Hello and welcome to The Download. I'm your host, Dave Richardson. And it is Stu’s days. And you know what, Stu? I hate to say it, but I've been getting some notes from people and they've been saying, Stu’s days have been boring lately. The market is just going up all the time and rates are drifting lower, and things are looking okay. And you guys are talking about the same stuff over and over again, and it's just really dull. So how about yesterday and Friday? How about the most exciting Stu’s days this year coming up right now? Stay tuned.

There you go. It has been quite a couple of days in capital markets.

Yeah. I think sometimes that as things chug along and volatility can be somewhat a feel or the ups and downs of your own portfolio, but there's actually a measure of it. And we've been ticking along at very low levels of volatility. And then, of course, yesterday, we spiked to levels that you rarely see, if ever, until today. And so you had, again, just a dull market that just kept drifting higher. And we've talked a lot about that. So we won't belabor those points. But then all of a sudden, we get a jobs report Friday. By the way, if you want the more purely economic view of what's going on with the jobs report and how that changes odds of recession and interest rate forecast, we had Eric Lascelles on. Just the episode before this one is with Eric Lascelles, and we go deep on the core economics of everything. But we get what could be interpreted a lot of different ways, but clearly the market interpret it as a little bit weaker than expected report. And all of a sudden, we see stuff moving all over the place. And, you know, Stu, I think one of the main things for the audience, before we even go into your thoughts and comments on it, is it was a long weekend here in Ontario, where we reside, and a long weekend for most Canadians. We've got our friends in Quebec who were not on vacation yesterday. But I got up in the middle of the night and there were already emails streaming back and forth. When you talk about investment managers and professional investment managers, when something's happening in the markets, they are all over it. And you were one of those people. So for those people who have people managing their money, you never have to worry. Those people are working 24/7, it seems. It's quite amazing. And again, I think the podcast, if you've been listening to us over the months and years, then you know the passion that Stu and his colleagues and people in this business bring to the table. I was up fairly early, too, and I'm not a morning person. But Stu, what do you make of what we saw on Friday, yesterday, on Monday, and now today as markets rebound a little bit today?

