Hello and welcome to the Download. I'm your host, Dave Richardson, and it is Stu's Days. I’m putting a little bit extra emphasis here. Stu, I'm pretty excited about our conversation today.

Sounds great, Dave.

And I know that you're almost as close to me in terms of having Denver Nuggets fever as the NBA championship continues. My beloved Denver Nuggets, they lost a game at home the other night, but tonight they're in Miami and hopefully they get it back. I still think they're going to win, and I know how much that's drawing all your attention away from these confounding markets.

Well, it's Denver Nuggets and Las Vegas Knights fever for sure. I'll tell you a quick story. I'm in a hockey pool. I missed the pick night, so my picks were all random. And I'm still ahead. I got someone on the Las Vegas Knights that is really working well because every time I open up the email the next morning, I'm ahead and I'm ahead by more. As an active money manager, I think it's likely concerning that the random pick from the pot is doing better. So there you go.

Well, I imagine with the kind of people that you hang out with, this is going to be a massive payout. Then you'll be looking to take that massive payout and invest it. And we're looking at markets that are really difficult to figure. You look at sentiment. Sentiment is still awful. It was awful at the start of the year. It's still bad. Volatility is super low. We've talked a lot about volatility, and we've come out of a period of fairly high volatility through 2022 and the earlier part of this year. And now, all of a sudden, volatility is extremely low. We've got mixed signals from bond markets, mixed signals from the Fed. I was listening to an interview this morning on one of the business channels and it was a debate back and forth around whether we're in a recession or we're never going to go into a recession. And I could listen to both sides and go, yeah, she's right: we're in a recession. And no, he's right: we're not in a recession. So, Stu, you've got all this money, what do you do?

It's a pretty tough environment to say, I'm going to go all in on equities from this particular point. Let's just go back and revisit some of the things that we like to go through. First and foremost— and I know you have Vericon— but the economy is slowing for sure. Then you get into it from an equity market standpoint: a recession. Then there's three questions that the equity investor has to ask themselves: Timing, severity, and the response, both monetary and fiscal, to when it occurs. Timing? Maybe we're in it now. Maybe it comes in the back half of the year. I think some type of slowdown is quite likely. Then, the next two parts, the severity and the response. The severity might not be as high as people think of when they talk about recession. And the response. There is some fiscal programs which are providing support and there are two big underlying themes that came out of COVID specifically: the reworking of the world's power system to decarbonize and the replacement of production facilities and supply chains. Those are two big underlying trends that will continue even if the economy slows down. You talk a lot about recession; timing, likely sooner than later. But severity and response are two positives to that type of situation. So you move from this economic environment that feels a little bit like malaise rather than a real significant downturn. I think in the back of your head you're still saying we've loaded all this tightening into the system, and we haven't fully felt it yet. Whether or not it's US consumers with long term mortgages or Canadian consumers where the payments haven't totally risen yet in response to those rates. So you have this latent concern. But again, I would say from a severity standpoint, we spend more time on trying to figure out the timing and when, rather than being overly worried about the severity at this juncture. So then you roll into the market and you look at the S&P at 4300. If the earnings were $240— which I don't think they will be, but that would be a no recession type scenario for earnings—, you're trading at 18 times. So on that front you have two sources of concern. The first is the earnings. That would be soft-landing-like earnings and that multiple is a little bit elevated. And then volatility is very low which often has been a source of concern. So you have those two negatives working against you. On the positive side, sentiment is quite poor. And when we talk about these roadmaps for different markets, many stocks have followed the roadmap of economic malaise. The returns have been plus or minus one side or the other of 0%, versus the market as a whole that has been driven by just a handful of stocks, influenced by technology and artificial intelligence and some of these new trends that have come out again. Before you get too negative, you go look at a whole swath of businesses that you might otherwise like to own for the long term. And their valuations are not unreasonable. While in the near term they're dealing with these issues the same way that investors are in the longer term, their prospects are quite positive. So on the headline number you say that's a little concerning but when you dig beneath, you can sit there and say well, there's lots of businesses in there that I wouldn't mind owning at these prices, and hopefully we have many of those in the funds. So it is a bit of a conundrum as we balance all these things. And sometimes as investors, we just have to acknowledge that we go through periods of conundrum.

Exactly. And then, as you said right out when I asked you about where you put your windfall from the big hockey pool win, this is just not an environment where you're going to dump it in all 100% at once. This is where you're going to employ a strategy where you're more cautious. And again, for anyone who's listened regularly to the podcast, we don't even need to say what that strategy is, but it's also known as dollar cost averaging to some people. And again, it reflects that, as you say. We had Eric on Friday, the job numbers out of the US combined with what you're seeing in the bond market, and so many measures that he looks at are just all over the place and it's really hard to peg exactly. There's a cloudiness— like the cloudy skies from all the fires across Canada in Toronto today— in terms of just where we go economically. And when you have that and you're in the summer season, it tends to be a time where you want to be a little bit more cautious.

