Transcript
Hello and welcome to The Download. I'm your host, Dave Richardson, and we are live and in color on a beautiful Stu's Day, with Stu Kedwell, co-head of North American Equities at RBC Global Asset Management. I should properly introduce you, at least occasionally, right, Stu?
Well, thank you, Dave.
I know your mom's had some complaints about my treatment of you and the respect and deference I'm showing you as a big power player in the Canadian investment industry.
Maybe just my mom, Dave.
Yeah, probably just your mom. And by the way, my mom's got some issues with you, too. So it's all fair. But anyways, we'll get to what people want to hear about because it's just been a really crazy week. So we're taping this on Tuesday, August 13th. If we go back to Thursday and Friday in particular, where we had the jobs report. A big drop in stocks followed through on Monday, and then a recovery last week that took stocks almost back to where they were. And now we've seen a really nice first couple of days this week. I know we talked about short-term volatility and reasons why volatility would pick up at this point in the summer. There's a seasonal element to it. Different stocks, where their valuations are, are particularly sensitive to bad news, when bad news is interpreted as bad news. But we didn't think that this was just some unwinding of the bull market. And that's exactly what's happened, right, Stu?
Well, yeah. When you look backwards, you always know exactly what happened, right? Sitting here today, we can look back on the last couple of weeks and say there was some building concern around the economy slowing. And then Japan tightened interest rates and it set off some unwind — in effect, like a margin call — on some positions that had to be unwound into this changing sentiment. Like all activity like that, it's pretty fierce because it immediately moves assets to prices that people are willing to pay. And then as it passes, it rallies back. And then on Thursday, the unemployment data from the United States was better. And so until the more aggressive unwind, the discussion in the market was the economy is slowing, and how quickly. And when there was some weak employment data from the non-farm payrolls, which is done on a monthly basis, that triggered some angst. Then the weekly basis wasn't quite as bad. And we have this push and pull about the economy slowing. And we just had our first day of what we call our risk committee — which is all the resources of the firm sitting in one room — and the discussion points that really come into play are first, inflation slowing is pretty important. So often when you get into these types of situations, you want to reverse the question. We think inflation is slowing; what would be top of our list that would cause a re-acceleration? And top of that list at this juncture is some of the global tensions and what could they do to the price of energy in the near term? I think that's top of the list. The second thing is, if the economy were to slow down more than we currently anticipate, how significant would it be? Because we've had days in the last two weeks where people are saying: soft landing vs hard landing. And how hard is hard? And how soft is soft? I think we got to have a little bit of a discussion around that because at this juncture, the debate between soft and hard landing is quite tiny in our minds. It could be by definition hard or soft, but it's not this big plunge in economic activity, which is pretty important when we think about the earnings backdrop. And the reason for that is because central banks have the capacity to lower interest rates, which then leads to the next spot, which is where you get into fixed income, where central banks have the capacity to lower interest rates. They haven't done so yet, but bond markets have predicted that to some degree. So the prediction by the bond market that central banks might lower interest rates, in effect, eases financial conditions, which then raises the odds that it's not as hard a landing as some people might worry about. And there's a lot of circularity to this type of discussion and the way markets function. And so that's been one of the features of today.
Yeah, I was having dinner with a colleague last night, and we got into the debate around the call for a soft landing versus recession. And there was a little bit of frustration that there's still a recession call out there, or people are still putting a significant amount of a percentage of a chance that there's going to be a recession. And my counter was exactly what you just talked about. We knew through all of this interest rate tightening after we see a spike in inflation, the design is to tap the brakes on the economy, slow things down so that those upward pricing pressures can come off. And in doing that, you're likely going to see some people lose their jobs. You're going to likely see the economy slow. And then you end up with, oh, we can have a soft landing where growth is one-half of 1% or below 1%. Or we can have a recession where we technically fit the definition of a recession where we have two small drops over two consecutive quarters of below zero growth. But the difference between the two is not that material. You're almost saying the same thing. It's like an argument with my wife. But there will be a winner in this argument — it'll be a soft landing or a recession. In the argument with my wife, she always wins, and rightly so, by the way, because I'm usually wrong. But we're just really on the line. So it's not really that critical. And then what you say is, well, what are we ultimately looking for to spark the next phase of the recovery that the market is already looking at? And the bond market is telling us that. The bond market is saying rates are going to be coming down. And so that should spur on the next wave of growth, which is really what we should be thinking about from an investment perspective.
