Transcript
Hello, and welcome to the Download. I'm your host, Dave Richardson, and it is an early, early Stu’s days because Stu Kedwell this week is on vacation. I was on vacation last week. I got home at about two in the morning on Monday, Toronto time. Stu, is it still Sunday where you are, because you're in Maui?
It is now Monday for sure. But it's dark.
It's a shame that we're not doing this on video. I mean, for this time of day, you look spectacular, Stu. You've been out in the sun? You've got a little bit of a tan there. You look relaxed. As we're going to say to most people, to investors, that's what they should be doing as well.
That's right. It's been an interesting vacation because markets open at 3:30 in the morning here. You get to have a bit of work done before the family wakes up and away you go.
This is an important point for anyone listening: Stu Kedwell never stops. Three in the morning, market opening. Midnight, market opening. Where he's traveling around the world, vacations don't even really exist in Stu Kedwell's world. Okay, so last week when we jumped on Monday, we were dealing with a very specific bank in the US that isolated its business in one particular sector. There were some unique circumstances around how everything unraveled. And we talked about how the US government and Federal Deposit Insurance Corporation jumped in, backed the deposits, pulled out their playbook for how to manage through these situations. There were another couple of banks in the US that got in trouble. Similar playbook. And if you look at market reaction through the week, it seemed to manage through it fairly well. We postulated when we talked last time, that when you see one bank, despite its uniqueness, typically that's a sign, especially with the monetary backdrop we've had— rates rising dramatically over the last twelve months— that when something else shows cracks along the way, the market tends to attack it. It's a case of fragility in a lot of different places. And one of the big areas where issues popped up was with Credit Suisse, a large European bank. Stu, take it from there in terms of what happened, how it's resolved, and how is this different from what we saw with Silicon Valley Bank in the US last week?
Well, there are similarities and there's differences. Credit Suisse had been struggling for some time. Often in periods like we had last week, if you have a weakness, it gets amplified during that period of time because just like Silicon Valley, the liquidity is the lifeblood of a bank, and when you start to lose deposits or start to lose liquidity, it doesn't really matter how much capital you have in those instances, that's what puts you into some duress. And Credit Suisse started to lose deposits last week. They had an issue when they put out their financial results and they said that the results wouldn't have been materially different. But they did have a clause where they said there were some weaknesses in their financial reporting, which didn't help, certainly. I don't think it was the significant event, but it certainly didn't help along the way. So, Credit Suisse is losing deposits. What you're looking for as a regulator is how do we put a floor back in place? How do we recreate confidence? UBS, which is the other large Swiss bank, was the logical combination in their minds. So they put those two banks together very quickly over the weekend. And the way they've done it, it'll leave a very well capitalized, a liquid bank. They provided some government support that should really help get people thinking that this is going to be one of the longer-term survivors and a strong bank on the other side. So that happened very quickly over the weekend on the European side. But these last throws of rising interest rates, that's where we're exposing some things that in normal times may not have been as much of an issue, but they get exposed quite quickly in these types of environments.
Yeah, like I say, there's always investors legitimately looking for weaknesses to shore those investment positions. You might understand this one, Stu: when I went to high school, I was not popular. I was more the intellectual type. And actually, back in the time when I was going to high school, I would dress like Alex P. Keaton. I'd throw a suit and a tie on. I was a meek looking kid to begin with, but I really stood out to the bullies in the class when I showed up in my suit and tie and I was pretty weak. So you can attack and if you don't have anything to back it up, then you kind of fail. And that's the SVB situation. And then of course, there's the Karate Kid, which is the ultimate tale of the kid who's bullied. And the great news about the Karate Kid is that he has Mr. Miyagi. Mr. Miyagi comes in and supports the Karate Kid and of course he's able to defend himself. In the case of the SVB depositors, Mr. Miyagi is the federal government or the central bank (or UBS or the Swiss government) who come in and have a playbook on how to support these things so that it doesn't get beyond the place in the financial system where the troubles start. For anything that happens, there's a playbook, there's a way that you can support these institutions and very clearly send a message to the market that this is not a situation like 2008-2009.
