Transcript
Hello and welcome to The Download. I'm your host, Dave Richardson, and it is Stu’s days, another tarrify Stu’s days. Stu, I think this may be an ongoing theme for a bit.
I think, unfortunately, it's likely to continue. The on-again-off-again nature of tweets and posts on True Social and all sorts of things, unfortunately, is likely to continue. The pace has been fairly frenetic. I was joking. An old stock market-ism is when you're fighting an 800-pound gorilla, the fight doesn't end when you're tired. It ends when the gorilla is tired. That's a great line for this environment. And we're seeing things get posted and then taken down and changed and all sorts of things. So we've had a bounce. It's been quite significant off of the lows from a couple of weeks ago. I think we have to think about this in a number of dimensions. From a longer-term standpoint, we often talk about the earnings growth. Companies are remarkably resilient at finding ways for earnings growth. Tariffs could be a headwind; artificial intelligence could be a tailwind. Undoubtably, companies will be more creative than we can imagine. But the other thing that comes into play in the shorter term is the multiple that those earnings trade at. The multiple is a function of interest rates and risk premium and the predictability and duration of growth. Unfortunately, each one of those three have taken a bit of a knock in the last couple of weeks. So as we get this bounce, we have to be a little bit wary of «up, up, and away» because this is likely taking a chunk again out of those three components. And earnings estimates are likely to come down based on what's gone on with confidence and what have you. We're in a situation where the economists are saying the S&P can do $250 of earnings without a recession, but the individual estimates are still in the 275 range. And often those in a good year normally narrow over time, let alone in this environment. So the stock market has bounced back right to where it was on Liberation Day, yet I think there is the possibility for a bit more lasting damage from this.
One of the things that I always remember from talking to you and listening to you over the years is that idea of in most years, you start off with estimates around earnings. So you put a number on the earnings for all of the S&P 500 or the TSX, whatever it might be, and then it's not unusual to see those early-year forecast or long-term forecast tend to be a little bit too optimistic and tend to ratchet down through the year, let alone if you have a period where businesses are operating in the midst of a really foggy weather pattern. I would imagine that even if you lift all those clouds, if the fog just clears tomorrow, that you've already had some damage done to earnings and economic growth just from where people have been almost stalled or paralyzed over the last two months waiting to have some clue of exactly how this plays out.
Yeah, it's one situation where you wouldn't want to bet against that. Maybe we put it that way.
Yeah. We see it with individual investors. I just did a presentation for a group of real estate professionals across the country. They're seeing the same thing. It's just people are individuals and businesses which generally are able to see through the clouds or want to try and see through the clouds a little bit more than individuals. Everyone's a little bit, let's just see how this plays out. And anytime that happens, it can't be good for profits, and it can't be good for economic growth.
A couple of things that we've been doing. You have the overall situation where markets have bounced back. So you're trying to take into consideration the intermediate term, which is a bit cloudier. When markets are under a lot of pressure, we tend to try and think about what good can happen. So when markets are under a lot of pressure, the statistics start to really come your way. When markets go down, it augments your long-term returns. So in the midst of some of the selling, even as recently as a week ago, the return potential went up. So we're trying to be mindful of that and take advantage of that in accounts. And then when come returns, maybe you're thinking about some different things and what this means for the intermediate term. And then the other thing you're trying to do is also think on the other side of this—because eventually we'll reach some conclusion and business will adapt—which areas might have the wins in their sales. And a couple of things that stick out is term premium in the bond market, so a slope the yield curve has been stronger, and we think that's going to continue. Now, that can be good for people that lend money. It's very different than what we've had for the last 10 years. The second thing is you see a lot of announcements of investment, not just in US home markets, but remilitarization, all sorts of things. There could be a lengthy period of investment, of capital investment. So that could be good for some industrial companies. It could also be good going back to the banks for loan growth. So while we might have a slowdown that impacts some of the numbers of some of these companies, there might be higher provisions for credit, there might be a slowdown as there's some uncertainty that you just mentioned. You're also in the back of your head trying to think, well, where will the tailwinds be on the other side of this? And through this volatility, how can we position the portfolio to benefit from that over time as well?
