Hello and welcome to The Download. I'm your host, Dave Richardson, and it is Stu's days— the first Stu's days in many weeks. If you've been checking your calendar, you'll notice that there's a few blanks in June and May. We skipped a couple of Stu's days, Stu. You're not avoiding me?

No, I'm not avoiding you, Dave. It's been a busy time in markets, but it’s good to be back.

Yeah, and what we'll do is maybe do a reset because so much has happened over the last 3 weeks, which is I think the last time we were able to connect, and a lot of interesting things. I was out this weekend with some friends, and they were just bombarding me with questions about things that are going on. And I can't think of anyone better to help make sense of it all than you, Stu. So we'll get into an Investment Stu. Maybe we'll start with something that's right up your bailiwick, which is bank earnings. Was there anything interesting in the bank earnings out in Canada this time around?

Well, the Canadian banks, Dave, had been really strong from a share price performance going into the number. Banks around the world have been pretty strong for a long period of time, and Canadian banks have just really kept powering on even when some of the U.S. banks started to consolidate some of their recent gains. So it's always useful to think about where you are going into the quarter. Increased enthusiasm globally around some CapEx that's going to happen in the country. We're going to have an investment forum in the fall from Prime Minister Carney and different infrastructure that might come predominantly out west. But some enthusiasm around infrastructure in Canada. So maybe that would lead to loan growth, strong capital markets, strong wealth management. So going into the quarter, there was a lot of excitement. Valuations have really expanded to levels that we really haven't seen in some time. Often when that happens and you get the actual report, the question is, is it good enough to live up to the expectations at the time? And I would say generally speaking, they were very strong. The areas that you thought were going to be strong were strong. Capital markets, wealth management earnings, net interest margins, which had expanded quite significantly in the past started to mellow a little bit. And loan growth is still one side or the other of very small. So you left the reporting season with a little bit of softness in the names. But those intermediate-term reasons around hopefully a revival in Canada are still intact. So the stocks were okay around the report, and that's how we left it.

Yeah. I guess they've done fairly well, and we'll ultimately get to what we saw Friday in technology and a few other things around what's going on there. But are you sensing that there's a shift in leadership or rotation away from largely what's been driving the markets for the last several years?

I would say it depends on the market a little bit. Markets have narrowed a bit in the last 6 weeks or so. In Canada, you had ongoing strength from financials and energy. Gold had given way some of their earlier-in-the-year strength. But in a good bull market, you'll have one thing picking up the baton from something else. In the United States, the real power has been semiconductors. I think we talked about that 2 or 3 weeks ago, in particular the memory stocks. It can be quite cyclical, but the belief that, for all the new inference and artificial intelligence, we're going to need more memory, and it'll be some time before that capacity comes on stream, which led to a lot of strength in memory prices and the stocks themselves. Of course, any time you get a very strong theme, the market will often take that to an extreme— the theme extreme, if you want to call it that. And the theme extreme, you have to think through it on a couple of fronts. The first is valuation. The second is the amount of money that flows into a sector in a very short period of time. And today the ability for Wall Street and others to create a mechanism to funnel that money in very quickly is quite high. We see an ETF form around a memory called DRAM. We see levered plays show up around the world. So when you get an interesting theme, the explosion in short-term money that you can see following it can be quite high. And that was in place for a number of weeks. And then you mentioned on Friday we had a bit of a reversal. Sometimes there's not really a reason other than just the buying that exhausts itself a little bit and you get some corrective activity. Again, like any time you have a fundamental theme that people are invested in over a longer period of time, you're going to get bouts of volatility around it, which is really just the market's way of letting off some steam or finding ways to try and profit in a shorter period of time.

Yeah. When valuations are higher, volatility tends to go higher as well. And we've talked a lot about that on previous episodes around the expectations that get to a certain point where you just can't meet them any longer or they're so high that even something spectacular is just, meh, that's okay, we've seen them do that before. And again, for whatever reason, the buying just stops. And when you've got those high valuations, you'll see a fairly quick pullback sometimes, as we saw on Friday. Although those stocks are back up again today as we're taping on Monday. But that's just a sign of that volatility when you get those valuations.