That's 100% correct. The saying in the market is putting things in strong hands. Crisis after crisis, after every 15 years or so, we seem to have something clear up and then finding a way to have that in strong hands. The period of time when that process is taking place can cause some disjointment, but eventually the system finds its footing and gets on its way again.
I just wish my father had been Mr. Miyagi. He would have helped me through high school, through all of this. So we've seen European markets had a very challenging last week out of this. If we look at North American markets, it was a little bit more mixed. Certainly, a lot of volatility. We saw any measure of volatility spike up through last week. But when you look at the week itself, the S&P 500 moved around 1%. As you look at what's happened here from a stock perspective, have regulators and governments done everything they need to do to shore up the financial system? Or do you think we're likely to see a couple more of these pop-ups as we work through this process? The European Central Bank, despite everything going on, raised interest rates by 50 basis points. The Fed is likely to raise rates again this week by 25 basis points. Do you think we're going to continue to see these little things flare up again?
I think it's possible that it'll carry on for a little bit again. All these banks in the United States, and deposits start moving around between banks, which is just natural human behavior. People make individual decisions. Higher interest rates led some people to take from deposits and put it in money markets. That creates some challenges for banks. If the bank is viewed to not necessarily being strong enough, then the deposit leaves the bank and goes to a new bank. That process of water finding its new level, so to speak, creates opportunities for some banks and challenges for others. And I think that could still take a bit of time. But to your earlier point, the central banks and the regulators have displayed this playbook. It's a deep playbook with lots of tools, and they know how to get people through. In the very near term, the way that I think about it is, when you get to interest rates, whether or not we get another 25-basis point increase or not, we're likely nearing the end because financial conditions during this process will tighten a little bit. Banks that are deposit challenged; they can't grow their balance sheet. They have loans. Those loans come up for due. They have to decide what do we do with them. They're probably going to ration their balance sheet and the new banks that may have received the deposits, they want to see how those deposits perform and when they can turn them into loans. We have to raise the capital, or we need capital to turn them into loans. So there's this disjointing process which tightens financial conditions and that's just something we're going to have to work our way through.
So as part of this process though, we talked about the stock market reaction on the other side of all of this. Despite the European Central Bank raising rates, we were coming into last week with the chance that the Fed was going to raise rates by 50 basis points at different points in the week. There was discussion that they wouldn't raise at all their rates this week. Now it's settling in around 25-basis points. But when you look at the longer end of the yield curve— and you talked about this when we were together two weeks ago—, that longer end is a better signal of how things are going to play out longer term. Obviously, those yields have stayed pretty well anchored. They weren't accelerating higher in a way that you would expect to continue to go through this with high inflation and much higher interest rates. Those longer rates had started to rise fairly quickly through February. The ten-year US Treasury got up over 4%. But since all of this started to happen with Silicon Valley Bank, we've now seen the ten-year drop. I think overnight it was at about 3.34. It's sitting at 3.47% now. So long-term rates have come down a lot. And even beyond that, you go to the two-year US Treasury which has dropped from 5 down below 4%. What do you make of this? Is this what you would have expected to happen and what does it portend for stocks and valuations? What's going to happen to the economy and earnings as we move out of this?
