Volatility has flared up due to the regional banking issues in the U.S. and the uncertainty unfolding in the European Banking sector. Listen to our latest podcast featuring Greg Sweet (Scotia Securities Director) and Jason Gibbs (1832 Vice President & Senior Portfolio Manager) as they discuss the state of the markets and some recent questions from long-term investors.
March 23, 2023
Speaker Key:
GS Gregory Sweet
JG Jason Gibbs
VO Voice-over
GS Welcome again to our listeners. I’m Greg Sweet, a Director at Scotia Securities Inc. Today we are happy to bring you a new episode of Let’s Talk Investing with the goal of empowering you in making important financial decisions. Today I’ve invited back Jason Gibbs, Vice President, Senior Portfolio Manager, and Co-Head of 1832 Asset Management’s Equity Income team, to answer recently asked questions for long-term investors. Jason, thanks for spending time with our customers today.
JG Thanks so much, Greg. It’s wonderful to be with you.
GS All right. Let’s jump right into it. The situation in the banking sector has unfolded rapidly over the last few weeks. What are the key points investors need to know to be up to speed with the recent events?
JG In times like this, I’m always reminded that life is not a smooth, easy, simple ride and, ah, if that’s the case, neither will markets be. So markets do tend to be volatile at certain periods over time, but they are very rewarding if you stick with them. So we have seen periods like this many times in the past and I’m not too sure exactly how it ends or how long it goes, but I do know it will end at some point. So I just wanted to start off by saying that before we get into it.
00:01:07
But, Greg, the United States has over 4,000 banks. It is a very different banking model than the Canadian model. But the current source of trouble is, two specific regional banks in the United States had what’s called a deposit run. And for those who know their market history, this is actually incredibly common in late history, thankfully not at all that common in modern history. But, but having said that, the latest issue is two specific American regional banks and these are, in the grand scale of things, fairly small banks, Silicon Valley Bank in California and Signature Bank in the United States. They had fundamental issues with the way they were managing their balance sheets, more specifically Signature Bank, in that they had a significant amount of bonds that lost value.
Long story short, in the age of social media… It’s amazing. The iPhone has only been around since 2007 and I think we’re still seeing the impacts of it. But in the age of social media, some kind of noticed that their bonds had lost value. Even if they were held to maturity, they would have been perfectly fine, but depositors left, left fairly quickly. And this bank, as many regional banks in the US, ah, ah… As is the case with many US regional banks, they did not have what we call a diversified deposit base. So when depositors decide to leave, and electronically that’s fairly easy these days, a bank has a major problem. Banks are built on trust and confidence.
00:02:36
So, to put it in very simple terms, depositors left. Those two banks essentially failed. And, um, if you want to think about it in big-picture terms, it is a bit of a hangover, a continuing hangover, from many years of low interest rates. And when you have low interest rates, ah, and interest rates rapidly reprice, as they did last year and, and this year, ah, often, almost all the time, you’re going to find issues with certain companies that were caught offside. And, you know, finally, Greg, I would say, to keep it in context, these are two small banks and, again, they did have fundamental issues that others were, were aware of beforehand and, and the rapid repricing of rates, ah, made that more of an issue.
GS You know, if you think about this backdrop, what advice would you give to customers who might be hearing or reading these headlines, feeling a little bit nervous about investing or their current investments?
JG You know, this gets to the core of how to be a good investor over time and I think of my personal experience with investing and obviously as a professional investor as well. It’s been about 30-plus years that I’ve followed the markets and the first thing that I would say is that, again, nothing is really that new. Things do tend to repeat over time. It’s just different actors and, and different stories. And I can remember my history as an investor. Ah, every single year going back 30-plus years, there’s always something that happens that no one expected.
So, again, life is, is not a straight line and, and often things happen that you cannot expect. And this is why, as I always say, those who try to predict markets are completely wasting their time. There’s not one person two weeks ago who thought we would be talking about US regional banks, right? So that’s the first thing I would say, that this is not, not new.
00:04:23
The second thing I would say is, we always have to remind ourselves… and I’ve seen it time and time again. There are two points in an investor’s history where they can make enormous mistakes. You know, it’s been very sad for me sometimes to see this happen. The first type of mistake an investor can often make is getting involved in euphoria. And again, remember, humans are very emotional and so markets are emotional. So often people can get caught up in investing in euphoria and we saw that a little bit in 2021.
