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This episode, Stu Kedwell, Co-Head of North American Equities, recaps the events of the first quarter -- from accelerated vaccine rollouts to rising bond yields. Stu also shares his thoughts on where interest rates could go for the rest of the year, and what investors should consider. [9 minutes, 22 seconds] (Recorded April 6, 2021)


Hello and welcome to The Download. I'm your host, Dave Richardson, and it's (S)Tuesdays! Stu Kedwell, Co-Head of North American Equities at RBC Global Asset Management. Welcome back for (S)Tuesdays.

How are you doing, Dave? Thanks for having me again.

I'm good. And now we got a new regular— or at least semi-regular— feature of (S)Tuesdays: the Stu Review. What do you think of that? I like it. There we go. It's good to have a flexible name like Stu, and that flexibility helps you as an investment manager. But Stu, all joking aside as always, with the Stu Review, interesting first quarter, to say the least, in terms of what's been going on in markets in 2021. When you look back at the first three months of the year, what really struck you or what do you think investors should take away from what we've seen through the first quarter?

Well, starting with the vaccinations, you had the approvals or the finding of the vaccinations in the fourth quarter of last year. You had this aggressive move towards a reflation and reopening. You’ve seen moves in the bond market in that period of time that hadn't been seen in some time. The 10-year bond really aggressively moved higher. And anything associated with what the economy might look like on the other side of reopening, doing extremely well. That was a huge feature. The way that manifest itself was the average stock that did better than the index. We can look at the S&P 500, which is a market cap weighted index, dominated by Apple, Google and Amazon, and what have you. We can look at the equal weighted S&P 500 where everyone gets 25 basis points no matter which company it is. The equal weighted index did better during that period of time. As strong as the headline was, it was a great period of time for the average stock because the average stock needs a better economy. Whether or not you're an energy company, a financial services company, an industrial company, the idea that the economy was going to reopen, that we were going to probably be vaccinated by the summertime was very powerful for the long nose of the stock market to sniff that out as we move through the first quarter.

Yes, and we touched on that on some of the podcasts. I encourage people to go back. If you haven't already, if you're new to the podcast, go back and listen to some of that. These are all five to 10-minute podcasts that we've done with Stu most Tuesdays in the first quarter. We touched on a lot of these issues. We looked at the energy sector, financial sector, what we call old industries or the older part of the market dividend focus that responded well in the first quarter versus tech that was pretty strong in the first few weeks of the year, but then certainly tailed off in the second half of the quarter. Then obviously interest rates as well. So Stu, that puts us here in the first week of April. What do we see carrying through from the first quarter into quarters two, three and four, as we go through the remainder of 2021, from your perspective?

Well, it's a great question. The first thing is, the economy is likely to be really strong in the back half of the year. Just as no investors had seen the economy contract like it did right after COVID, in all likelihood, very few investors will have ever witnessed the strength that we might see in the back half of the year. Now, the key question from an investor standpoint is not how strong will it be, but how strong will it be relative to expectations. And that is something that's obviously a little bit harder to reconcile at this juncture. We look at the move in interest rates. That's not a bad starting point because when a 10-year bond moves the way it did, and you're trying to figure out, well, the Fed has told you we're going to try and stay on hold in terms of raising interest rates for as long as we can, and there's this tension in the marketplace where, well, what if the economy's really strong and the Fed's on hold, will we have inflation? So, when the 10-year bond was at, say, 1.75% towards the end of the first quarter, you can sit there and say, well, what if there's no interest rate increases for the first year, the second year, what have you? And embedded inside of a 10-year bond is one 5-year bond for the next five years and another 5-year bond for the five years after that. Then you can use math and say, well, what is the bond market when the 10-year bond is 1.75%? What is it telling me about a 5-year bond in five years? And that rate, when the 10-year was 1.75%, was probably around 2.25%. That's probably not a bad spot where the market's going to digest things for a little bit. If inflation runs around 2% eventually and a 5-year bond was 2.25%, that would mean that the real rate was around 25 basis points or 0.25%, which is probably not far off what the economy could actually handle. Today real rates are still negative. But once you get there on interest rates, it creates a bit of a pause all over the place because you have bank stocks that have done really well and then you say, well, what if rates don't go a lot higher? What if they just are here for a while? You've had economy stocks that have done really well and people are starting to say, well, it's strong, but maybe it needs time to digest a little bit. And what we saw right off the bat, as we started the second quarter, was a bit of a move back towards some of the traditional growth stocks. So, the Microsofts and the Apples and things like this, the Googles, have had a very good run in just the last three or four days, as money has rotated around a little bit. The discussion becomes, I know the economy is going to be strong, but is it going to be strong enough to maintain all the momentum that was in place? Maybe I should move the portfolio around to hedge my bets a little bit to say, what if it's really good, but not spectacular relative to expectations?

That's really interesting and it does explain a little bit of what we have seen over the last week where some of these growth names, as you suggested, have really come back nicely. And interesting to put it in the perspective of hedging your bets and in terms of where growth may be and given where interest rates may go over the next six to twelve months, after this huge run that they've just had in the first quarter.

The two things that investors always focus on are the absolute level of something— definitely important—, but also, the rate of change is almost more important. A 10-year bond, I think everyone would like to see it at 1.6, 1.7 or 1.8%, and that's a healthy level for all sorts of things that make money off of interest rates. It could always be higher, of course, but it's not a bad level. But if we were at 1.4, 1.5, 1.6 or 1.7%, that's a very good rate of change. If all of a sudden, we have a couple of months where we just sit here. You know, the stock market likes rate of change. So, if they decide that's dwindling a little bit, they might go look for it somewhere else. And there are some of those big cap technology names— and we've talked about the three buckets in the past—, there are some very highly valued tech companies where we're unsure if the growth will live up to expectations. But there are some very solid tech companies— the likes of Google and what have you— where valuation has been reasonable and there's growth to come on the other side of the economy as people start doing, say for Google, travel searches and all sorts of things. Yet the core business is still really strong because people are still watching YouTube like crazy and things like that. So, you sit there and say, well, maybe this business, it's not a bad spot that I might look at. There are others like it that fit that cap. So, we like to look at ratios a lot. You can look at a business that you own and one you don't, and if the relationship was, say, four shares of one to one share of the other six months ago, and that relationship went to two shares of one to one share, you might say, well, maybe I'll just flip that ratio back a little bit inside the portfolio. I've still got good exposure to both, but I've just altered it a little bit as I look forward.

Yes, and that rate of change thing really strikes a nerve with me. I go to the doctor and he tells me I'm 30 pounds overweight, but I've lost five pounds each of the last five years. And then I lost 10 pounds this year. So, my rate of change is actually improving. Stu, you should have me as a stock on your radar. So that was a great Stu Review. Stu, thanks for your time again today.

Thanks for having me, Dave.


Recorded: April 6, 2021

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