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In this episode, Stu Kedwell, Co-Head, North American Equities, RBC Global Asset Management, gives his thoughts on the factors driving market behaviour over the last few months, and how they play into investment decisions. Stu also unpacks the forward-looking nature of the market -- how it not only saw ahead during the depths of the crisis, but also projected the economic rebounds seen in recent weeks. (Recorded July 7, 2020)


Hello and welcome to the Download. I’m your host, Dave Richardson, and I’m joined for Stu’s days by Stu Kedwell, co head of North American Equities at RBC Global Asset Management. Stu, welcome back.

Good morning, Dave. Thanks for having me, as always.

One of these days, we’re not going to be able to do Stu’s days because you’re going to take a well-deserved vacation. But at least we’ve been able to keep it going thus far through the pandemic. And that’s really the topic I wanted to cover today. I was having an interesting conversation with Dan Chornous who was on the previous podcast, off-line yesterday, about the markets and really how the markets as a forward pricing mechanism or as a mechanism that looks forward and somewhat tries to predict what’s coming down the road, has, up until this point — at least seem to have — done a fairly good job of projecting the path through the virus. So in other words, the market was a little bit ahead of seeing the full danger and depth that it could create in terms of an economic crisis through the middle of February and into March before a lot of political leaders really started to put lockdown measures in place and take the virus as seriously as they needed to. And then the markets seem to get ahead of what might be a recovery out of the virus. And again, we’re speaking purely economical here. We’re not talking about the health piece of it. And now the markets continue to go higher as cases are starting to spike again in some parts of the US. And, Stu, just how do you make sense of this from an investment perspective? Do the markets have it right or what are they missing right now?

Well, it’s a very interesting question and it’s something that we were discussing a lot. I think there are a couple of things that we need to think about in this environment. The first is the general market behaviour. Environment bad and getting worse? That’s concerning. Environment bad and not getting worse? Stock markets start to improve. Bad and getting better? Markets start to really do well. Good and getting even better? Markets start to do really well. And then markets normally kind of top out when it’s good, but not getting any better. So I think that’s part of the rule here, because while cases are spiking, you see states shifting from phase two to phase one, or phase three to phase two. You haven’t seen big shutdown activity, which really threw people for a loop in March. Warren Buffett at his annual meeting said the economy had never really experienced anything where you were driving down the road at a very fast pace and everything just got immediately to the side of the road. And while the cases are rising, the question will be: can the economy muddle through this path, which does keep some activity flowing? And that’s a lot different than an outright shutdown. So maybe that’s what the market is trying to figure out. The second thing, it really has been dominated by a handful of stocks. And we’ve talked about this for a while. But even in the last week or two weeks, as the cases have risen again, the market leadership of Amazon, Microsoft and Apple has kind of reasserted itself. Those stocks have very good financial conditions. They have very interesting growth trajectories. There are always questions over regulation or taxes in the future but the market tends to look out 12 or 18 months and chances are these businesses will be quite strong during that period of time. And when you have these big companies doing so well, they kind of drag the rest of the market with them. Some of the stocks that maybe are a little bit more exposed, if the economy slows down a little bit again, those actually haven’t done as well. And some of the areas that had spectacular gains off the bottom after being impacted significantly — like cruise lines and casinos and things like this —, they’ve really stopped participating in the last couple of weeks. So it has been dominated by some of the big software companies, some of the big consumer electronics, some of the payment stocks and semiconductors, those have really driven the markets during this period of time.

Yes. It’s been really incredible to watch some of these leading tech names. Of course, some of them are big companies that are virtually everywhere, especially in a virtual setting. Then you have companies like Tesla that, again, has this incredible technology. There’s a lot of aspirational value to Tesla. And people get excited about the vehicles and such, but it moves forward. Is there a point where these companies just get to valuations where they can’t go higher regardless of what we’re going through in terms of Covid-19? Because I think we would’ve said coming into this that the valuations on some of these companies were stretched.

Yes that’s also a very good point. We don’t see that in some of the very large companies, while their valuations are elevated relative to history, they’re not at 2000 levels. But there are a handful of stocks that have become kind of story stocks. You mentioned Tesla. When you look at those valuations, one thing that we spend a lot of time looking at on those market-barrelling stocks is price to sales. Traditionally we will look at price to earnings, right? A bank would trade at 10 times earnings or 11 times earnings. And in some cases, these stocks are trading at 20, 30, 35 times sales. Which is really considerable. It means that the margins eventually have to be very robust and the sales growth has to be tremendous in order to get you your return in the next 3, 5, 7 years. And we have seen that historically where companies like Wal-Mart or Microsoft at their zenith were very good companies and they ended up being very good companies, but they just didn’t end up being very good stocks because the market’s enthusiasm for them pulled all of that forward. Microsoft hitting its high in 2000, it was many, many years before it reached those levels again because of the valuation, not really because of the business itself. Same to be said for Wal-Mart — I remember, just before I joined Global Asset Management, when I was in capital markets. Some of these stocks had valuations of 40, 50, 60 times earnings because the market was so excited about their future growth. By and large, much of it was delivered for some of these big leaders, but the stocks themselves were never that great.

Well, again, an incredibly interesting market. We got earnings season coming up so we’ll get into a first peek of that next week, Stu. As always, thanks for your time. Always interesting.

Great. Thank you, Dave. Thanks for everyone’s time.


Recorded July 7, 2020

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