Transcript
Hello and welcome to The Download. I'm your host, Dave Richardson, and we are joined by our old friend who we just never seem to have on enough. And that would be Scott Lysakowski, Head of Canadian Equities at Phillips Hager and North Investments. Scott, a day after the US election, probably about the worst time we could have you on, I'm sure, in talking about election and market reactions. But how are you doing otherwise?
Great. Yeah, well, lots going on. So definitely a good time to catch up. And yeah, you're right. Big reactions out there in the market on the election results last night. So I think I said at the outset, I stayed up past my bedtime to see some of the results come in and the market reactions overnight and then up and at it this morning. So I'm caffeinated. I might need my second round of coffee shortly.
Well, now that I know, if I look straight ahead, I'm looking into Scott's office across the way. We're in Vancouver together, but for some reason we didn't get together this morning. I got a killer Espresso at our favorite place, Revolver. Maybe we'll go after the recording and get caffeinated up a little bit more. But let's not bury the headline. Let's go right to the election. So as we're sitting here right now, let me just pull up the numbers here. The Dow is up 1,300 points, S&P up 120 points. I believe these would be all record highs. We've got the 10-year yield. Where's that sitting now, Scott? 4,40?
4,45, I think.
4,45. So that's up almost 20 basis points. Gold is down big. Copper is down big. The oil stocks. So instead of me doing the analysis, you're the expert, just out of the gate, the market reaction this morning, what are you seeing? The market's calling some winners and losers, clearly. What's happening?
Yes, so definitely a strong reaction today. I guess a couple of things the way we think about it, it's still relatively new from an actuality perspective. But the one thing that we observed is that the markets had been contemplating this outcome for some time. A lot of these moves you're seeing today are a continuation of what we observed in the markets in the last couple of weeks. That's one thing. And that makes it challenging going into events such as this, because on the one hand, it's a very unpredictable outcome. I think the results look like they were more than a coin toss. But going into it, I think it was widely expected that it would be a very close race. And a lot of people calling it a coin toss outcome, which brings in a different dynamic. But going into it, you say, we're not entirely sure what's going to happen. And then adding that layer to it, if you told me you knew what was going to happen, I could say, well, generally speaking, it's going to be good for these stocks and these parts of the market and bad for others. But then we add that extra layer of what has been already positioned in the market and what are the market expectations. So it's a fairly complex dynamic, as you can appreciate. And the one that thing that's challenging for us while it's important to financial markets, it's not really our strong suit to be predictors and forecasters of these large, uncertain macro outcomes. We need to be aware of it because there are implications. But at the end of the day, we're fundamentally stock pickers. And so these things are just really complex and it’s really hard to have a strong opinion on them either way. I always say there's two types of forecasters out there, those who don't know and those who don't know they don't know. We fit into the camp of we don't know, and we know that we don't know. And what we try to do is stick to the places where we have an edge. So going into this, we didn't have strong opinions. We did observe that this outcome was being somewhat reflected. We've seen a big move up in bond yields in the US and in Canada to a lesser extent. We’ve seen some strength in the US dollar. The US dollar, that's a big one. And then the impacts on commodities. Now you look at it and say the outcomes and the reactions are fairly obvious and straightforward, but big ones. I guess a couple of things that stand out to me is, obviously, the US market is strong. Canada is positive, but not as strong. It would be really hard for me to say that the outcome of the US election is positive for Canada. I wouldn't entirely say it's overly negative, but it's not positive. Just directionally, US is our largest trade partner. The strength in the US dollar has adverse effects for the Canadian dollar. We're a net importer of goods, and so a weak dollar adds to the risk of importing. Your import prices go up. And so you run the risk of importing inflation, which may put the Bank of Canada on pause or at least slow down the amount they can cut. So there are some implications. Obviously, the commodity markets are a big part of our market. But the thing that actually is standing out to me, and it seems to make sense, but it's the one thing that I actually think there might be a silver lining for Canada, is it's not only the strength of the US market, but it's actually increase in the breadth of strength in the US market. We've talked about — probably for the last, I don't know, half dozen podcasts I've been on with you — the narrowness of the US market and just the dominance of those large stocks, Mag 7 or Top 10, however you want to slice and dice it. That's been the driving factor for equity markets globally. And what we're seeing today is not only strength in the US large cap market, but you're also seeing significantly more strength in the mid- and small-cap parts of the market. The Russell small-cap index is almost 5%. This idea that the outcome of the US election is positive for the US market, and it'll be good for the large stocks and even the very large stocks in the US, but I think there's a belief out there that this is a catalyst to think it's going to be good for the rest of the market as well. That's great if you're looking at mid- and small-cap US. We've talked about the equal weighted US, all the conversation has been around those big seven stocks. But we're also saying there's a great opportunity in the other 493, and now the market's starting to recognize that and reward that. And similarly, and maybe this is hope — and we all know that hope is not a strategy — but as the market starts to look outside of those dominant mega-cap stocks in the US, down into mid-cap, we start to look for strength in equity markets outside of the US as well, which could be a benefit for Canada. But I think the first step is, this is good for the US, and by default, it's not good for Canada. But that said, I think there are some pockets of opportunity that we see in Canada that would be benefiting, and we're seeing some of it today, and certainly some pockets of weakness as well.
