Hello, and welcome to the Download. Happy New Year. I'm your host, Dave Richardson. We're here for the first Stu’s days of 2023. Stu, I went back and calculated, and all fifty-two Stu’s days in 2022 were down days in the market. That's how depressing the market was. It was up on all other days, just down on Stu’s days. Is that the data that you've been looking at, too?

I think I saw it a little bit differently, Dave, but I'll take your word for it.

I may have been a little bit off, and one of my New Year's resolutions is to view things more positively in 2023. So I'm off to a rough start.

Or don't let the facts get in the way of a good story.

Well, that too. You're the brains behind this operation. I'm here for minor entertainment value at the front and back end of the podcast.

Then we're in serious trouble.

Yeah, I know your brain always works, but sometimes I'm just not that charming. All right, well, at least we're off to a good start in terms of having fun on the podcast. And again, we're looking forward to a great year. And at least as we move into the early part of the year, we always like to go around the world as much as possible and take a look at what we're thinking is going to happen throughout 2023 and where those opportunities lie. And we're starting with Stu today. He is the co-head of North American Equities at RBC Global Asset Management. His expertise is in North America, but as we've already suggested, he’s a pretty smart guy and he has his eye on everything going around the world. But before we look ahead into 2023, we took three weeks off over the holiday season. Anything interesting happened that people should be taking a look at over those three weeks? Or was it just a good time to go to California and sit in the rain like I did?

Well, yeah, it's always a good time to go sit in the rain in California. But for what is supposed to have been a fairly quiet period of time, there were some fairly significant events taking place. Not necessarily in order of importance, but during the break period or since we last spoke, we had a very significant shift in the COVID policy in China which is leading to a significant health challenge in the short term but is also likely to lead to herd immunity a lot faster than we would have had three weeks ago. The second is the weather in Europe that has been very warm, which has significant implications at this juncture because of how tight energy had been, and that has really depressed natural gas prices in the short term. But it also takes some of the pressure off on inflation and the way that energy was eating into consumption. And the third thing was a shift from the bank of Japan around interest rate policy, the increase in the cap on the ten-year bond, and that resulted in a strengthening of the yen. And I think the last dollar of negative yielding debt disappeared during that three-week period of time. So, no more negative yielding debt, which is quite significant and a bit of a peak in the US dollar around some of this action. Currency markets and interest rates? When you ask an equity guy, why do you focus on those? Because those are where the big flows are. So a peaking of the US dollar is a significant event and changes in interest rates are significant events. That's happened since we last spoke. And then meanwhile, in the United States— maybe it doesn't make the top three, but it certainly belongs on the list— better inflation data and the economy, particularly in the service data and the ISM cooled quite dramatically, which allowed the bond market to continue to rally. And while we still think the Fed is going to be resolute here, from a talking standpoint, it does remove some of the pressure on the interest rate front. So those are some big shifts. Those are some big icebergs floating by for quite a period of time.

Yeah, Jerome Powell even called me up on the phone over the holidays and said, Dave, we're sticking with this. He's talking it up big. Actually, he didn't call me, but I'm sure he will soon. But they're still going to talk a big game. But it does look, when you look at all the underlying data, that we are likely past the worst of inflation and certainly the worst of those interest rate hikes.

I think so. Whether or not Jerome Powell actually called you or not, I'm not sure— and he is going to talk a big game here— but the point also is that what's going on is Fed induced. There are slowdowns that are the result of elevated prices. There are slowdowns due to over-leverage. And there are slowdowns that the Fed induces. And this is one of them. And the reason that's important is because they can change course. And when they change course, it will have different implications than having to work some of the excesses out of the system in past downturns. That likely is a 2023 event.

And we're kind of in that phase in the middle where we're pretty sure they're changing, or they're about to change course, but it's not 100% carved in stone. So you still got that uncertainty and that's what's breeding the continued volatility in markets.