Yeah. When you look at shorter term interest rates, you're picking up attractive levels of current income from corporate bonds. For Canadians, there's some tax advantaged opportunities because a lot of those bonds return back to par, and you get that as capital gain. So when you see the interest rates in short term corporate bonds, on an after-tax basis, they can be even better. When you do break-even analysis, if I could buy a bunch of stuff that's yielding at 5.5 or 6%, that might be the earnings growth you might see. So in order to get the same return from stocks as bonds, you need the same multiple, the earnings growth in that 6% range, and I can collect it elsewhere. Those are great points, Dave, but it is a bit of an imbalanced market because the headline numbers have been okay, but they've been heavily driven by a handful of stocks. Underneath the surface, we find good businesses that we think are going to deliver nice returns over time for us, but then we go and compare it to fixed income and we say, well, that doesn't look too bad either in some of the rates that you can get there. So that's just the market we're in.

Let's just close off today after all those insights and let's just do a little primer on what we call market breadth, which is what you're referring to, and go with the S&P 500, which is a market weighted index. You say a handful of stocks have been leading the way. So you've got 500 stocks, but you've got maybe a half dozen or a dozen stocks that have been on fire, and 490 that are doing, as you say, not a whole lot of anything. That means you've got very narrow market breadth. Maybe you can put your own words around that.

Yeah. So a good analogy would be if we have an index of you and me. We could do it a couple of ways. So it’s two people; 50% exposure to each person. Or we could do it on weight. We could add my weight and your weight together and we could divide it up and again we'd be right around 50%. But if you had different people, different ages, all sorts of things, you could see how the index could look different if we did it based on weight than if we just did it based on the number of people. And this year the stocks that have big weights in the index— the likes of Microsoft and Apple and Nvidia— have been the strongest performers. So if those seven stocks had no weight in the index and they all doubled, it wouldn't affect the headline index. But because they have such big weights and they've done well, it has really propelled that headline index. And that's what I mean by breadth. So the returns this year have been due to a smaller number of stocks. And that's why when we look underneath, and you look at some of the good people, so to speak, that are in the index, they don't have that same weight, their stocks haven't been meandered as people have worried about recession and all sorts of things, but there are some more interesting values in some of those stocks at this juncture.

And then things can go two ways. You could have the rest of the market, the ones that have been lagging behind, the 490 or however many— 493, I guess, in your example— they start to pick up the pace and start to catch up. That means the index continues to go higher. Or those ones that have been leading slow down or even drop in value. And that takes your index number lower, even though, again, it's concentrated in a small number of stocks. Typically, when you see breadth narrow like this, does it tend to break out on the good side where the other stocks catch up? Or does it tend to break down the other way where those other stocks just kind of run out of gas and fall back to everything else?

Well, that's a great question too, because historically narrow breadth was not a very good sign. And eventually they would get to the leaders. But going back to the conundrum, there are a handful of periods of time where the reverse happens, which you just discussed, which is the leaders take a break and the rest catch up. Today if you looked at the S&P 500— I saw the stat last night and it's give-or-take— but the overall stock market has beat the equally weighted stock market by around 10% this year. So that's where that discussion is around. Can you find good businesses to own in this environment? Because the equal stock hasn't done that well this year. It's been heavily concentrated in a handful of names. If we have a shallow recession and monetary policy runs at course and begins to loosen in the next six to twelve months or whatever, it could be better for that broader market. And that could be the scenario where the average stock catches up to the market cap weighted stock. The other thing too on the market cap weighted is that when we have a lot of enthusiasm around a specific trend, as we've had in artificial intelligence, sometimes the market gets a little over its skis on those trends. Those are very powerful long-term trends, but they'll ebb and flow as well. So we're in this environment where we're going through it stock-by-stock and saying, what are the scenarios in front of this stock? What would it look like in a good period? What would it look like in a recession? If we can find stocks that already reflect a recession, then those are going to be very good investments and that's what we're busy beavering away on.

And of course, that is exactly how you define your expertise and the value that you bring to any investment process as a professional investor: your ability to dig deeper and find where those opportunities exist.

That's exactly right because that's just embedding a whole bunch of positive options in the portfolio for down the road and we don't know exactly when they might appear, but if I walk around with a bunch of positive options, I know I'm going to make a bunch of money one day.

Excellent. Well, Stu, thanks for that. That was a super primer on what's been going on in the market and some things to look for. As always, it's what makes Stu's day the favorite day of the week, as we say. And I'm off to Miami now. I'm going to game four. So I'm pretty excited. Except that I can tell you, based on the price I'm going to pay for my ticket, that would belie the belief that we're in any kind of recession, because there seems to be enough money to pay for expensive NBA tickets.

And no doubt we'll know where's the best place to get a good coffee in Miami when you're back.

Absolutely. And I'll just follow along the trend that we've been in coming out of the pandemic: it's about enjoying once-in-a-lifetime experiences. So, Stu, thanks again and we'll catch up with you next week.

Thanks, Dave.