Hello, and welcome to the Download. I'm your host, Dave Richardson, and it is Stu’s days. Stu, welcome. We're going to focus on what you were saying on Monday. I didn't know you were scheduled to speak to a bunch of investment advisors. But my phone lit up with friends who were attending the speech. And they’re saying: Stu’s on fire, Stu’s got lots of great stuff to say, what an awesome speech! As we would expect. The listeners to this podcast would expect you to be just effuse brilliance from the stage as you do for 10 or 15 minutes every week here on Stu’s days. But why don't we dig into and share with the listeners some of the highlights of what you were talking about. If people are listening regularly, they have a general sense of your view, as we respond to different economic data points that are released and how they impact your thinking around markets and different rallies or pullbacks in markets. But what were a couple of things that you were looking at that are particularly interesting given where we are right now?

Thanks for that, Dave. It's always great to be out talking to advisors. They were probably alert because the room was so cold you could have hung meat in it. Everyone was very attentive, which was fantastic. And as I say, always great to hear what's going on with advisors and their clients and how they're finding their way through this topsy turvy environment. And we talked about a variety of things, and we've mentioned some of it in our prior conversations around how the strength of the market this year has been really focused on a handful of stocks. We talked about the artificial intelligence stocks, so to speak, and then the rest of the market. And the rest of the market has meandered through this earnings slowdown. When will the recession be and how bad will it be? Which is a little bit easier to understand. And for those ten stocks, in particular in the last month or so, some speculative activity has really returned to some of those areas of the market. We've seen bullish sentiment rise. We've seen a lot of strength. Stocks like Tesla were up many days in a row. Not that it's necessarily AI, but it gets lumped in the speculative bucket. Nvidia and some others were very strong. And the broader market is going through this debate around what will happen to the economy. And when you're creating scenarios as an investor, you're always trying to marry a couple of things. You have this intimate understanding of the underlying business that you may own. Discussions with management. What happens in this environment, what happens in that environment, how do the margins of the business unfold under different scenarios? But ultimately, when you're creating those scenarios, you need to have some framework for the economy. And we work closely with Eric on that. And things have been slow. Maybe the debate of: did we have a technical recession, have we had a bit of an earnings recession, is it still to come? These are ongoing discussions. And one of the things that we spend a lot of time looking at is the slope of the yield curve and that difference between short-term interest rates and long-term interest rates. And when we started the year, the slope of the yield curve was around minus 100 basis points which means the two-year bond was 1% or 100 basis points higher than the ten-year bond. And what that says is that there's this view in fixed-income markets that there's a tightening of interest rate policy, there's a tightening of monetary conditions strong enough that the economy is going to slow. Otherwise, why would I accept a lower interest rate five and ten years down the road? Normally that slope is positive because there's economic growth and there's the possibility for inflation that I want to get paid for. We had the US Silicon Valley and that type of thing play out and the slope of the yield curve went from minus 100 down towards minus 50 or minus 40 basis points, and that looked to be a more normal roadmap because often what happens is, as the economy slows, the yield curve eventually goes back to a positive slope. And it's during that process that you have the debate around earnings. But as it goes back to a positive slope, eventually market and participants say: it's back to a positive slope, the central banks are going to start easing off the monetary breaks, the economy is going to start improving, earnings are going to get better. And during that process, right around when the yield curve slope goes positive, the stock market starts to find its footing. And generally speaking, that illustration is still in place for the broader market. So, that was certainly a topic of discussion. We've had encouraging inflation data. We still have strong consumer data. There's lots of deposits still floating around from some of the COVID stimulus. We have fiscal stimulus on the side of decarbonization and reshoring, lots of articles around construction, not necessarily for residential development, but around factories and plants and things like this, although housing in the United States has remained pretty strong. So we had this debate around the meandering path of the economy and the yield curve has gone back to a more negative slope. And people are readjusting to how long interest rates might be high, not so much how much higher do they have to go. So it extends the period of time that we're having a negatively slope yield curve. And when we look back through history, when we see extended periods of time of negatively sloped yield curves, eventually that leads to a slowdown. That was one of the things we discussed and then, as I say, that meandering component of the stock market, the broader stock market, components have certainly followed the recessionary path. Some of those stocks look more interesting. That's where we've focused our attention in this environment because they will respond once some of the early cycle stocks, six months, twelve months from now, when we come out the other side. So that was some of the topics of discussion.

