Hello and welcome to The Download. I'm your host Dave Richardson, and it is a super special edition of Stu's Days where we're always joined by the Global Chief Investment Officer of RBC Global Asset Management, Stu Kedwell. And Stu, we're launching a new segment today. This is Stu's Views on the News. What do you think of that?

It reminds me of a show when I was a kid, which was Gary Gnu, a cartoon in the morning: All the news with Gary Gnu.

All the news with Gary Gnu. Or all the news with Stu Gnu. Ah, well, someone will probably send us a note and tell us what we should be calling this. But it's really one of these, Stu. We always get together for a good 30 seconds or so and talk about what we're going to talk about for the next 30 minutes. And what kept coming up is some of these stories in the news. You've been out with some investors over the last week. I've spent the last couple of days in Montreal talking to a lot of investors. And they're asking questions about some of these things that are happening. One example is this Situational Awareness fund. And how do these funds work? About margin calls. About South Korea and the Korean market that exploded all around really a couple of stocks. You had people leveraging their house to go and buy more of these stocks and then they dropped 30% and there's a big problem. So, Stu, maybe the best example from an educational standpoint or lesson learned, when you look at that Situational Awareness. And maybe I'll give it to you because you can likely explain it better than I can and what happened and what are the lessons that we can take away.

Well, yeah, it was definitely an interesting couple of weeks, and in some respects, history always rhymes to some degree. This fund maybe using a bit too much leverage unfortunately is a story as old as time. I think there's two approaches from an investment standpoint. The first is, you look at something, and you think you have it figured out, and then you ask yourself, well, what happens if I'm wrong? And so then you're trying to reap return, but you're managing risk. And then there's another component that says, well, if I'm right, how do I magnify the results? And this is the same thing that we see from investor psychology, all through time. Sometimes psychology is quite bearish. Sometimes it's quite bullish. When psychology is bullish, you often get a cohort of people that try and magnify the return potential during that period of time. When I started in the business in 1996, a couple of years later was Long-Term Capital Management which was the same type of fund using a significant amount of leverage to try and amplify returns that were available in their strategy. So, in the case of something like Situational Awareness, one of the discussion points with all of artificial intelligence has been how it will be very good for the semiconductor stocks and the companies that are supplying the picks and shovels, building out data centers. And it might be a challenge for some traditional business models that could be threatened by artificial intelligence. Will software be rewritten by the machine and so forth. So, in a conventional portfolio, you might have more exposure to the semiconductor stocks and slightly less or no exposure to the software. In some hedge funds, you might magnify your exposure to the semiconductors, and you might actually not only not own software but shorting it, which means betting against it. It's probably worth just a couple of seconds on what shorting means. By definition, if I'm short of something, it means I need to somehow get it back. So I go to you and I say, Dave, can I borrow your car? And you say, yeah, sure, here's the keys. And I'm driving the car down the street and then I decide, you know what, I'm happy on the bus. I'm going to sell Dave's car for a day. I'm going to go sell it to someone else and I'll buy it back tomorrow when I need it. But for right now I'm going to sell his car and I'm going to take that money and use it for different things, and I'll buy it back tomorrow. Well, if the price of that car starts to rise and I'm short of that car, for a little while I might say, well, it'll fall back down, it'll fall back down. And then something happens and the price of the car keeps rising, and eventually, someone says, look, you better act and buy back that car. And that is what they call a short squeeze. So I've borrowed something, I've sold it, it starts to rise in price relative to my position, and eventually I need to buy it back at a higher price. What Situational Awareness had done was they had bought a bunch of stocks and then sold short a bunch of stocks. And you take your money and you do this and you maximize the value, how far your money can spread across these two trades because you're convinced that you're going to be right. And then when the trade starts going against you, your broker comes and says, look, your margin account needs some more money because these trades are now in a deficit. And if you can't put up more money, the broker says, I'm going to go and cover your shorts and sell your longs so that the loans I've made to you are still money good. So anytime you see high levels of exuberance, you're going to get a small percentage of the actual owners of these securities involved in trades like this. And if they unwind, it creates all sorts of volatility. We have to always remember that if there's 100 shareholders of a certain company, 97 or 98 of them might be extremely content. But if 2 of them change their mind, it creates volatility that then makes the other 98 go, am I missing something? And we don't know if those two are changing their mind for a fundamental reason or maybe they're using too much leverage. So the decision is being made for them. And that's the volatility that really comes out in periods like this. And as I say, we've seen it unfortunately a number of times. Almost once a year you see some situation like this where someone has used leverage, and that leverage ends up creating activity that creates volatility that makes people question some of the underlying assumptions in their holdings. So, Situational Awareness, in the case of some of the memory stocks, there was these units that magnified the returns available in some of the Korean stocks. I read one statistic where there was something like 2 brokerage accounts opened in Korea for every Korean, during a period of time. So that's an enthusiasm. That's like I want to get involved in this. And it has created a bit of a challenge anyways for some of those investors. There's no right or wrong when you're using leverage. But for sure, when you use leverage, it's going to magnify the results.

