was looking upwards by mistake. But I wasn't out there with my goggles on or anything like that.

And were you at all concerned from an investment strategy perspective that the few minutes of darkness might create havoc in markets around the world? Or was it a non-event from an investment perspective? I guess we should cover that off for anyone who thinks that the eclipse might have affected markets.

I think it likely had no effect.

I ended up, just by coincidence, in Cambridge doing a speech, and I hadn't really thought about it. I had booked this months ago. So, I'm half an hour away from totality. I finished the speech and just right on time, I could drive straight south. So I drove down. I was south of Delhi, Ontario. And I was out in a farmer's field, and I got the full darkness for about three minutes. It was actually pretty cool. But I did glance up at the sun, and I'm worried I probably should have had the shades down. I'm a little less disciplined than you, Stu, as probably the listeners know. But it was pretty cool. But I was watching my stocks all the way through, and I didn't see anything happening. So that was good.

The one thing you can probably say, Dave, is when there's the next eclipse, markets will likely be higher because I think that's 40 years from now or something.

I use that line in one of my speeches this week, Stu. That was good. You're right. Yeah, because the next one is 2044. So, yes, you got another 20 years. And 99.9% of 20 year periods, the market is up over that time frame. So pretty good bet. So, Stu, let's go to the real news that did move markets this week, which was the CPI report in the US. This morning we've had the PPI report, but the CPI took the headlines yesterday. All of these reports that we're getting right now and that we've gotten throughout 2024 have had a similar trend in that they come in a little bit above expected. So even last week, we were on Friday with Eric Lascelles. We were talking about the strong job numbers in the US, which again points to continued strength in the economy there. And then we get the inflation report yesterday, and it's 0.1% above expectations, and the market reacts it by going down, yields go much higher. And I've got to think that all of this has got to be challenging for you as an investment manager when these numbers are higher than expected, but it's not like we flashed a 5%, and directionally, we're still seeing things move to the downside overall. So how do you process this as an investment manager when you're looking at these reports, they come out, and how do you think about managing through all of this?

Well, it's a great question. From the get-go, when we sit down and think about our investment policy committee or, as portfolio managers, the scenarios that we're running, we generally thought that the last mile on inflation was going to be harder. So you have higher interest rates. There's this three-legged stool — or whatever you want to call it — around how this all comes together. You have interest rates. So they have a direct impact on companies that borrow money at a short-term interest rate plus a spread, which is a lot of a small and mid-size business. Then you have financial conditions, which take into consideration interest rates. But then you also have longer dated bonds, and you have stock market. So bigger companies that can access capital through both of those — as spreads had been lower, longer-term bonds were lower, stock markets have been stronger — the cost of that capital was lower. So monetary conditions had actually eased as stock markets had risen. So that's one leg. And then the last one is that fiscal stimulus is still pretty strong. So it complicates things because if it was just interest rates and you know that that is having an impact on a segment of the economy, then you'd be more confident around that last mile. But it's all these things combined that make this getting it firmly into that 2-3% range or right back to 2%, a little bit more tricky to work your way through. From a portfolio standpoint, you're always trying to think, how could the path of interest rates impact different businesses that we might own? I think the reason that you got the reaction in the markets right now is because there had been a lot of central bank talk around lowering interest rates in the back half of the year. You could sit there and say, well, 0.1% is only 0.1%. But it's 0.1% at a time where people begin to express some concern about has the Central Bank been too dovish or have they communicated too easy a policy too early? And that's just a process of markets sorting their way through this process. At the end of the day, you have real interest rates that are positive, meaning that the level of interest rates less inflation is a positive number. So that historically has been better times for fixed income. And we just have to work our way through this process of the last mile as things proceed. And the violence of the moves where whether or not there's going to be three cuts, two cuts, one cut. This is a constant part of the discussion. And maybe markets are always hard to say exactly what their price for and where they're at. But maybe markets had advanced a little bit on hopes of sooner cuts. So we had to reprice some of that in the latest period of time. Does it change the intermediate term? I think real interest rates are positive that will slow the economy over time. In Canada, places where you see a more direct impact of interest rates, things have slowed more meaningfully. In the United States, we know there's a bit of a delay on the way their mortgage market works. So I still think there's this slowing that's embedded. And people often say things are so good, why would they even contemplate cutting? And the answer to that is, of course, when things slow down, it tends to be quite quick. So the reason that they want to get ahead of it is because they know that. So they want to try and message on-off-type behavior to create this soft landing. The problem that they then have is animal spirits, because as soon as they message to people that they are thinking about this, then people say, well, if they're thinking about it, it's not likely to take place, so I can go behave this way. And then they get a piece of data where they have to then say, oh, my God, should I have behaved that way? So it's this circular dynamic around the different components of policy, animal spirits and what have you. And that's what we're living through this week.

Yeah. And by the way, we had Eric Lascelles on Friday. After the jobs report, we're talking about all of these issues from a purely economic perspective. I'd encourage you to put it on half speed. Eric had a lot of coffee that morning. So if you like to click on the 1.25 or two times speed, with Eric this time, he was blowing through that. So put him on half speed. You'll still get two times speed. But that's the previous episode to this one. On your comments, Stu, I just think about it in terms of why can a small amount create a big reaction? So my wife and I have been together for 30 years. We've established a very trusting relationship, obviously, with expectations. And so I've always done the thing where my wife asks, when are you going to be home? So I think I'm going to be home around 9:30, so I say 10. That gives me a half an hour of space. And then I typically get in at 9:30 or 9:45, sometimes 9:50, and everything's good. So I established that reputation. So that one time when I show up at 10:05, it's five minutes. It doesn't seem like a whole lot, but she's upset because I've telecast to her over time a certain set of expectations. So she's quite upset when I'm late. And that's that 0.1% on inflation. The Fed has said, we're likely moving towards lower rates, and then this falls out of line, and you start to hear noise, different Fed members coming out and saying, well, instead of three cuts this year, maybe we have one. Or instead of three cuts, maybe we have none this year. And it just jostles the market, and the market reacts to it in short term. And just like my wife, it's reasonable that they react that way.

