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This episode, Dave catches up with Scott Lysakowski, Head of Canadian Equities at Phillips, Hager & North Investment Management, and looks at the factors driving the strong performance in Canadian equities. [10 minutes, 01 seconds] (Recorded October 21, 2021)


Hello and welcome to The Download. I'm your host, Dave Richardson. And I am joined by head of Canadian Equities at Phillips, Hager & North Investments, in Vancouver, Scott Lysakowski. Scott, how are you doing today?

Great, Dave. Thanks for having me.

Feeling very artsy today, Scott? You've got a big art delivery that delayed our taping here. What did you buy?

A couple of pieces from a local BC artist. We'll find a place to put them on the wall. Got a few blank walls to fill; slowly but surely, we're getting the walls filled.

Not just an expert stock picker, but also a great art picker as well. Beautiful stuff. Too bad we're only audio here on the podcast. But, Scott, we were going back and forth about what we might talk about today, and I referenced an article that I read yesterday from an analyst at Bank of America, and she was talking about dividends— dividend paying stocks and dividend growing stocks look particularly attractive right now. Then she pointed out particular sectors where she thought there was the most potential, and it was really interesting to read an article from an American analyst pointing to Energy, Financials and Materials as the three areas where there's great potential for dividend growth. Right away, what does that scream at me? That screams Canada! You came to me this morning with some thoughts around how well Canada has done this year, relative to the U.S. and other markets around the world. Why don't you talk about Canada? The positioning? And what's happening right now is kind of exciting.

Sure. Those are great points to touch on. The TSX is outperforming the S&P 500 on a year-to-day basis. That would be both in Canadian dollar terms and local currency. No surprise there. Leading the charge are some of the sectors you mentioned: Energy, Financials, Industrials and Materials, particularly non-gold materials in Canada (that would be base metals, forest products and chemicals). The same analyst that you quoted put together a really good report early in the year, showing how the current environment actually set up very well for Canada in terms of relative performance versus the TSX. The points they made were a few. One was from a composition perspective. We've mentioned this before on the podcast, Canada is very cyclically biased as a lot of its market cap is taken up by the more cyclical sectors (Energy, Financial, Industrial, Materials, as you mentioned). That's about 70% of the TSX versus the S&P 500 which is probably about 25% represented by those sectors. There's a compositional difference there. The other piece is that the TSX is an all-cap index, so it has some exposure to small and mid-cap stocks, whereas the S&P 500 is a large-cap index. It has some of that cap bias as well. A couple of other features that set up well for Canada. One is from an evaluation perspective. The TSX is trading at probably the deepest discount to the U.S. market, going back to the tech bubble. And it's about a two standard deviation discount right now. Typically, historically, when the TSX is traded at- or greater than a one standard deviation discount, the forward returns are in the 3 to 8% range relative. That sets up for outperformance when Canada is trading at a discount. One of the other things, which, given the sector composition, is not overly surprising, is that the sales and earnings recovery sensitivity of the Canadian market versus the U.S. is very high. The TSX has a much higher beta to GDP from the sales perspective, and has a much higher earnings recovery during periods of economic recovery. That sets up really well for Canada, as we know we're in the midst of an economic recovery. Two other points, which I think are also not that surprising and somewhat related, is that the TSX tends to outperform the U.S. during periods of strong commodity prices, and we've seen that year to date, we've seen that re-accelerate in the last couple of weeks on the energy side, especially that the TSX tends to outperform when we're in strong up cycles for commodity prices. Then finally, the valuation of the TSX tends to recover during periods of strength with the Canadian dollar. The strength in the commodities, the strength in the economy should be positive for Canadian dollar. I know Dagmara [Fijalkowski] and her team have spoken of a positive Canadian dollar in the past. That sets up really well. That discounted valuation, plus that increased sensitivity to a recovery in the economy, strengthen commodities and recovery in the Canadian dollar, all set up actually really well for Canada here.

Yes. A great point on currency, which a lot of investors don't pay probably as much attention to as they should. If you're going to see strength in the Canadian dollar relative to the U.S. dollar through this period, if you do go and invest in the U.S., that's going to reduce your returns, because when you bring those dollars back to higher Canadian dollars, you're going to buy fewer Canadian dollars with your U.S. dollars from your U.S. dollar investment. It is something to be conscious of. As a professional money manager like yourself, if you're running a U.S. equity fund, you're going to be doing some hedging of currency to protect investors from that. But individual investors, if you're buying individual stocks, something to keep in mind when you're buying down in the U.S. You do have these periods, as we saw, Scott— what would have been from 2000 to about 2010—, where the Canadian market significantly outperformed the U.S. and, in certain parts of that cycle, outperformed a good chunk of the world.

Yes, it's hard to say that we're setting up for a ten-year relative performance cycle for Canada over the U.S., but we have been talking about that cyclical exposure in the Canadian market for some time. It's really proved itself out to start the year. It took a bit of a pause through the middle part of the year but just to start this quarter, the TSX is starting to outperform the U.S. again, and we're starting to see some evidence of some of these setups play out.

Certainly not promising a ten-year period of outperformance right now. And also keep in mind that, at the same time things may be favoring the narrowness of the Canadian market, those same things can turn and leave the Canadian market out of favor. Canadians always have to keep in mind that Canada is only about 2 to 3% of global market capitalization in both stocks and bonds. As much as you might like Canada right now, this is not something that you're going to want to have 100% of your assets. That would be a dramatic overweight. And then don't forget, you probably work in Canada, you're earning your salary in Canada, you're working for a Canadian company. You're tied to the Canadian economy. So there's lots of reasons to diversify around Canada. But this may be one of those periods where being a little bit overweight Canada makes a lot of sense.

Well, I think the setup is pretty good, and I think that it's hard to say that we'll have a ten-year run, but I think the setup is pretty good for Canada. And if the cyclical recovery continues to take on, I think Canada will prove to be a good place to invest.

Scott, thanks for that great update on Canada. From the sophisticated Scott Lysakowski on the Download. Dave signing out and we'll see you in a couple of weeks, Scott.

Thanks, Dave.


Recorded: October 21, 2021

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