Transcript
Hello, and welcome to the Download. I'm your host, Dave Richardson, and it is Stu’s days. Stu Kedwell, co-head of North American Equities at RBC Global Asset Management, is joining us. An all-around good guy; a smart guy. Stu, two weeks ago, we did Stu’s days on Friday. Then last week, Stu’s days on Thursday. Then Stu’s days on Wednesday. We are trending in the right direction. Next week, we may actually do Stu’s days on Tuesday.
That's right. Or every day is Stu’s day, really, Dave.
Oh, well, I don't think that's true. Maybe your wife and kids feel that.
Definitely not.
But, I'm really not part of that camp. And I hope all this fame and fortune you've gotten off doing this podcast hasn't gone to your head, because that's when we start to go downhill, when that happens.
Well, that's highly unlikely, but we'll keep on chugging. The market is a humbling place.
A humbling place. I also understand, though, that you were not humble on the exercise bike yesterday. You were part of a really interesting project yesterday.
Yeah, we went spinning for sick kids. I think we've done it for five years and we've raised $50,000 for sick kids. It was great. But it was definitely warm in that spinning room. I was spinning and I looked at my heart rate monitor on my Apple Watch, and I was running about 25 beeps more than normal. And in my head, I quickly did 220 minus my age, and I realized that I was running a little hot.
And you don't want to do that, at your age.
That's true. Although the pint afterwards felt very medicinal. Guinness has so many wonderful things in it. It did me a lot of favors.
And shockingly low calorie, which a lot of people don't know. We share lots of good numbers on the podcast with you: low calories on the Guinness. So great work with that yesterday. I heard you were rocking the headband, and that's good, if it was hot in the room. Maybe as part of the podcast— we'll have to work this out with our producers—, we'll get that auctioned for charity. Stu’s day's sweaty headband. Raise some more money for the kids. Okay, Stu, let’s get into it. A couple of angles I want to take today. One is, I'm watching the ten-year treasury rate fairly closely and it’s a good broad-based interest rate to give you an idea of where the economy is at today and where it's going and helps you with valuation in the stock market and such. And back in the fall, we were sitting at about 4.33%. That’s where the US ten-year treasury peaked. It bottomed out last month at about 3.33%, in January. And now it's bouncing up just below 4%. And it seems like people get really excited around that 4% number. Do big numbers like that mean anything, especially in the modern world? When we get to 4000 on the S&P, or 22,000 on the TSX, or 4% for treasury yield, do those round numbers mean anything really?
Well, 4% on a treasury bond— we'll talk about that in a minute, whether or not it means something, and there are some longer-term financial implications that ground to 4% ten-year—, but in general, there's so much psychology in the markets. When I started, some of the old traders would say that markets always reach for these big numbers. A stock that gets to 99 will get to 100, and markets will sniff out 4000 on the S&P or 4% on the ten-year. And these big figures become talking points. But it's really just psychology. I don't think it's any more than that. 4% on a ten-year bond is kind of interesting because, for most of my career, you would think of 4% on a ten-year bond as the combination of the three things that make up an interest rate over time: the inflation number, the real rate of interest and the term premium. So a lot of times you would have thought, okay, inflation, 2 to 2.5%, 2 to 3%, real rate, 1, 1.5, 2%, something like that— 1% is a real rate that is a bit of a headwind. So 4% has been a lighthouse, so to speak. When adding up all those numbers in different configurations, you often end up at 4%. And when we talk about the stock market trading at 15 times earnings, some people will do what they call an earnings yield. Rather than say the multiple that the stock market trades at, they'll say what's the earnings yield, which is putting your earnings into the multiple. And a 15 multiple is around 2.75% of risk premium above the 4% that would sit in the ten-year bond. And a lot of people might use numbers like that in their long-term valuations. In the short term, what people sniff. But longer term, those numbers sit in a lot of models, and they do so because of that combination of real interest rate, term premium and inflation. If you thought inflation was going to be a lot higher for a longer time, that's obviously what pressures interest rates.
A couple of weeks ago, on this podcast, we talked about psychology and markets and different price levels and the way you can use technical analysis to help make better decisions around investing. That's one to check back if you're interested. And how these different levels play psychological factors and can be used to identify opportunities or to make better decisions in markets. So Stu, that's great stuff. I always like your old traders stories. I get a vision in my mind of that trading floor that you were sitting on as a young Stu Kedwell with those older fellows who I guess look like us right now.
If you can believe it, Dave, I used to be able to carry sixteen coffees.
That's why you got to where you are. The kid who could only carry eight, he's not working here anymore. So Stu, one of the things though that you've built your reputation on is how fantastic you are on the analysis of Canadian banks. We've got some earnings out of Canadian banks this week. And one of the things you also do a great job at is digging into those numbers. The banks have so much involvement in the Canadian economy. They're so large that they give you clues about things that are happening in other parts of the economy, other parts of the world. So what have you seen thus far in the bank earnings and is there anything it's telling us?
