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This episode, Stu Kedwell, Co-Head of North American Equities, weighs in on the headlines around rising inflation, and discusses the key near- and long-term considerations for investors. Stu also previews what to expect from Canadian banks, as they begin to report their quarterly earnings. [12 minutes, 05 seconds] (Recorded May 25, 2021)


Hello and welcome to the Download. I'm your host, Dave Richardson, and it is (S)Tuesdays. A delayed Stu's days. Stu Kedwell, welcome back.

Hi Dave, how are you doing?

Good, good. I took a vacation last week. I heard you called in to talk to me and I wasn't there and you were sad.

It was a disappointing week for me, Dave.

Don't worry. I'm back. I know I look like I'm about to retire, but I'm not there yet. It was interesting watching what's been going on, though, with a two-week gap between recordings. One of the particularly interesting things that happened just after we recorded the last podcast was really the first big numbers around inflation. Then we've seen a fairly interesting, almost counterintuitive reaction to those numbers. What did you think of when you saw the numbers released and then, what's happened since? How do you interpret them?

Well, it's a great point. It's a good reminder that markets are relentlessly forward looking. The day before that inflation print came out, there was an article from Stanley Druckenmiller, a well-known hedge fund manager in the United States, saying that the Fed should be removing some of the stimulus that they're providing because inflationary pressures were quite high. Then we had the inflationary number get reported, which from a headline standpoint was extremely strong. Although, when you got into some of the details, there was a bit of a sideline into how it could be a little bit transitory. There was some reopening context that might not repeat, areas that would certainly be subject to debate. So, it ended up marking a bit of a short-term high in interest rates. We're talking a couple of weeks and what have you. So, I wouldn't say it's significant to the intermediate term, but it tends to be around some of these big events, like a big sporting event. It's like you had your Super Bowl right around the print. Then there's a bit of a sigh afterwards. The Federal Reserve and other central banks were quick out to say that this inflation we're experiencing right now is cyclical and that it's a bit transitory and while they think it could be a little bit elevated and helped them get to their goal, they don't think it's like 4% from now till forever. And then they also said that if it is, we have the tools to deal with it, which you would expect them to say. And if it persists and growth is strong, eventually we're going to get some removal of stimulus. But what it allowed markets to focus on is to say that the likelihood of something extreme happening on this file is likely downplayed a little bit. You saw a little bit of rotation in the marketplace where some of the growth names that have both a secular and a bit of a cyclical story continue to do quite well. You had some areas like in the pharmaceuticals and in the staples area, which aren't really thought of as big cyclical stocks start to perform a little bit better from a relative strength basis, and a modest easing in some of the most economically sensitive. As I said, it is a great reminder because markets are relentlessly forward looking. Even as we sit here in the summer of 2021, people have started to talk about not just 2022, but even 2023. I think I mentioned an earnings forecast that came from one economist at ISI that said that the US might exit 2022 annualizing around 250$ on the S&P 500, and in fact, a number of strategists have come out with 240$ or 250$ in 2023. Then the question becomes, is the businesses that I own or that we own are going to be growing faster than the stock market, 2023 over 2022? In order for that to happen, you need a reasonable economic backdrop, which looks like we're going to have, but you also need to have some strong demand and consumers and businesses pulling through your products to drive that type of revenue growth that will drive earnings growth, in that time frame where, as I say, the economy could still be OK, but it's not likely to have this huge cyclical burst that we're having right now as everything reopens. If you're talking 2023 over 2022, you're not talking re-opening trades, you're talking about good businesses just growing in and of themselves. That's become a bit of the discussion in the last two weeks or so. It'll be highly dependent on this notion that inflation is improving, that the economy is good, that eventually stimulus will get to be removed in a very measured fashion. That's a bit of a Goldilocks scenario, but that's something that's taken place. It seems like a lot took place while you were on vacation, actually, when you think about it. But that's where the discussion is going to migrate.

