Hello and welcome to The Download. I'm your host Dave Richardson, and it is the ever-popular Stu’s Days broadcast, which is now no longer on Tuesdays most weeks because of our horrible schedule, Stu. It's now Sfridays, or whatever we are calling it whenever we would occasionally end up on a Friday. Which seems to be more the regular. The good news is for anyone watching us— and we do have people that we report to—, they know we're working on Friday.

That's right.

The Friday before long weekends, Friday in the summer when the weather's beautiful, we're not slacking off at all here. We're working right into the weekend.

That's right. Well, there's lots going on. We like to keep working.

There is lots going on, which is a problem. Stu and I are, we're pretty intuitive. We've been doing this for a long time and hopefully you've been subscribing for a long time. And if you haven't, subscribe and follow us to where you get your podcasts and subscribe on YouTube so you can see both of us, two of the prettier faces in Canadian financial services. I believe Stu was recently recognized for his physical appearance. So you’ll want to watch us on YouTube. But we always go through a little preamble. And because we've been doing this so long, we want it to be a natural conversation because that's, I think, what most people like when they're listening to a podcast. Like they're sitting in on a conversation that Stu and I might be having in the office. And we started to go on all the different topics that we could attack today, Stu. And like you say, there's a lot going on for a Friday in July.

Well, there's macro stuff. There's individual company stuff. There's lots going on.

Stu, we've been in and out of the war in different ways, and it's starting to feel like it's going to linger a little longer. It probably already has lingered a little longer than we would have hoped. In fact, we would have hoped it would have never started at all. But the net result is we've got oil back up well over $80. We've got 10-year US yield popped above 4.70% yesterday. As you're looking across everything that this impacts— by the way, Gordie-Howe Bridge was open today, but tariffs are back on the table. So my little hockey stick making company that I had going with the maple trees in my backyard, that's got to be put on hold because we got tariffs back. So out of all of this, Stu, what are you thinking of the most in terms of the portfolios you're managing?

Well, I think you always start with interest rates because they're kind of the bedrock to valuation, and more. Interest rates have been range-bound, or maybe at the top end of the range, as you say, like 4.6, 4.7%. The real interest rate has improved quite a bit over the last couple of years. It's higher. It's within a stone's throw of its longer-term average. When you get higher oil prices, there's always this delicate balance between: should the Federal Reserve or central banks respond to maybe some near-term inflation caused by energy prices with higher interest rates, or should they acknowledge that the higher oil prices themselves are a depressant to some degree on activity? That's always a delicate one. It depends on the mandate of the central bank. The European central banks, where it's a very much inflation-focused mandate, they often respond more frequently than a dual mandate where you're responsible for both inflation and unemployment. There's no question when oil prices rise, it ends up being a suppressant to different activity. We do have the Federal Reserve coming up next week. There's about a third of a chance priced in of a higher interest rate. As I say, you never know which way they'll err, but the combination of higher oil prices and slightly higher interest rates in and of themselves are a bit of a suppressant. Interest rates, in our minds, are in a range. And you're collecting coupon. The big difference in the total return performance of bonds versus 2 or 3 years ago is that the coupon is higher. When you think about a 10-year bond with a duration of 7, the duration is a measure of how much would the price change for a 100-basis point move in interest rates. If we went from 4.7% to 5.7%, you might lose 7% on a 10-year bond, you'd have picked up 4.7% in coupon, so you're down 2.3%. When you see these plus or minus 20 basis point moves, you're not seeing the same type of significant changes in the underlying price of the bond that you would have when rates were down at 1% or 2%. The next thing, energy stocks have perked up a little bit, but they're not racing out to new highs. I think that's reflective of we've seen this tension before. When oil prices went up so high, energy stocks didn't totally follow along. When they crumbled following the apparent reopening of the strait for a period of time, they also didn't fall to the same degree as well. I think what energy stock investors are sitting there saying, there's more tension in the oil market, that's going to lead to some additional cash flow, and that's why on both sides, they've been reasonable performers. But if you say, well, should they be rambunctiously higher? Well, the Strait could reopen. And if it did reopen and oil prices tumbled, should they be significantly lower? Well, the chances of it opening, closing, opening, closing remains. The oil prices, the oil stocks, they're fine. The one area in the market— we were going to talk about sectors that has been quite poor on a relative basis— is consumer discretionary. Big weights in the consumer discretionary play a role, things like Tesla and what have you. Even when you look at the average consumer discretionary stock, it has not led the market. And while the economy is pretty good, historically you used to always say, the US economy is 70% consumption so the US consumer leads. And that has not been the case in the last 3 to 6 months. So that's a notable difference. Part of that is this tension around higher interest rates, higher energy prices impacting consumption, impacting housing. So there are some big parts of the US economy that aren't firing quite the same way. Where it is really firing is on the data center buildout. This week anyways, it's a lot of capital spending. So it's been good for the industrial sector. It's been good for pockets of technology, but it also comes with a big discussion point. And we can talk through that a little bit. Just on the economy side, I think those are the three things. Then of course the trade. More tariffs. Versus the first go, the market is taking this in stride a little more because they know that tariffs are likely to exist at some level. Part is negotiation, part will be an actual payment. But again, we've had some events this week where the market can say well, I've seen this movie before. So the ones that cause the most uncertainty are the first time viewing of the movie, right? So that's where we're at on some of the top-down stuff.