Yeah. And that leverage, just for everyone, that’s basically borrowing money to invest. The most common leverage that a Canadian investor would have is their home, a mortgage on their house. The house is worth $100,000, they've got $25,000 that they put down to buy the house. The other $75,000 is a loan. So you've leveraged your $25,000 up to $100,000. Now, what's different is your house price doesn't move 10 or 20% like some of these stocks have been doing lately in a single day. There's not a ticker going across your front lawn saying this house is now worth 20 or 30% less than it was yesterday. Whereas in the stock market, we can all see those moves right away.

Two great points about that. First, there's not the sign going across your lawn what your house is worth. And secondly, if there was a sign and your house goes down, the bank doesn't make you put more money up immediately the way they do in a margin account in the stock market.

Yeah, and that's one of the things I think this podcast has achieved, is that people listening realize that bankers are nice people, you and I being great representatives of that. But yes, that is true. Somebody comes and knocks on the door and says, hey, we need $20,000 or we need $30,000. That doesn't happen in housing. But nevertheless, it's leverage. And one of the things you can see out of leverage used judiciously, used properly, is buying a house and having a mortgage and paying down that mortgage over time. It works very well. It's a way of accumulating wealth. And in most cases, particularly over the last 50 years in Canada, housing prices have risen. So you're getting the full appreciation of the value of a house along with your down payment. And you're able to do that because of your ability to leverage. But that's done in a very, very cautious way and up against an asset that's nowhere near as volatile as what we'd be seeing with these assets.

Yeah, that's bang on. However you go about investing, one of the things we've talked about over and over again is the importance of scenario analysis. When I enter a transaction, whether or not I'm using leverage, I want to understand this wide range of outcomes because there'll be things that I haven't necessarily thought of that might present themselves. Or there might be things I have thought of, but they'll be interpreted differently than I imagined. What is my buffer? What is my ability to withstand some of the different scenarios? And trying to do your best about rolling the movie forward and understanding all the different ways it could play out relative to my position is very important as an investor. The other thing that goes undiscussed during some of these periods of volatility is, going back to the first principles, the financial plan that becomes unbelievably important. Because when there is strong returns that maybe people have witnessed, it's impossible not to be lured to find some interest in strong returns. But you go back to your financial plan, and you made assumptions about the types of returns you might earn, the amount of money that you need at the end to generate the income and the retirement that you want. And the financial plan is what allows you to turn the volatility into your friend. So there'll be periods of time when markets are down and you can re-engineer your plan so that you can add to assets at attractive prices. And there's other times when markets do extremely well and you might be advanced relative to your financial plan, and then you can turn the volatility that you see in those environments into your friend as well by re-engineering back to your financial plan. So, there's always fascination with what's going on in the market. The things that we need to do as overall investors is marry what's going on in the market with our financial plan, the timing that we have when we need the money, all sorts of things that come into play. With our financial plan, we can deal with quite a bit of certainty. Dealing with the market, just as we've seen, the level of certainty, in the short term anyways, is a little bit harder to predict sometimes.