The other major mistake investors can make is selling everything when the headlines are bad. That’s a huge, huge mistake. I always go back to… if you look at a hundred years of history… look at a century of history of, of how equities have done, bonds, cash, gold, real estate. The data is all there. By far, what you are going to find is that publicly traded equities, and even if you have a wonderful business, private business of your own, has been the best way to create and preserve wealth. Now, when I say that, people will say, well, you make it sound too easy. The price you have to pay for that, to realize those returns, and it’s always been that way, is an ability to deal with times like these, volatility.
Remember… and, Greg, it’s something I’ve said before as well, ah, but I’ll say it to those listening again. Be cautious of the media, particularly social media. Remember, they are in the game of trying to get as many eyeballs as they can, to get as many people listening as they can. So if you have an all-day media channel saying, think about the long term, they’re going to have ten people watching, right? So what they do is try to scare people. So be very cautious of getting too involved, in, in the media of the day.
00:06:15
Ah, the final thing I would say on, on this topic, Greg, is, once you do block out the noise and think about history and think about long-term, remember that your, your odds of doing well in the financial markets dramatically increase the longer your time horizon. And that is in direct contrast to what some in the media will want you to act like. You know, they will want you to trade all the time. Over a month, a week, a year, it’s… No one knows what’s going to happen and if they tell you, they’re, they’re just making it up.
Over ten years and beyond, and there’s a lot of data to this point, your, your odds of, of losing money in a diversified portfolio of good businesses is dramatically reduced, dramatically reduced. Because, again, storms come, but they also end. They eventually end. And, ah, ah, in the immortal words of, of Ned Goodman, a mentor for, for many of ours, he would always tell us he has never met a rich pessimist. So if, if you’re investing in a state of pessimism, you’re not going to do well. You will not do well. Over time, a lot has happened in the world, but optimism has always won. Think about Bill Gates, Steve Jobs, and even Elon Musk. They are not pessimists. They are optimists and they’ve done very well.
GS Very high-quality advice. Super-sound judgment. You know, the reality is that the fundamentals of investing, long-term investing, have not changed based on the news that has emerged over the last two weeks and I think that’s really important information for our customers to hear and have confidence in when they’re thinking about their long-term plans.
00:07:50
So we’re going to shift to the Canadian banks. When you think about the Canadian banks, has the recent events changed your stance on the stability of the Canadian banking sector?
JG Oh, not at all, Greg. Ah, I think we should be very, very proud of the system that we have. Over the last hundred years or so, ah, as Canadians, we have built an incredibly sound system. And again, I’m, I’m a huge reader of history and I think if you want to be a good investor, you have to understand your market history. There were bank failures in Canada as well as the United States in the late 1800s and in the early 1900s.
Canada kind of learned a lesson, though. The last charter bank failure that we had was about a hundred years ago. It was called the Home Bank of Canada. That was about a hundred years ago. Since then, more or less, Canada has built this model based on an oligopoly. So we all know we have the Big Six banks. They have one regulator, a very well-thought-of regulator on, on the global, ah, scene, and we have a wide distribution network.
00:08:53
And we… And, very importantly, Greg, always when you think about the Canadian banks, think of diversity. When we’re, when we’re thinking about investing, we always talk about diversification. You can never have all your eggs in one basket. You can’t just own, I don't know, 100% gold or, or 100% real estate. You, you can never go all in on one thing. And that was one of the issues that’s happened with these US regional banks. They, they only had a few big customers and big sectors.
Well, if you think about the Canadian banks, they’ve got obviously US banking, Canadian banking, international banking. They also have dominant wealth management, dominant capital markets, trading franchises. They’ve been around for a long, long time. Ah, they’re stable, highly regulated. They have a very well-diversified deposit, ah, base, clearly, right? So their customers… Our, our customers are very diversified across the country.
And so when you add that all up, high capital levels, high liquidity levels, diversified customer base, ah… And remember, the Canadian bank, banks actually made it through the Great Financial Crisis in wonderful shape. Ah, we are kind of, ah, the model that many around the world look to. So very happy about, ah, the, the status of our Canadian banking model.
GS So, Jason, I think that’s a really good transition. You, you talked about the 2008 financial crisis. So when I talk to Canadians, I think the memory of the 2008 financial crisis has added to some of the trepidation. So, in your opinion, are we at the cusp of another 08 repeat?
00:10:27
JG No. I don’t, I don’t think so. This is not 2008-2009 and I think it’s very natural for, for people to have that period ingrained in their memory banks. Ah, trust me, Greg, I was a portfolio manager back then and I still remember those times. Those were not fun times. That was a major, major balance sheet problem in the, in the sense that… What I mean by that is that there were a lot of big banks, mostly in the United States and Europe, that had balance sheets that were insolvent, right?