Yeah. Some of the things you see right away and that you would have expected would be the idea of a stronger US dollar and a stronger US economy. And so that fills out all those areas like mid-cap, small-cap, the move in yields, and really tough on some of the more interest rate sensitive stocks. If I look at the stocks that I have a scan on every day — I've got a mix of a lot of different things to pick up some trends — but if there's a key trend, it's US dollar strong, that's the reaction. Yields higher, the likelihood of a recession probably takes a little bit of a hit in the mind of traders, at least today, but it's one day. One of the other things that I was reading about — and I wish I brought it up a little bit more on the podcast; maybe I did as we were talking last week with Stu — but the idea that when the election is really close, and it is a coin flip, at least in the view of investors and just everyone, which is where we came into last night in terms of who would win and lose, that's where you do get a pop. It's usually a positive pop no matter who wins because there's going to be winners and losers based on the policy expectations of each of the candidates. And so when you have that really tight election and then it swings very clearly one way, you always get a pop. It's just different stocks that are popping with the Trump victory versus the Kamala victory. I should also mention — I should have said this right at the start as well; so here's the bad podcast host here, Scott, and I’ll apologize about five times for missing stuff — but if you came here looking for a political opinion or a political reaction, this is not the podcast for that. There are hundreds of podcasts, thousands of podcasts. In fact, I think most podcasts these days are political. You can get one side, the other, whatever side you want. We're not talking politics here. What we are looking at is the way the market is reacting. We're looking at what we thought we knew coming in, what we think we might know now, how you want to think about the positioning of your portfolio and the discussions that you have with your financial advisor. So this is purely economics and markets. We’ll leave the hand wringing and the celebrations and all the other stuff to other podcasts. And by the way, if you do like this kind of conversations, please click «subscribe», click «like». Give us a five-star review. We would love that. Review Scott more than me because, again, I'm pretty weak this morning, it looks like, despite all my caffeine and the great coffee I had. So Scott, we look at the US dollar strength. I think a lot of Canadians think of Canadian dollar vs US dollar as really the only exchange rate they think of. We say US dollar strong, immediately Canadian dollar weak. And again, what we've seen overnight is a fairly muted reaction between the US and Canadian dollar. It's really the US dollar and a lot of other currencies that you're seeing that big move in. But the overall trend, as we've talked about on the US dollar has been down. So after this knee-jerk reaction, post-election, you're still in a relatively weak spot for the US dollar. And that's going to be one of the factors that has to help stock markets like the Canadian stock market and a broader range of stocks as you start to get into the future. The valuations are much more attractive than the US market, even now, beyond the Magnificent Seven.
