Transcript
Hello and welcome to the Download. I'm your host, Dave Richardson, and it is a very happy Stu’s days, even though it's Thursday. It’s not Stu’s day technically, but every day is Stu’s days. So I guess we're okay. My fault again. Sorry, Stu.
Not a problem at all, Dave.
I mean, you're just one of the top investment managers in Canada, managing a couple of hundred billion dollars, or somewhere in that range. And I'm just a staff member in my role and it's my schedule that gets in the way. So I apologize to the listeners because I know they love their Stu’s days.
Yeah, I might be the top investment manager in this office, but I'm the only one in this office.
Well, I was actually out last weekend with some people that know you very well, out in the industry, and they said one of your hallmarks is your humility, which is always a good thing because I actually think investment managers sometimes start to think — particularly when they have as much success as someone like you've had — that they're smarter than they actually are. So being well anchored in terms of your abilities — not to say that you don't have a special ability — but being anchored in just what you can and can't do is one of the things that keeps you so consistent and grounded all the way through.
Well, the market is a humbling place, so you always have to be well rooted in how you could be wrong. Any good investment decision starts with: how could I be wrong?
That's right. And I'm sure you'd even say that as many times as you're right, you're also wrong plenty of times. But what a professional investment manager tends to be is right quite a bit more often than they're wrong over time. And that's enough to make the difference.
Yeah. And then also understanding that when you're wrong, you need to limit the risk. My partner would say, we know we're going to be wrong, unfortunately, so how do you pull the chute before things get too bad on those decisions? And if you can be right more often than you're wrong. When you're right, it's way better than when you're wrong. Those two are a pretty good combination for the long term.
Excellent. I thought we were going to have a multifaceted podcast today because we were going to take a little bit of a look of something that's going on in the markets. And then we've got a listener question which is going to side more in the educational, but we've whipped in a nice start with the philosophical. So we're really going to be rolling today. This one was worth waiting for. Stu, you mentioned one of the things that's just happened in the market. We talked a lot over the last three years about interest rates and inflation. That's been such a critical part of driving what's going on in markets. And we've had what's called an inverted yield curve now for almost two years, where you've had shorter term rates, higher than longer term rates, which is usually a precursor to some kind of economic slowdown. But something just happened in terms of a shorter-term versus a longer-term rate that you thought was worth taking note of.
Well, just in the last little bit, for the US yield curve, the five-year interest rate has gone below the ten-year interest rate. Normally when you think about the yield curve, short rates are lower than longer rates because the economy grows over time and there needs to be some term premium in the bond market. So normally the yield curve has an upward slope, meaning that farther out, interest rates are higher than shorter-term interest rates. And we haven't had that for quite some time. Ever since inflation was high, the tonic to inflation has ramp up short-term interest rates. The longer end of the yield curve doesn't match the increase because they're like, well, that's going to slow the economy down. So you get this inverted yield curve. The degree as to how much is always open to debate. That yield curve, that negative slope, has been as much as 100 basis points almost in the last twelve months. We are now down to just 20 basis points of inversion between short-term and long-term interest rates. But as this happens, one thing that's got to happen is it's got to start somewhere. So for the very first time, we had the five-year interest rate in the United States move below the ten-year interest rate. And the reason that this is important is, as the yield curve goes back to a normal slope, there's a handful of ways it could do it. It can do it by short-term interest rates falling dramatically, it can do it by longer-term interest rates rising a little bit, or it can do it by longer-term interest rates being stable as shorter-term interest rates come down. And if you had to pick amongst those three, you might pick the last one because it means that what's going on in the economy persists and it's a recognition that inflation is coming down. There is some weakness in the economy, but it's not too much. And the yield curve over that period of time could go back to a normal position. So being positively sloped and the economy finds its way through that, that's like what a soft landing might look like. So that has been an interesting dynamic this week.
Sorry, Stu, I got a little preoccupied there. There's a bunch of economists scurrying around my backyard looking for the recession. They've been looking for it for a while. It just hasn't come. So you say soft landing. I'll have to tell them. It'll get them worried.
Yeah. So anyways, that's probably been one of the more interesting things and just the ongoing enthusiasm for artificial intelligence in the stock market. But that's been going on for some time.
We said last week that we had a couple of disappointments actually over this month. If you look at US inflation, Canadian inflation, it popped up month over month in December, and that was a little bit of a disappointment. We've talked a lot over the three years we've been doing this, that nothing moves in a straight line. Everything we've been talking about in terms of all the signals in the market, you feel pretty comfortable that we've likely topped out on short- and long-term rates, or short-term rates anyways?