Yeah, that's exactly what I was talking about with the investors that I've been out with over the last couple of days, the core of everything is that financial plan, because that sets up what your objectives are, the time you have to reach those objectives, and the path that you're going to take. I don't know if you use any GPS app, but I use Waze because it's a sourcing model where other drivers who are using Waze can indicate traffic situations, accidents, construction, things that are up ahead on the road. You start off with your Waze, and I'm going to go from home to work, and it carves out the route for you. But then if something happens along the way as you're driving in— oh, there's an accident on this route— so now it sends you over to another route to avoid that to keep you on track to get to where you're going to go. And Waze is like your financial planner. So you've got your financial plan, it gives you your path, and then you and your financial planner are working side by side as you're going through the years, in this case, not just a half an hour, an hour to work. It helps you avoid those little accidents along the way. But just the north star of that financial plan guides you and helps you avoid some of the pitfalls that you can have, like some of these funds. One of the things that's so important when we talk about long-term capital back in the 1990s, which we remember, and Situational Awareness, these were really smart people and they would tell you so. They were the smartest people in the room. They didn't think that this could happen to them. And then sure enough, it did. It can happen to anyone if you don't understand the risks you're taking. As you say, what can happen if I'm wrong? Because if I don't think I can be wrong, then I'm not thinking about what can happen when I'm wrong. And oftentimes this is what happens. So that plan keeps you on track.

Yeah. And it lets you know in advance, if you go back and look at the stock market over the last 10 years or 20 years, you can see, just like we're seeing right now where history rhymes. I know in my career as an investor, I'm going to have to deal with a variety of environments. I'm going to deal with some bearish periods where people are pessimistic. I'm going to deal with some optimistic periods where people are very excited. And that financial plan just reminds you that the market is there to serve my financial plan, not vice versa.

Yeah, exactly. And again, for anyone who's not a regular listener, you can follow us anywhere you get your podcasts. You can subscribe to us on YouTube. If you like, leave us a 5-star review. We haven't had as many of those lately. We're just not getting reviewed, period. It's not that we're getting bad reviews. We're just not getting as many reviews. So we'd love a couple of 5-star reviews. Our moms are getting tired, Stu, of being the only ones giving great reviews. But you can go back and listen to Stu over the last, I guess, almost 7 years we've been doing this, Stu. And one of my favorite things that Stu talks about— and I’m listening to him for about 30 years myself, which has been a privilege, by the way, Stu— is this idea that when you go into this, you're know you’re going to hit recessions along the way. You're going to hit down markets. There's going to be bad news. There's going to be surprises. There's going to be things that move the market. But that long-term path is likely going to take you to where you need to go, and you just have to live through those things. Quite often, as smart as anyone is, they don't know when those things are going to happen. You know they are going to happen between here and 30 years from now when you're investing. And if you go in with that mindset, you can react to it in a way that's not emotional, but, oh, okay, I knew this was going to come. And we said when this happens, here's how we were going to react, and you stick with it.

Yeah, when it gets to the fundamentals of the amount of earnings that are coming out of a company, or the amount of earnings coming out of the market, we know as investors that management has the same goals that we do. When earnings are depressed, they do everything they can to improve them. The second part is, as investors, we apply valuations or multiples to those earnings, and that's what moves around a lot more. If 10, 20 years down the road, earnings will be higher. On the eve of the financial crisis, earnings were $100. Here we sit 16, 17 years later, and we're at $400 a share for the S&P 500— or $380. So you know over long-term earnings compound, but it's when they change ever so slightly, the valuation of those earnings tends to get magnified in both directions. And it's that magnification in both directions that we try and take advantage of in the long-term financial plan because we know underneath we're trying to capture the compounding of those earnings, but we know that there's going to be periods of enthusiasm and periods of a bit more concern. And the rebalancing, the adding and taking from risk during those periods of time can be very fruitful to long-term investors.

Yeah. And what you want to avoid is getting out on the extremes. So there's going to be times when you're more optimistic, less optimistic. But you don't want to get overly exuberant or overly negative. And you'll see that at the extremes of the market. And a lot of people get outside of those bounds, and that's really when a lot of mistakes happen.

That's right.

And one of the things we talk about and what we like on this podcast is that we bring on professional investment managers And not only do you get to hear their brilliant insights, but you also get to see their demeanor. And that's one of the things that I'm always impressed when I get to spend time with experienced portfolio managers is the always rational way that they approach the markets. They don't have the big swings up and down. Oh, I made a bad call. It's just, okay, what's the next step? Constant. Which, as I always say, makes them terrible people to sit beside at a dinner, but fun to have on a podcast and fun to work with. No, they're actually really interesting people to have beside you at the table because portfolio managers have to watch so many things and be aware of so much that's going on in the news. And like Stu, they have Stu's views on the news.

Thanks very much, Dave.

Thanks, Stu. We'll catch up with you next week.