Yeah, I think a broadening out. And before I get into that, I think you brought up a really good point. The best thing about this outcome is that it's now known. I mean, these election cycles are exhausting, to say the least. As we sit around the table — and I think I mentioned we were, coincidentally, having our strategy sessions globally as an investment team across all the parts of Global Asset Management — so we're gathering and we acknowledged it yesterday. Someone said: why would you be having these sessions before you know the outcome? And there's two points. One is we're not trying to predict this outcome. And two, it's very timely to discuss what's going on and have this unemotional reaction. Okay, now we know the result. Now we can actually just move on with our daily lives. The best part of this outcome is that now it's known. Sometimes they refer to it as a market clearing event. You saw lots of prepositioning. You saw lots of insurance buying, because people didn't know what's going on. And now all those bets are settling up in the next day or two, or maybe a week or so. And then we can just move on with our life. Now we know this unknown, and we can start processing this into our outlooks. So that said, generally speaking, a strong US dollar is not really great for the overall Canadian economy. There are some interesting pockets. So we talked about commodity prices, and there's some weakness in the metal space. But just even as we speak, the oil price has turned positive. So that's an interesting dynamic. The view that the new president will be more pro-US oil and bringing that more supply on, and that would weaken prices. But I think the market on balance has removed that as a major impact, a negative headwind on price. I think the global trade impacts things like copper and gold a little bit more directly. Those markets are weak. We talk about Canada as a net importer of goods. As the Canadian dollar weakens, the cost of our stuff is going higher, which is a hit to the consumer. It's a risk to inflation. What we do export is commodities, and commodities are priced in US dollars. And so, just even looking at my quote screen right now, one of the things I track is Canadian heavy oil, which is a lot of what the energy producers produce, Canadian heavy oil in Canadian dollars. So we factor in that discount that heavy oil trades at for quality and transportation. And then we factor in the currency. And Canadian heavy oil in Canadian dollars is up today, and it's actually up more than the oil price, not surprisingly, given the move in the dollar. So for parts of our market, a week dollar is actually fantastic because the product that they sell, they sell it in US dollars and they have a Canadian dollar cost structure. And that's a big driver of our market. We talk about the energy sector, and that's a big source of the earnings power. So that's an important positive data point. The other thing, the move in interest rate certainly has an impact on the interest rate sensitive stocks: utilities, telecoms, real estate, etc. There is a benefit, and we're seeing some of the financials in our market acting very strongly. We're seeing the financials in the US — regional banks are very, very strong. And so that's part of that breadth piece as the market moves deeper into that small and mid-cap. So you're seeing some of these really interesting moves. And it's not all bad. And so, we're seeing some pockets of positivity that we're quite mindful of and hopeful of. Going into this, I've been talking to all of our various distribution partners, advisors, financial planners, talking about opportunities in equities, opportunities in moving outside of the GIC market. And because we mostly focus on Canadian equities, talking about making the case for Canada. And certainly, making the case for Canada gets a little bit harder with today's news or yesterday's results. But I still think some opportunities exist, and it really points to that breadth piece. If the market is saying, now I feel we've got this market clearing event out of the way, clearly the market believes it's good for growth and economic growth is going to not only just benefit those seven big stocks, now I'm going to see economic growth that's going to affect the other 493 and the other hundreds of stocks that are in that small- and mid-cap market. And again, that can lead to people who might start looking outside of the US as well and just saying: where are some opportunities within equities that we think have an attractive risk-reward? Some of the things that we monitor, while we can't predict these outcomes — and we're not going to place bets in our portfolio or try to benefit from outcomes either way — we are looking for what is happening in the reaction. And one of the things that we have been seeking is something that we call either a change in leadership or an emergence of new leadership. Everyone says: how can you get bullish on equities when the S&P 500 is at all-time highs and the valuation looks stretched? How can you get bullish on equities? I've often said, we're looking or we're studying