There's lots of quotes that can be borrowed from in this time frame. Yogi Berra, who was the New York Yankees catcher had a lot of good ones. One was to the effect of: that restaurant got so popular nobody went there anymore. And sometimes when you see these significant extreme movements, it's just hard to keep them going in the short term.

Look at that. You must be watching my videos. I used that exact analogy in a video I did a couple of weeks ago just around the same topic.

There you go.

There we go. And this is why you should listen and sign up for the podcast and subscribe on YouTube. And follow along, particularly on Stu's days, because if you spend enough time around Stu and you do that by listening to the podcast, you actually get smarter. Your investment capability goes up, and you just get smarter overall. It comes to me via osmosis here in the room, but you’ll have to get it over the airwaves. So, Stu, the other factor. We'll stay in this tech space. We're going to move all around. We call this the Investment Stu where we throw a bunch of things into a pot, stir it up, and talk about it. But you had Google come out. They were doing a bit of a capital raise. And then you got this whole series of IPOs, which I know you've talked about before on the podcast. But now we're starting to get to the point where we're going to see them out in market. And that brings a lot of supply into place. Again, we've had fantastic demand in the stock market, but is that something that investors need to think about when you see all of this big IPO activity that's coming?

Well, yeah, for sure they do. For every event there's the bull case and the bear case. And so on the bullish side the companies that are putting the money to work see a level of demand for compute. So that means for artificial intelligence, for inference, for asking questions, working on different problems, figuring things out. They see a level of compute needed that is mind-boggling to them. When you're talking about Google, over the next 6 months or so, raising almost $80 billion. And this is already a big company. And so on the bull case, you say, well, if these companies are raising this capital, it's because they think that demand is going to be extremely large. The second thing then, the other side is that there also is a bit of a prisoner's dilemma in place where nobody wants to be left behind as well. So will all the capital earn a return? Because that leads you to a bit more of the bearish side. Here is another line: there's no good opportunity that capital can't ruin. If you have too much capital, you put too much resources into it, and the demand, even if it's very robust, it just doesn't live up to those expectations. So, across the whole spectrum of the stock market we need to think through all of that very carefully. And you sit down with a company that is investing in a data center, and they have their contracts with this credit-rated party. They've locked down how they're going to supply it, how they're going to finance it, the types of returns they're going to get on it. So you run all your assumptions and work on the cash flow that will come out, and then you have to work on the valuation of how that cash flow will trade. We're still in that phase of time where it's the optimism over the cash flow, not the cash flow itself, that is leading to these bigger swings in asset prices. You mentioned Google with their capital raise, and there are some very large IPOs coming down the pathway. And these are also very large capital-intensive businesses. It’s like everything in the stock market: you have to weigh the level of enthusiasm that could persist for some time relative to the amount of cash flow that will actually come from all these investments. And in each one of these cases, the cash flow is farther out there. So mostly we're talking about the likelihood of the arrival of cash flow rather than seeing the particular evidence of its actual arrival. That's why you get volatility. But when there's enthusiasm, people are often excited, they want a horse in the race. They want to be exposed to the possibility of a favorable outcome.

Yeah. This is one of those times when it's so challenging for investors. I would argue it's been one of those challenging times for a while now where you just see these areas of the market moving forward so quickly. You know there's real demand there. That AI is a real thing. And you see these different areas pop, and we've seen different areas really have some big runs over the last couple of years. And as you say, recently it's chip stocks, particularly in this memory area. So you're just tempted: how can I not take a bite of this? How can I not go and play in this space? I'm missing so much. But at the same time, there's a reason why you don't do that and you're always going to be better. We want to have a little bit of exposure to things where there's opportunity and growth. But a diversified portfolio is just a better way to manage it because when you often get out to extremes, that's when things get dangerous. And if you're out there on the tightrope, that's when you can get yourself into real problems, if you don't know exactly what you're doing or if someone just starts to shake the tightrope from the other end.