100%. I would say, the last of the positives, in Canada, we had very strong employment. The US employment has remained pretty good. So the debate here is, in the near term, the economy is slowing, but if unemployment remains low, then maybe, a soft landing is in the cards. Do we need a soft landing? Do we need a little bit more of a slowdown to convince the central banks to ease off a little bit? That’s a major question. We've talked a lot about the slope of the yield curve, which is negative— about as negative as it's been for some time—, so I would say scenario one, which has the higher probability, is that longer-term interest rates stay around these levels or maybe a little bit lower, and as time progresses, the central banks decide that they too can ease interest rates. What do I mean by that? If a ten-year bond is around 3.5% and a two-year bond is around 4.25%, that's a minus 75 basis point slope. Inside of every bond is embedded other bonds. So I could buy a ten-year bond or I could buy a two-year bond and I could buy an eight-year bond two years from now. So if I see higher short-term interest rates and lower longer-term interest rates, it's trying to predict when the central banks might lower rates. So I would say scenario number one is that as the year progresses, central banks will be able to ease off. That's how the yield curve will regain a positive slope by declining short rates, which would be positive, I think in general, from an economic standpoint. That said, we do have to be cognizant it is a smaller probability event in our minds. But with unemployment in such good shape, so low, and wage is pretty good, if the economy has a soft landing and rates are going to stay higher for longer, then that slope of the yield curve could also adjust itself by longer rates rising a little bit. That wouldn't be our primary scenario at this juncture, but it's something that we have to be aware of. For the equity market as a whole, the kind of tearing down of interest rates is normally positive for valuations. It's interesting, last year, earnings estimates were as close to what was actually delivered in the history of estimates being shown. Yet for all that quality of earnings estimates, it was the multiple that changed quite significantly and led to the decline. And that decline impacted stocks— some stocks much more significantly than others. So as we come into this year, if we have a softer landing, maybe the earnings will hold up better, but we also may struggle a little bit with having a valuation expansion. So normally what happens is today we sit here in a slowdown, the earnings might decline. If the current estimates are around 230 for the S&P, it might decline even to the 200 to 210 mark. That might cause some softness while those earnings get worked through the system. But then as interest rates start to drop and the stock market starts to look beyond the current earnings and say, well, earnings will recover, the multiple expands on those recovered earnings and you get a very nice return from the equity market. Those are some of the things that we're going to have to work through this year. If in fact we get a soft landing, we may get more earnings, but we may not get a major change in valuation that often comes with a decline in interest rates. Lots to think about as we go into the year and we're going to be ready for a variety of outcomes.

Yeah, and as we say, there's still that possibility of the different outcomes. Would you say that what you're seeing over the last month, though— and this is what Jerome Powell and others would be looking at as well—, is that you're starting to see a little bit more of that most likely scenario, the chance of that playing out versus the downside scenario?

Yeah, I think that's true. Inflation, from our standpoint anyways, is likely to come off a little bit faster than people expect. The short end of the yield curve looks quite attractive to us. And then within the equity portfolios, notwithstanding headline changes, there's still a lot of attractive opportunities. When I look inside the portfolio, we have all sorts of stocks that we think could be quite interesting through the year. So shorter-term credit, shorter-term interest rates look interesting. And there's certainly a fair swath of businesses out there that do as well, and many of them also, from a timing standpoint, which is always the hardest thing to predict, but we're collecting lots of dividends and those dividends arrive and we get to buy more stocks and get to sprinkle new opportunities into the portfolio, which is certainly additive to the longer-term return potential of what we see.

A lot of the stuff that I've been reading here the last couple of weeks of 2022 and early this year, seem to point towards, like you say, short end of the yield curve or shorter, the one- or two-year area of the yield curve, and then real quality on the stock front. The dividends, like you always preach, that seems to be the consensus area of where you want to be right now.

Yes. Obviously, I'm biased. I've had some dividend stocks and things like this for well over twenty years, and when you think about high single digit returns and half of it is coming to you in a dividend, there's always the chance that something takes off or turns favor. But in a financial plan, I'm pretty happy with dividends and dividend growth in almost any environment. So I think that fits the bill today, but I think it fits the bill for the long term as well.

Absolutely. We'll never get off that. I don't have a coffee with me, so I won't even say our drinking game word. We'll get into that in another episode. Let's look at Canada. One of the things you mentioned I did want to come back to was the peak of the US dollar. And we talked about it on some of the episodes with Eric Lascelles and some of the other guests that we had on last year, the idea that as US interest rates were moving dramatically higher, it created incredible strength in the US dollar. But Canadians didn't notice it. The Canadian dollar weakened a little bit relative to the US dollar, but nowhere near what was happening with the yen and the euro and the British pound that in some cases were down over 20% against the US dollar. We've seen, and what we talked about in several episodes is as soon as the market gets that sense that maybe somewhere over the hill US rates are going to start to come down, that the US dollar would soften. And sure enough, we've seen that happen and you referenced it. But once again, if you're looking at the Canadian dollar vs US dollar exchange rate, with so many Canadians look at— it's probably the most commonly known economic number amongst the Canadian public—, you haven't really seen it. The Canadian dollars move from 73 to 75, maybe a couple of percent. But that US dollar drop against other currencies has been in excess of 10% since the market received that signal. So that's going to create some other opportunities. We're going to get into that with other guests. But Stu, let's talk specifically about Canada then. Is everything that's transpiring, including this big change in China, does this set Canada up for continued outperformance relative to the US or underperformance because of the structure of the Canadian market?