Yeah, 100%. And just to bring it close to home, if you had a variable rate mortgage in Canada and you were staring at prime rates of 6.5 or 7% — whatever it was 12 months ago —, today, prime hasn't fully come down, but you can now lock in for five years at 4.5 or 4.75% or something like this. So that delta is quite a change relative to what people thought might happen, even if it never did happen. The whole idea around markets is that at any given point in time, they need to reflect the odds of a variety of scenarios. We know that the outcome at the end of the day is discrete, but until then, we have to shift odds, and that's prices moving around. And it creates volatility. It's uncomfortable, but it's the way of dealing with new information as it finds its way to markets.
And we did come back again with a discussion last week around dollar cost averaging in the face of increased volatility. It looks like that increased volatility is going to remain there. Now, it's come down from the levels that we were seeing in the middle of the day last Monday, but it’s still elevated from where we had been through the year. I was actually looking at a chart of the VIX through the year, and it's almost a flat line around 12 to 15 through the first part of the year. And then you see that spike. I guess it kissed 65 at one point last Monday, and it's drifted down. We're sitting around 20 right now. But again, that is elevated from 12 or 13 and very stable where it was before. And as we go through that period where some good news is good news, some good news is bad news, some bad news is good news, some bad news is bad news, that whole cycle where things are coming out and it moves markets, that it's not surprising that you're going to see some volatility. And again, looking for opportunities in that volatility. But if we're long-term investors, recognizing the direction we're going longer term has become more clear. And then in the interim, using that dollar cost averaging strategy to build your positions so that you don't get whipsawed by any volatility that does take place over the next few months.
Yeah, 100%. Nobody likes volatility because they watch their account go up and down, they watch their share prices go up and down, all sorts of things. But personally, I embrace volatility. It's when there's the most things to do. So as a money manager, it's not such a bad thing.
Yeah. Again, as you just said, volatility creates opportunity. Because things are moving. And when things are moving, that's going to create opportunities for you. As some of these big stocks were falling — because they were the stocks that people had been using carry trade to buy — they get called and you say it falls down to a position where someone's going to buy it because it's no longer super expensive. It's now at least somewhat reasonable. That creates an opportunity. And what you need to be able to do as an investor — and this has been an ongoing theme — so what's the difference between Stu and someone who's just starting to invest? Or maybe they invest quite a bit, but that's not what they do for a living. They've got other things they're interested in. Not Stu, who's 100% focused on markets and very dull and boring all the time. It's that lack of emotion that Stu brings to the table as an investor. And that's one of the things you want to learn. Don't let emotion drive your decision. Just because there's volatility doesn't mean there's something you have to do, but it could present an opportunity if you're able to shut down the emotion, take that step back, take a deep breath, analyze, and see where the opportunities are. Of course, your advisor can be a key part of that as well. But that's what I see from being able to spend time over the years with people like Stu. We've had Dan Chornous and others on this podcast over the years. It's that lack of emotion around these kinds of times, their ability to just always shut down the fear or the exuberance, depending on which way the market is going, and to just go fall right back on to their analytics, their process, and the way they define those opportunities to take advantage of anything that's going on in markets. Actually, this is good because you can actually see it now on the screen. I've been talking about this when we've only been on audio, but now you're watching it on the YouTube channel and you can see that complete lack of emotions. Or occasionally he gets angry at me. But other than that, it's just a calculation.
Well, and I think the thing is, too, preparation means envisioning that all sorts of things are going to happen. So even last week, without predicting when the Yen carry trade might have some bumps, there was a pretty general awareness that it was a little bit longer in the tooth. So just like your favorite sporting event or whatever it might be, when a football game gets down to the two-minute warning, they got the two-minute warning playbook. They got playbooks for all sorts of things that can happen. So you imagine this stuff happening before it does. And that in and of itself is pretty settling. So that's half the battle.