the wrong test. The US large cap market is at all-time highs and is trading at a valuation that appears higher than its average. But there are lots of parts of the market that are trading fairly reasonably valued within their long-term averages and offer a very similar earnings growth stream that the large-cap or the mega-cap stocks in the US would offer. That's been true for some time. You need a catalyst for the market to believe in that scenario, if that makes sense. And so this idea that now the market is saying, okay, the uncertain outcome is now certain, and we believe — or the market believes — that it's positive for growth. And now we don't have to just only rely on those small number of stocks to get earnings growth. Now we're actually going to get it from everywhere else. And the reality that the analysts and the forecasters that come up with the forecast for all those companies, they actually have been forecasting for growth for some time. And we'll focus on Canada. But the Canadian market is actually projected to have a decent amount of earnings growth. I don't know about the outcome of today's election. If I were to mark to market the analyst forecast for earnings growth over the next one to two years for the TSX, there's some puts and takes, but it probably washes. If you said maybe you'd knock a few points off, an interesting data point that I've been pointing to when you make the case for Canadian equities is that the TSX is actually growing its earnings at a similar — slightly lower, and maybe you could argue even a little bit lower or will be going forward — but similar pace of earnings growth as the S&P 500. If you look out over, 2024 is basically in the bag, we're nearing the end. For 2025 and 2026, the market's looking at 12 or 13% earnings growth in 2025 for the TSX. That's fairly similar to what you see in the S&P 500. The S&P 500 might be at just a few points higher. It's not like you're getting lots of earnings growth in the US and no earnings growth in Canada. You're actually getting a decent amount of earnings growth in Canada. The same can be said if you're looking at Europe or other parts of the market, but I'll focus mostly on Canada. We always point to valuation, but we often have a line within our group: valuation is not a thesis. You need a catalyst. You need people to say, wow, this earnings stream is growing at a similar rate of what I can get in other parts of the market and I get it for a much cheaper valuation. So, underneath the hood, this Canada relative to US, there are some things percolating, and they have been percolating for half the better part of this year, or since mid-year. I think that was a really important inflection point where we started to see earnings estimates for the TSX stop going down and the forecast for earnings growth into next year is fairly robust. We probably need to make a few adjustments. One is maybe on the commodity prices, but like I said, weakness in the oil price is offset by strength in the Canadian dollar. I just walked through that exercise. So that's a wash. And then the other big pocket of earnings for the Canadian market is in the financials. And a steepening yield curve in a strong economy is generally good for financials. There's a lot of calculus going on. There's an immediate reaction, and then this has to marinate for a couple of days. Not to say that we just sit on our hands. We say volatility creates opportunities. So there's opportunities in the market today that we are taking a very, very close look at and taking advantage of some of these reactions or, in some instances, potentially overreactions. And then also factoring in this market clearing event is now embedded in our forecast. We don't have to risk it as much. And now we can think about, okay, what does this really mean going forward? So lots going on beneath the surface and more than just this is good for the US and bad for Canada.
Yeah. And I was hoping you were going to get to the steepening yield curve because that's a big thing for financial services stocks. And of course, in our Canadian market — you know better than anyone — we've got lots of financial services stocks. So that's a plus. The weaker dollar ends up being a weaker dollar against the US over a longer period of time. It's good for Canadian manufacturing. I was looking at the IMF numbers and forecast for growth, and they have for 2026 — which the market is already looking towards — Canadian growth being the strongest of the G7 in 2026. So a growing US economy tends to, because of our proximity, drift over the border and start to create opportunities in Canada. So again, you get that knee-jerk reaction, that big strong-armed leadership there, that moves the needle immediately. But then you start to think of what it actually means. And I guess the one thing, though, when you look at the US relationship with China and the expectations of where that goes with the Trump victory, that's what puts a little bit more of a negative view on the metals. And that's the other big part of the Canadian market. And that's where you're seeing particular weakness today.