There's a couple of things. I think we should probably go back to these three buckets of stocks that we had in this environment. And there's been a bit of an impact on each of those three buckets. So bucket one was some of the growth stocks with very high expectations. Bucket two has been what I would call quality normal businesses that could use the benefit of a slightly a better economy, and valuations are reasonable relative to that type of expectation. And the third bucket is some of the very more safe, secure cash flows that tend to benefit from interest rates in the stock market. So as we've gone through this multi-year process of inflation peaking, interest rates peaking, and the prospects of earnings bottoming, the later innings of that, because monetary policy is still biting, the later innings of that often come with a little bit of an economic slowdown. And this time around versus what we haven't seen really since the financial crisis is that with the prospects of economic slowdown, central banks have something to do about it. They can lower interest rates. And investors can be a little fickle around that dynamic. If they think the central banks are up to the task and they're going to lower interest rates in advance of some of the slowing, then they tend to look through it. And if it's behind or if they're viewed to be a little bit behind, perhaps, then they can be a little bit more excitable. And we've certainly seen a little bit of that in the last couple of days. I would say on the first bucket of high expectations, some of the stocks didn't quite live up to those expectations. So that affected the valuation of those names. Not that their long-term growth prospects are really that different, but it's just the weight of high expectations. The second was that basket of companies that can use a slightly better economy. The unemployment data on Friday, after a string of maybe some slower economic releases, was also below expectation. You could debate whether or not it was due to very hot weather, but it certainly seemed to be a little bit softer. And that sits on top of the central banks. Fed Governor Powell gave a press conference on Wednesday, and intimated that there's a very high likelihood in September, they cut interest rates, whether it was 25 or 50 basis points. I think there were some market participants that when they saw Friday, then immediately jump to 50 basis points. And then also what happens is a lot of investors, not really ourselves — or not ourselves by any stretch of means — but some people use more leverage in some of their trading strategies. So the weakness that began on Friday picked up steam over the weekend and hit Japan pretty hard on Sunday night. And we don't need to get into the dynamics of what they call the Yen carry trade, but the other thing that has been percolating in the background is that the Yen has been strengthening. And if you've borrowed, using that currency to fund a lot of your trades — and interest rates went up once in Japan — it affects that trade. So you might shrink the book size related to it. And it certainly carried on with the momentum that had begun in the last Friday. And just while we're going through that, we should also cover off the last bucket of stocks, which is some of those more secured cash flows that exist inside of utilities and real estate and things like this, which had started to do better as interest rates had peaked. And that carried on a little bit, even in the midst of the volatility. When we get a day like yesterday, what we're looking for is to see which stocks are behaving differently than we would have expected, given that backdrop. And I would say many of them were quite consistent. The ones that are a little bit more economically exposed were hit a little bit harder. And it's really just this timing. And just like you might not know that the stock market would sell off on Friday and Monday, you also don't entirely know when the stock market will decide that the worst of the earnings has been seen and there's enough stimulus in the system to get it going again. That's the bucket of stocks that we are probably the most interested in going through this process. So that was certainly something that we looked at yesterday and continue to look at today. Markets are bouncing today. Was yesterday the low? Those are very difficult decisions to know for sure. Often when we get this type of action — it was a rumbling correction — it takes a bit of time. It hits different stocks at different times. Seasonally, we're coming into the fall, which is not always the best for equity markets. So was it the low? I don't know. And I don't think it really matters if it is, to tell you the truth, because we're looking at these three buckets and we think that we're going to find a reasonable opportunity certainly in bucket two, and in all likelihood in the first bucket as well, the way some of the prices have changed. So we see a big bounce today that negates a lot of the sell-off we saw yesterday. Is it the end? I don't know. And it's just not the way that a long-term investor would really go at it anyways. I think the one thing I would just finish off is that when we see action like yesterday, my grandma used to always say «my word» when something was astonishing. And certainly, it's only human to look at some of the price action and say, wow, that's quite something. But the other side to it is that we know days like this are going to take place and they're going to happen again. So it's not something where we spend a lot of time admiring or whatever, looking at the action and going, «my word». We just get on with business and it's part of being an investor.

Yeah, and stay tuned because Stu is committed. We're going to do a special two-hour podcast special on the intricacies of the Japanese carry trade because I know how that excites everyone. And again, one of the things that's tossed out there. But this may be just as simple and I keep coming back to this because I think it's so critical, not necessarily for this time, although I think in this instance, it does prove helpful for people to have been listening to you saying this now for almost two years, which is that we get a peak in inflation — which is October 2022 —, twelve months later, you get a peak in interest rates — which looks like it's going to be October 2023 —, then about twelve months or a year later, you get a bottom out in earnings. So it's not entirely surprising that if you're expecting the bottom in earnings to be somewhere in around this fall of this year, some of the economic data that would lead you into the fall would start to look fairly soft. And at different points in time, that economic data might be surprisingly soft. You might get a number here and there that just makes you say: my word. And in the middle of the summer, say in August, which is not unusual to see because half of the world that's working in financial markets is on vacation this time of year, you can hit almost like an air pocket. You're flying along in an airplane and everything's going nice, and then all of a sudden, there's just a lack of air. It's not a very comfortable feeling when you're on the plane, but then you just carry on from there. So it's not unusual in the absence of all the market participants being there, that this tends to be the time of year where you see some of this stuff in August and September. So none of this is a surprise. And then let's layer on, as we've talked about with your three buckets of stocks, but one bucket of stocks in particular, which are this small group of stocks that has performed at a level that you just don't see a lot of, in a particular space in artificial intelligence and big tech, and the valuations on those stocks are stretched, and we talk about it for months and months. Well, all of a sudden you get a little bit of bad news and, hey, well, maybe it's time to take some profits here. And once profits are being taken, then some other people are forced to take their profits as well. You can see where you could get this volatility. Then let me just layer in a couple of other things. 95% of years have a 5% correction, and about 70% of years have a 10% correction. So again, when you've got this strength in markets, which has very low volatility, very high returns coming into this part of the year, to have a little bit of a pull back — although it never feels good — is not that unusual. And then again, we keep going back to, okay, well, if earnings are going to bottom out, that means they're going to start going up sometime in the not-too-distant future. Interest rates have come down. We likely think rates are coming down further. So you look out a year from now and you're likely in a better spot. And that's where the stock market is generally looking at this point. Anything I've said that you think is out of line or that you'd want to refine a little bit as a professional investor?

