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Market sentiment has been largely focused on two questions: how fast will inflation decline from here, and how will earnings hold up in a slowing economy? This episode, Stu Kedwell, Co-Head of North American Equities, discusses the factors at play in the current market, and how investors can tilt the odds in their favour by investing regularly and dollar-cost averaging. [13 minutes, 52 seconds] (Recorded: February 23, 2023)


Hello, and welcome to the Download. I'm your host, Dave Richardson, and it is Stu’s Days on a snow day, here in Toronto. I'm glad we're once again late with Stu’s Days— we're taping this on Thursday morning, February 23rd— because I know the listeners are very excited about hearing how you dealt with these mounds of extremely heavy snow, Stu. This was not just your regular snowfall.

Well, you got to get at it early, Dave. So I was out twice last night and once again this morning.

Really? That is impressive and disappointing.

That's right. But I didn't salt it till this morning because that seemed like it was going to be a waste.

Again, we always come back to this dollar-cost averaging approach with you. Now, it works in reverse with snow shoveling. You got to remove it quick, right? Deposit it to the side of the driveway?

That's right. Get out there every hour, even if it continues coming strong, and just work your way through.

Wow. I hope my wife doesn't listen to this podcast. She's going to be putting a lot more pressure on me. I went out with the giant plow this morning and plowed it all. It was an unbelievably tough snowfall.

Yeah. I do like to look at forecast as well. And I knew that freezing rain was coming, so I wanted to have a good chunk of it gone by the time the freezing rain showed up.

That's why we call this podcast Stu’s Days. You're doing the analysis; you're doing the projections and you've got a solution for the problem. And the problem right now, Stu, aside from the snow we had today, if we're looking at markets, is a market that's pulled back a little bit over the last couple of weeks. We've talked about in previous weeks, and we had Eric Lascelles on, talking about some of the economic reports that have come out just over the last three weeks that have been surprisingly strong— I guess that would be the best way to say it. And that gets people a little bit nervous about what the central banks, the Federal Reserve and the Bank of Canada, how they're going to react to this and how it all plays out. We had Sarah Riopelle on a couple of weeks ago and talked about some of the meetings that you had. You work with Sarah at managing the portfolios, and you took some money out of equity markets and moved it into cash and fixed income. And as you say, there was a little bit of a forecast that there was going to be some heavy lifting here for the markets. For listeners, how do you pull it all together around what's going on and what's changed? Or has nothing changed?

Well, it's an interesting question because stuff has changed, and stuff hasn't changed. I think investors are always thinking about two things. The first is, from a fundamental standpoint, I'm going to have a couple of scenarios in mind on earnings. What does it look like if things are strong, normal and poor? Right now, I would say the earnings that are being expected— call it 220 or 230 on the S&P— are kind of normal. If we had a reacceleration in the economy, those earnings could even be a bit better. And if we had a slowdown, it's probably down 15% on the earnings. The next thing you do is you think about the multiple that you pay for those different scenarios. We think about it like you have nine boxes. I can pay a low multiple for a pessimistic forecast. And ironically, that's the best. Because that's when you're getting lots of optionality as an investor; eventually the forecast will improve and eventually the valuation will improve. And what we saw in the last couple of weeks probably was a slightly elevated multiple on a normal forecast. From a very long-term standpoint, you may not really do anything with that. The next thing that you try and marry in is some behavioral finance, which boils down to the old Warren Buffett: buy fear and sell cheer. We started the year with the bullish sentiment down around 20%, and by the end of January, we were up to 40%. And the amazing thing is it's whippy because we're now back around 20%. We're at one of those stages when you read the bearish narrative, you look around the room and a lot of people are nodding their head. That doesn't mean that it's not correct and it doesn't mean that it won't play out. But the bearish narrative kind of feels more comfortable right now. So we're pretty aware of that. And as an investor, you always have to ask yourself: if you're comfortable, how could that change? Right now, there's been a handful of strategists who came out and said: we either lose by earnings falling or we lose because the Fed has to go a lot harder on interest rates. I doubt that either extreme is likely to take place. By that I mean, I think all central banks will be very diligent on inflation. I think the size of increases might surprise to the downside, but the length that they're at these levels might surprise to the upside. And on the earnings front, I think they likely will be under some pressure, but not likely as much pressure as a really serious recession. And it leaves us in one of these markets where we have some rather abrupt ricochets as sentiment moves from one side of the boat to the other. There's a lot going on in the short term, but I don't know if there's a lot that's really changed in the longer term. It really lends itself to scenario analysis for the market as a whole, but stock by stock. It lends itself to collecting dividends and looking for dividend growth. And that's the environment we're in. It's not an up-up-and-away environment, which some people might like, but for long-term investors, a great time to be dollar-cost averaging, which you know I like a lot. But this malaise that there's some things that have to solve themselves inside investors’ minds. And those two things really revolve around the pace of inflation declining and when it declines, what does the earnings picture look like and how quickly can it pick up?

