Hello and welcome to The Download. I'm your host Dave Richardson, and it's a pretty exciting day today because today marks the return of Stu Kedwell. You might ask, where did he go? Well, this is a very busy man. This is the Global Chief Investment Officer at RBC Global Asset Management, which under your perview is what, $800 billion-ish?

Ish. Yeah, in that neighborhood.

Yeah, that's right. Well, markets move every day. We're sort of sitting around that $800 billion right now. But it's more than I have in my piggy bank, so that makes you pretty important. And this is our first World Cup Stu’s Days, but we won't belabor the point because we've been doing that with all of our other guests the last couple of weeks. So, Stu, I guess the reason we haven't done a podcast recently is just that nothing's going on.

That's right. It's very quiet.

So, there you are in your global layer headquarters. And when you're looking down from above at everything that's going on around the world over the last couple of weeks, what were some of the things that really struck you as being the most important for investors to think about?

Well, first and foremost was the first FOMC meeting with the new head of the Fed, Kevin Warsh. And I thought that was quite significant on a number of levels. On the one hand, you could say on your first meeting, you're going to establish your credentials as an inflation fighter, so you're going to err on the side of hawkishness. But I thought even within that, inside of the press conference, the level of commentary was a lot shorter than it had often been. And the mention of inflation was much more of a focus than some had expected it to be. And he used lines like, all the members of the Fed were united. And it's not that you wouldn't have heard that from Jay Powell before. But then the second interesting part was President Trump saying he's got to do what he's got to do. Which was a different leg. And we've talked about the bond market. Yields have bounced around a little bit, but there's a couple of things that you look at. The first is the real level of interest rates which is the number you see printed minus some estimate for inflation. So the real yield had gone up over the last 3 or 4 years— it's been flattish this year— at an attractive level historically. But what you want to see is the Fed saying, I'm going to protect the longer end of the yield curve. So in the first Fed meeting we had a rally in the longer-term bonds. Shorter-term rates went up a little bit, but what you really want to see, the 10- and 30-year area of the yield curve were lower. So that is a positive.

Sorry, Stu, to jump in. That's a positive because the way that markets are reacting to what they've heard and the impression that's created by this new Fed head is that inflation is going to be managed. We are going to pay attention to it. And so yields can come down because the expectation is that inflation will be managed effectively going forward— or at least to the best of their ability, because no one's perfect. We've seen that over time, but at least the market is saying, hey, we've got some confidence in what he's going to do and what the Fed is going to do overall.