Yeah. And again, I encourage anyone who's just new to the podcast — we keep getting lots of new listeners and watchers every week — go back and listen to some of the classics from Stu's days in the past, where we talk at different points about process. We'll continue to do that. We'll do other different Stu’s days editions where we talk about a particular process that's followed at a particular time in the market. But from an investment perspective, this idea of the dollar cost averaging, particularly when markets are expensive or volatile, has been a hallmark of one of the things we've talked about as something you want to watch for as an investor. And then last week gave you a great example of that. Now, the other thing we're looking at today, because this was a really interesting one. And just because of the way the stock moved — and this one's always fascinated me, so we'll dig into this, and I know you've got a perspective on it — but the CEO of Chipotle, Mexican Grill, it was announced today that Starbucks has basically recruited him over to become the CEO of Starbucks. And Starbucks stock has jumped. Chipotle stock has fallen. And it's not by a small amount either. These are fairly big moves, right?
Yeah, they're big moves. And it's maybe not a perfect segue, but when we were talking about the economy and central banks and what have you, they're doing the same things that management does of business. They're always trying to figure out how do we steer it as best we can. And boards of directors and shareholders and management of companies are doing the same thing. A company like Starbucks has struggled coming out of the pandemic with some of the traffic issues. You do your Morning Espresso, and you've been to a lot of the finest coffee shops that you could ever imagine. And there's not as many Starbucks on that list as there used to be, I'm sure. I'm not even sure if Starbucks was ever on your list given your strong base.
I'm a bit of a coffee snob. It's one of my character flaws, Stu.
So Starbucks had been a very poor performing stock, and some investors got involved. And that's where you get into this scenario analysis where you say, what could turn this company? We can take just three simple screens on Bloomberg. We could say, well, what's the company's revenue growth been like over time? What's the company's margin profile been like over time? And how has the valuation changed? So if you look at those three things on Starbucks, you can see that they've had a revenue problem. The margins have actually not been so bad, but the revenue growth has stalled. And as a result, the valuation has deteriorated quite significantly. So if you're sitting there and you're saying, how do we restore value into Starbucks? You got to fix the revenue, right? Maybe there's small improvements on margin. Sometimes margins are a problem. But when you're trying to get revenue back, sometimes you need a bit of a shot in the arm. And Starbucks went and found Chipotle, which has been a fast-growing fast-food chain. And this guy is a bit of a wonder kid in the industry. He's had success at a number of different firms, and they've brought him in. So when you look at the stock today, there's a couple of things. You can go back on those three graphs and you can say, boy, when Starbucks had revenue growth, its valuation used to be this. So very quickly, we could say, well, if they had full revenue growth and it went back to, call it 16 or 17 times a cash flow or mid 20-times earnings, the stock would be X dollars, say, 90 bucks or whatever it might be. So if the stock immediately went to that level, you'd say, well, we've already priced in a full recovery. This guy, he’s been there a day and he's already been successful. So what the stock market tries to do is to say, well, this is a change and we have to handicap. We have to attempt to put odds on the possibility of a turnaround. And that's why the share price jumps because of this guy's skillset. Now, whether or not he'll actually deliver, that will all come out in the process of time. But that is the way that the stock market tries to adjust the odds of success by taking the share price up. And what they're saying is that this guy has more success than the management team that was in place. And conversely, on something like Chipotle, which had been a higher valued stock, immediately the stock market says, well, why is this guy leaving? Does he see a bigger opportunity in Starbucks than he had in Chipotle? So they marked the price of Chipotle down. Now, again, this will all come out with the fullness of time. But it's a great example. Just as we talked about markets as a whole, it all happens on individual stocks where the stock market needs to say: this is the good outcome, this is the bad outcome, these are all in between, and we need to apply odds to the likelihood of that arriving. And we do that by adjusting valuation to these different scenarios. And when good things happen, the stock price goes up. And what that does is it pulls forward a degree of the success. And we have to say, is that appropriate? And on the other hand, they might say, well, this business is not going to be as successful. And maybe we could sit there and say, well, we think it's going to be just as successful as it was. So maybe that's an opportunity. So as share price moves, you have to reevaluate how you think about those scenarios relative to what's priced into the stock.
Yeah. And there's different things that are happening all the time that are affecting individual companies — or a pair of companies, in this case — or economically, a bigger picture, a fiscal policy, a government policy that affects a whole swath or all 500 stocks of the S&P 500. Some to their benefit, some to their detriment. But there's also those individual cases. And for you as a portfolio manager, you're looking across every stock, but you're looking for where those opportunities are created, particularly when it gets almost case to case.
