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Stu Kedwell, Co-Head, North American Equities, joins Dave for a deep-dive into the concept of momentum, and how it’s factored into active management as market narratives shift. [7 minutes, 37 seconds] (Recorded March 9, 2021)


Hello and welcome to The Download. I'm your host, Dave Richardson, and it is (S)Tuesdays, which means we have Stu Kedwell, co-head of North American Equity at RBC Global Asset Management, on a new camera today. He lets the kids use the good computer for homework. And so, he's using it today. It's too bad this is just audio. But if you could see him on video, he looks beautiful. More clarity than I've ever seen before from Stu.

Well, thanks very much, Dave. I have been told I have a great face for radio.

No no, you look fantastic today. But now we'll get into the really murky because what we're going to talk about today is something that, quite frankly, even got beyond my scope. But it was a question that I was thinking about myself this morning as I was watching what's been going on in the market over the last few weeks. And it deals with momentum. Just in some ways, the structure of the market sort of works against or for itself at different points in time. It also explains why I couldn't get a date at high school. And then I ended up in my early thirties marrying the best girl in the world. So, there you go. Because things can turn on a dime. So, let's talk about momentum and what we're seeing going on in this rotation in the market and momentum.

The market is always searching for what is the narrative of the day. We've talked, I think, in past podcasts about how that narrative has switched in the last three or four months from more narrow growth, very e-commerce beneficiaries of stay at home to the Fed providing a fair amount of liquidity. Interest rates were going to be low. We're going to have vaccines. The economy was going to get better. As the economy began to improve, interest rates started to rise. The market started to broaden. And then some worries about inflation started to surface. That has been the shifting narrative, which may or may not last, but we think that that narrative will last for a while because vaccines are going to get rolled out. There's a fair amount of pent-up demand and the economy is going to be quite strong in the back half of the year. But inside of the market, there is a dynamic the way that money flows around from one set of stocks to another as that narrative shifts. It's akin to holding a box of water up and shaking it from one side to the other side. Even if you've brought it back to flat, that water bounces back from side to side for some time. One of the things that we look at as an active manager is the volatility index. It's been pretty volatile, and not surprisingly in the last couple of weeks after being calm for some time. What that is indicative of is, positions are changing and that can often have a short-term crescendo. Whether or not we saw that yesterday or we saw that last week where, interest rates move through that 1.5% range. Many of the more expensive growth stocks have been very poor performers. Not that their business prospects have changed, but you can fundamentally make the argument that higher interest rates mean that their future cash flows are worth a little bit less. But in reality, what's also happening is that there's a bunch of algorithmic and factor-oriented investing that has to reconstitute itself as the narrative shifts. And one of the big things that defines that is momentum. A lot of quantitative models will have a momentum factor inside of them, and in fact, you can go and buy the momentum factor on the S&P 500 or on the TSX. And people like momentum because over the long haul, it's been a pretty interesting factor to have exposure to. Yet when that basket of stocks changes, it can be quite a violent period of time for that momentum factor. One of the big discussions in the last week was, will value stocks and will energy stocks become the new momentum factor? If in fact they do, that means that everything that's in there has to come out. That tends to cause a lot of shakeout. I think that's really what we've seen in the last week. As I say— and this is Warren Buffett's comment: in the short term, the stock market is a voting machine; in the long term, it's a weighing machine. So, as an active manager, we want to be on our toes to see, as we get extremes in prices in all directions, can we take advantage of what we think that business will be worth two, three, four or five years down the road, relative to its current share price, as things move around with the great rapidity that we've seen in the last week or so?

So Stu, that's incredibly complex, which is why I'm glad you're the one managing the money. Does this suggest, as I listen to it, that an active manager still has an advantage over a machine? That the combination of man and machine still seems to have an advantage over just machine? Is that the right way for me to interpret it?

I think that's exactly right. So, we have all the calculations going internally to see what type of changes might come if you were using a purely rule-based quantitative model. One, we can see some of those changes coming in advance if we want to be in front of them; and two, as they're happening, we can decide if we want to try and be on the other side. For example, if you took some of these more highly valued stocks, we can go back in time and say, well, when the 10-year bond was 2 or 2.5%, say in 2017, what were their valuations and how close are we to those valuations today? Just as the market might be spitting them out from a momentum standpoint, what used to be expensive businesses might look more interesting and may already be discounting an interest rate level that we think would be fairly bearish. So, you need to have your scenarios going all the time. You have to always be thinking and saying, what's discounted in these share prices and how can we make money from this point going forward?

Yes, and it's almost if we think about the way that computers have changed our lives and machines have changed our lives and all kinds of fantastic benefits. But when I what to hug I go and hug my wife or my kids. If that lasts a little bit, that the computer still can't match, whereas an experienced active manager, with the help of the machines— I mean, we're not doing it alone, the machines make you more powerful than you've ever been before—, but still, that last bit of touch, that experience makes a difference in terms of the way you're looking at all those numbers

It can be very helpful, no question.

Wow. But you can't get machines like this new machine that you've got that makes you look even better than you actually look. So that's pretty good.

All right. Thanks very much. Dave, thanks for having me.

OK, Stu, thanks. We'll see you back with Stu’s Days next week.


Recorded: March 9, 2021

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