Yeah, for sure. I think we've seen the high of inflation and we've seen the high in short-term interest rates. The pathway of dissent is always open to discussion. I think one of the reasons that fixed income becomes more interesting in that environment is that I'm collecting a coupon and I've lowered the odds of big changes in my principal, particularly when I'm at the shorter end of the yield curve. For the market, it's interesting because a settling allows corporations to begin to have a similar view to prepare their business. Imagine you're managing a business and just as we're trying to envision scenarios, you're trying to manage the business for scenarios. You were sitting there last year thinking, one scenario could be ongoing inflation. These types of pressures. I have to be thinking about this. Another scenario could be inflation declining significantly. Those are pretty wide scenarios to manage a business for. Companies try and hedge their bets and prepare for all sorts of things. As you begin to narrow the outcomes, it allows companies to prepare their business with a little bit more confidence as well.
Yeah. One of the things, as I've been out talking to different groups over the last couple of weeks, as we've had these surprises on inflation — a little hiccup, you'd say, as inflation is coming down — does that not create some opportunities? Because you've seen that with some of the longer-term yields. We talked about the ten-year yield in the US and Canada that has ticked up a little bit. Not specifically related to the disappointment around that inflation report, but just in the air, we've had a little backup and maybe we're not through with this inflation, and it's affected the stock market. This has had a little bit of a pullback. And of course, we'd had an unbelievable run through November and December. But you look at that as maybe some of these little hiccups — which I'm sure we'll have more along the way because again, nothing moves in a straight line — is that going to create some opportunities at different points through the year for you?
Yeah, without question. When we think about any normal year, we get big movements in stocks in both directions. So we'll be definitely ready to be prepared to take advantage of that. I think companies also are seeing it the same way. So in this environment, there are two forms of strategic activity that can take place. The first is that private equity can buy businesses. That normally requires a lot of financing. It's not that it's unavailable, but it's still a little bit expensive relative to where it was, versus strategic M&A, company-to-company that comes with synergies. I take costs out. So if I'm sitting there and I'm running a business, I could say, boy, if I buy this company that expands my business in this area, it gives me some synergies. I'm thinking about that uncertain environment. You're saying, well, if business is slow, I'm going to get the cost savings. So that's going to help. And if business starts booming, well, I'll have bought this new business which will start doing better and I'll have the cost savings. So in this environment, often you'll hear people in capital markets talk about pipelines of activity starting to fill up. And often the first part of the pipeline that fills up is mergers and acquisitions, and it's strategic-to-strategic.
And we've already seen a little bit of a pickup in that. Not a huge amount, but a little bit.
A little bit. But I think as the year progresses, in order to get a transaction done, managements normally need to agree on what the economic environment looks like. So as we get a little bit more certainty on how that's playing out, you get more agreement on that. You need to have the ability to make the business more efficient or find new sources of revenue to justify any premium that you might pay. But you still don't have competition of significance from private equity. So strategic-to-strategic still looks a little bit opportunistic in this environment. I think that's one of the things we'll see as the year progresses. We talked about the election last time, but the other thing that is holding some of this M&A back is some certainty on how the election might turn out. And the reason for that is you have competition agencies that look at things, all sorts of things. So once you have some certainty as to how they will look at deals — which normally is, which type of government are you going to have? — that, too will help unlock this.
As the year progresses, generally M&A activity is more of a signal that things are going to be better in the future? Or worse? Or does it not really signal anything at all?
Often, they say M&A takes place at tops and bottoms, and we haven't had any in a while. The broader market is not at the top. So what companies are doing is they're saying, I want to prepare myself for my business to be even better in the next upturn. So I think that's the type of activity we're looking at. And again, it's always about finding synergies? Can I accelerate that business's revenue? We saw a large asset manager buy another large asset management business in the United States this week. And without question, the business they're acquiring will benefit from the larger company's distribution. You may not get an immediate cost synergy, but right off the bat, you can take all those products and put them across more distribution.
We've already segued here into the listener question. I would share the listener's name, but I didn't get specific permission. So it was a very astute question. A person who shall remain nameless at this point. But they went beyond just M&A activity and also asked about the IPO market — initial public offerings — so companies coming public, and whether that activity picks up at this point of an economic cycle, and of what does that signal and how do you manage that as an investment manager or look for those opportunities out in the marketplace?