That's 100% right. And it did coincide with a ceasefire, which has received lots of attention as to the different parts of it and what have you, but a decline in the price of oil, which takes off one of the inflationary pressures as well. But I think his commentary gave confidence to the idea that he was going to respect the long end of the yield curve. And to your point, the most important thing that we want as a long-term equity investor is someone to protect the long end of the yield curve because that's really the bedrock of valuation. So you think about a business in the short term. I've put money into my property plant equipment. I get some inflation. I end up with more cash flow relative to that investment than I thought. So in the short term, you're like, woohoo! But on the long term, eventually you need to replace that property plant, and then you get into concerns on the equity front because now I need to replace it with these more expensive dollars, and will I get a return on that inflation? So inflation is not the friend of the long-term equity investor because it shows up in terms of potentially declining multiple. So that was significant. Clearly, the ceasefire has been significant. But even before the ceasefire, the second thing is that breadth in the stock market had started to improve, and the average stock was doing better. One of the games I like to play with our portfolio managers, I call it mystery charts. So I put a chart up in front of all the portfolio managers and I say, would you buy or sell that? Without telling them what it is. And one of them was a transport. The transport stocks have been doing better, the railways, the trucking companies, and these are the types of things that do better when the economy is in slightly better shape. And they're coming out of what had been a more mediocre period for them. So, you had the ceasefire, you had the first press conference from the new Fed chair, you've had a broadening stock market. Then the last part that you've seen is memory chips. Memory stocks have been very strong because memory prices have surged. But at the same time, you've also had some weakness in what they call the hyperscalers, the people that provide the data centers like the Microsofts and Amazons and what have you of the world, as a couple of dynamics have presented themselves, which lead the stock market in the short term to wonder, will they get the returns on all this capital that they're putting to work? And then to keep growing, how will they come up with all the capital? Google raised equity. We talked about this in the past about how, so far, all the investment has been out of their operating cash flow and some borrowing. And the idea that they might need some additional equity raises the bar for the returns that people want to see on it. An analogy would be, you decide to buy a piece of artwork for your house out of your pocket. Whether or not I like the artwork or not doesn't really matter. It's coming out of your pocket. But if you were going to sell me 1% of your house to buy the artwork, then all of a sudden I get an opinion on it. And when you see Google, a $2 trillion or whatever, selling $80 billion of equity, it's quite de minimis in the grand scheme of Google, but now it just raises that question about am I getting the returns on that capital spending? And that has corresponded with what they call the token usage. And I think we've covered off some of those discussions before about the usage of tokens exploded. Then companies said, this is costing us a lot of money. Could we use different models for different queries and start to be more efficient with those tokens? And it all grinds into, will they get the returns on that investment. And then the final leg of that that we have to be watchful for, earnings have been so strong, and that earnings strength has really been driven by a lot of this capital investment. The duration of the capital investment. How long will it last? How big will it be? That has a couple of implications. The first is when you have big capital investment. Say you're selling semiconductors, you sell me a dollar of semiconductors, so that dollar goes into your revenue. But when I expense that dollar, I get to amortize it over the useful life of the semiconductor. So you get a dollar of revenue into the economy's income statement, but you only have maybe 20 cents of expense because I'm going to do 20 cents over 5 years to pay for that dollar. So CapEx cycles tend to generate earnings surges, and then that's where it becomes very important. Like, in the next year, in order for earnings to keep growing, not only does there have to be that dollar of CapEx again, but there needs to be like $1.10, $1.15, and so forth. And that's the debate that people are having over the size, the length. It's not that people are doubting the efficacy or the efficiency that AI might bring, but once you start having to pay for this capital with maybe equity, debt, and your cash flow, it just mixes everything together and causes a little bit more consternation. And it's happening at the same time as some other opportunities in the stock market are also presenting themselves as the market broadens. So it's always an interesting time. There's always things to think through. And when we get into these periods of time, of course, we always have to remember that the stock market might be a little bit exuberant on some parts, might be a little more worried in others. Company management are focused on the same things. So if you're a big hyperscaler and you're managing your business, you're figuring out, how do I re-optimize and maximize my revenue. So there's a scenario analysis always taking place. In our meetings, we're running the bull and bear case on all these companies. It's a very iterative process because it's a fast-changing environment. That's what's been going on in the last couple of weeks.

Yeah, and it's not just whether or not that revenue is going to be produced from all of that or this return on investment is going to come from all this investment in data center infrastructure around AI. But there's also an element of the timing of when that revenue comes as well. Am I waiting 10 years to see this happen? Or is it next year or 5? And that has an effect on that valuation. And then, when you're gauging whether that company is worth it or not based on the potential of what this investment should generate, that changes the dynamic too.

Yeah. Well, that's the old Warren Buffett line about investing, from Aesop's fables. How many birds are in the bush and when are they coming out? You're bang on. We can all agree that there's going to be lots of CapEx and it will likely be beneficial, but once that gets digested, then the exact timing of it becomes more important, and the exact timing of how much capital will be spent and when the returns will show up. It's just the way the market matures. We look at the bush, we say there's lots of birds in there. And then a week later, markets are up a little bit and you're like, well, how many? And when are they coming out? And that's the discussion point that is constantly taking place.