Yeah, well, that's a great analogy. And I think every investor has different objectives. But when we sit down and we think about compounding our capital over long periods of time, it’s about having exposure to areas of growing cash flows. At any single point in time, you can always say, well, I want exposure just to those cash flows. This was an interesting statistic: one of the brokerages in New York has a big conference every May, it's called the Strategic Decisions Conference. It just finished, and we had some analysts down there. One of the points that was made to me, which is very apropos for what's going on in the markets today, was that at last year's conference, the word Anthropic was not used once. So here we are 12 months later, and Anthropic dominates the show. Inside of a portfolio is a bit like a symphony. There's different sets of cash flows working for you at different points in time. And if you're entirely exposed to just one and those start to ebb, then it's harder to sometimes make changes in your portfolio that get you back on the right path. A couple of years ago, you may have decided that software was just the place to be. And those businesses, many of them will still prosper, but the valuation of those changes quite significantly. Meanwhile, semiconductors and some other areas have come on. You've had this rolling movement within the portfolio about where the next earnings might come from. People are always focused on where earnings will be in the next 12 to 18 months. So in a diversified portfolio, you're getting exposures to the different rolling earnings growth versus just being heavily weighted towards one. And you kind of know that. If I pick just the one and I'm bang on, it will be better. But from a long-term compounding standpoint I want to expose myself to the whole piece. I was a clarinet player, Dave, back in grade 7 and grade 8. And you would have to have known that I picked the clarinet because it fit in my knapsack, not because I necessarily was going to be a great clarinet player. But if you put all your chips down on me and the clarinet in the band you would have missed all sorts of things over time.

I was quite talented on the triangle. Of course, that's been a big hit. I've made a success of that.

What about the cowbell, Dave? I feel like you might be a cowbell player.

Well, I categorize it all into «specialty percussion». Another way of looking at a «specialty percussion» area would be emerging markets, where you've got a lot of different options, but they lump it into one area. And you and your colleagues looking out at the market overall, and just seeing what's been happening— because emerging markets have just been on a tear for over a year now— you took a look and started to think about the positioning of where you want your equity portfolio and made some decisions. And maybe we're not going to talk about the details of the decision but looking at when you would look at making a move in a portfolio. What are the things that would drive you to make that tactical decision at a particular moment?

Like anything, you have to make a list of why you own something, and then if it performs in a manner that far exceeds what you expected, do you think it will persist? Some of the positives around emerging markets, many of them are still in place. Improving currencies, improving political regimes, a consumer that is younger, a demographic that's more favorable, lots of natural resources in many of the emerging market economies. That was certainly on display with Taiwan Semiconductor, one of the largest providers, one of the large stocks. And then some of the memory stocks are also inside of emerging markets through Korea, through SK Hynix and Samsung. And as those markets did well, many of those themes were driving markets. But then in the last 3 or 4 months, the ball was really being carried by just memory. And as Korea did exceptionally well, the question was, do we think that the underlying themes are strong enough that we could withstand a correction in memory and still benefit? And we just took the decision in the short term that we would move to the sidelines a little bit, just move it back to neutral. Not underweight— you still have a good number of things on that list— but just to recognize that you had outsized gains due to something that wasn't leaning on all 5 principles that you might be invested in. So we moved emerging markets back to neutral. When we look at where we have some of our technology basket in our exposure, we rank them on commodity technology versus proprietary and where is patent supported and all sorts of things. And memory has been exceptionally strong, but at some point, it is the more cyclical component of the market. So, we move some exposure in emerging markets back to the United States where you tend to get more of that proprietary intellectual property component in the investment case.

Yeah, and I think we've talked about this— not on the podcast, but just off on the side at different things we've attended— when you start to talk about memory and this part of the chip market, or just chips overall, they are almost like a commodity and a commodity on steroids. And if you were listening to this podcast 3 or 4 months ago, Stu, we were talking quite a bit about gold. And when we were out and about, people were asking us about gold everywhere we turned. And now I don't think I've gotten a gold question in about a month. And it's because you saw gold shoot up to about $5,600 an ounce, and now you're sitting around $4,300. And you can see within a commodity that's going, over time, to move towards its cost of production or marginal cost of production, that when you get way into the Netherlands above that, it can fall back pretty quickly. And you've seen that with gold. And some of these areas, as you say, when there's a shortage, that shortage is acute. But you're able to bring resources to it fairly quickly to resolve that shortage. And then all of a sudden you flip over a couple of years from now and there's a glut of it in the market and prices move as you would expect. And that's sort of in the history of chips and memory in those types of areas of technology.