Well, it's a little bit of all of the above, unfortunately. It's not as cut and dry. I think, for the Canadian dollar, it will likely take a period of time. I think the next six months will probably be the more interesting six months in Canadian housing as we get through the spring selling season, and it'll give us an idea as we start to see some volume trading. Prices have come down. Certainly, it would be a manageable level, but we haven't really seen a lot of volume trade. And as a market participant, you like to see volume and price. That will probably have happened within six months. And I think people get the feeling that the housing market is a bit more balanced, even if the price is a handful of percentage lower, but a bit more balanced. That will be helpful to the perception of the Canadian economy. It might take until then for the Canadian dollar to participate in some of the other currency strength against the United States. From a commodity standpoint, natural gas has been a struggle with the warm winter. If China aviation went back towards its normal levels, that would be another 2 million barrels of oil a day. So there's some tailwinds that could present themselves on some commodity consumption. And then the broader commodity complex too. The copper has already been quite tight. Iron ore, these types of things, they would certainly benefit as China gradually reopens. So I think it's an okay set up for Canada. In some of the global areas, Canada was a little bit stronger last year. Some of these global markets and EM markets are challenging— like ten-year downtrends against the S&P, and they're doing so with pretty good breadth. So I don't know if Canada will outperform some of those markets, but it looks okay.

Yeah. One of the things I'm reading about a little bit and that more people are on, particularly as some of the cryptocurrencies have fallen out of favor with a broader range of investors: a lot of similar type investors have an interest in gold and silver and we've seen some rally there. Is the setup that we've got for 2023 favorable to precious metals or is this just a reflection of what we've seen over the last couple of months with US yields coming down and the US dollar weakening?

Well, I think it certainly helps with the US dollar weakening. I also think with some of the geopolitical changes that have taken place in the last twelve months, when every commodity is traded in dollars, and the ability to always get your hands on US dollars was a bit of a challenge, which led to some of its strength. But you start to see central banks start to build some gold reserves back up through last year. The set up for commodities in general is not bad. Gold is not bad. Just to have some diversity outside of just the US dollar, I think that's picked up a bit of steam in the last couple of months.

Yeah. But in a good Canadian dividend portfolio, if it's well diversified, you're going to have pretty good exposure to all of those areas, right?

Yeah. Gold has been tougher from a dividend standpoint to get exposure. There's only a handful of gold companies that operate in jurisdictions that we would feel really confident in a dividend-oriented portfolio. It's not that there's anything necessarily negative about some of these other jurisdictions. They have a little bit more volatility and we like to keep it a little bit down the middle of the road for the dividend areas. But rising gold prices can produce rising cash flows and the valuations are not totally untoward in that area. But the nice thing about the Canadian market is you look across energy, even a little precious metal, the financial stocks, the consumer stocks, they tend to be higher yielding. The businesses are solid. Some might say solid, yet unspectacular. I think they're solid-solid. So you're sitting there collecting mid-single digit dividend yields with the likelihood that those dividends are going to grow, at least at inflation, if not more over time, that's a great recipe in my mind for long-term returns. And it's just whether or not investors, I think, will be looking at some global sectors. The US equity market capitalization grew to such a level that that might rebalance itself a little bit, and that can help Canada, but it's likely to help some of the global markets a little bit more.

Yeah, and I should have been less specific in terms of saying Canadian dividend portfolio. More of a Canadian portfolio will give you lots of exposure to all those different areas. I'm sorry, I positioned that poorly. So overall, if you balance out the different risks and potential outcomes as you would see it, if things play out the way you think, this should be a little bit better a year than what we saw last year?

It should be. I think so. The timing of it. One of the things I have written on my wall is a quote from JP Morgan. When asked what stocks will do, he said: they'll fluctuate, young men, they'll fluctuate. But all things considering, as we progress through this year, we'll see both the worst of earnings and we'll see the worst of the impact of interest rates. And as we've talked in the past, good-and-getting-better, good-and-not-getting-better, bad-and-getting-better, that is not a bad time to be investing in the stock market. And I think we'll see that sometime this year.

Excellent. Well, I'm back in the office. I was working late last night and I've gotten to know the cleaning people fairly well over the years. And the cleaning person came by last night and said: do you know the crazy guy who writes on his wall upstairs? And now I know the answer. Stu, you shouldn't be writing on your office wall.

You have to come look; for my birthday, they gave me a present. You have to come have a look at it. But I love to keep things and put them on my wall. There are all sorts of great things just as I stare at them. «The mortal enemies of intelligence are time and wishful thinking»; that’s another favorite. We have to be open minded to a lot of different scenarios, but I think we're making progress, relatively speaking.

Yeah. And actually, there's a lot of interesting stuff on the wall in your office. And happy birthday, by the way. Happy New Year. And Stu, thanks for a great Stu’s days to kick off 2023.

Great. Thanks very much, Dave, and all the best.