I think that's all well said, Dave. Even when you look in this corrective activity, as we're talking, the average stock is down 4% from its highest, or something like 4.5%. The headline indices are down a bit more. So in this process, in the weekend, you always go through a variety of readings, and there was one strategist, as a great reminder, that said: returns come when revenue or sales growth starts to re-accelerate. So this process of the reason that the central banks are lowering interest rates is because monetary conditions have been tight, which means demand has been pent up. Because there's things I can't do, I can't get financing or I don't feel confident, all sorts of things. In the last couple of days, the Senior Loan Officer survey in the United States actually showed some green shoots on loan growth. So the notion that during this last phase before tightening, before easing kicks in, that's when you're waiting for that revenue growth. And when revenue growth starts to accelerate, that normally drags stocks with it. It's very similar to earnings bottoming, too. When we have more revenue, it's easier to have more earnings as well. So that's something that will likely be in the next three to six months. And we've had this discussion about looking backwards, it looks quite precise as to when things took place. It's not very precise. These are generalities. And if we could be right within two or three months, that would be pretty good from a long-term standpoint. And of course, that brings me to dollar cost averaging. I haven't put my dollar cost average hat on for a while.

Don't do it, Stu. Don't do it.

But just a wonderful environment for dollar cost averaging, which has been for some time. But just a great way to negotiate your way through this type of an environment.

I think over the last six months, I'd argue that we've really been almost over-emphasizing how enticing environment it is for dollar cost averaging. And this is just another reminder what happened towards the end of last week and then yesterday, how effectively dollar cost averaging can be. You just said it, which is the bottom line of it. Again, if I'm going to put my finger in a window, the market's going to bottom on August 8th. If I can't absolutely 100% know that, then boom, I just save all my cash and then I roll the cash in on August 8th. But when it's a moving target of two or three months — and again, sometimes you can't even get it that right — but say you're confident you can find a spot somewhere over a two, three, maybe even six month period, this is where dollar cost averaging just comes in because you're going to be layering that money in over time and you're going to get quite a bit of it in at that bottom. And some of it you're not going to be right at the bottom. And then the days like yesterday don't feel anywhere near as bad if you're deploying new money that way.

Couldn't have said it better myself, Dave.

See, I do listen to you, Stu. A lot of people ask me, do you I actually listen to Stu? I go, yes, everything. You should listen to. That's what I say. Stu's days are for everyone.

And the listeners don't even get the benefit of seeing your hand action, which is spectacular.

We do have some YouTube videos going up. We're going to start to get videotaped regularly, but that means I have to actually get my hair looking okay, which is hard these days, Stu. I'm not as consistently good looking as you. So Stu, we've got the dollar cost averaging. We've talked about the three buckets. We've got that fantastic thought in terms of how this plays out. And although it feels a lot different from other periods, when we look back historically, it looks the same. So is there anything that you think investors should be looking for as we go over the next two or three months? Is this likely the precursor to a period of a little bit more volatility or do these things tend to come and go fairly quickly and then we just move forward from there?