100%. And that's why I mentioned those three graphs. If you were going to go look at any company, whether or not you're an expert on selling their wares or whatever it might be, and you can just say, oh, boy, why has this revenue growth changed so much? Is that an opportunity? Why has the margin profile of the business changed so much? Why has the valuation changed? And within those three ingredients, that's why you find big moves in stock prices, because if the revenue growth re-accelerates, the margin expands, the multiple will go up. And those are not additive, they're multiplicative — I don't even know if that's a word, Dave — but you take those three things and they're more than just a sum. So you get bigger changes in stock prices. That's why in any given year, you talk about how markets, three times they correct by 5% and one time by 10%. Individual company share prices often do much more because through the year, you have discussions around revenue, you have discussions around margin, and as a result, you end up having discussions around valuation, and you end up with these bigger swings in underlying securities relative to the market as a whole.
Stu, what always interests me, when you have a CEO change across two companies that have tens of thousands of employees around the world, can one person make that much of a difference? Is Starbucks up 10% and Chipotle down X% because this guy makes that much of a difference? Or is the market saying this guy has had the ability to go and look almost on the inside of both firms, and he's making a call that for the next number of months or years, he'd rather be at Starbucks than Chipotle, and they're betting on his ability to make that call? Or is it a bit of both?
I think it's a bit of all that stuff. I think in this instance, probably just the lure of turning around Starbucks is quite high. And this is a generalization, but a good company is not as vulnerable to losing their leader, because if that person was a good leader, they probably had a great team, a business firing in all cylinders. There's a learned memory of how to make things work inside that business. So this would just be a generalization. You're probably more tempted to say the reaction to the person leaving is maybe a little bit overdone. There's a lot of other people that have contributed to that success. When someone new joins a company, it's very similar to all sorts of situations that we find ourselves in where we know what needs to be done, but it's just hard to do it. Sometimes a fresh set of eyes can just come in and say, we know what needs to be done, let's get at it. They can do it through leadership skills. It's not so much that they necessarily identify something brand new. They just get at it in a manner that allows the organization to breathe a sigh of relief and get at what's necessary to turn the business around.
Yeah. And I guess you've seen dozens of examples that have worked both ways over your career investing.
Dozens, yeah, for sure. And there's some great lines from Warren Buffet. Turnarounds often don't. And when great management meets a poor business, it's often the business that wins. So you have to always be aware, there's been some great personalities that got involved in businesses that were just in tough and nothing happened. But if you have a good underlying business that just needs a little bit of tinkering for someone to unlock a potential value event, those are things that you definitely watch for.
Yeah. And I guess as you're out at these different companies and you're looking beyond just that leader, but you're also looking at the breadth of that management, if you're going to have it as a long-term holding. Because again, at some point someone's going to need to step up or in the best cases, as you mentioned earlier, they've groomed someone to step up and just keep things moving in the right direction.
Yeah, 100%. And in the case of Starbucks, the day when you do have Starbucks on the Morning Espresso, I will know that they have entered the pantheon of coffee shops, the Dave Richardson stamp of approval on the coffee shops. And that would likely be a sign that Starbucks's turn was at hand. Not going to happen, Dave?
Well, I got caught at one of my specialty coffee shops. I have all the fair-trade coffee and organic and very specialty coffee shops, very specific roasting techniques. And they've sourced the beans from all over the world. And they actually take the time to make you a coffee instead of just pushing buttons and making a coffee. It's handcraft in a sense. And then one time I made a quip about Starbucks in one of these shops, and the owner went, wait, wait! You have to remember this place doesn't exist if Starbucks never existed, because Starbucks took what they call the first wave, which is sitting in a lovely cafe in Tuscany, sipping an espresso out in a small little village, to being able to have that experience somewhere in North America. And then this next wave, the third wave has taken another step. That innovation is such a big part of the world, and I think, particularly really North American business culture.
I 100% agree. The greatest thing about business is just it's always evolving. There are always new things. There's always a change. It's the most fantastic part about being an investor. They change the puzzle pieces every day.
And in a tip of the cap to your mom, I still think you're the wonder kid. I know they called you that one. I still think you're it.
Thanks very much, Dave.
All right. Thanks, everyone. And we'll see you next week on Stu’s days.