Hello, and welcome to the Download. I'm your host, Dave Richardson, and it's starting to get confusing, what Stu’s Days really is. It was supposed to be every Stu’s day, but we seem to be pretty much never taping on Stu’s day anymore. In fact, this time we've gone all the way around and cycled through an entire week to Stmondays. I think this is the first time we've done that, so hopefully people are tracking along. I know we got lots of people listening, so that's fantastic. I was at a conference down in California, of all places, and I think everybody that I talk to listens. And they particularly love you, Stu. They basically say I could be just tossed away to the side, but don't lose that Stu.

I think it's the exact reverse, Dave. If I got on a podcast and talked for ten minutes, it would be like listening to the weather.

Wow. It was tough on the ego, Stu, but it's stuff like that that keeps me unbelievably humble after all these years.

And motivated.

And my wife, too. She keeps me humble as well. So, Stu being the star of things, we're going to zero in today on the key questions that we would ask someone with your depth of knowledge. We should remind everyone that Stu Kedwell is the co-head of North American Equities at RBC Global Asset Management. Top Gun in the investment world, as they like to say. Did they actually give you a gun when you won that award, Stu?

No, there's no gun.

Like a big jet plane or something? Like a trophy?

No jet plane either. The trophy component is, I suppose, underwhelming relative to what it sounds like it might be.

Well, it is a cool award to win.

A paper airplane.

A paper airplane. But we spoke with Eric on Friday after the jobs number, and wow, that number in the US was quite something. And of course, the Fed last week, they tightened and kept the saber rattling going. The Bank of Canada, the week before was more, I guess, muted in their forward look. They're probably pausing, or they're saying they're going to pause for a little while. When we wrap it all together, what do you make out of where we are economically and then the link to markets?

Yeah, let's start first with earnings today, and then we'll try and link it all together. The earnings reports this quarter have been, I would say, okay to a little underwhelming, but not really that underwhelming relative to where people's heads were at. And by that, I mean this is probably the lowest quarter of surprises. Normally, estimates come down a little bit and then companies manage to beat them. So that percentage is at the lower end. And when we look across a broad swath of businesses, last year, you had revenues growing at a very robust pace due to inflation and the cost side hadn't quite caught up to things. In this quarter, we've seen a little bit of the reverse where revenues were still growing, but costs grew a little bit faster in the fourth quarter than revenues. So you have what they call negative operating leverage. And that's probably going to be the story for the first half of the year, which then dovetails into all the economic readings. You mentioned the employment was pretty strong. The Federal Reserve? You could hear what you wanted to. If you were in the camp that rates are going to be higher for longer, you could probably find a way to hear that. And if you're in the camp where rates might have to come down, you could probably hear that too. Myself, I probably migrate back to what we've discussed, which is that the central banks want inflation to be under control. Not that rates are going to go a lot higher, but they might stay at these levels for a longer period of time than people want. As far as the employment data, which was very strong and threw a bit of a kink into the ability for rates to come down in the very short term, some debate was also not dissimilar to where we were on inflation last summer, where we knew in all likelihood that it was coming down, but right around the peak there was a couple of bumps in the road and that threw you for a loop every so often. If I bring that back to the earnings, when you see businesses having negative operating leverage, they are going to go look at their cost structure. And just as during parts of COVID, you might have hoarded the supply of some goods, there is a comment out there that businesses have been hoarding labor a little bit because it's been so tight. And will they look at their cost lines en masse here and try and make some adjustments? Because over time businesses like positive operating leverage. They like their revenues to be growing faster or at least at the same pace as their costs. So while the employment data was extremely strong, I think there is some positives because it means the economy is probably a little bit stronger, but I don't think you would say that this is the trend of even stronger employment from here. In all likelihood, it backs off.

Employment is a lagging indicator. You look at some of the other more coincident indicators like retail sales, we're seeing that roll over a little bit. I haven't really heard your comment from anyone else with respect to businesses hoarding labor, and this has been without a doubt a very unusual cycle that we've been through, particularly following the very unusual cycle that we came through before COVID which was the longest continuous expansion in history. We've now had an economic cycle that may end up being a three-year cycle from trough to peak. And as we've talked about many times, it's created some dislocation in the system that created that desire to hold on to labor. And you're seeing it in a particular area, technology, where you're seeing big announcements about layoffs again as they run into some real issues on the cost side. And it's hard to not imagine that rolling through the rest of the economy.

