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About this podcast

This episode, Stu Kedwell, Co-Head of North American Equities, looks at the market reaction to positive CPI data in the U.S. and what it says about the possibility of interest rates moving lower in the future.  Stu also discusses how businesses and consumers can manage their expectations in the meantime.  [12 minutes, 8 seconds] (Recorded:  November 14, 2023) 


Hello and welcome to the Download. I'm your host, Dave Richardson, and it is Stu's Days. A very special edition of Stu's Days. It's Stu's Days on the subway. Stu is down in the subway in Toronto. The exciting TTC, the Red Rocket. What else could we call it, Stu? You look pretty comfortable?

A good friend of mine used to call it the 52-window sedan.

There you go. Just keeping in theme, Stu, were the windows clean or no, not so much?

Not up to my standards, Dave.

Certainly not up to your standards. But this is a very important report. If you get nothing out of today's podcast, how's the data signal down in the depths of the subway in Toronto?

It is amazing. It's not everywhere, but from Bloor to St. George, it's incredible.

There you go. So if you're in the core of downtown Toronto, you can take your phone, your iPad on the subway and it's pretty much just like you're working at home. And another special feature for today, we'll have some of the sounds of Toronto in the background along with Stu's thoughts on the market. And hey, the market is powering along like a subway through a tunnel today. News out of the US CPI number came in flat month over month, below expectation in general. Some of that is energy prices that have fallen, but the rate in the core is down as well. And that has taken the expectations around what the Federal Reserve is going to do down to pretty much zero, about raising interest rates again. And that has just been a game changer in markets and a super powerful rally. What do you take out of everything that's going on this morning, Stu?

Well, no question, Dave. I think generally things are unfolding as you might expect. But when you get these specific announcements and people see it with the whites of their eyes, the reactions in markets are quite volatile. People often use the word volatile on the downside. But the up can be volatile as well. And you're sitting there today with interest rates that respond quite significantly to lower inflation. And the reason for that is real interest rates were positive. So the number you see on the headline minus inflation was a positive number. So you were receiving real interest rates and now you take inflation down. But, you also think, well, maybe real interest rates don't need to be quite as high either. So the combination can be significant and people will say, well, why is the reaction so big? And we've talked about it before, where the markets are always trying to reprice the odds of certain things taking place. And today what you're repricing is the idea that the Fed can be more patient, that, yes, they know monetary policy is functioning with a lag, but if they start to see any slowdown, they can change their tune a little bit because they have this dual mandate around inflation and unemployment. They were very focused on inflation and likely will be, but if that concern is receding a little bit, should you get a slowing economy where unemployment ticks up, then they can respond to it a bit faster.

That dual mandate is important. We talked about it with Eric Lascelles a couple of weeks ago on the jobs report because the jobs numbers have been softening up both in Canada and the US. Unemployment rate has ticked up, a lot more than people would realize if they were watching the numbers every month as we do here. That dual mandate and the focus can shift very quickly when people are losing their jobs.

Yeah. From an investor standpoint, do I want to look across the valley? If earnings are slowing or a bit more challenged and everyone thinks the central banks are going to have to be quite tight regardless, then people's patience on what across the valley will look like, shrinks. And then when you get announcements like this, it expands in a hurry. And that's why you see such volatility.

And you've got this period then, Stu, which we were talking about before we got on in terms of back and forth on earnings. Some of the companies that have reported have laid out that they think the next year might be a little bit more challenging. But you put that in the face of these potentially lower interest rates, maybe even rates coming down over the next year, and that's that volatility you're talking about, right?

