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This episode, Scott Lysakowski, Head of Canadian Equities, Phillips, Hager & North Investment Management, discusses the factors driving the strength of the Canadian market so far this year. Scott also dives into why sectors like health care, financials, and energy have performed well and looks at the opportunities and risks ahead as the year plays out. [10 minutes, 09 seconds] (Recorded April 8, 2021)


Hello and welcome to the Download, I'm your host, Dave Richardson, and I am joined by the Head of Canadian equities at Phillips, Hager & North. The world famous Scott Lysakowski. Scott, welcome to the podcast.

Thanks, Dave. I don't know about world famous.

I know you're very jealous of Stu’s days. Lysa-Thursdays?

Yes, something like that. Scott’s Days? Every day is Scott’s Day.

Thurskowski? Anyway, we were talking before we started recording about fun podcasts that we both listen to and how some of them are incredibly entertaining. Of course, economic and investment podcasts are very difficult to get to that point, although we try our best. And that was probably an epic fail to kick off. But what has not been an epic fail and I think is always surprising, humble Canadians that we are, is the strength of Canadian markets through the first quarter. Over the last week or so, we've been talking and doing more of a first quarter review with some of the guests we've had on, Scott. And if you think of what's the sweet spot for when the Canadian market's going to do well, you need financial services stocks to be doing well, you need energy stocks to be doing well, and boom, both of those things come together in the first quarter. And Canada's had a nice little run here.

Yes, that's right, Dave. It's been a great start to the year. And even if we look further back. I think back to that early November timeframe when we got the US election results out of the way and, of course, the big positive news on the vaccine. And from there, we've seen a very different leadership in the market. And as you pointed out, some of the more cyclical sectors— energy, financials, industrials and some parts of the materials sector— have really led the way. And the markets have been very strong. Year to date, we're probably north of 10 or 11% for the TSX. Financials and energy have been very strong. Health care in Canada has been strong, but that's mostly recovering some of the cannabis stocks. But as you point out, the big drivers of the Canadian market have been some of the more cyclical components. And we've long talked about the differences in the composition of the Canadian market versus the US. If you think about some of the more cyclical sectors or more economically sensitive sectors, they would be energy, financials, industrials and materials. That makes up about 75% of our market, which is quite different than the composition of the US. I think those sectors probably are only about a quarter, maybe a third, if that. So, in Canada, when we hit that cyclical type of recovery, as the market gets the news on the vaccine, they start looking forward to more of a reopening and a more broader economic recovery as we move out of this pandemic. Canada does quite well. And I think they’re one of the leading markets in the developed world. So, it's been a long time coming because we know that Canada has underperformed the developed market peers, particularly the US market, for some time now. So, it's nice to see some leadership coming from Canada for once.

But really important, as you highlight, as investors take a look at Canada and their overall exposure to Canada. First, many Canadians already have a significant overweight position in Canadian equities. And then you have to understand the limitations that are created by the composition of the Canadian market, which you articulate. So, Scott, is this something that you expect to continue as we move through the next three quarters of the year? Or have we seen the best of the relative performance for Canada?

Well, it's hard to say. My bias would be hopeful that we continue our relative performance, but we have to stick to some fundamental principles. I guess, looking at it in a couple of ways. First, we can look at history a little bit here and use that as a guide with the TSX trading at an all-time high. The one-year forward returns from previous times when the TSX has traded at an all-time high have not been great. And I think that goes back to that composition piece. It's a very cyclical market. And so, when things are good, they are sometimes followed by not so good. It's hard to say if history will repeat exactly in this environment, because as we know, it's a quite different environment than what we've seen in history. The other bit of history we'd look at is the one-year returns off the March lows. I think in Canada we're the best in history, if not in the top one or two, for one-year periods of returns, and if you use that and then look forward a year: in the past, if you look at the other top 10 return periods and the forward returns then, the forward returns are not as great, they're actually often negative. Not necessarily setting up for a massive drawdown, but it's more of a chopping type of environment. If you compare that to the US, usually when the S&P 500 is trading at an all-time high, the 12-month forward returns are actually quite good and typically are positive. And then again, I think in the US, the one-year returns for the S&P 500 to the end of March were the best or among the best in history. And if you look back at the other top 10 periods, the 12-month returns would be favorable for the US as well. So, while I'm hopeful Canada can keep things going, it might be tough if we use history as a guide. The other piece that we'd look into is more of our bottom-up fundamental work, as you know, and we probably shared this with the listeners in the past. We're big believers in bottom-up fundamental research and building up our forecasts for the overall market from a bottom-up company specific timeframe. And when we look at the bottom-up returns to the markets, again a bit slim pickings, as we've seen a pretty healthy recovery across a number of sectors. We do see some pockets of attractive risk reward. I think there's some life left in some of the more cyclical sectors like energy and financials. But we've consumed a lot of that risk reward on this recent rally. So, we're hopeful that we see some continued strength and performance from the Canadian market. But we are exercising a little bit of caution here as we've had a pretty good run.

Yes, and it's a great reminder for people, after this period of relative strength and given that many Canadians, again, have a significant overexposure to Canada. As we always say, Canada is about 2 to 3% of investment markets around the world, but many Canadians are in excess of 60 or 70% exposed to Canada. So always a good opportunity to review your portfolio and make sure that your Canadian holdings make sense, given your view of the market and given the objectives that you have from an investment perspective. Just one last question, Scott. Just overall, when you're looking out across the portfolios that you and your team manage, is this a time where you're putting on more risk, taking less risk or are fairly neutral on where we're at right now?

I would say that we're still fairly constructive over the long term. We have to remember we're in the very early stages of an economic recovery, and particularly for folks in Canada— and Ontario specifically—, it feels like we're right back at the beginning of this pandemic from an economic shutdown. So, we have to think forward that we will get through this and the economy will recover. And if you listen to some of the work from Eric Lascelles and his team, there's quite a bit of pent-up demand building up inside the consumer's bank account. Yourself and myself, we're all eager to get out there and get back to doing the things we like to do. And that's going to be very positive for the economy. So, one of the things that we think about is, where are the opportunities and what opportunities are still mispriced? And when we stack that up, like I said, the risk reward has become slightly diminished. And so I'd say on the margin, we're dialing back risk a little bit and just really trying to reallocate it and focus on the areas where we still think there's a reasonable opportunity from a risk reward perspective. But we're just exercising a bit of prudence here, as a lot of that recovery has been brought forward in certain parts of the market.

Yes, and I'm glad you mentioned Eric's work on the podcast for your podcast service. Just before this one, we taped it yesterday with Eric Lascelles, Chief Economist at RBC Global Asset Management, who has just done some research mapping out stages of the economic cycle and how it relates to investment performance. So that ties into to the comments Scott was just making. Scott, not a lot of comedy. No one was driving along in their car laughing out loud to this podcast, but fantastic information. So, it's always great to catch up with you.

We'll work on the comic relief.

Maybe we're only useful when we're being dull and serious.

At least, we're useful.

Exactly. There's some positive out of this. So Scott, we'll be checking in with you over the next month. Thanks for joining us again today.

Thanks, Dave.


Recorded: April 8, 2021

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