Yeah. And if we pull it together around the decision that you and your colleagues made to reduce equity exposure in portfolios, that wasn't necessarily a change in your long-term view or your next 12-to-18-month view of equities. It was more about equities having a tremendous run from October to the middle of February in terms of moving up. Back in October, the prices were really attractive. They move up 15%, they're not as attractive. The outlook doesn't change, but the price has. And you've got to reflect that in terms of the actions you take.

That's right. From a long-term standpoint, in general terms, if you said earnings grow at 7% and dividends are around 2%, if I pay a certain valuation for the stock market and I leave at the same valuation, I'll compound at 9%. We don't know what the exit valuation is, but we know from a long-term standpoint that that's hovered around 15-times earnings. When I say I'm a long-term investor, to me that's ten-ish plus years, like, shooting for retirement, long-term compounding. If I pay a premium to 15-times earnings, there's a possibility that that premium will get eaten away, because in my ten years, I'll come back to average. So, there's times when valuations are below average, and I get to add to my long-term return. At times I'm at average, I get earnings growth and dividends. At times I'm above, I have to keep that in mind. So when we see a big move in the market the way we did, and valuations were a little bit extended, it's just a time to tactically harvest something without really changing that longer-term return dynamic. It's not dissimilar to buying a ten-year bond. If you buy a ten-year bond and hold it, you're going to get the coupon. But if that coupon or if that interest rate declines in a year's time, you're going to get capital appreciation as well. So any investment has the fundamental cash flow and earnings that it's going to deliver, and it has the change in valuation. And the change in valuation is more art than science, but we try and marry views of inflation, investor sentiment, psychology, all sorts of things to think that through.

Yeah. And if we're sitting here as markets have corrected a little bit— and again, the overall forecast hasn't changed very much at all—, we go back to your Buffett saying to buy fear and sell cheer. And if you take the extremes away, there seems to be opportunities to buy discomfort and sell comfort. For most investors, it's so hard when there's that discomfort. It's hard to put that money in and commit it. But that's generally when you should be taking a look. And that move in sentiment that you talked about— 20% bullish to start the year, 40% one month into the year, and now very quickly rate back down to 20%—, that's reflecting a discomfort among investors and represents likely some opportunity. And then, as you said, this is the kind of environment that you love as an investor, because what works here is regular investing, dollar-cost averaging and dividends, and solid companies that are going to be able to navigate their way through a slower economic environment. It's kind of perfect, isn’t? It's like, most people don't like shoveling snow, but you do.

Well, there is a satisfaction to it, I have to admit, shoveling snow and investing.

In this kind of environment, you've got to focus more on value than you were, say, in 2021, when markets were jumping 50% in the year.

You can look at the daily volatility in the stock market and say: that's a place to get rich. Or you can look at the daily volatility and say: I don't want to have anything to do with it. Or you can say: I'm a long-term investor and every day this volatility gives me the opportunity to tilt the odds a little bit more in my favor for the long term.

Exactly. And I think that's what my wife was saying when I was lying on the couch last night, watching TV instead of shoveling the snow a couple of times last night so it would be easier this morning. So as always, we keep coming back to it: you're right and I'm wrong. Well, my wife is right. Sorry. You're wrong occasionally. My wife's never wrong. But again, this is such a lesson, I think, these last two months. So glad you went through it this way in terms of the swing of emotions, the swing of valuations. But when you step back, you rationally think that: I don't think a lot has changed in terms of where we're likely going to go over the next 12 to 18 months. So if I've got the right plan and I stick to my principles and disciplines, I should be able to navigate this pretty well.

That's bang on, Dave.

Wow. Okay. I thought you were going to disagree with me, but that's a good way to end, Stu. Hopefully this is the last big snowfall of the year. Thanks, Stu. We'll talk to you next week.

Thanks, Dave.


Recorded: Feb 23, 2023

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