Hello and welcome to The Download. I'm your host, Dave Richardson. And it is time for a Super Stu’s Day, Wednesday edition, featuring our favorite Stu, Stu Kedwell. Stu, how are you doing?

Great, Dave. We've already broken our New Year's resolution, which is to try and always do them on Tuesdays.

Did we make that New Year's resolution?

Yeah. I stopped going to the gym too, so it's okay.

Okay, that's good. You know what I've been doing here, I think I mentioned it, I've been doing a lot of hiking. You ever do any hiking, Stu?

Sure, but not probably at the same pace and altitude that you're strapping on early on this year.

Stu, this is the downside of doing these on YouTube now. People can see my rather husky frame, and I'm looking for the hikes that are rated «easy». That's my speed. There's no high altitude. If I happen to think I might be able to do one of the medium level ones like I tried yesterday, it's a very quick lesson learned that I am still at «easy».

Yeah. Well, you're building. You'll be ready for next year. You'll be ready for when you go back.

I hope so. I'm actually hoping to build down some of the size. You haven't given up on the exercise already? You're a consistent exerciser.

Yeah, but it actually reminds me one of my favorite stories when I had a personal trainer briefly, and we were talking and I said, should we talk about my goals? And he said, yeah, sure. And I said, I don't want to be Mr. Universe or anything. And he said, no risk of that happening.

Well, yeah, I guess that's probably true because you're following earnings and inflation reports and doing all that stuff. And you know that your favorite concept of investing, which we'll get to later in the episode, as we always do—because we like that to be the crescendo of any given Stu’s days—but the idea of just exercising a little bit every day, that consistency, that's how you build, whether you're trying to be Mr. Universe or just trying to be a super healthy Stu that's looking younger every day.

Well, I think you're bang on there on the consistency front when we think about markets this year, because already in the first two weeks, we've had periods of excitement and enthusiasm, and not full despair, but some periods of despair. And unfortunately, I think that might be the story for a while. We started the year concerned about inflation. And it’s probably worth revisiting, just a general construct. So for a long period of time, it was hard for central banks to get inflation above 2%. And that was when real interest rates were very low and nominal rates were very low as well. And we've switched after a period of elevated inflation where inflation has certainly come down, but it might be harder to bring it below 2% than it has in the past. Some people might say that's concerning, which it is generally over time for your purchasing power. But the important thing in that backdrop is that real interest rates are around 2%, which is pretty good relative to history. Certainly, a number that when we consider the entirely of the debt stock out there, that we'll be a governor on the economy to some degree. So real interest rates are pretty attractive. But as we started the year, people were worried that inflation was going to re-accelerate, and that's part of this «it's hard to get it back below 2%». Then you get a lot of worry into the market in a short period of time. Inflation was reported. It was still above 2%, but it was not as bad as people expected. Then you get this relief rally. We've seen that around a variety of markets where either enthusiasm gets priced in and then it disappears quickly, or angst gets priced in, and then that also relieves itself quickly. And we've seen it right off of the consumer electronics show, where some of the stocks were very strong and there was lots of interesting things, but it wasn't quite good enough for the hype. No stocks sold off. We had some worries about inflation. It wasn't as bad. Bonds have rallied. Stocks that benefit from that have rallied. So that's been the macro push start to the year. As an investor, one of the things you're always trying to look through is what is steady throughout those periods of time. And the one thing this year that's probably been the steadiest has been the financial stocks. Financial stocks are often the leading indicator for markets. If you're worried about credit, if you're worried about things slowing down, then those stocks tend to be like the canary in the coal mine. They tend to roll over first. And through all this volatility that we've had, even in the first two weeks, they've been fairly consistent performers. And many of the large ones reported today, and the numbers were quite strong. And not only were the numbers strong, which I think people expected, the look forward was also pretty reasonable. And one of the big reasons is the slope of the yield curve. So we've talked about the slope of the yield curve being positive. In the United States, we're seeing some of the net interest income estimates starting to tick a little bit higher. Net interest income is the difference between what banks receive on their loans and their securities and what they pay in deposits. That is heavily influenced by the slope of the yield curve. There's been that positive. Then capital markets activity, which has been robust. Most of the commentary around the pipelines is still pretty good. So financial stocks were consistent throughout, and then some of them have popped on strong earnings today. Anytime something pops, you're going to have to revisit it a little bit. But generally speaking, for the backdrop of the economy, that's not a bad setup.