Yeah. The bond yields in the US have had a more dramatic move. And again, this is something that's been in play for several weeks now. It's not all of a sudden we've gone to 4.45. We've been going to 4.45 over the last month. Directionally, bond yields in Canada are up. We're looking at 3.30 from 3.25 type of thing on a Canadian 10 year. But they're not in that same breakout type pattern as the US. So maybe the market is contemplating that inflationary impacts may prevent the Bank of Canada from fully doing what's in their program. But we're still looking at 3,30 on a Canadian 10 year. The other aspect of the Canadian market that we've been making the case for is, there's relative valuation, and immediately you're going to look at relative valuation to US equities. But I think we have to think about valuation of equities in Canada and the TSX relative to our other options in Canada. So I talked about that earning stream in Canada that is going to grow 10%. The analysts are saying 13%, but let’s just knock a few points on that for this dollar, like the washing of the impacts of a new president in the US. We'll call it 10%. So you got an earnings stream that grows 10% each year, over the next two years. So that's 20% earnings growth. That's pretty good. Maybe that's more like 15%, but still 15 is pretty good over two years. That's not really tied to one particular sector. It's not like we need $100 oil for that to happen, and we don't need rip-roaring banks. When I talk about that earnings inflection, it comes in many sectors. I think most of the sectors, if you looked at the last 12 months earnings versus the next 12 months, are showing positive inflection. So that's a good thing. Maybe the benefits of a steepening yield curve offset the weakness in commodity prices and the TSX as a whole. Again, that calculus needs to be run going forward. You got a relatively attractive earnings stream that’s going to grow. We'll call it 8 to 10% a year. What you're paying for that is roughly 15 times earnings. In the past, I've walked you through this equity risk premium model where you take that 15-times earnings. The inverse of that is the earnings yield. You buy the TSX, you're going to get a yield of earnings. That's around 6 to 7%. You back out the 10-year bond, and that gives you that equity risk premium. By buying the TSX versus buying a Canadian 10-year bond, you're certainly stepping out the risk spectrum. However, then the next question is, are you getting compensated? And so this is where it's very different in Canada than the US. So in Canada, the earnings yield is six in change and the 10-year bond is three and change. You get 3%, or 300 basis points of premium. So you're earning a higher return for taking risk, which is great. In the US, if we're just looking at the US large cap market, which everybody does, the S&P 500 is trading at 20, maybe even north of 20 times earnings now. So let's just call that a 5% earnings yield. And now you've got 4.45 on a US 10 year. So you're getting less than 1%. You're getting half of 1% of equity risk premium. And while we can feel really good about what the implications for the US economy, and so you can argue that maybe we're not taking a lot of risk by buying US stocks, but that premium that you're getting compensated for is quite small. So in Canada, I think that the yield on the TSX would be very close to the yield on a 10-year bond. Very different risk profiles of those two instruments, but you attach a 3% dividend yield on the TSX on an earnings stream that grows at 8 to 10% a year over the next two years in a normal economy, and you're getting a 300 or a 3% premium for taking that risk. So that's one of the things that we've been talking to investors and advisors and financial planners about. For the longest time, a Canadian investor has been able to park money in a GIC, earn 5%, sleep at night. It's been fantastic. The dynamic of that 5% has changed. We know that 5% is a lot lower. And the opportunity cost of that 5%, now when we look back with the benefit of perfect hindsight, has been pretty high because even the most conservative balanced portfolios or even just a bond portfolio, they've returned in excess of that over the last 12 months. So I think we're just coaching investors and saying, if you're looking for an opportunity to earn that yield and maybe take a step off the sidelines, we've got some market clearing events out of the way. A soft landing appears to be a little bit more of a highly probable outcome. And you want to move out on the risk spectrum. Being in Canada is not the end of the world. And they're actually getting compensated for taking that risk. That's something that we've been talking about on a valuation perspective. It's not just that Canada is cheaper than the US, because that's been true for 10 years. The Canadian equities are a very compelling risk-reward opportunity, and you're actually getting compensated for the increased level of risk that you're taking. So that's a key message that we've been trying to get out there lately.
Yeah. And we're going to have Andrzej Skiba on and Stu Kedwell. We're going to have Eric Lascelles to continue on the election coverage, and we'll be talking about all of these issues in US markets, global markets, and the US as well over the next couple of days. I hope everyone enjoyed this. Scott and I always get going on a preamble, and we have a great discussion and we don't tape it. So this time, we just decided we just flick on the record button a little early and get more of that style of conversation. So I hope everyone likes that because Scott always has some incredible ideas to share. And I think there was a whole lot in that discussion. So Scott, thanks for that. I know you got a little bit more work to do. So do I. But let's connect together maybe this afternoon and grab a coffee and sausage roll or something. And we'll get you on maybe a couple of weeks from now, and we might have a little bit more clarity around the way things are playing out and even some more certainty around the way things may play out. So Scott, thanks a lot and enjoy the rest of your day.
Great. Thanks, Dave. Good to see you.