Yeah. And in the «here and now», every incremental story you hear is about demand outstripping supply. Eventually there will be more supply. Whether or not it's memory or, going back in time, to fertilizer, all sorts of things, companies will get in this period of time, and it can last a couple of years, where the stocks get valued on, not the earnings that they're doing today, but how long will earnings remain strong before they revert back to their cyclical norm. And people will say, well, they're worth this in mid-cycle, and there's this many years of additional earnings that we're going to reap, so we'll add those two together, and that's how we'll value the stocks. The only thing that we have to be careful in that analysis is that when the cycle turns, people often just go right back to the normalized earnings. They don't really get the benefit of this excess cash flow that they may generate, because often what happens to that excess cash flow is they put it back into new productive capacity which then sows the seeds. Now in this instance the memory companies are trying to be very particular, and they're trying to sign long-term contracts and get everything all bedded down to try and extend the cycle and preserve the economics. We'll see, it's just too early to tell. As I said when we started, you always have the fundamental components of how this could work, and then when it gets into the enthusiasm machine as well, and you get single-levered and double-levered, and the amount of options that might be taking place on these companies, we have to acknowledge that some of that activity is not fundamentally driven. And those are the two things that we have to always be playing off against each other.

Yeah, it's always interesting whenever we get into these areas— and we could have pointed to energy producers, the oil area, gas, gold; now we're in this chip sector— and any number of these areas that have gone up extremely quickly and gotten to elevated valuations. You'll read an analyst report on a particular stock in the sector or the sector overall and say this time management is a lot smarter. They've learned their lessons of the past, even though these lessons tend to come along about once every 25 years. You stripped out a lot of the management that was there before, but at least they've studied it and they've learned that lesson in the past. Except that when that money is sitting right in front of you right now, there's that big price on something you can produce. You've generated that cash flow and hey, I'm going to take that cash flow and I'm going to make a little bit more supply because I can get this price right now. Again, it always works against itself. And you tend to see, as you say, things just normalize over time. And that's why you want to be very cautious as an investor chasing after something— that's different from having an exposure to something— but chasing after with excess assets is almost always a recipe for a bad experience from an investment perspective.

Yeah, I think what I would add to that is it just requires a different toolkit. You need to be conscious that if you buy something into an accelerating cycle, you need a game plan for what if the cycle decelerates. The other thing that I would just mention on this is that sometimes as the shareholder base changes hands from maybe more traditional investors to value investors to growth investors, maybe to momentum investors, that activity also puts some pressure on company management because the last thing they want to do is disappoint their shareholders. And it is a delicate balance to make decisions for every one of your shareholders to optimize in the long term. So as stocks do extremely well, you have to acknowledge that the expectations have changed, the shareholder base has changed. Maybe everyone's not going to react the same way to news that you might change hands. And the tools that you choose in the toolkit, for each situation, become quite important. Like, if I'm buying something that's been down for a long period of time and I've decided that its net asset value is twice the value of the company and I start buying the shares. In that situation, you're trying to play the «when, not if» game. And those can be disappointing because it can take longer, and then you don't get the return that you hope for. The ideal thing is you buy something that's down low and the cycle changes the next day, and you get this magnificent return, and you think you're brilliant, but really just the cycle turned faster than you thought. Other times the cycle takes longer and the return is then delayed. When you get into the buying high expectations game you need to have a very thorough understanding of those expectations so that you can make sure that they are being met or continuously exceeded. And the same thing, if that carries on for a long period of time, then you're going to make good money. But if it changes abruptly, that's going to cause a significant change in the share price. So you just have to always understand, what situation am I buying? We always talk about these 4 things: is it revenue growth? Is it margins expanding? Is it valuation rising? Or is it the company putting money successfully to work into their business? Which of those 4 am I leaning on? And that really centers on which tools am I using in my kit?

Yeah, that's a great way to put it. To finish off, we'll just quickly take a look at some of the bigger picture economic announcements that have come over the last couple of weeks. Maybe we'll start with the war. It's ongoing and we've seen the price of oil move around a lot. Maybe this is just my perception— you can correct me if I'm wrong— but it seemed like there was a while where every little shred of news that was coming out of the war, moving energy prices or moving towards peace, the market was just hanging on every bit of news. And it doesn't seem to be the same now. I don't know if the market seems fatigued by it or they've sort of settled into well, this is probably longer than initially planned, but it probably ends up working out okay and ultimately energy prices go back down. Any sense that the market is reacting to the war differently now versus where we were even a month ago?