Yeah. What you've seen since the election, too, is we saw those stocks pop a ton in the couple of days right immediately following the election. Then they settled back down. Now we come into this year. Some of that was, I think, concerns around inflation, concerns around just how many interest rate cuts you're going to get and what that does to the economy and different things going on with yields, but then ultimately you get the reports today. Reports are strong. The outlooks are good. You commented, I think a couple of episodes ago, on being at a bank conference and hearing from some of the Canadian bank leadership who also had positive things to say about the year coming. You start to piece it all together and you get a day like today where all of a sudden, well, inflation maybe not as bad as we thought. And so rates come down a little bit and then banks report earnings, and we've got a runaway rally today after a first couple of weeks that was pretty mixed and pretty subdued in markets.

I think that's bang on. I think when you get Trump will be inaugurated next week, there's a lot of discussion around how regulation could ease a little bit. Will there be more mergers and acquisitions? Even in the banks, like some of the capital rules might get more clarity on that, and they might be a little bit better, which a bank having excess capital, obviously, they can return it to shareholders, or they can use it to make more loans and things like this. So the backdrop for the economy continues to look pretty good. Where we are always trying to measure that off in the stock market is how much of that is factored in to the good side and whether or not it's factored in enough. And I do feel like we're going to be in a period of time where we rotate maybe a little bit more violently than we had in the past between some of those sentiment changes.

This is just the thing, and we've talked a lot about this as valuations have continued to rise. And one of the things that enhances volatility is higher valuations because, again, your expectations are higher when your valuations are higher. It’s harder to meet higher expectations, So any disappointment creates an air pocket in the stock. And so, again, as we have this news, as we're waiting to see how everything plays out with those elevated valuations, any news that isn't good is going to create that volatility. And then we just have to accept that we've had two really good years in stocks. And that doesn't mean you can't have another good year, but it does make it harder to have a 20-plus% year when you look at the historical data and what happens after you have two years like we've just had, the kind of year that typically follows.

Yeah, I think that's a great point. The analogy I would think of is when you think about your diet or your food budget or whatever it might be. We all got to eat. But maybe I love filet mignon. I could eat beef tenderloin seven days a week. But if it's $60 a pound, maybe I'm not going to eat beef tenderloin. I can find the same things. I can find good nutritional content. I can find tasty food. I can redo our diet. I can find different foods that deliver the same outcome at a different price. And that is a thing that portfolio managers are very actively doing. The comment about the stock market versus a market of stocks, is the comment about, I need to eat. What should I eat? How can I find the same benefits at maybe a better price? Or how can I conserve some money and still get the benefits of collecting dividends, collecting coupons, this, that, and the other thing inside my portfolio?

Yeah. Then again, we say valuations are elevated, but like you say, that's the market. But in the market of stocks, we start looking stock by stock, and there's big swaths of the market where valuations are still okay. You start to go, well, do I want to or I need to own all these big, highly valued stocks? Or can I maybe find, like you say, the beef tenderloin that's somewhere else or a different cut of beef that maybe if it's prepared the right way, it might be just as satisfying. Maybe a little rib steak is more my cup of tea, but that's why I look like I do and you look like you do. But that's the same idea around stocks, right?

Yeah. Let’s not carry the analogy too far, but great management teams will take that rib steak, and they'll put some Dijon and marinate it and turn it into something that could be quite close to beef tenderloin. And as investors, we really benefit from those strong management teams in those instances because they take a business, they expand the margins, the margins expand, the free cash flow generation goes up. Valuation often improves when that takes place, and we get far better returns than are available just from headline earnings growth. So I think it is going to be one of those years where we're going to have—not that we're not always doing that—but really thinking through carefully, how can this business's margins change? A little bit of revenue growth, better margins, better valuations can lead to pretty different performance out of different stocks works relative to the whole market on the top level.