It's really been fascinating watching this. We had Marcello and Rob on, we were talking on the podcast the other day. And by the way, you want to listen to some of the others. We have Stu to pull everything together because he sits in that layer up 1,000 stories high above the sky in Toronto, looking down at everything that's going on. So, sometimes, we go a little bit deeper. So subscribe to the podcast, follow us where you get your podcasts, subscribe on YouTube, give us some feedback. But the whole parallel— this is for me, when I was back buying stocks in the late 1990s and early 2000s. And I remember the technology cycle as it went through the internet boom. No one would debate now or then that the internet was going to be life-changing for all of us in terms of the impact it's had on the world. And no one's going to debate what the impact that AI is going to have— or the railroads, 100 years ago. But you move through the cycle of the companies that start to garner attention. And the flow is almost the same as I recall. I was saying, in early 2000, I was buying Seagate Technology, Western Digital, Micron Technology. And then I said, there was one other that I think I was buying at the time. I had to go back and look at my statements. And it was Corning. So it was on the weekend. I go, is Corning having a big run? And sure enough, I look at Corning and it's having a big run. And I go, uh-oh, hey guys, this is where we were coming towards the end. Because you cycled through everything, and then everyone figures out like the most boring stuff is the least interesting, and that's what's running right now. But what they would say is you're just looking in terms of the scale and the amount of revenue that these companies are producing, that it is different, but also important to remember, back then, as some of those companies cycled out of favor, many other companies that the broader market, as you say— and what you're seeing is that build-out in the market, the broadening of the market— did really well through that period. And again, it just harkens back to the idea of diversification and that value ultimately does matter.

Yeah, and a couple of things on that. As a long-term investor, the first thing you would look at is the chart of the S&P earnings growth over like 100 years, and it's 7-8%. And that's what drives your long-term returns. And that line, when you look on a chart with that type of scale, looks very stable. And if you did it on a 50-year basis, it'd be still quite stable. 10-year basis, still quite stable. But in a given couple of years, you might be above or below that trend line. And then if you put stock prices on top of that line, long-term, not too volatile. And as you shorten the time horizon, they get more volatile. And what tends to sometimes happen is that when earnings is above that line, the stock market is even farther above that line because there's a lot of excitement. And then that can jump around on both sides of the long-term trend. And it happens for the market, it happens for different companies at different times. But your point is bang on. If you own a diversified pool of companies and you're always focused on the ones where the optionality is hopefully in your favor, you can deliver that line or slightly better with less volatility over time.

Exactly. And that I know is the Stu Kedwell philosophy on how you invest, which is what we bring to the listeners every week on Stu's Days. Or in June, maybe only a couple of weeks. But it's great stuff anyways. And of course, we've got a real depth of guests that we have on. But Stu, it's always great to catch up with you and get your thoughts on everything that's happening. Part of it is information flow, which is only going to increase with AI. But it just seems to be a really, really interesting period in markets. And that's why I know how busy you are as you run around the world in the role you've got right now.

Yeah, we'll have to cover this the next time but we got Canada Day next week, and then we'll be back at it afterwards. I was also at a conference with a bunch of business leaders and some ministers of the Canadian government, and I think that there's also some cautious optimism growing around the trade file. And we'll be back to talk about that in the next session as well.

Look at that. That's a teaser. A Stu-easer. He's not only a great asset manager, he's learned about marketing and broadcasting. So yeah, that's right. You throw the teaser up. So hopefully the listeners will be back. Stu, have a great Canada Day. You are following the soccer, right? I know you follow.

I am, but it's not my sport. It's hard not to watch and not get caught up in it, but really it's not my area of expertise.

Well, I mean, it's just like hockey, but you know, it's a ball and they're wearing shorts and that stuff. No skates, no sticks. Which is probably a good thing. So Canada Sunday and Canada Day Wednesday. Stu Kedwell, next on Stu's Days. Stu, have a great weekend. We'll see you soon.

Thanks, Dave.