A hundred percent. Something we've also talked about is that the market has bifurcated. There's been a handful of stocks that have done quite well, but there's been a broader number of stocks that haven't been as good. And the one thing that you always look for is: do stocks go up when there's bad news? And it's been difficult for those stocks again, because people say, well, the central banks are going to have to remain very vigilant. And I think they still will be vigilant. It's just all relative to expectations. Maybe that eases off a little bit. But if you see companies delivering bad news and starting to go up in share price, then that's the market's way of saying we know that, we're looking forward. And today there was a big home improvement retailer who delivered numbers that were in line with expectations. The guidance wasn't great, and the stock has really done quite well off the back of it. Again, how much does the market already know around earnings? And then that slight tilt, perhaps, on interest rates, it has a big change in dynamics. And that breadth thing that we've talked about in the past. Today, the market is quite strong, but the more interesting statistic is that the broader market or the equal-weighted market is doing even better. The average stock is doing better than the index, versus we've been in the reverse. So those periods of time when they talk about the Magnificent Seven, when there's not going to be much economic growth, earnings are going to be driven by themes— maybe it's artificial intelligence, cloud storage, you name it— that is a very narrow-driven market. It still drives some returns, but maybe not as healthy as when lots of stocks are working. So we'll have to see the statistics. At the end of the day, people will ask: was it a 90%-up day? Did much of the volume trade up? Did much of the names participate? So we'll see how it closes and to see if that was confirming or not. But, yeah, that lower inflation data certainly has triggered some movement today.

We look at today, you've got your Magnificent Seven, and then you've got your S&P 493 that we've talked about before. And today the 493 are winning for once. And that has just not been the case throughout 2023. And it's been something that you've talked about repeatedly on this, waiting for that broader market, that S&P 493, to actually show some life relative to that small group of stocks that's been winning. And that's what we're seeing out of this rally, which, again, is giving that message that the data that came out today, the message we're getting from the Fed, is that we're pretty close to over, if not all the way done. And then, as you say, you look out a year from now, what are they doing with rates? Where's the economy? And then where is the economy going to go beyond there? And it's starting to look a little bit better than it was even just three weeks ago, because November has been quite a strong rally overall.

Markets are always trying to figure out what the economy and the backdrop will be in 6 to 12 months. And that backdrop can be different if central banks don't have to be quite as vigilant as expected on the interest rate front.

The other thing as well, just straight off of base valuations, lower interest rates are going to make whatever the companies are earning right now, those profits and their future profits are worth more.

That's right. In particular during a period when profits might be struggling, it doesn't force people into decisions, it allows them some leeway, which is easier to manage the business during periods like that.

And you had a great analogy. We'll just close off with this, Stu, in terms of how you can think about what's going on in maybe your personal life as a consumer, homeowner, mortgage payer, or whatever it might be, relative to a company, and some of what the company goes through as interest rates go down. Or even, for that matter, with the amount of debt that governments have. Even governments and the amount of debt that they have as interest rates go down. Why don't you tell that story, just to close things off?

Well, if you took an individual or a business and they generate so much cash flow a month, whatever that cash flow is, yesterday, you might assume this much of it's going to get eaten up by interest payments. Then you have what's left over and you think that they’ll have to be pretty stingy with what's left over. Today what the market is trying to recalculate or recalibrate the odds around is, maybe those interest payments could be a little bit less, which means that the amount left over is a little bit more. That little bit more can then be used in more varied ways. In simple terms, if you were a taxicab driver in Toronto yesterday, you're sitting there going, that guy's going to get on the subway and do his podcast from the subway. But today you might be sitting there, and there might be a little bit more change in this guy’s jeans tomorrow, and maybe he'll take a car instead of getting on the subway because he's got a little bit more income, because of very small change in interest rates that may have come from better inflation news.

Or even the wealth effect from his portfolio being up. I'm sure your portfolio is today, Stu. It must be a pretty good day to be an investment manager.

I don't tend to think about it like that. But it's not a bad day, that's for sure.

I know you don't. You're always focused on the long term, buying good businesses, getting good income or payback out of those companies. Which is why Stu is still on the subway, despite what's going on today. He's not taking that cab. Even keel, always frugal.

The subway gives you a little bit more money to put into the funds.

Excellent. Well, Stu, thanks for joining us from deep down below Toronto. It was a unique experience for us, and hopefully we'll see you next week above ground. Hopefully you do get out of there because it's pretty crowded this time of day in Toronto.

That's right. Well, great. Thanks for having me, Dave.

Thanks, Stu.


Recorded: Nov 14, 2023

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