But it's not that you're not always doing that. It's just that at different points in the market, the value add that you get from doing all of those things in terms of your returns is enhanced in a period like this. You're going to be rewarded for those efforts, for making those choices, for finding those great management teams—or chefs in the analogy, grill masters—versus just throwing your money at everything or at a handful of things that, hey, it just doesn't matter, it just goes up. So I'm just going to keep throwing my money there. I got to be a little bit more precise, analytical, maybe even have more experience, more expertise to be successful in a market like this. And that is going to be a little bit of a shift for a large swath of investors. Over the last year, you just had to make one decision—and we talked about this before—I'm just going to take more risk. If I just take more risk, I'm going to be rewarded for it. That may not be the case. Today might be a bit of an exception, but so far this year, that has not been the case. You've had to pick and choose. It's likely when we go through two years again, where if I just take more risk, I win. That doesn't last very long. This year might prove to be one of those years where, like you say, you've got to pick and choose and find that good value that's beneath the surface, and it just makes it a little harder.

Yeah, for sure. One of the financial statistics is called the Sharpe ratio, which is risk adjusted returns. And I think this is going to be a year where we're going to look to make decisions where we think we have a good understanding of the downside, and we think we're getting reasonably compensated for the risk we're taking in terms of the upside. And hopefully we can put together a series of reasonable returns on that basis. And that might be independent of what headline indices do one way or the other.

So that's what that meant when I ran into an investor the other day and he goes, I love that Stu Kedwell. Love those Stu’s days. That guy is really sharp. Is that what you're leading to?

Yeah, well, there's a number of ways to measure the Sharpe ratio. But I did put a tie on for you today, Dave.

Well, I already mentioned that you look pretty sharp. So the Sharpe ratio applies to Stu. He's got a high Sharpe ratio. Very high. So, Stu, when we get into a market, this is going to be my last question because we've gone a little long here. But a critical question here. Because actually, I've got my IPTV box over here in Portugal, because the regular cable TV, I don't quite understand yet. I'm working on it. My Portuguese is getting better. So I'm watching old episodes of Perry Mason. My favorite Flintstone character of all time was Perry Masonary. And of course, he never asks a question he doesn't know the answer to. So I'm going to be Perry Mason here. I'm going to go, is there a way in a market that gets a little more volatile, where it's a little harder to find the winners or losers, where you want to have a strategy, almost like the strategy you would use when you're exercising and try to get healthy, at the start of the year, where you're going to exercise? Is there a strategy like that in investing that we could use that would work in this environment, Stu? You have a suggestion for people?

Well, there's this strategy, it's called dollar cost averaging, Dave. I'm not sure if you've heard about it.

No, no. It does all that?

Yeah. As you say, consistency is normally a great tonic, particularly in times like this. For some time, we've had valuations that have been elevated. Business quality is really strong. It's not clear how elevated, but elevated. But earnings growth has been there. It's been dependent on a handful of companies. If you've been dollar cost averaging into these funds, you've been getting exposure to those. Now we think that the earnings pool might broaden a little bit. Dollar cost averaging is a great way to continue on that path. It's a way to really smooth out volatility when asset prices are at average or above levels. So dollar cost averaging, I don't know how you say it in Portuguese for you, but it's definitely one of my favorites.

Euh. I won’t even try. I’ll find out for next Stu’s day what the actual term is. And what we were talking about before we started taping this whole idea that I might want to own some of those stocks, but they're expensive. But I know I want to have equity exposure, and I always say this, all joking aside, with that lead up, dollar cost averaging just gives you that ability to just wade in and buy those things that you know you need to own long term to generate the returns you need. But you want to be a little bit cautious. And then even still, as your dollar cost averaging, even if things go the other way, go the wrong way on you, you stay disciplined to it. You're going to come out on the winning side of it if you stick with it over time.

A 100%.

A 100%. Just like, if you keep exercising the way you are, you have that filet mignon, but you just keep doing it every day. Get on the bike with the headband and you'll be looking as sharp every day as you look today, Stu. So thanks for another Super Stu's days, and we'll actually try to catch up with you next Tuesday.

Okay, great. Thanks, Dave.