Any specific areas that you think will look particularly interesting there? When you say early cycle stocks, what are those kinds of industries typically?

Well, there's a variety of them. Normally it's where there's pent-up demand. In a normal economy, you wouldn't spend money on bigger ticket items. That type of thing would be an early cycle indicator. If we took financial services, one of the early cycle businesses is capital markets. Maybe there's M&A that's been waiting to be done and businesses can't quite agree on in order for mergers and acquisitions to take place. Both companies generally have to agree on the economy so that they can determine what the valuation should be. Of course, in this environment, the buyers say the economy is poor and the sellers say the economy is fine. And you don't get business done. There's capital that needs to be raised because some balance sheets are still a little stretch from past actions. So inside financial services, normally the area that we look for to lead us out— and this was very similar to in the financial crisis; the market found its ultimate low in March of 2009, but the amount of business that began being done in November of 2008 was off the charts— so capital starts getting raised, those types of events take place. Capital markets would be an early cycle business. We look for that inside of the financial stocks we own.

When we were talking before we started recording, you've got historical incidences in the not-too-distant past where you've seen this yield curve inversion persist for an extended period of time. They're typically associated with markets that most people would say are not particularly good. They're bad memories of those situations. Is there anything that would be different this time? Because again, you're drawing the distinction between this small set of stocks that has moved really far, really fast, but the rest of the market, as we've talked about, has not done anything, reflective of a tough environment. Does that make it different this time than the other periods where you've had an extended inverted yield curve?

Where you're most vulnerable is when the median stock is expensive. That means lots of stocks are expensive, and the headline can be very expensive. So going back to 2000, the S&P 500 traded north of 25 times earnings, and lots of stocks were expensive. So there was a lot of things to work through as the market declined. In this instance, we have a handful of stocks that are more expensive. They're not necessarily at those levels that they saw during the tech bubble. So you could argue at length how much of that needs to be worked off. And then the second part is that the median stock is actually not far off its historical average valuation. So you could have some earnings risk as you work your way through a slowdown, but it's not like you have the double whammy of having to deal with earnings and valuation falling. I think that's one difference as we sit through things right here.

The other thing that you spent some time on, coming back into the dividend space, which is your particular area of expertise, banks and capitalization and some of the push around regulators to shift the capital ratios of banks. And that what's your perspective on what's going on there?

Well, that's a great question too. Yesterday the Canadian regulator increased what they call the domestic stability buffer by another 50 basis points, or half a percent. So a well-capitalized bank, come this November 1— or it might have been December 1, I can't remember— but come the turn of the year, 11.5% would be the minimum capital ratio. Now, the Canadian banks are extremely well regulated. They're regulated on capital, and they're regulated on liquidity, which are two of the key features to the long-term success of a bank. Regulators and bank management know that not all loans perform. They prepare the bank for all sorts of circumstances. And what the regulator is doing by adding another half a percent to this minimum capital ratio is putting another layer of insurance or another layer of preparation on the skids. And they could sit there and say, well, maybe we might even do another one if things remain as good as they are right now. And they also say, well, we can lower it during periods of stress. And that's the part that's maybe a little bit interesting here. So it was lowered during COVID and investors were quite accepting of that because of the unique circumstances at that time. In a more garden vanilla type of slowdown, investors might always think about the high-water mark and might sit there and say, well, it's got to go back to those levels. That's something we're going to have to think through as things evolve. But the other side to it is that when you have to hold more capital, it does pressure your return on equity, so it can pressure your earnings a little bit. But we also can't forget that more capital makes the bank safer. So when we look at valuations today, we've gone through a period where some estimates have fallen because activity in some capital markets; businesses have been lower, maybe due for a cyclical turn at some point. Provisions for credit have been a little bit higher. So we've seen some negative estimate revision. It leaves the banks trading at a valuation that is only seen 5% of the time. That's a positive. So then you say, well, how does that normally end? And it normally ends once the estimate revision turns positive. So that's what we're waiting for. But all that said, I go back to that: the regulator says more capital. They're already very well capitalized, but the regulator is making the system safer. The dividends are quite healthy. Businesses is slowing a little bit, but valuations have contracted because of earnings with no corollary benefit of being safer, as per the regulator. So those are some things that we got to think through going forward as well in this environment.