So remember what happened during that time. The, the Americans had a housing bubble. People were getting housing loans that didn’t have jobs. It was, it was out of control and many of those securities were packaged up and, and put on balance sheets. So you had a lot of bonds that were worthless. And when you have a situation like that, that’s much more serious, clearly, and that is not the situation that we have today at all.
And we’ve done a great deal of, of work on this and Nick Stogdill, our lead bank Analyst and Portfolio Manager, just a couple of days ago actually gave a presentation on this very question. And it’s, it’s pretty simple. If you look at the capital levels of banks, the, the leverage, the liquidity, the regulation, it’s much, much better today than it was before by, by an order, by a massive order of magnitude. So they’re, they’re much better capitalized. They have, they have much more capital, less leverage. So it’s, it’s not the same situation although I, I do understand how people still have, still have that in their, in their memory banks.
00:12:07
GS Yeah. So that’s really good context. Thanks, Jason. I think that’s going to reassure a lot of Canadians that are listening to our episode here today. So, ah, last question for you. You’re a money manager, right? You and your team are constantly looking, ah, at the market for opportunities to add value to our customers. You know, given these broad market concerns around inflation and interest rates, maybe it’s the risk of a recession or a hard landing, has your outlook on markets changed? And how are you managing the risk-return trade-offs of today?
JG Ah, this gets to the core of, of what we do because this is a question that we get even beyond the last couple of weeks. It’s, it’s often a question. What do you think about the economy? What do you think about the macro outlook? How do you think markets will end in this year? And that’s… Those are dangerous questions if you’re going to be a good investor in the sense that no one knows what’s going to happen in the short term and you will not be a good investor if you try, try to predict what’s going to happen and position yourself that way.
It… Because market timing does not work, a fundamental rule of investing. A lot of people will tell you they can market-time. I have not seen one person in my 30 years that was good at it. Some people can get it right-on on one event, right, where they… Maybe they go all cash and they feel happy for a few months. I’ve never seen anyone then be able to get back in time when the markets do well. And again, there’s a lot of data that will tell you that if you miss the top five or ten best days in the market over your investment horizon, which can be ten-plus years, you’re in a lot of trouble if you miss those days. So that’s the first thing that I always think about.
00:13:47
And, and in our group, Greg, on the equity income team, I always try to get everyone centred on, our job is not to predict markets. Our job is to buy and own the best businesses that we can find at reasonable prices and protect the capital and savings of our unit holders, of which of course we are, we are one. And that’s, that’s, that’s what the job is. So once you get, once you get past the noise of the news and you start looking at companies, which we do every day, we’re looking at a collection of businesses across a variety of industries. Think about what I, what I said about banks and how diversified they are.
We own the best banks in North America that we’re very happy with, the best insurance companies in North America. We own energy and energy infrastructure, companies that are, as, as many of you would know, have a significant amount of free cash flow. And we’re always concerned and watching balance sheets and making sure we have the best balance sheets.
So that is what we do and then we try to figure out, what is that business worth and is the market giving us an opportunity at times like this, which… We’re finding those opportunities to buy those businesses cheaper than what we think they are worth. And that is what we do and that’s how you, you have to think about investing because that’s where you have a competitive advantage. Nobody has a competitive advantage in trying to predict what indices are going to do, what markets are going to do. I’ve never seen anyone do it right. So once you stick to that, what you will find is, over ten, 15, 20 years, you, you’re owning essential businesses that will get through this storm and you’re getting the opportunities to buy them at cheaper prices and that’s how you do well.
00:16:31
Now, it sounds simple when I say that, but remember, part of the, the price of, of getting that is, you’re going to have to deal with times like these because there will be volatility. Sometimes it goes on for longer than we think. You, you just never know. Maybe it does go on for a bit longer than we think. There will be cyclical upturns and downturns in the economy, that’s very normal, but the best, best businesses make it through and, and we’re all owners in those businesses and we’re very happy to be.
GS I like that. It makes me think about the fact that, like, volatility is the price you pay for real growth and, um, that’s reassuring to know, that there are professionals like yourselves that are taking that really logical approach, um, of finding great companies and making sure that we have an opportunity to buy them at what we deem to be reasonable prices. Um, love that, Jason. Thank you. So, Jason, we’re going to wrap it up here and I can’t thank you enough, um, for spending some time, valuable time, with our customers.
The decisions that Canadians make during periods of uncertainty like we’re in today significantly impact their ability to achieve their long-term financial goals. And here at Scotiabank, our goal is really to help customers make informed decisions. I’m confident this discussion today helped deliver on that advice commitment. And to our customers, thank you for your continued trust. We hope you sleep well knowing our incredible team of investment professionals are working hard every day for every future.
00:16:46
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00:18:19
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