It's the speed with which bond markets worried about inflation and that dynamic of tightening financial conditions. If you come to get a loan and you want to do something in the economy, there's two things that come into play. One, can you get it? And the second is, what interest rate will you pay? If you can keep getting loans, then the rate needs to be higher to slow the economy. If you have trouble getting a loan, then the rate doesn't matter as much because you can't put that money into the economy. So what we've seen, and the pace with which it happens with the benefit of hindsight, is always remarkable. But in the last two weeks we've seen the lagging impact of monetary policy, which you never know exactly where it's going to bite. Financial conditions are likely to be tighter. Financial conditions will then help ease the inflation concerns. And then that gets you into eventually the point where inflation comes down. Interest rates can begin to lower, and then that becomes stimulative eventually. I think we're little ways from that, but that's the way that the cycle works. Keeping in mind this discussion we've had a number of times, which is inflation peaks, a year later, interest rates peak, a year later, earnings bottom. Sometime during that period of time when earnings are bottom is when stocks find their footing. The general plot without knowing the subplot, and the subplot has reared its head here in the last couple of weeks. That's what we're going to be negotiating in the next little while.
Any of this has dramatically shifted your view on where earnings are going to move?
Every company has a balance sheet, and that balance sheet requires funding. So understanding which companies are going to need money in the next 3, 6, 9, 12 months. Maybe that's going to cost a little bit more. They need to finance new sales. They need to finance inventory. We need to run through all those types of calculations. But all of those things are what causes a little bit of pressure on earnings. It's also the part that helps slow inflation. So all that needs to be studied. What can you say for sure? It's probably difficult for earnings to accelerate in this environment, but I don't think we were really in that camp. We're just trying to figure out if earnings are flatlining. They'll likely slow down, and the degree to which they do that will govern share prices. Stocks have come down and they sit right in the middle of two ranges of a more significant slowdown and a softer landing.
I guess, as we look back to last week's discussion— well, actually the last couple of weeks discussion—, and then today, this is a not unexpected turn of events given what central banks were trying to do in terms of controlling inflation. The old adage that the central banks need to break something when they're raising interest rates and trying to slow down an economy or slow down inflation. And that's happened. So you're going to hear that noise. You got to pay attention to it. It's like an ambulance. You hear the ambulance siren, if you're driving along in the car. It could be going the other way, but you're certainly looking in your rear-view mirror to see if it's coming up behind you. So you got to be aware of it. But this is likely the ambulance coming the other way. It's just part of life. And so, you try to put that in the background and the fundamentals of the longer-term cycle are really still intact. This is still pretty much how we expected this to play out and you make decisions accordingly.
I think that's bang on. The specific events are not likely to be expected. That's one thing. The degree to which Fed tightening hits different things, you never know. But generally speaking, everyone has the same objectives. Moderate inflation keeps the economy growing. If we're nearing the end of the tightening cycle, they're not going to overdo it just for the sake of it. Inflation is coming down. In the last week there was some good news on the producer side. As inflation comes down there can be an easing of financial conditions. Easing of financial conditions restarts economic activity and that's part of the cycle.
I think overall this is something we always want to be wary of. And again, a professional investor is watching this very closely. If you're investing through a professional investor, an investment manager, they're watching all these things. But generally, as an individual investor you want to be careful not to overreact to these things going on.
Doing a financial plan is never more important. Thinking about your investment objectives. Very hard for us to comment on risk and return objectives of an individual on a podcast like this. But if that financial plan has been done, the roadmap has been set, these types of things, while never enjoyable while they're happening, are part of the history of markets, for sure.
With this spike in volatility that we saw, I like to come back to it all the time: dollar-cost averaging. Right, Stu? This year has been a classic case for using dollar-cost averaging approaches.
It has been a textbook case for dollar-cost averaging for sure. And even within the market too— and you mentioned it last week— the S&P was generally speaking at a headline level not that significant. There are pockets of stocks like we've talked in the past about growth and value. I'm not as much a big fan of that trade from one to the other but as interest rates lower different cash flows get valued differently. Some stocks did quite well last week and many of those are in portfolios just for consideration.
Excellent Stu. Just for the record, you continue to be my Mr. Miyagi from an investment perspective and I'm sure many others who listen to Stu's days, religiously. Stu, thanks for getting up early in the morning on your vacation to help us out and give us some guidance around the things that are making headlines for us. I really appreciate it.
Anytime, Dave, and thanks very much for having me.