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About this podcast

This episode, Stu Kedwell, Co-Head of North American Equities, discusses the themes to watch for as companies report their first-quarter earnings. Stu also talks about earnings expectations for the future amid a slowing economy and rising costs. [11 minutes, 18 seconds] (Recorded April 12, 2022)

Transcript

Hello and welcome to The Download. I'm your host, Dave Richardson. And it's (S)Tuesday— on time too!—, which has been a rarity for us lately, Stu. We've been a little bit delinquent.

Well, it's been a busy time, Dave, but it's good to be back.

It is busy. We were out last week doing some speaking engagements with some advisor groups. That was a good time and some interesting stuff there. I'm sure we'll get into some of those topics that we got to in terms of the questions that we were getting from that group. But speaking of busy times, always a busy time for an investment manager when you've got earnings season on tap. We're about to see just a flood of earnings reports coming out in both Canada and the U.S. for the first quarter. As you look at it, what do you see coming in earnings and what do you expect to hear from companies in different parts of the market?

We expect companies to highlight some of the challenges that they've worked their way through and the persistence of those over time. It's always great to get more information right from management themselves, because we've been in a little bit of a vacuum. As you get into quarter end, companies enter quiet periods and we've had this period of time where the yield curve is flattened, which we've talked about a lot, although in the last week it's subsequently re-steepened a little bit. But we've had this vacuum where, when markets don't have new information, they tend to meander a little bit and discuss what's on everyone's mind quite a bit, and they tend to trend a little bit. The last couple of weeks has really been about how much accommodation is going to be removed and will that tightening, to some degree, impact future economic growth. Will inflation be passed through? Are we seeing the zenith of corporate profitability— that doesn't mean profits won't grow—, but in terms of margins and returns on capital and what have you? You have a little bit of murkiness around the earnings picture at the same time as you don't have the same backstop from the central bank, which has led to a little bit more volatility. It'll be nice to get some real information around just going through a company's income statement. What is your revenue line look like? What is your cost of goods sold line look like? What are those margins look like? Are you passing on costs? Have you seen the worst of some of the impacts on your inflation? Are you making new investments? What types of returns do you want on those investments? Things like this. The banks kick it off and then next week we'll be very busy and we'll get into tech and all sorts of sectors. But the things that fundamental investors are preparing themselves for, simultaneously: right now, concern is elevated, so you're always running those scenarios about what could be the impact on earnings if things slow down. But you also have to prepare yourself because the sentiment has turned more cautious. The cautious side of the boat is a little bit more crowded now than it had been. What if we get information that companies can manage this and that maybe we've seen the worst of inflation? We did have a U.S. CPI this morning, and while the headline was 0.1 higher than what economists thought, some of the underlying stuff, the core inflation was modestly better. Things like used car pricing, which had been a big source of inflation, actually starting to come down. As a fundamental investor, if in fact we were getting into the soft-landing scenario, that would be better for the stock market and would likely cause a reversal in some of the relative performance that we've seen within the market. By that, I mean, in the last month, we've seen strength from utilities and defensive stocks, and weakness from some of the more economically sensitive stocks. If we saw signs of a soft landing, that might reverse in a real hurry.

A lot to unpack in your comments there, Stu. But the one thing for folks to always know is, you do have almost a dead period of earnings reports. It really happens every quarter. But it seems like this first quarter one is always one that creates a lot of angst. In that last three, four weeks of March and into the first week of April, there's just nothing going on, so the market is looking for clues, but there's not as many clues out there. The stuff that it's had to focus on has been mostly negative in terms of the reporting. Still, obviously, issues around inflation, although in that report this morning, as you say, there could be some signs that things are turning. You mentioned how cautious people are in the mood. What are a couple of examples of things from the reporting that you see over the next two or three weeks that might get you to feel less cautious about what's going on in the market?

Well, let's use an example: we won't name them, but a large U.S. investment bank that would have had one of their best years ever last year, and the price to book value at the peak of that activity might have been 1.4 to 1.5 times book value. In the last couple of months, that ratio has dropped to 1.1 times book value. The stock has come down by around 30%. We're always trying to marry the long term with the scenarios in the short term. This investment bank is not dissimilar to the stock market. They have compounded their book value over the last ten years by around 8.5%. If you said, okay, in the next ten years we're going to have periods of really strong and vibrant capital markets and periods that are a little bit quieter like we're going through now, which has taken place, they'll probably compound their book value in some neighborhood like that going forward. Then you're looking at the valuation and you're saying, boy, that has corrected a fair amount. Now, it doesn't mean it can't go to 0.95 or 1.0, or whatever in the heat of that concern. But if you have a range of 0.95 to 1.5, you have both the simultaneous discussion around how business is slow near term, but the stock market has tried to factor that into some degree. They're all going to start this week. That's what we're really looking for. We can see a bunch of near-term indicators that we know activity is slow. The thing that people are maybe particularly girded for this time is because of the war in Ukraine and the impact on commodity markets. People are wondering if there'll be outsized losses in some of the commodity markets. But again, even if they are, they're not likely to be permanent business changing losses. So, to your point, we're in a bit of a vacuum. The anticipatory stress is often worse than the actual announcement, like anything in life. We'll just see as we get some reports in the next couple of days.

Just like I have that big anticipatory stress, whenever we're about to take this podcast, and then it works out okay. Not because anything I do, but because you're so smart and you carry the load. What would be a couple of things that you'd look at that would make you a lot more concerned versus where you are right now?

From here, probably something on the margin front. I think revenues are going to be okay because of the backdrop, and employment is great, and the economy might slow down a little bit, but we're still talking about a pretty good backdrop for revenue growth. The margin component will be pretty important in the next twelve months to get to those earnings expectations. But really, what we would look for in the near term around some of the areas that had been pressured is, the news comes out, maybe it's not that great, but the stocks shrugged off. That's like saying, well, okay, everyone knows that now, so we can go on to what might happen next. That would be more important going forward at this juncture. We've talked about this before as well, but in the short term— Warren Buffett would say the stock market is a voting machine—, we like to think about it as if people are on one side of a boat versus the other. The boat, for a long-term investor, hasn’t headed in the right direction but people move from side to side and we're just looking for signs that maybe we've moved a little bit too far in the short term. That's what's on the menu this week.

We keep coming back, it seems almost every week, to this idea that it really isn't a lot of a surprise this year that we're seeing choppy markets. There's just so many different things going on. Things were relatively calm last year and usually a calm year is followed by a year that's a little bit choppier. Of course, we've had a pretty incredible thirteen-year run in markets from the bottom of the global financial market, and it can't go straight up. This is not surprising and we just have to let things play out. I always like to check in with you on earnings season because it's one of those things that gives us that next data point to get a clue of why things have been happening in a particular way over the last several months, or some clues or signs that things should be better or worse as we move forward. That was a great way of positioning it, Stu.

Thanks very much for your time, Dave, and thanks for the people listening. We'll catch up next week.

Talk to you later.

Disclosure

Recorded: Apr 14, 2022

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