Hello, and welcome to the Download. I'm your host, Dave Richardson, and it is a slightly delayed Stu’s days with our beloved Stu Kedwell, co-head of North American Equities at RBC Global Asset Management. I should throw that title in from time to time because it is important that people know that you know what you're talking about.

I suppose so, Dave.

When you have a title like that, you know.

Cheap cooking bottle washer, as my mom would say.

Well, you see, it's that humility that keeps you on top.

Well, the market is a humbling place.

It is indeed. I think most listeners are in Canada, but for those listeners outside Canada, it is the May 24 or Victoria Day weekend. So we all had Monday off here, so we pushed Stu’s days back a day. How big was the weed pile from Victoria Day, Stu? I know this is your prime weeding weekend.

Yeah, if you're a weeder, this is the time of year. I would think I was getting new dandelions in half an hour. I would turn around, I'd be like, wow, there's another one, I got to go get it. And I'm walking the beat. I'm walking the beat when it comes to the weed season on my lawn, for sure.

A perfect lawn. I got the lawn tractor to do mine. Somebody emailed me about this whole idea that you continually mow. You mow almost every day. And you just clip the tops of the weeds off. Grass is more robust than the weeds, so you just kill off the weeds. It's like you're running your own golf course. Takes a little bit of effort though. But I like being in the outside, rolling around on the tractor. It feels good.

Yeah. I can see that. I got one that's like planting trees. You take them out by the roots one by one. So we're from different schools on that, Dave.

Well, the trajectory of our careers speaks for what approach our listeners should follow. So let's get into that because, as well as the weeding season, for regular listeners, we talked many times how nothing is more like Christmas Day to you than bank earnings season. And we got a couple of banks out already. Anything in those numbers? I guess they weren't great, but that was what you expected, right?

Yeah, that's bang on. They were both a bit lower than the headlines expectations. But they're reflective of the environment that we're in. If we take a step back, the economy is down shifting. The recession has been very well discussed. That's a tougher revenue environment, so it's the same for banks. You start to see a little bit of slowing in loan growth, you see less capital markets activity, these types of things. But the thing that stood out in both of these banks was more on the expense side. Just as lots of businesses are dealing with inflation, there's some expenses that were loaded into the pipeline. Whether or not it's technology costs, data costs, employment costs, these types of things, that coalesced at the same time as revenue started to slow. There was lots of discussion in each case around commercial real estate exposure and what that might mean, but again, it was relatively manageable. So we're just in this holding period where we're trying to work our way through a slowdown. Dividends are attractive. Both banks today, as a matter of fact, increased their dividends. Looking through the cycle, return potential looks more interesting, but it's just that last period of malaise that investors are working through.

Yeah. And Canadian bank stocks have certainly had a rough couple of weeks, and we talked about that with Scott Lysakowski, just in terms of everything Canadian and the nature of the Canadian market, you've got the big financial institutions and you've got the commodity complex or resources materials. And both have had a tough little run. So Canada itself has been a bit of an underperformer, albeit after a couple of years of really good relative performance to the rest of the world.

Yeah. The cyclical component tends to focus a little bit on global growth. Banks are often more cyclical. I do think— and we talked about this before—, that discussion between Canada and the US has changed a little bit because of some of the big changes in the markets over time. So we're a bit more of a fan of stock by stock, sector by sector, when it comes to North American markets. But areas of the market in general, whether or not it's the S&P or the TSX that are a little bit more cyclically focused, have struggled in the last six weeks or so. And the S&P is not too far from its highs, but it's narrowed around a handful of stocks that are very driven by artificial intelligence. We've joked about Chat GPT, but the use cases for artificial intelligence are definitely multiplying quickly. And the basket of stocks that are either providing the technology, the software, using artificial intelligence, many big tech stocks in the United States have been stronger performers, the likes of Google, Microsoft, Nvidia, etc. A basket of artificial intelligence stocks might be up 40% to 50% so far this year. So that's been a benefit to the S&P as a whole, but if we go back and look under the hood, what's happened in a majority of the S&P 500 looks not dissimilar to what's happened in Canada, where some cyclically exposed industries have definitely paused, or their share prices anyways.

Yeah. As you're going to find more and more uses for AI, think of it as if AI is supposed to be artificial intelligence, but we have real intelligence. Same idea. I can come up with lots of reasons for my boss to give me different projects, different things to do, and a raise. But think that AI is going to come up with lots of different ideas for it to do itself along with the ideas we have, and it doesn't ask for a raise. Is that part of the thinking in terms of inflation and how much maybe AI taps the brakes a little bit on longer term wage growth and inflation, or is that way too far out to be thinking about that?

