Hello and welcome to The Download. I'm your host, Dave Richardson and it's Stu’s days. You rarely see Stu Kedwell, Co-Head of North American Equities at RBC Global Asset Management, this excited. It's bank earning season and nothing gets him fired up like this. You must have spent the whole weekend, and up until now, just resting, relaxing, getting ready for all this huge news that's coming over the next few days?

That's right. It's like before the Super Bowl. We're making a big pot of chili for 8:00 tomorrow morning when the conference calls start.

I guess you don't gather around. You gather around on Webex or Zoom. You used to get together, with the party hats on and all your slide rules and calculators out, that kind of thing?

That's right. I wish it was as exciting. Tomorrow, we start with the Royal Bank at 6:00 in the morning and then downloading the supplement and the report to shareholders and getting to work for the conference call at 8:00. That's the way it works for each bank during reporting season.

It's going to be sweet dreams for you tonight, but are the earnings going to be sweet? What are you expecting? Maybe more so than the crystal ball, are the Canadian banks in pretty good shape? What are they're going to say about business going forward for the remainder of the year?

I think they're going to be reasonably good. I think that the stocks have done quite well. The foundation for an intermediate term investor is quite strong. The capital ratios are high. As economies recover, loan growth should pick up. Different pockets of consumer loan growth might pick up after being impacted by the pandemic. You have well-managed businesses with excess capital, good dividends, prospects for mid-single digit dividend growth. That's part of the intermediate term thesis. I don't think there'll be any real impact to that. Where the short term is running through, I mentioned that you open up the supplement and if you are a bank investor, you want to know about the income statement, you want to know about the balance sheet. The income statement starts with your net interest revenue. As interest rates gradually start to rise, that has been a headwind, that should become a bit of a tailwind. The net-interest margin should gradually expand. Then you have the loan growth and what type of loans. We've had a lot of mortgages which are secured, so the net-interest margin is tighter than the broader balance sheet. Mortgage growth will likely slow as the year progresses and hopefully credit cards and commercial lending will pick the ball up and do some of the heavier lifting. While you have rising interest rates in capital markets, you also have the prospects for loan groups that might have higher interest rates on them as well. Then you get into the non-interest revenue, and last year was a boom for capital markets. The comparisons this year are going to be a little bit tougher. Very strong for wealth management because of the speed with which asset prices were rising. Again, a little bit of a tougher comparison getting into this year. You have all your revenue dynamics and then you have expenses. We've talked about inflation, so there will be some expense pressures on pockets of the banks. But the nice offset in a bank is that, when there's a bit more inflation, there's generally higher interest rates and you get one that offsets the other. I think it'll just be updates on that and there'll be a lot of discussion because the banks have so much capital about what they might do, from a capital allocation standpoint. We're always fans of being patient and diligent with the usage, not letting it burn a hole in your pocket. But all things considered, I don't expect anything earth shattering.

A lot of these stocks have had a fairly good run over the last several months. Is it the case where some of this good news, particularly around a net-interest margin, is already built into the stock prices?

To some degree it is. We've seen valuations rise. We can look, going back to capital markets, into the yield curve, and you can get an idea about how many interest rate tightening are already factored into the yield curve. As an equity investor, you're taking that projection and using it in your expectations. To say interest rates are rising is good for the stocks, they have to rise more than what's factored in in order to be an additional benefit. But all that said, the nice thing about banks is the dividends. While valuation has expanded, I wouldn't say to levels that really impacts intermediate term performance, but the nice thing bank stocks over long periods of time tend to have spurts and then a little bit more calm periods, and then spurts and calm periods. Unlike some other stocks, although many have dividends, but the nice thing about banks during that calm period is you're receiving the dividend. And for a number of the stocks that we own, just as we're fans of dollar-cost averaging, we have dividend reinvestment. We're building positions in those stocks during those calm periods as well. Through thick and thin, over time, the banks have been good dividend growers, so the little piece of candy that comes to us each year grows over time. That's one of the key tenants of bank stock investing.

I'm glad you're continuing to stick with this celebratory and party theme around the earnings reports, but are you expecting, this time of year, to see some announcements around increased dividends or buybacks? Or that's a different course; that's usually later on in the fiscal year?

Since we saw so much in the fall, after OSFI let the banks all resume usage of their capital and usage of dividends and things like this. I'm not banking on it, so to speak, but I also don't think that the banks went to the full range on their dividends in their initial announcements. I expect to get back more towards a regular, some banks semi-annual, some annual. As earnings grow, dividends will grow commensurably. This year is a bit of an awkward year just from headline earnings growth because we had a lot of releases of credit provisions last year and we'll start to see some of it this year. But the irony is, if you release less provisions this year than you did last year, it's a bit of a headwind to this year's earnings growth. Something else we spend a lot of time looking at is pre-tax, pre-provision earnings growth, because that's one of the factors that plays into the long-term strength of the business.

Again, it's one of those things where it's been a pretty good story, and can that story continue to be good with, again, as you say, some tailwinds from potentially higher interest rates and perhaps higher than people have built into the stock price now? That's made banks, if you look at the profile, do well with higher interest rates, do well with good economic growth, pay solid dividends. In this kind of environment where, again, we've already seen interest rates rise and at the long end we're expecting shorter term rates to start to really ratchet up, what are the other sectors of the economy that really do well in this kind of an environment?

Normally the stock market does reasonably well twelve months after the first Fed tightening. In general, the reason that the Federal Reserve or central banks are raising interest rates is because the economy is strong. It tends to benefit a bunch of businesses that have a high incremental profit margins on additional dollar revenue. The economy is doing better. Revenue is growing a little bit faster. That's quite good for profits. It's good for some of the value-oriented stocks, but in general, it's good for more economically sensitive stocks. We've seen it in some of the commodity areas, some of the financial stocks; things like this can be a benefit. As the stock market and capital markets priced in a lot of interest rate tightening, the next concern is, will it be too much and will it start to govern economic activity? What is interesting in the current structure of the yield curve is what's being priced in as a fair number of rapid rate increases in the near term, but then really nothing come 2024. That will be interesting. We've always talked about the valuation of a stock or the stock market as a function of its earnings and the multiple that it trades at. When interest rates are rising, you tend not to get multiple expansion, so what's driving your performance is the earnings growth. That's where we've seen some of the increased volatility and what have you. Will we have too much tightening that could cause a bit of an upset to the earnings? We don't really see that yet, but that's always part of the discussion.

And then, as we talked about with some of the other guests, you've got different patterns of interest: increases, tightening, loosening, going on in different parts of the world which creates that opportunity, creates the need to look at different markets in different ways and think about that broader diversification.

Well, that's the role that the risk committee and the IPC play. Sometimes when you have earnings acceleration at better valuation elsewhere, it pays to pay attention to that.

Absolutely, because diversification always wins. Again, even though we obviously key in on your specialty and your area of focus, there's some very basic principles of successful investing. We've talked a lot about regular investing, dollar-cost averaging, dividend reinvestment, starting early, investing enough, having a plan which is really critical. Outside of what we talk about a lot here, but then the diversified portfolio, those are really the keys to that success. You always come back to those basic principles because that will drive your success as much as that stock picking or making sure that you've got the right people picking the stocks for you. It's long winded. But I feel like I'm killing your mood, so I'll stop talking. There's a big smile on your face because you're excited about this Christmas in February. Get ready. I hope it's everything you dream of.

Well, thanks very much, Dave.

All right. That wraps up Stu’s day for today. Thanks again and we'll talk to you next week.

Great. Thanks, Dave.