For new listeners—because we've got a lot of them more and more joining, and particularly through these periods of uncertainty—I'm talking with Stu Kedwell, who is the co-head of Global Equities at RBC Global Asset Management, and someone who is a renowned investor in Canadian circles. He's very humble. He's going to give me a dirty look for that one. The podcast is The Download, but we have Stu on pretty much every Tuesday. So we've renamed the day of the week «Stu's days». That's where we started. If you love what you're listening to—and I know you do because of all the five star ratings—click subscribe. We're also on YouTube. Most people prefer listening to us than looking at us, but you can watch us on YouTube, you can subscribe to that, and we'd love you to do that as well. So, Stu, if I'm an individual investor, one of the things we were talking about before we started recording is the idea of when you start to look at long-term returns—and this is one of the things you always want to think about as an investor, and for me, it's one of the things that I talk about with advisors who are advising investment customers—is this idea that when the market goes down, what most people miss in the fear and the anxiety about, well, could it go lower? So we were sitting today as we're talking, the S&P 500 is at 5,400, pretty much right on the nose. We got down to close to 4,800 at the bottom, post Liberation Day. And just the difference, if you look forward 10 years—so if you think about where things are going to go off 4,800 as your base and what your future return is going to be over the next 10 years, and you look at 5,400 as your base—what a difference that makes. And if you think that way about it, you're much more likely to get through all the cloudiness and to get through the fear and anxiety and actually act when your forward returns are better. And that's one of the things you want to do as an investor is you want to invest when the odds are more in your favor. Now, it doesn't mean that it stops at 4,800. So it did this time and bounced back. It could very well go back down to 4,800 and maybe even lower. But things start to get more interesting when you get to particular valuations. And that's something that you think about as a professional investor.
If you took the S&P 500, 7% earnings growth over a long period of time has been a pretty good number. They arrive at it in a number of different ways. As I say, if you sat here today, you might think, well, tariffs could be a headwind, but maybe there'll be efficiency gain from artificial intelligence and things like this and it could be a tailwind. So estimates for this year's earnings range between $250 and $275. So in 10 years’ time, it wouldn't be unbelievable to see the S&P earning $500 to $600, even if we had a modest recession this year and the starting point was lower, likely some type of recovery and then back on that track to some degree. You have this earnings number that sits out there on the horizon, and then you can apply a valuation to it. You could apply a long-term average, which might be 15 or 16. It could be as high as 18. You have goal posts for a bit more of a sanguine scenario and a bit more optimistic scenario. You can run that to path back to whatever the starting point is. That is a great marker to have on your map. It's like you head off to see something significant and you know it's going to take you a couple of days to get there. The second thing that you can do in those environments is run a lot of statistics. When the market is experiencing that dramatic a sell-off, we can look at a variety of internal statistics in the market, and they've happened before, which is the first good thing to recognize. The second thing is, when they've happened before, we got lots of examples, the return potential—forget valuation—just the return potential during those types of sell-offs is normally pretty good on a 6-12 month basis. Unfortunately, just how far we've come in the last 10 days, on the bad days, you're thinking about the longer-term goal post, you're thinking about the statistics on some of those stock market technical data. Then when we go through recovery and you try and think about the things that caused the recovery, then you have to sit and say, well, they persist. Are they factored in? You have to begin to think about it in a little bit of a different manner, unfortunately, in a volatile environment. A lot of money managers like volatile environments because there's lots of money. I don't mind the environment from inside the portfolio standpoint, although I know it drives unit holders nuts. There's a great line that capital love certainty, but it's the uncertainty that creates the returns. Unfortunately, all that's likely to persist for a period of time. What investors should be thinking about is to be flexible in their approach. During downturns, you want to be thinking a certain way. During path of recovery, you then want to think, well, is the recovery good enough? Is this the stopping of selling pressure or are we actually embarking on a new up leg? That's a more difficult discussion at this juncture, unfortunately.
Now, the other thing that happens. So you talked about who are the winners likely to emerge on the other side of all of this. And then when something like this is happening, generally the stuff that went up the most before it was happening has fallen the most from the peak. And then when you get the bounce, those end up being the ones that bounce the most, as we've seen three through this cycle. Do you start to set up your portfolio with an eye more towards what's going to emerge out on the other side, or do you still want to take advantage of some of the stuff that you think might get the bigger bounce in the near term? Or is it a bit of both?