Normally you can go back through time and look at IPO activity. And often when it's at its peak is right when the stock market's at its peak as well. And we haven't had many IPOs for some time. So I do expect that we'll start to see a rise in IPO activity. And early in that period of time is often a very good time to participate, because the companies that come to market are either of the highest quality to reopen the door, or the companies need the money, which means the terms that you get are more attractive. So the initial phases of the IPO market starting again can be quite interesting for investors. As that progresses, you have to be a little bit more wary. Like anything, you have to think through as time progresses. And then the IPO market often culminates with this unbelievable enthusiasm for some business that's going to grow to the moon. And as an old advisor used to say to me, in a good wind, even a turkey will fly. That's the period of time where we need to be a little bit more concerned, but we're not really there yet.
Yeah. So what you're saying is we're going to have to wait to sell our podcast publicly, take the podcast public, and make some money off this, Stu.
That's right. We have to give people a very exciting glimpse to the future. This is basically the future of entertainment, Dave. We both know it. So when we decide to part with a small percentage of our podcast in the public markets, it'll be a rare opportunity.
Yeah, well, those economists are still scurrying around as I look out the window, but I don't see any turkeys flying, so I'll let you know when I see that happen. Stu, around an IPO, it always interests me. For someone like you, when you're evaluating an IPO, how different is that from evaluating an established company in terms of what you've got to do to become comfortable with what you're going to invest in?
Well, there's multiple types of IPOs. The nice thing is when they go public, they have to give you a prospectus, which has a tremendous amount of information in it. So you can start with that. And while you don't have the experience of seeing the business in the public market over many years to construct your scenarios, you are given a lot of information to try and understand what would that business look like in the bull case and the bear case and what have you. But you do have to take it all with a little bit of a grain of salt, because you only try and sell things. When anything has been sold, the seller knows all, but the buyer needs a thousand eyes. So you need to think through that. Why are they going public? Do they need the money to grow? Do they need the money to build the business? Or is the owner just cashing out? Those are all very important questions. How are they incented to grow the business in the future? You're given all this information you have to take it into consideration, and there's been some phenomenal IPOs over time. There's also been some that you would not want to be anywhere near. And that's just par for the course.
Yeah. Do you read that whole perspective, Stu?
Well, we read what we think are the pretty important parts. They give you a section called the risk factors, and you know that's been written by the legal department. So anything that the business is exposed to has to go in there because those people are worried about their liability. They normally give you a financial forecast and they explain how the business performed in different environments. So you give that a very good read. So there's a good chunk of it that you're going through in a very significant manner to try and understand those types of outcomes that the business could have.
Now, with an IPO, say there's something that you really love, you may not be able to get as much as you want, correct?
You want to understand your scenario. So you're saying, okay, the business is going to go public at this price. How much would I like to own at that price? And you might go into the bankers and say, look, we're good long-term shareholders. We would like to own a lot of this company at that price. And that might help with what type of allocation. Everyone's always jockeying for an allocation. And then the stock opens, and most of the trade happens in the first couple of days right after the IPO. So you need to understand right off the bat, what price would we keep buying this company at? So all that reading you did on the IPO, you're trying to understand: what could this business be worth in three to five years? If you get a very small allocation and it pops a lot, sometimes you're exiting quite quickly. In other times you're buying and finishing building your position because there's liquidity and you still think, I'm going to compound at a pretty good rate of return over time. So, again, that can go any number of ways.
You're going to anticipate that the IPO market is going to come back a little bit this year. Is that your expectation?
I think so, because there's a lot of companies that have been owned in certain situations where they need to go public. It's a cyclical business. So again, if we could show you a chart, there was a period of COVID where there were lots of them, and then we haven't really had any. Some businesses just trade privately, which has certainly taken place. But the public markets play a pretty important role to provide capital for businesses to grow over time. And I don't doubt that that will come back.
Excellent. Well, Stu, that was really interesting. EdStucation is always interesting.
As long as you're not going to call me Sturkey.
No, but I'm spending a lot more time looking out the window because I'd like to make some money off this podcast. I'm getting close to retirement. Anything we can do to bolster the portfolio would be nice. And if it's completely unexpected like this, then, hey, who knows?
That's right.
I've been able to corral a bunch of great guests. I think the future is bright.
Maybe we could take it to one of the big platforms.
Oh, we're already there, Stu.
Oh. Okay.
We're everywhere. We just haven't seen your big brain up on a billboard yet. That's what's coming next. Or in a bus stop. That's probably the next spot.
I'm not sure that would help. Or hurt.
The kids look on Instagram, so we got to get into that demographic. But lots of stuff for us to strategize on, Stu. And we'll look forward to our IPO. I think everyone else will. And we'll look forward to the next Stu’s days, next week. Stu, thanks a lot.
Thanks, Dave.