Well, on a couple of fronts, there's been so much news that you become a little numb to it. Ceasefire, then shooting again, then ceasefire. Well, this time we're going to follow through on the ceasefire. People just begin to dismiss it almost to some degree. A couple of things that are interesting is that the oil stocks have stopped going down. They've actually traded quite well, even though the price of crude has meandered around. A lot of inventories have been drawn down. There is more of a concern as we get through the summer and into the fall that there could be something acute. I wouldn't say that that risk is really in the market today. I think that would be a bit more of a concern. As Canadians will know, Air Canada came out and said, don't worry, we have all the jet fuel we need if you want to fly to Europe. So if you're having to remind people of that that they're focused on it and that that's something that could present itself later in the year. The energy stocks I think are saying this is going to be around longer. Will it be acute? I'm not sure. It's a risk that we do worry about. As for the rest of the market, there’s a lot of CapEx in the United States going into data centers and other things. Employment has been pretty good. You could argue some of it's for the World Cup, but a lot of it's in healthcare. Maybe those are not forever categories. But surprises in the economy front have been a little bit better, relative to what people have expected. The economy is not barnstorming away from people, but it is not in bad shape. Canada is quite strong out west, a little bit softer in the center. Housing is meandering. Home sales up, prices down. The three bowls of porridge exist in every one of those scenarios. But in each one, we have had a little bit less of the cold porridge and a little bit more of the hot porridge. And so the overall backdrop has been pretty good. Earnings have been strong. They've been heavily weighted to just a handful of stocks, but the broader pool itself has been okay. So there's not enough that has stacked the deck one way or the other. And so the status quo has continued in place, which has been reasonably favorable for markets.

Yeah, I like the Goldilocks analogy. Again, I was using this one the other day when talking to some people, some investors out on different travels. And just the idea that it seems like things are in the «just right» bowl and that's where you want them. And then just occasionally you get a bit of news. So we get the inflation reports of the last couple of weeks out of the US and that comes in a little bit hot. So that gets you worried, and you see yields move up. And you get the employment reports, which are solid and that leans in that direction too and sort of heats up the bowl. Sometimes when I heat up a bowl of porridge in the microwave it heats up a little bit more than I want, even though it's still in the «just right» range, but it's kind of, ooh, that's a little bit hotter than I like. And then you get a couple of other things like Canadian GDP and you start to go, well maybe that's a little bit on the colder side. Or you look at energy prices being elevated and how a potential for higher rates and that grinds down the economy and economic growth and potentially profits. So that sits in the cold. But again, when you look at it in its entirety, as you say, it is sitting there in the middle and flop back a little bit back and forth. But things still look pretty good and you want to be invested.

Yeah, maybe just to finish, since we've had two of the same analogies today, I'll borrow from my mom, which is: great minds think alike, but unfortunately, fools rarely differ.

Oh, well, that's good. Your mom hasn't called me a fool recently, has she?

No, we're for sure in the «great minds» part.

Very good. Well, then let's finish off with what's on our minds here in Toronto this week. We kick off the World Cup. Who is the Stu Kedwell pick for the World Cup champion? I know who we're cheering for, but that would be buying a penny mining stock and having it go to $1,000 in a couple of months. That’s the odds on our beloved Canada. But where are you leaning?

Thankfully, people don't listen to this podcast for FIFA because I know so little about football, I call it soccer. So, yeah, I don't even know where I'd venture. I'd I'll take Canada.

OK, well, you've been listening to your mom. I actually have my mother-in-law staying at the house with us right now. She's been a little under the weather. So we've got her at home. She is of Portuguese descent. And so if I'm smart— and you just said I was smart because we were alike— I better be cheering for Portugal. Of course, we'll be cheering for Canada until such time. But it's pretty exciting. As you said, it's interesting that you mentioned that you're seeing some of the impacts in employment in the US economy. And I'm sure it's a great thing for Canada. Certainly, people are really excited about it out in the market. And it likely won't happen again in our lifetime.

That's right.

Okay. So I think we get a big call of a «goal» for the quality of this podcast, Stu. Hopefully we won't miss you for the next 3 weeks. We'll catch up with you next week. And take care.

Great. Thanks, Dave.