It's a bit of both. I tend to like to err on what I think is going to emerge on the other side because I feel like it's a little bit more defensive in the grand scheme of things from a portfolio standpoint. The other thing that we should notice is not just within a portfolio, with some of the movement in currency markets, we'd already seen strength from international stocks leading up to this, and we've seen that carry through. It's been amplified by some strength in the local currencies. When we look at long-term trends of the European stock market and what have you against, say, the S&P 500, they're really testing 12 to 15-year downtrends. They're doing it at a time when there are some sea changes potentially going on in currency markets. That's another thing that we're very watchful for. You get lots of experts on currency. I'm the last one on that conversation. But currency moves tend to be very long term in nature, like multi-year strength and multi-year weakness in the US dollar. I'm on the lookout that this is the beginning of a period of maybe more weakness for the US dollar. We talked about it a number of months ago, the Canadian dollar hit its worst the Sunday night of the initial tariff. It was 1.47, here we are at 1.39. And it's been similar for the pound and the Euro and things like that as well.
Yeah. And something important to look at. Dagmara Fijalkowski, who we've had on as a guest many times, we'll have her on again, she's been talking about the extended period of US dollar strength and expecting for a while now to see the US dollar weaken. And sure enough, if you look at the US dollar against other currencies—there's an index that tracks that—it got up to around 115, and it's sitting around 101. It was actually under 100 at one point last week. So just right off the top, there's a 14% drop in the currency. And that's a significant amount. Again, if you buy a stock in the US, you convert your Canadian dollars to US dollars, you bring them back. If the Canadian dollars appreciate, you buy fewer Canadian dollars. So you might have won on the stock purchase, but you lost on the currency. And again, long term, those things tend to even out. But in the near term, it is a factor in your decision making. And the US dollar isn't just showing that weakness against the Canadian dollar, as you mentioned, it's against all currencies, really. And that even might even be part of the overall strategy around what the US is doing around tariffs and trade, etc.
Yeah. I do think the one thing we definitely take a note of is the dollar was weak at the same time as the stock market was weak and the US bond market showed some weakness. And it's rare that all three of those things are weak at the same time.
And let's just touch on that very quickly, and then we'll wrap up, Stu, is the bond market. So we saw coming out of the fear that the tariffs might cause a recession, we saw the 10-year US Treasury, which is a benchmark long-term bond that you'd watch around the world. It's just the safe haven. The yield dropped from 4.40 to... Well, let's even go do the whole drop. It dropped from 4.80 down to 3.80. And then in over a three-day period, it moved back up almost to four and a half. That's unusual bond market behavior. And one of the things that we often talk about is you'll see that volatility in stock markets. We'll see big moves in the stock market. But then you look over at the bond and currency markets, and what you'd like to see there is some stability. And initially, we saw quite a bit of stability in the bond market. Then we saw things looking to get a little bit out of hand there. And coincidentally, that is when the 90-day extension was put in place on the tariffs.
Yeah, there's a great line from President Clinton's presidency. One of his advisors, James Carville, said, if I come back, I used to think I'd want to come back as the Pope or a 400 baseball hitter, what have you. But what I really want to come back as is the bond market because you can discipline anyone. The thing about the trade deficits, there's the current account and the capital account. So a trade deficit often comes back in the United States through the capital account. There was a concern there, well, if there's less current deficit, there'll be less capital surplus. The whole funding mechanism of the bank or of the country. I think it was magnified by a bunch of leverage in the short term that some participants use. But still a reasonable shot across the bow that inside of economics, there's a lot of systems that counterbalance each other. So when you think through the impacts of this—and I think that's why we're seeing some start/stop nature around some of this—that is likely to continue.
Yeah, and we should get into that leverage stuff a little bit more because one of the things that I think people understand is, it's one thing if I've invested in something and it goes down and I'm losing my own money, it's a completely different thing when you're losing somebody else's money. And that can create bigger swing. So I'm glad you brought that up. Well, Stu, we better stop there because we've covered a lot of ground here, and we always have more grounds to cover next Tuesday. So again, please subscribe. Stu, thanks again.
Thanks so much, Dave.