Wow. Fascinating. And then, just to finish up, you lost something very special to you with an important message in it, and when you tried to find it, you were left without the response you wanted. Maybe you can let the listeners know what you left behind in Las Vegas, the significance of it in terms of what you learned from it, and maybe they'll return that book back to you.

I was sitting there at the pool at the casino reading The Alchemy of Finance by George Soros. I have to admit, there wasn't that many of us around the pool, reading that book. And I lost it. And I called the lost and found and she said, what book were you reading? I said: The Alchemy of Finance by George Soros. And the woman on the phone said: boy, that sounds like a real page turner.

So a lack of urgency to get this important book back to you because it had something that you were saying, in terms of the inverted yield curve, where we started the discussion today. A good lesson, particularly as it relates to thinking about the bond market, which we've been talking about, that has been quite a bit more interesting since last fall. What was the main line from George Soros that you like?

That was the reason I went and bought the book. I had read that George Soros said, when yield curves are inverted, you need to extend duration, to buy some longer-term bonds. Sadly, I lost the book before I got through that part of the chapter. But that is the notion, around an inverted slope yield curve; the bond market's way of telling you that the economy is going to slow down. Yield curves can go back to a positive slope by the longer-dated bond selling off and those yields rising, but it is the rarer occurrence.

Which doesn't mean you're not going to have some turbulence in the interim, but it bodes well for bond investors going forward. And again, we keep coming back to when the bond market bottomed out back in October. You've seen a pretty significant rally in a diversified bond portfolio since then. And it's something to keep an eye on because there is still the opportunity as inflation gets managed under control. And it's stubborn. It's not going to come down immediately, like a lot of people might think, but it will eventually come down. And to do that, you need a slower economy, and that slower economy will produce lower yields and you'll generate gains off those bonds that you buy at higher yield points. And so that's a potential opportunity if you're a bond investor and you like to take a look at bonds. Many people who listen to the podcast are on the more conservative end of the spectrum. They're looking at stocks and bonds, but they own lots of bonds. And so last year, a very tough year, but what that keys up is the opportunity for better years ahead and you're starting to see that play out.

And even most private clients tend to migrate towards shorter-dated bonds; five years and less type. But, when you look at some of the spreads between the Fed funds or where central banks are setting rates relative to inflation expectation, those spreads are pretty wide. There is the potential for total return, like the price of the bond improving, but the coupon, the carry is quite good, even one-, two-, three-year type corporate credit where you're getting mid-single digit coupon returns. For some of our domestic investors, you're getting a capital gain kicker as the bond returns to par. It has been an awfully long time that the bond market had coupon, let alone the change in the price of the bond as interest rates moved around.

And speaking of returns, we'll have some information for you on the posting for where you can return Stu's book, if you happen to be in Vegas. There’s probably somebody's at a slot machine or playing video poker with that book there, benefiting from the wisdom Stu was hoping to gain from it.

They were going to read it on the Stanley Cup parade. I thought they were going to start reciting it.

All right, Stu. Take care.

Great. Thanks very much, Dave.