I think that's fair. No question. We always talk about how business changes over time. And the only thing you know is that what is currently in place is not likely to continue to be in place. Business is competitive, management's incentive to get cash flows and earnings up over time. So they're going to look at all those levers to pull in what is still not a bad economy, but likely a slowing economy. A couple of other things that I think have come out through this process is that there's kind of three camps out there. One camp says that we're going into recession; earnings are going to drop, the stock market will drop when those earnings present themselves, valuations will contract. The second camp says the economy is maybe finding its footing a little bit and while the growth is not going to be strong, it is improving. Our in-house view— or Eric’s, our economist—, is probably a little bit more positive relative to where our old forecast was. I think the interesting thing in that camp two, we get so focused on the real economy when we talk about all these statistics and while inflation is declining, if it's still at 3, 4, 5%, even if there's no real economic growth, the nominal economy is still growing, which I think helps camp number two a little bit. This is why earnings might be a little bit stronger than they've been. But in that camp, from a stock market standpoint, a broad market standpoint, you need earnings to be a little bit better but you really do need inflation to continue coming off to justify today's valuations. If you put it into some type of historical regression model, you probably need inflation to come back down to 2 to 3% to justify today's valuations. But the last component, which is another thing that has been in place for the last three or four months— and we talked a little bit last time about changing leadership— is that for the headline market, you do need inflation to come down to justify today's multiples, which are in the upper teens. But there are still a lot of stocks out there that have reasonable valuations. That idea that it's a market of stocks rather than a stock market, and if the economy is going to be a little bit better and those valuations are still at reasonable levels, can the average stock do better than the stock market? And those are the three camps that persist and there are arguments around each one of them, when we think about it. When we build portfolios, we prepare portions of the portfolio for each one of those outcomes a little bit. Because what we're really trying to do is that, as the fog clears, we'll get back to that longer-term process around attaching ourselves to earnings growth and dividend growth and things like that. But that's where we're at in the very near term. Last week was quite something, after the Federal Reserve met Wednesday, I think Thursday was the largest day of short covering and the largest day of single stock options purchased, basically ever. And then Friday, that was thrown off course a little bit by that stronger-jobs number. So crossing the river, touching the stones, that's the type of environment we're in right now.

Yeah, and as you say, the three camps would fit into the approach that you use most closely, and other language you've used in previous episodes, as scenarios. So you're going to play to different scenarios. And the fact that those three camps are in place, if we tie it to last week's podcast— or I guess it's a week and a half ago podcast now— we were talking about technicals; the market crossing through major technicals and actually hitting up against a really important region to determine whether it's going to go higher or lower. And again, I think it was Stu at his best. So I encourage you to go back and listen to the last episode of Stu's Days. But with that uncertainty, with those three scenarios out there, you would almost put an equal chance on all of them, wouldn't you, Stu? They’re pretty close in terms of outcome. It's not surprising that the market is having a difficult time finding some direction. As you say, the fog has got to clear. But this fog might be here for a little bit as we wait for that labor market in particular to show some signs of loosening up.

Yeah, I think that's a good point. Also, we're in an environment that is dominated by the macro narrative. Every so often we talk about individual companies and then sometimes we talk more about what's going on at the top of the economy. And we're dominated by that right now, so there's a lot of levers that are getting pulled based on small changes in interest rates, changes in inflation, these types of things. So it's impacting all parts of the portfolio. If we get a bit of a settling in the macro environment, then we can go back to the market's narrative which will shift to individual companies and what's going on at a company level, and that too can be a better time. But yeah, you're right, I think the process of identifying different camps through scenario analysis is to appreciate the elements of each camp and understand how things might sway from camp to camp, and then move the portfolios around accordingly.

And I know a lot of your competitors are watching what you're doing, so if you see a big balloon hanging outside your office, just pull the blinds down, because they're probably trying to figure out these scenarios as well. And I know you'll take the lead, so you got to watch for that, Stu.

Yeah, that's a great point, Dave.

Have you seen any balloons?

No balloons yet, but they're putting up an office building beside us, so I think the crane operator might be onto something. I see him with my telescope.

Yeah. You know, when I get suspicious is when my mother-in-law is lurking around. That's usually when I'm being surveilled, but not for stock market tips. Anyways, Stu, as always, great catching up with you, and we'll check in next week and see if we get any more clarity as we continue to go forward with markets that just seem to be looking for direction.

Great. Thanks, Dave.