Hello, and welcome to the Download. I'm your host, Dave Richardson, and it is Stu’s days. But again, because of my terrible travel schedule, it's Stwednesdays. So, Stu, my apologies again for getting you late. It's my fault, isn't it?

Not a problem at all, Dave. You're a busy guy.

But you're in important meetings too, right now. It is quite something to be able to catch you. We'll share that many years down the road about what's going on there, but I wanted to tell you, I'm out a lot with customers or investors and with advisors, and they really liked last week's podcast on commercial real estate. So if you're new to the podcast— and maybe it was because we actually did it on a Stu’s day— for those of you who have concerns, are worried or just ask some questions about what's going to happen with commercial real estate, Stu did a fantastic job of laying that out in last week's podcast, in roughly ten minutes. It was quite awesome. But Stu, just before we get into the meat of the issue here, I'm behind on my Ted Lasso, but are you up to date?

I'm up to date. I would say the third season is slightly better than the second, personally. The market may not be at an inflection point, but I feel like the series is, because I think the team's going to start winning. They've had a tough start to the year, and he came up with a new system at the end of the last episode. And I think we're about to make the turn in Ted Lasso land.

Excellent. My daughters have caught up on the second season, so we can start watching it together again. It's a great family viewing, I guess. They're teenagers, so they're okay. But from Ted Lasso, here's the question: what do we believe about earnings, as we've seen companies report? And then, what you also watch a lot in your role: what are they saying about what's coming down the road? The earnings look backwards, but what are they saying about what's coming up? What are your thoughts so far on earnings and areas that have been stronger than expected or weaker than expected? And how do we make any sense of this?

The earnings themselves have been okay, I would say. Maybe a little bit better than expected, which is often the case, although often you get stronger earnings. And then, what type of guidance do you get? And the guidance this time has been a little bit murkier than it's been in the past. We went into this earnings season hoping or thinking, from a consensus standpoint anyways, that this would be the worst of the year-over-year change in the first quarter. That still might be the case. But as we sit today, earnings are expected to flatten and actually improve in the back half on a year-over-year basis. And I think there's a couple of things that throw some cold water on that still. The first is, we've talked about what's going on in the US banking system which is going to crimp some loan growth or the ability to provide loans. And then the second thing is, we've been looking at unemployment and some people think, unemployment needs to go up to help the Fed in their quest, which is likely true. But at the same time, when it does go up, it's going to be a bit more of a headwind for the economy. And on Thursdays, the US government will report what they call jobless claims. And a shorter-term moving average— a 13-week moving average of jobless claims— just peaked above the 52-week average of jobless claims, which has been not a bad trending indicator for unemployment. So maybe we're going to get a few more job losses, unfortunately. 3M reported earlier in the week that they went through some layoffs. We have seen some more of that activity through the earnings season. So when we think about the year progressing, there's two headwinds now on the earnings front. The first is the availability of credit and the second is maybe upticks in unemployment. So that's how it's developed through the week and when you layer those two things in, it does present more headwinds in the second half on the earnings-being-better story.

Yeah. And so we're taping this on a Wednesday midday and so that number will be out likely when you're listening to this podcast right now. You can just flip over to one of the business websites and you can see where that jobless claim comes in this Thursday to track along with Stu sharing that number. Any sectors that are showing surprising strength as we've reported thus far?

Well, some of the consumer staples have still been pretty strong and it's been the remnants of price increases that keep going through. The degree with which that continues is subject to debate. You're seeing strong revenue growth from the likes of Pepsi and others, but you're not seeing volume growth to match it. So that's really just pricing going through to preserve margins. Microsoft was very strong. People were concerned about cloud computing slowing down. We've talked about ChatGPT and some other things; it does appear that artificial intelligence will be additive to the growth story there, but it's not sector wide. There's been pockets of things like in semiconductors and what have you where activity has not been as strong. There does seem to be a bit of a slowdown going down in some companies that provide products to businesses like PCs and other types of hardware and things like this. There's been a bit of a slowdown there. So we've seen a bifurcation in every sector. Just like JPMorgan is very strong, regional banks are not as strong. Microsoft is very strong; some of the others are not as strong. So it really has been a company-by-company story so far.

We've talked about this before and I think it's an important point to continue to make, if you look at much of the last decade, the ten years leading into COVID: low interest rates, low inflation, stocks that are doing fantastically well. The bet you actually make is, let's take on risk, let's look for growth. And the more growth I can find, the more I win. I could buy anything and I'm going to win. But how much do I win? Now it's a much more, as you say, bifurcated market— I didn't think you needed to swear, but that’s okay— but a bifurcated market where you've got winners and losers and that's where you've got to be a lot more careful and have a lot more expertise in terms of picking where you want to be. When you go through a recession— and you see it with some of the metal and oil and gas stocks, for example, that have had some really huge pullbacks as the prices in the underlying commodity have come back— you'd say, that can really hurt your portfolio if you're sitting there in the wrong position versus some of these areas. And then, as you say, specific companies within an area that are doing better than others. As an investor, you've got to be able to find those to negotiate through this and it's really hard to do.

There's probably a few more stocks in the portfolio than normally. You're spreading things out a little bit. We've talked in the past, normally in periods of correction, you get a leadership change. The names that were strong before are not always the names that are strong afterwards. Definitely within energy, you see different performance from more oily oriented companies versus natural gas and things like this. So being in companies where you think that the cash flow growth can persist over time and the free cash can be delivered back to you in dividends, those two things are big protectors against any valuation change that you might worry about. Even though interest rates have come back down, we don't expect them to really go back to levels that we saw during COVID. If anything, the ten-year bond has moved almost a percent down from its high. And the driver over time is going to be the delivery of free cash flow to investors in dividends and growth. Those are going to be the two important factors going forward.

One of the things I do when I'm doing investor presentations is I actually ask the question to the audience: are interest rates high right now? And you see a lot of nods. Yeah, interest rates are high. And the answer is really no. Ten-year yields in the US tend to float between 2 and 5%, depending on how strong the economy is historically. And we're sitting this morning, I think, at 3.4%, or in that area. So you're dead in the middle of that range. Interest rates are really just normal right now. You got to adjust because they were at zero before, and that's disruptive when you go through that adjustment. But once you get through that adjustment, you're going to be left with interest rates that are likely even a little bit lower than here, which means a little bit lower than normal. It's a pretty good base for where we're going to go in the future.

Yeah, I think that's a good way to think about it.

Oh, wow. I thought you were going to say that wasn't. I'm getting too many things right this morning, Stu. I'm starting to feel smart. Maybe I'm believing in myself again.

That's right. Bring it back to Ted Lasso. I don't want to ruin it for you, but the «believe» sign doesn't make it all the way through this season.

I don't believe you.

But it's because the believing part is inside of you. You don't need a sign to make it work.

Oh, wow. That's my high school graduation ring. My dad had that engraved on the inside: seek inner direction. It really didn't help me. I probably needed a sign. All right, Stu, great summary of what we've seen in earnings thus far, some of the challenges going forward. A couple of things to look for if you're following along with us. Thanks for taking the time today, and we'll catch up with you next week.

Great. Thanks, Dave.

Okay. Thanks, Stu.