Well, it is far out, although it's happening at considerable pace. When you look at the amount of users of Chat GPT, it's one of the fastest user base growth of all time. I think there's these competing interests. On the longer term, inflation is going to be tougher to wrestle down. You have the reshoring of a lot of production. You have the decarbonization of the economy. These are two significant long-term trends that tighten up certain labor markets and are likely to be a little bit more pressure on inflation. Artificial intelligence could be a very large productivity tool that could dampen some of those trends. We still think the base case is going to be harder to get inflation right back down to 2% and hold it there. But inflation is in the process of coming down. So the debate really was between 2 and 3,5%, or 2 and 3%, with the presence of artificial intelligence, maybe longer term, it helps contain or be at the middle of that range whereas the other two push it more towards the top.

As we get back to the banks and the costs that they're experiencing, you say that you're seeing that across firms, but the banks are particularly labor intensive, or a lot of their costs are related to human capital versus other industries. Are you convinced the banks are going to be able to get those costs under control? And if not, is that a sign? Or if so, is that a sign for the broader economy in terms of what way the labor market is going to go and where wage pressure is going to go over time?

Well, because there's variable compensation inside of a bank, the banks have been pretty good over time at balancing revenue with expenses. I still think we're in this period where revenue growth is getting a little bit tougher to come by. And the calls on revenue, if you think about the income statement, they're all still having some pressures. Capital wants to get paid more with higher interest. Employees want to get paid more because unemployment is still very low. And governments likely want a little bit more tax revenue, like trying to balance the budget in the US. Governments around the world are also looking at corporations and saying, is there a little bit more for us? So those three things need to get balanced. We talked about a month ago, unemployment claims for the very first time peaked above a longer-term moving average, so there are some signs that the employment market is not quite as robust as it was two or three months ago. No one likes to see anyone lose their job, but ironically, taking away some of that employment pressure may help a little bit on the wages front. When you see business slow, it'll need slightly less employment. That's going to be part of the process here. It's a balancing act. Central banks are trying to bring down inflation without too much of the dire consequences that often come with it. That's where the market gets in this holding period, because you're seeing some earnings get depressed in the short term, but at the same time, there's not this liquidation of asset prices that can often come in that very short tense period of time. So people are still willing to look longer term and say, well, earnings might be depressed, but this is what they'll be on the other side. On the value, this is how they could trade and compare that to where current prices are and compare it to fixed income. It's one of those sanguine environments where valuation is not cheap, it's a little bit expensive, but it's not expensive enough to really derail things. Earnings likely are coming down, but maybe not for that long, because even when we get a recession, it may not be that deep. And then sentiment. You made the point before about the most anticipated recession of all time. You match that with the investor sentiment, which is quite poor. People are braced for something. So that's why in the short term, the stock market trading is often more art than science, and we're just trying to balance all those features. We do know, longer term, what drives stock prices is dividends earnings growth. Valuations, we would use some normal levels out in the future. So when we're thinking about normalized returns, we're trying to use those types of figures. In the short term, you could make very compelling cases that we’re a little bit elevated and we're due for a pullback. And you could also make a fairly compelling case that this pullback has been so much discussed, it won't be what people think it might be.

We should go back and mention that the banks that have reported in Canada did increase their dividends. So that was a nice plus for people who like dividends. And I know somebody who really likes dividends.

I do like dividends. The other one I do like in this environment— and get your cup ready— is dollar cost averaging. When the environment veers in both directions, which it could right now, dollar cost averaging through that process of time, through that malaise, is a pretty interesting investment proposition.

And that would be your general response— since we're sitting between Victoria Day in Canada and Memorial Day in the US—, the old «sell in May and go away» line.

That's right. «Sell in May and go away» is a great one. I used to sell August long weekend. There's all sorts. Buy when it snows, sell when it goes. That was another favorite from Don Vila, who was a great technician when I started in my career. I think malaise is the story of the day.

But as you mentioned, what we were talking about before, you don't like to sell a dull market, right?

Well, that's right. You're getting the best of a two-handed Stu Kedwell, for sure. But when we look at the sentiment data, when we look at the survey data, people have brought their equity exposures down. And sometimes in those environments, you get bad news, and the markets just don't really respond to it. We're open minded on both sides, and that's the environment we're in right now.

You know who loves a two-handed Stu Kedwell? Our listeners. And who hates a two-handed Stu Kedwell? Your weeds.

That's right.

The weeds on your lawn. Because that is a productive weeder, a two-handed Stu Kedwell. So watch out, weeds. And we'll keep watching the markets. And we'll be back next Tuesday with another update from Stu. Stu, thanks as always, for your time.

Great. Thanks, Dave.