I still cry every time I watch Big Fish. I don't know why that one gets to me so much. It's a Wonderful Life, too. Some of the other movies make me cry. It's easy to jerk the tears out of me. You're right. You have that lessening impact every time you watch the sad show. But one of the things you mentioned in relation to the data centers. We were discussing the Houthis firing missiles now. You had all this work to get around the Strait of Hormuz to find different ways of getting out. Well, now you're blocking off another one. And just all of the build-out of infrastructure in general. You travel quite a bit. I travel all across Canada. I go into any city, and even smaller cities, and I've never seen so much construction, roadwork, buildings going up, everything. And that's happening all around the world. And then, you layer on this the data centers. An enormous amount of capital spending.

Yeah, and that capital spending needs to come from somewhere. You've heard a lot of CEOs say before COVID the world was focused on efficiency, now it's focused on resilience. Resilience is more capital intense. To your point around Saudi Arabia, you used to send the ships around the tip and into the Suez Canal. If you're going to build a pipeline, that's kind of duplicating an asset you already had, right? It takes more capital. So that capital has to come from somewhere. The government has to borrow it. It has to divert it from another form of spending. All of that is capital expenditure. So that money has to come from somewhere. The data centers, a massive buildout. Google this week increased their CapEx from around $180 billion to $200 billion or something like this. $20 billion from one company. That's a lot of money when you're talking about a $30 trillion US economy, and you're going to spend an extra $20 billion, just one company alone. I think that goes back to the interest rate comment. Real rates are within the range of normal, but we had a long period of time when central banks were trying to get inflation up to 2%, and yields were quite low. Now we're probably in a period of time where the coupon of rates is more attractive, and the periods of time where you make some performance from bonds is when the economy goes through a little bit of a dip. But otherwise, if the world is going to be more capital intensive, there's going to be more demand for money to spend. And if the demand for money goes up, then the cost of it also will rise. That's one of the big changing dynamics. We've talked about the hyperscalers, the people that provide the data centers, the Googles, what have you, they used to be spending out of their own pockets, now they're actually borrowing money, so they're competing for the capital. They have to pay interest on that capital to keep the buildout going. And that has created another discussion point in the market. It is economy-wide, but it's also very company-specific. And we've talked in the past about how you have these 4 drivers of how a stock moves. So you have the revenue, you have the margin, you have the valuation, and you have the capital that it puts to work. So if you own a bank stock, they have a dollar of earnings, they give you half of it back in a dividend. So that capital comes back to me, and then I get to do what I want. I can put it in more stock, I can go and spend it. Obviously, I want the bank to put the half they're not giving me back to good use, make new loans and drive new activity and make a return on that. But when the dividend payout is higher, you don't have quite the same concern with what the company is going to do with their capital. When they don't give any of it back to you, and they keep it all, and they invest it, it's very important what type of return do they get on that investment. That is the discussion point that you hear repeatedly around artificial intelligence. On the one hand, the demand is very high. All these use cases, are they going to make companies money? If I'm going to put an extra $25 billion into my CapEx and I'm going to depreciate that capital over 5 years, I need to have at least $5 billion— it's going to cost me $5 billion a year in my income statement for the depreciation. If I want to make a 30% margin, then I probably need $10 billion of revenue to make $3 billion of operating margin on my capital investment. To get to the returns, this is what people are struggling with. And when companies have great runways of putting capital to work at higher returns then their valuations expand. When people have concerns over the returns they're going to earn on the capital they spend, the valuation often contracts until people get a better sightline. Obviously it's absurd, but if I owned a company and you said: what are you going to do with your excess cash flow? And I said, well, I'm going to light it on fire. You'd say, I can't give you any value if you light it on fire. It’s absurd, but it just proves the point. A dollar that stays in the hand of management. Company shareholders are very beholden to the success that management has with putting it to work. So if they can turn excess dollars into $2, $3, that's great. If people question the returns they're going to get, they factor that questioning in by suppressing the share price for a period of time until they see evidence that it's going to work. And that's what we're going through right now. And then you see capital expenditure go up, so people say, well, that's good for the stuff they're going to buy. But then there's another camp that says they can't keep buying it if they don't get a return. Because at the end of the day, everyone eventually will be logical. So there's just a lot of dynamics going on on this discussion, and people are looking for clarity for how that will emerge. And that was probably the last thing that took place this week.