Yeah, no, I think that's true. In this case, there has been a variety of Central Bank speak, but I think the day before, one of the governors actually came out said he still had three cuts on his game plan. And then there was also this notion earlier in the week that some of the large investment houses had very good models around what inflation might be, and maybe they had received some different data from the government that allowed them to predict it. So again, going into the number, the market's expectation was 2 basis points lower and up 10 basis points higher. So again, it's indicative of maybe how people were positioned. The market has tended to get that right in the past. So that's a great point. It was the totality — since we're talking about the eclipse — of the event in and of itself was one thing, but it was really about how people's expectations and positioning sat in the short term around it.

Yeah. So here you are, you're invested in a great company, you know their debt structure, and you wake up yesterday morning and that stock is down 1% or 1.5% because of this inflation news. Are you looking across your holdings and are you thinking, does this change my position? Or if I get a little pop like that, do I add a little bit more? Is that a chance to add? If I was looking to add, do you manage that actively around something like this?

Yeah. If we were buying a stock on Tuesday, we were buying more of it on Wednesday. Different businesses use interest rates in different manners, but most of the companies that we own, just as we love dollar cost averaging on investing, they would do the reverse on their balance sheet. They would ladder out their exposure. So they smooth out the interest that they pay on their debt. Changes in interest rates. Some days, they issue debt at slightly higher interest rates, some days it gets it lower. That process is ongoing. I think one thing we have discussed is that companies with very large debt levels that have interest rates, even though they follow that strategy, the embedded interest rate inside of that debt is lower than today's interest rate, and they have larger chunks of debt than some businesses. We would measure that by the debt-to-cashflow. So some businesses are one to two times debt-to-cashflow. That's quite benign. Other ones are four, five, six times debt-to-cashflow. I would say already we were a little bit concerned about the ones with bigger balance sheets because while you think interest rates are in the topping process, it's not also likely to go back to where they were during COVID. The attractiveness of interest rates is that you get these better coupons than you've seen in some time. I don't know how much lower they'll actually go. Modestly. But you still have this headwind in some businesses with what we call bigger balance sheets or more debt-to-cashflow. I'm not sure we were really that interested in those before, and I don't know if you become more interested just because they're down 1%. But generally speaking, if you're buying a business and you liked it on Tuesday, you're still carrying on on Wednesday.

Yeah. And then so again, I try to bring it back to an individual level. If we look back to last year at this time, we were expecting rates to start to have peaked and start to go down. Then we got some bad numbers and rates continued to rise through October, where again, we think they peaked for this cycle and they've started to fall back. They got down from 5 to 3.75%. We're up around a little over 4.5% this morning as the data this year has been strong. As an individual, I bought a house last fall, and the part of the anticipation of that was a rental property, and that I'm going to get good rent because the economy is going to be okay. But most importantly, rates are going to be coming down. So I sit here today, I'm still waiting for those rates to come down. They may come down much later than I expected. So I can imagine for a company at a larger scale, they have gone through the machinations of trying to figure out exactly when rates are falling and I imagine you see some companies who have gotten it right and other companies who maybe were too optimistic, like I was, around when rates were going to come down. Do you see the difference in the valuation on those companies? Do you have to constantly reevaluate who's positioned correctly versus who's not positioned the right way as rates stay higher for longer?

Yeah, it's a good point. There are some companies that issued a tremendous amount of debt at very low interest rates. And you might see that business at the same valuation as another one. And you sit there and say, the fact that they raised a couple of hundred million dollars at 2.5%, that value now sits with the equity holders because those bonds are worth less. In those cases, that may not be properly recognized in the stock market. In other cases, people have done an acquisition and they've waited to finance it, and you're thinking, this is going to pinch a bit more. You might be a little bit more concerned on that front. When people buy their houses, you have a ballpark interest rate in mind. And most companies finance things reasonably conservatively. So you're thinking plus or minus 25 basis points when you finance this thing anyways. And that's what we've been dealing with in this environment.

It just highlights, again, on a very basic level and the type of transaction I imagine a lot of listeners are involved in. But then you think of these massive corporations, and they just do it at a scale and complexity that would be way beyond what any individual would recognize in their life. And then you, as the investment manager, you have to dig through all those numbers and understand all of those things as you're making investment decisions, which is why what you do is so hard, and it's so hard for just an everyday investor to do things at the level that you do it.

Going through the balance sheet. And we're lucky, too. It's not just the equity people. We have a big corporate bond department, so we can go and look at spreads, we can look at terms, we can look at how the bonds are trading. Why are they trading there? You might see a company's bonds trading at a low level and think, is that the bond market's way of saying they something's wrong with the company, or is it really just because of the coupon on the debt and it's just math? And in those instances, that means that value is accrued to the equity holder. If it's the other that there's something they're concerned about, then maybe you learn something and say, I should be concerned about that as well.

Excellent. Well, that's a fantastic look at the way these short-term numbers are influencing your decisions, decisions at the company level, and individual decisions from an investment perspective. So you've certainly shone the light on what we need to know around this issue. Although I think the sun is right behind you, but your head's blocking it, Stu.

We definitely saw a few memes like that.

All right, Stu, we'll catch up with you next week. Thanks again.

Great. Thanks, Dave.