I think it's probably the beginning of a period of volatility, unfortunately. But that's just part of the process. The thing is — and we've seen it in the last three or four months — that if the stock market's time horizon shrinks, that's a good time to lengthen yours. And vice versa. And so when we get into these very compressed periods of time and certain trading strategies are perhaps unwinding, and it's doing it at a time when we're waiting for some of the central bank interest rate cuts, that's a good time to think about the other side of that valley and say, oh, boy, if it's 12 months from now and interest rates are lower and business activities picked up and all these types of things, which we don't know exactly when, but we know with a high degree of certainty that we'll be discussing those sometime in the next 12 months and envision, what do I want my portfolio to look like when we're talking about that? Those are the things we're normally thinking about.

Now, Stu, I was looking at a couple of things just coming out of yesterday. I like to see where things are, especially after the reversal today, and look back at those extremes. At the close of yesterday, a diversified fixed income or bond portfolio that I look at, one-year trailing return — so the one-year return to the end of the day yesterday, just to be precise here — if I look at a 60-40 portfolio, a balanced, well diversified portfolio that many Canadians would have as their core holding, so properly diversified, not just all concentrated in the US, not all stocks, but lots of nice bonds, lots of different stocks everywhere — around 12.5% on a twelve-month basis, which is really quite fantastic. And I know that when we talk to Sarah Riopelle, she talks about a portfolio right now that's pretty neutral, and that's the view that you would have. Anything that's happened with rates moving down as quickly as they have, and this volatility in the stock market that changes you from a view that being neutral right now is not the right place to be? And does this create any opportunities to shift one way or the other? Or is it this one where you sit back and watch for a bit?

Well, no, I think when you look at a balanced portfolio, the movement in some longer-dated bonds, to your point, when you've done 10% from the bond market, you've done a lot more than your coupon. And there's periods of time when you think you might get your coupon, and there's periods of time when you might get coupon plus. And we're probably moving more into an environment where the bond market is doing its coupon. We talk about the actual lowering of interest rates because that finds that grease is parts of the economy, but the bond market tries to get ahead of that. Yesterday morning, at its lows and yields, the bond market was maybe even too far ahead of that. I'm not sure. I think when we think about a balanced portfolio, we'll be thinking about doing the same type of thing that we just talked about on dollar cost averaging. The next leg of returns that will come from a balanced portfolio will be earning the coupon on our fixed income, but finding our ways into the equity market to capture the earnings growth that will come on the other side. So we'll be doing a very similar process as the dollar cost averaging that we just discussed.

Exactly. On a bit of a grander scale than the average person, because you're doing it on behalf of a few million people.

That's right.

That's right. Well, Stu, again, I guess the Olympics have been fairly exciting. If I'm looking for some entertainment, but it's a slower patch in the sports here for us sports fans. But the markets have certainly provided that entertainment for us the last couple of days. It's good to get a little jolt here and there, even in the middle of the summer.

Yeah, I guess so. I think the last couple of days, some people could do without, but it's definitely part of being an investor over the intermediate term.

But as always, it's just a reminder that markets don't go up in a straight line or that there's little hiccups along the way. And you want to make sure that you're thinking about things the right way long term to take advantage of these things which are an inevitability. And you got to take it in stride. The other one I always like to go back to with you, one of my favorite stories that you tell is that you just think at the start of your investing career that you got 40, 50, 60, 70 years to invest, and you're going to have a recession about every six or seven years. So it means you're probably going to go through 8 to 12 significant down periods through your investment career, but a lot more rough along the way. And that's the way you need to think about it.

Yeah, like 60 or 70 years for me would probably take cryogenics from here. But yeah, no, the idea that you can compound your money and you're going to get that last doubling period is going to be very valuable to you. And the price of that is dealing with volatility and the odd recession and things like this and really trying to put more to work during those periods of time to maximize your longer-term outcome.

Excellent. Well, let's hope that this bounce back holds and that things are quiet until we get to the fall. But, Stu, always great to catch up with you on Stu's days. A lot of wisdom and quality stuff from today's episode.

Great. Thanks very much, Dave.