Yes, well, it's been for quite some time, with Covid excepted, that scenario where you've had pretty good solid growth, pretty good solid earnings, low inflation and low interest rates. That can allow markets to perform very well as they have over the last dozen years since the end of the global financial crisis. I think what people need to remember on the inflation debate is, you're comparing year over year numbers and where we were last April, for everyone to go back and remember, it seems like forever ago through the midst of this crisis, but the entire world was locked down, almost in sync at that point. So, you're bouncing prices off very depressed levels, very depressed levels of economic activity. So that number alone doesn't suggest that inflation is a huge problem. It could just, as you say, and some of the underlying information around, suggest that maybe the view that it’s transitory is starting to take hold. And then you've got tremendous earnings coming with good economic growth, controlled interest rates. Hey, that's a pretty good scenario for investing!

I think that supports higher valuations. I think the one area is unemployment. You still read about a lot of businesses that just can't find workers. You start to hear businesses that are giving iPhones, if you come to work for me, upfront bonuses and some wages starting to increase. So that's one thing that we would have to keep our eye on. But for now, it looks pretty good. I know we have the banks starting reporting this week. That can be a pretty good backdrop.

Yes. And Stu, just before you go into that, I just want to say, for those who have not listen to this podcast before, this is Stu Kedwell, the Co-Head of North American Equities at RBC Global Asset Management. This isn't just some guy I met on the street. When it comes to banks, Canadian banks, no one knows more. So sorry, before you start talking about the banks, I want to make sure that people know you. You've got some background on this.

Well, that's very nice of you to say. I think there's some people I meet on the street that would prefer not to hear what I have to say. But the banks will start reporting. For the quarter itself, we'll be looking for signs on the credit card spending and some real business-oriented signs, account openings, things like this. Credit should still be very strong. Maybe there'll be some credit releases. These are types of things that the market tends to look through. But that environment that we just spent the first part of the discussion talking about can be pretty good for banks. Gradually rising interest rates, which means that consumers are not necessarily shocked, which can create provisions for credit. Commercial loan growth eventually will resume once the economies reopen and find their footing. Credit card usage will start to improve, payments will start to improve. Wealth looks to be still pretty strong. So, it can be not a bad environment for the financial stocks. What we'll be looking for in this quarter is not necessarily crushing numbers or what have you. We’ll be looking for signs that intermediate term belief is correct.

Stu, it's been, I guess, the way it's always been for a long time. The Canadian banks are a little bit out of cycle with the U.S. banks in terms of their reporting. They're about a month behind -- a lot of the big companies in Canada and in the U.S.-- in terms of reporting their quarterly results. We've seen a great quarter if we go back last month around the U.S. banks and other firms reporting. Yet in a lot of cases when it came to their stocks and of course, Canadian bank stocks have been fantastic investments this year, they've risen dramatically. Can these banks do enough in terms of the reports to justify where they've moved so far this year?

Well, that's a great point. One line that we keep in mind: heavy is the head who wears the crown. And they've been extremely strong as of late. But what we look for when we think about these businesses— and I'm talking over three or five years— is a still reasonably attractive current yield in the context of the current interest rate environment. Sometime in the summertime, we'll get a new head of OSFI, and we'll probably hear about how dividend increase, and maybe how some share buyback can kick into gear. But when you're sitting there in this interest rate environment, if you had the equation of a 3.5 to 4% current dividend yield and dividend growth, say, in the 4 to 7% range, that can create pretty attractive total returns over the long haul, notwithstanding what the share prices might do on any given day. We think that's a really good combination to get our unitholders to where they want to be down the road.

Yes, and I think a great advice for investors is to think about investing for the long term. That's investing. Trading is trying to figure out what's going to happen based on one report in the few hours after that report is released and what happens to the stock, or stocks, if we're talking about all Canadian banks. And you, as an investment manager, are an investor and that's why you've been so successful. That's something I think everyday investors need to keep in mind.

One hundred percent, Dave.

All right, Stu. We ran a bit long today. It's almost a double podcast to make up for last week's miss.

That’s right. A twofer.

Exactly. So, thanks for your time. And we'll see you back next week and see how those banks ended up doing.

OK, thanks Dave.


Recorded: May 25, 2021

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