Yeah, if I take $20 from my wife to go and buy a bag of milk and some other groceries, and I keep showing up time after time with just a bag of milk and nothing else, at some point she's going to ask me what I have to show for. A bag of milk? $7. There's another $13 that I should be spending wisely, but clearly I'm not. I'm doing something else with it. And I'm not giving it back to her as a dividend. So she's going to start to doubt and start to put a tighter leash on me. And that's kind of what you're seeing with some of these companies. Just amazing as you look through some of these reports that come out. Google reported this week, as you say, and increased their CapEx. The fact that these companies just used to be cash cows, they just used to spit off cash. Now they're actually cash flow negative in many cases.

Yeah. And this is a really important point in the argument as well. When a company has a dollar of cash flow, a portion has to go into reinvesting what they call maintenance capital. That's just to maintain the current business. To be clear, Google is taking their cash flow to invest for the future. The capital is hoped to have a return, and it will have a return of some degree. It's just people are debating how high will that return be relative to their expectations. If we take a totally different business, like a pipeline company. A pipeline company might have a billion dollars of free cash flow after the dividend. They will take that billion dollars, they will go and borrow maybe another billion and a half dollars, and they will put 2.5 billion into new capital investment to keep driving the growth. So they too have negative free cash flow, but that portion, that's going from investment. Now the difference there is on some of these old stable businesses, we have a greater degree of confidence. It may not be a booming return, but the return is within the goalposts, so we can really think through quite clearly how that's going to work. If you took a utility, for example, where they're allowed a regulated return on equity. If they put a dollar to work, we know they're getting that return. That's at one end of the spectrum. Another end of the spectrum is like, I'm putting it into a growth company, I really have no idea what my returns might be. So, this data center sits in the middle of that fairway. They are going to earn a return, but the question is how big will it be and how sustainable. And especially after strong runs, that's where the discussion starts to flare. And that's the point we're at right now.

I quite often like the dumb positioning of my question, showing my limited knowledge relative to you, and that's why you're here. But I think it helps everyone understand. I always hear analysts talking about free cash flow. Positive free cash flow, that's good. Negative free cash flow, bad. But there's nuance to it, just like everything with investing, which is why we have Stu’s Days.

That's right. Well, it's great to talk.

Actually, you know what, I think we're at a good time right. We’ve been running a little bit long with some of these. And I think you covered off a lot of what's been going on, why we're sitting in an unusual point. And then some of the stuff around capital spending and what's driving the moves in some of these stock prices. I guess the only other thing maybe just before we do wrap up— so we can finish where we started— not everybody's finishing up that whole week working right into 5 o'clock on Friday like we are. And that is sometimes reflective of the season. There's a seasonality to the stock market as well. And this is a period that is the dog days of summer, so to speak. And that applies to the stock market as well.

Well, the fall can be a bit of a tougher time on the stock market. August, September, October. If you look back seasonally, those are not the strongest months. And we've been very strong into them. And as I say some of these discussions are starting to emerge, and some of these discussions unfortunately are not going to come to a conclusion immediately. So that's one of the dynamics. We have the midterm elections. We have maybe some intermediate-term challenges as we move through the back half of the year, particularly after a period of very strong performance. So, we're always taking that into consideration as well.

This is why we've actually gone a record 3 episodes without mentioning an idea that even if the market's softening but you're putting new money to work and you're a little bit worried, you might not want to put all the money to work at one time There could be a strategy that might work.

It's just dollar cost averaging, Dave.

What? What are you talking about?

You think through times and, obviously when markets are at highs, you say, well, I wish I'd accelerated it, but it's just a great way to marry a long-term financial plan with how I put capital to work over a long period of time. And I know eventually there'll be some variation in the environment, and I'll end up with a good average cost relative to my longer-term financial goals.

And again, it's just been such a winning strategy. I think the other one— as we always talk about— is diversification. You’ve seen those rolling bear markets through different sectors. So diversification, regular investing, all the basic principles of investing that we talk about that just seems so boring when you hear this story about this stock doing this in a short period of time and this stock doing this, and gold and crypto, and all these other things that have popped up over the years. It seems dull, uninteresting, but building wealth successfully over the long term sounds really exciting, but you got to be patient, and you use the principles and you generally win. And it's when you forget those principles that you usually get hurt. And these have been the kind of markets I think that really teach a lot of those lessons. And they're important to learn earlier rather than later.

You got it. And even just segmenting in your head what capital might be used for different objectives and setting off a long-term investment that's going to deliver against needs that are a number of years down the road. What you're really trying to capture is earnings growth. And hopefully, you can accelerate returns by having companies whose valuation improve a little bit during the period of time. And you're always rotating the portfolio. Like you say, diversification. Everything we've talked about. The strength of the economy, all sorts of things. Who would have thought that healthcare would be having a reasonable move in the stock market as well? So, there's always things to do. There's always capital to take from these things that maybe are reflecting too much optimism and sprinkle it over here where there's additional returns. And that also is just part of the long-term plan.

Excellent. Well, Stu have a have a terrific weekend. I think we're scheduled for late in the week again next week, so we'll catch up with you next week with another edition of Stu's Day. Thanks again.