Hello, and welcome to the Download. I'm your host, Dave Richardson, and it is Stu’s days. Do you like that little emphasis on the «Stu’s days»?

Do you have a machine in the hotel room that does all those tricks today? The voiceover tricks?

No. I don’t know if you remember, I used to go to the Ontario Science Center, which is still around in Toronto, and they had this machine that you could hit different buttons and change it so that if you said «coffee», you could make it really high. «Coffee». And then you could make it really low. «Coffee». We’d play around with that. So I'm pretty adept at doing that just myself with my own voice. It's quite a skill, Stu.

It is. I just remember the one that used to make my hair stand up.

Oh, did you do that?

Yeah. Static electricity.

Yeah, I could never get to that. There was always a big line-up. I'm chronically impatient, so I never did get there. Did you look good with that stand-up hair, Stu?

Yeah, when I was rocking the center part, back in the day, and then the hair would stand up. For grade four or grade five, I probably looked pretty good.

Wow. Well, Stu, I know, as we did our little pre-podcast discussion about what we're going to talk about today, this is going to be an electric Stu’s day because this is Stu’s math lesson. But Stu, can I ask you to say «dollar cost averaging»?

I'll say it, but I think in one of your booming voices, it might sound better. Dollar cost averaging.

There we go. Because the drinking game that we have here on Stu’s days podcast is whenever Stu says «dollar cost averaging», you have to take a sip of coffee, not anything else. And you're going to need the coffee to get through this episode, because Stu is going to do the math on fixed income and what you need in terms of earnings to equal out just how you think mathematically about the investment decision. Because we've talked about it last week, we talked about volatility in markets and how you need to run countertrend to the old «buy fear and sell exuberance» from Buffett. But the math behind it. You've got that saying, but there's actually math behind it. And that's what you want to talk about today, Stu.

Exactly. We talked about the behavioral finance. I remember when I started, there was an old portfolio manager who used to say: wait in the weeds, take it off when stocks are down, and then feed the ducks when things are strong. And investors need this toolkit and an important part of that toolkit is behavioral finance. But the other side to it is the actual math of finance. When the S&P is at around 4,000 like today. If I had two machines that I could put in front of you, one is the S&P and you could say, well, I could own that for a very long time, earnings will probably grow 7%, with another 1 or 2 in a dividend, and that's very satisfactory for a long time away. But everyone's time horizon tends to shorten up at different stages of the game. So, I have two boxes. One, I can buy a two-year bond, I give you my hundred dollars, or in this case— I'm going to compare it to the S&P—, so I give you my $4,000 and I can have 4.5% a year. And that's from the government. There could be additional spread from credit. There could be additional spread if interest rates change. But these are shorter-term rates, so they don't have too much impact on the principal. So that $4,000, generally speaking, is going to be $4,400 in two years. On the other side, I take my $4,000, and while I don't know what the stock market might produce, I can say, well, if it gets to $4,400 in two years, how much earnings are required in 2025 to justify $4,400? And that is also a little bit more art than science, because we have to decide on what multiple we might use. But say we use 16-times earnings— which is not cheap, not expensive, it's within the range of what it might be over time—, that would require $275 of earnings in 2025 at 16 times to get you the same $4,400. So one is $4,400 from stocks, one is $4,400 from a two-year bond. That $275, if we take it back to the current estimates for next year, would be around 14% growth over two years. So, call it 7% a year, in line with the long-term historical averages. But the one thing that we've talked a lot about is the possibility for a slowdown next year. And as an asset manager, you're always looking for where are the different relative returns available to me on a risk-adjusted basis. And we talked about the slope of yield curve, we've talked about ISM, we've talked about a lot of different indicators that suggest that the economy will likely slow down next year. So that $240 that we're basing that growth on, there might be some risk to that. So I've got these two buckets, and as I say, one is from the government— it doesn't even include a little bit extra from credit spread—, and that coupon that comes to me looks pretty attractive when we compare things in the grand scheme of things. So, that behavioral finance aspect was «buy fear and sell cheer», so as things get better, what is also happening from a math standpoint is that the range of outcomes that make my equity investment better when I feel better are starting to narrow. And if we go back and do that same math for when the S&P was 3,500— you say, at 3,500, I could take stocks, or I could take that 4.5% from a two-year bond—, the amount of earnings is about 12% less that I need to make the break-even on my investment. So, when we're sitting here being money managers, we have a bunch of things to choose from, we have different asset classes, but when it comes to the equities, we often try and reverse-engineer what's required for success. And when markets are down, less is required for my equities to be successful. And when markets are stronger, more is required. And we can compare that to what's available inside of fixed income. And the big difference in fixed income recently is that we're getting coupon. We're getting actual money that's coming to us each and every day through the interest payments. And as I say, whether or not that's through a government-oriented bond or a bit of extra from a credit standpoint, it's interesting.

And if you're a fixed-income investor, go back to the last Stu’s day's episode at the end of October, about four weeks ago, as we talked about how interesting fixed income was becoming. I should also mention, that clicking that you were hearing was not Stu hitting a calculator to do the math there; that's actually his brain clicking because he's that damn smart. He does all the calculations in his head. But I think the highlight, from behavioral finance and behavioral investing perspective— and that I always find intriguing as I'm out talking to investors—, is that we've had this really fantastic rally over the last few weeks in stocks, which is actually turning. And we're actually seeing it in the way investors are making bets, investing money, getting excited about stocks again. But where we're sitting today, as Stu points out with the math, this rally, it feels good. It feels good to buy stocks. You haven't seen quite as much on the fixed-income side. Fixed income right now is a really hard pill for a lot of investors to swallow because we've had the worst fixed-income market I believe since 1780, or certainly within any of our lifetimes. So everyone is just, yuck, I want nothing to do with fixed income. But, on a relative basis, it's starting to become interesting to take a look at. And we talked about that on the previous podcast, but Stu has really just highlighted the math on it right now, that where we're sitting today with stocks, we need earnings to grow over the next 12 or 24 months to generate a return that we would likely expect out of fixed income. We're coming into a recessionary environment. So instead of earnings growing, we're kind of at a point where we're hoping that earnings stay exactly where they are, when you go into a recession. And again, if you go into a recession but we've got inflation under control, then interest rates will likely come down, so that adds to your bond return. We're never making any specific recommendations here— you need to talk to your financial adviser to find out what's right for you— but again, just using that behavioral finance piece and be a little bit contrarian in the way you think. Ask those questions because there are some areas of the market that are getting relatively attractive right now.

Great point, Dave.

So, Stu, is that advice you got earlier in your investment career, from that person, to lurk in the weeds, is that why you're obsessive about weeds on your lawn?

Maybe it is. Maybe that had a big impact on me, and I didn't even notice it until you said it. But what I do know is that that advice is about turning markets into your friend. How do you become opportunistic? Where is a little bit of extra value? Where is a little bit of extra coupon? Where's a little bit of extra money? You need to always be comparing things and saying, well, that looks pretty good, but how does that compare to this and what's available? And that's something that we're busy doing every day.

Yeah, and that's where that fight is won over the long haul. It's just getting a little bit of extra here and there at different points in time, which helps you beat the market and achieve more over the long haul. They're not necessarily big, exciting moves, but they're little things that add up a lot over time if you do them consistently.

Yeah, 100%.

All right, Stu. Well, that's fantastic. I think everybody's got the calculator out and they're running that math because that was a lot of fun. But again, a really important point around where we're sitting. And again, just a way to think about not always just following the herd, identifying where there could be a counter trend and you can take advantage of it as an investor.

Great. Thanks very much, Dave.

See you next Tuesday. Or next Stu’s day.