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This episode, Stu Kedwell, Co-Head, North American Equities, takes a closer look at the factors behind the sudden spike in U.S Treasury yields last week, and what it means for investors in bond and equity markets. [8 minutes, 10 seconds] (Recorded March 2, 2021)


Hello and welcome to The Download. I'm your host, Dave Richardson, and it's (S)Tuesday, so it means Stu Kedwell is with us, Co-Head of North American Equities at RBC Global Asset Management. And quite frankly, our most popular guest on the podcast. As always, we tape these podcasts and we actually have a visual connection, even though we just play the audio to you, mostly because of me. Stu’s hair continues to look fantastic through the pandemic, despite growing out more than I've ever seen it.

Thanks very much, Dave.

But speaking of growing out — so here we'll segway, this is how you make the connection as a podcast host — the other thing that was growing out last week and causing lots of concerns were yields. The U.S. 10-year Treasury climbs up from below 1% to start the year, and clip's up 1.5% — I think it was almost all the way to 1.6% for a very brief moment — but then settles down. And all the stock market's looking at what's going on in the bond market. Yields going higher, bonds going lower. And you see some volatility pull into the equity markets. If you're an investor sitting watching this, what do you make of it?

It's a great question. A lot of people in the investing world will look at technical action in the short term. And they have these levels in mind. We've talked about 1.5%, the level on the bond that would really just get it back to the pre pandemic levels. So, you would have these large pools of capital globally that might set stop losses at 1.50% or something like that. When the market gets near these very important levels, it's almost like they can sniff them out. So, I think it was Thursday afternoon watching the action, almost like it was a bit of a sporting event, the 10-year yield hit 1.50% and a whole bunch of stops that were immediately triggered. And I think we had 1.66% within about 20 minutes, but then finished the day back under 1.50%. It's kind of the market's way of cleaning the cupboard so to speak. All the people that were very focused on that level. And I think in our minds, 1.50% was an important level, because that's like the bond market recognizing that things are improving, which we're positioned for in the equity market. But at the same time, it's not a level that really interferes with the intermediate term story and equity markets. And if anything, as I say, that confirmation from the bond market was interesting. On Friday, that move in the yield curve in the 10-year bond still seemed to throw people for a bit of a loop. It is interesting, in the first two months of the year, after a very strong month of equity returns, the final Friday of each month was a down day. I think it is a little bit of rebalancing as people would naturally sell some of the strong performing of the equity market and then, put that money to work in fixed income. Again, for those who are technicians, interestingly, both days the S&P 500 touched the 50-day moving average and then bounced quite significantly on the following Monday. The tenor of how things bounced is still pretty consistent with a broadening stock market, improvement in companies that stand to benefit from the reopening. Last week in Canada, we saw things like some of the real estate investment trusts that have been hit by some concerns over occupancy and how rent would change. They were quite strong. We did spend some time buying those stocks in the last six months. So that was a welcome improvement. But you had a pretty good balance sheet. Some of them changed their dividend policies. We think that will rebound over time. But people start to think about what's next, what does it look like once we reopen, even if it takes a bit longer than we thought, that's really been the focus of markets. We've talked about it in financial stocks. We've talked about it in some of the commodity stocks. But the market continues to look for things where they'll be improvement following reopening. And that was really the message that was confirmed by the bond market.

And Stu, last week we were talking about bank and bank earnings. You just mentioned dividends and payouts from different types of firms in Canada and the U.S. You get to a 1.50% yield on the 10-year Treasury. Does that become problematic or change the attractiveness of some of these dividend paying stocks in the near term?

Not really and I'll tell you why. The market as a whole still yields more than the 10-year bond. And as the economy recovers, those dividend streams will grow. There still is relative attractiveness from dividends and dividend growth. In many cases, some of the higher dividend yielding stocks still have quite attractive spreads to the underlying a 10-year bond. That's something that we definitely keep on the horizon. But we've talked about this as well, relative to history, people talk about the tech bubble. Well in the tech bubble, the US Treasury bond yield at 5 or 6%. There was a very attractive and very legitimate alternative. Today, we have headline valuations that are still lower than prior excess. There are pockets that have those valuations and we don't really have very much exposure to them. But in general, until it was really higher than 2%, we don't think a 10-year bond would upset the equity market. Even if we got there, it's likely indicative that the earnings power of the stock market is higher. We'd have to evaluate that when the time comes.

Very interesting. And I hope everyone listening just caught that, around the thinking of positioning your portfolio with that rate switch, which are likely to continue to go higher over the long term. You could see some back and forth in the near term, putting it in historical perspective. But then also thinking about how you want to position your portfolio right now. And as you say, you don't have a lot of exposure to these kind of crazy growth names that are just at nosebleed valuations. You started to see some of those stocks have a hard time as rates go up.

When we look at some of these really high valuation stocks, many of them appear to be very good companies. We look at, what would be required to make that stock successful in the next 10 years? It would take unbelievable growth from the company. If your portfolio is filled with 10 or 15 of these, the odds of each one of them delivering on those expectations is not too high. So, it is an area where you have to be extremely selective and that's how we go about it in our portfolios, should we be entertaining a very high multiple stock. We want to have a very good understanding of how the company will deliver on the expectations required to make it a successful investment going into the future.

That's right. So, always remember that when your hair grows out a lot because you're locked down during the pandemic, that first haircut back to normal takes a lot off. You’ve got to keep that in mind. Stu, that's why you're the most popular guest right there. Great stuff, great analysis and thank you. We'll talk to you next week.

Thanks, Dave. Take care.


Recorded: March 2, 2021

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