Well, it relates a little bit to what we just talked about on interest rates. Interest rates play such an important role in how a bank earns money. A couple of themes that have stood out is first, when interest rates start to rise, banks normally make more money because their net interest margin expands. And this quarter I would say we're starting to see the maturation of that. It doesn't mean that they wouldn't benefit if rates went a little bit higher, but the majority of the benefit has likely been felt to some degree. And then the second thing is that a good chunk of a bank is the amount of assets that they originate. For a business, it’s volume times price; and for the banking world it’s assets times your net interest margin. That's how you create half your revenue. And asset growth also started to slow a little bit in some of the traditional businesses. So interest rates rise, demand for loans starts to drop and that's how the economy cooling shows its way inside of bank statements. Then there's a whole bunch of noninterest revenue which some is cyclically depressed for a variety of reasons. But all things considering, I would say the revenue lines were pretty much in line with expectation. The one area that was quite strong was the trading results. And probably the best leading indicator for trading results is what corporate bond spreads have done in the past quarter. And they narrowed. And when they narrow, that's normally pretty good for trading, just as a rule of thumb. So what we're seeing is loan growth starting to slow. We're seeing the benefits of net interest margin starting to mature. We're seeing trading still quite strong, and provisions for credit, I would say, were in line for expectations. And because the economy has remained quite strong, people are still braced for that, for provisions to rise. That hasn't really happened so far. And then the last component is that expenses have been a little bit elevated. Just as the banks deal with some of the inflationary pressures that all businesses are dealing with. Like any good management team, they'll get to work on that over time, trying to keep those in check under different scenarios. The numbers themselves have been you never like to say totally consistent, because there has been a little bit of share price movement, but whatever camp you were in before the earnings were reported, you're probably in the same camp afterwards.
Probably in the same camp. But are the banks in any way reflecting what the expectation is, maybe the most anticipated recession we've ever had in history? A potential slowdown or a drop into a recession? Anything there that's giving us any clues or more evidence that that's coming around the corner?
Well, there were some credit measures that ticked up a little bit from where they'd been, but they're still, in many instances, below where they were pre-COVID. So it's hard to totally draw that conclusion. When you see loan growth start to slow a little bit, it's not an immediate cause of recession, but it's the type of precursor to slowing activity. When you start cutting off loan growth and the economy is fueled by loan growth. That doesn't mean it goes into a big recession, but it is fueled by loan growth, and you're starting to see that slow a little bit. It's slowing because interest rates are higher. As a business, if I could borrow money at this price before and I could go do something with it, now I have to be able to do something better in order to pay a higher interest rate. So you're seeing some combination of that, but again, it's quite consistent with an economic forecast of zero to 1% growth.
Jerome Powell is peering up into Canada and looking at Canadian bank results. There's nothing that's changing his thoughts in the direction that the Federal Reserve has to go with interest rate policy in the US?
I don't think so. I think probably the biggest thing that the central bankers are looking at is what they call hard economic data— which is the real numbers. Then there’s the sentiment-driven economic data. And the hard numbers remain strong. The sentiment data remains a little bit more mundane. There's a big gap between what people think and what's actually happening. The «bears» say that that will close by going to what people think should happen, because everyone's braced for something. And the «bulls» say that we're braced for it but it won't come, and then people will begin to unwind a little bit. There's a lot of deposits in the system which delay recessionary type activity. For the average person, the ability to withstand a slowdown is still pretty good. And then of course, the interest rate side, we always talk about it from a lending standpoint, but for savers, all of a sudden, they've got some more glue in their pocket. They're doing better. So there's just so many things going on right now. I'm hesitant to say that there's a real shift in any direction going on here.
What we've talked about in the last couple of episodes is that in February, that hard data has come out a little stronger than people would have thought given the backdrop. And here we are again, and we talk about technical levels. Markets are sitting at some of these key technical levels, now waiting for the next shoe to drop, which is a whole bunch of data in March that's going to give us more clues around where we actually are in this economy. And it's going to start with the big jobs number in the US next week.
That's right. I think most people are still in the camp that if the economy hasn't slowed, it will. Revenue might be okay, cost pressures will exert some influence, and that's the period of digestion that we're going through and seeing how it resolves. The other important thing too is that there's not this area that you're just saying, well, that's just lit up in terms of too much leverage in that particular area. There are other ingredients that go into something that takes it from a normal slowdown— there's no such thing— to something more significant. I think that the best analogy is that difference between the survey kind of soft data and the hard data. There's a lot of people out there feeling like things are hard and that we should be braced for something, but it just hasn't quite arrived. And that's the gap that we're focused on.
Well, a lot of the folks at the charity ride yesterday were expecting a slower Stu. He's older every year. But he shows up at the charity event and he kills it. Kills it for the kids. So once again, Stu, thanks for doing that and thanks for joining us on the podcast.
Great. Well, thanks for having me, Dave. And we'll talk to you soon.