Hello and welcome to the Download. I'm your host, Dave Richardson, and we are joined by the head of Canadian equities at Phillips, Hager & North, Scott Lysakowski. Scott, how are you doing today?

Good, Dave. Thanks for having me. Good to see you.

One of my favorite things to do is to mix around the letters in Scott's name to spell different interesting phrases. So, if you rearrange letters in Scott Lizakowski, it says: I love Canadian equities. I think I might be missing a letter or two, but you've probably done that one. Scott Lizakowski has S-Q-U-E. I think I can almost get to Canadian equities out of your name.

Sounds like something you tasked Chat GPT with and it came back with a slightly different version.

Well, I did do that, and so I'll have this now to start more podcasts when you appear as a regular guest.

But yes, I am a fan of Canadian equities.

I did give you a good coffee place, though, in Calgary.

That was great. As I was saying before we got on, you're more than just a pretty face. You're good for a good coffee recommendation anywhere in Canada. That was excellent. And the beans I brought home were well received.

Scott, let's get to Canadian equities, because we're now a good chunk of the way through the year. I think we had some optimism around the Canadian market coming into the year, particularly relative to US market and some other global markets. How are we looking?

Yeah, so Canada relative to the broader markets globally has not had as robust of a year. I think a lot has changed in the last couple of weeks, but if we look at it on a year-to-date basis, Canada is kind of flat, versus the US whose S&P 500 is up over 13%, and of course the Nasdaq, up close to 30%. That would lead you to believe Canada has really been suffering. But there's more to it than that. I think we've all heard— or it's been discussed quite broadly in the press— about the narrowness of returns in the US market, the Magnificent Seven contributing most if not all of the returns in the S&P 500. If you look at some other stats, if you look at the equal weighted S&P, which is something that we often look at, especially as the US has become more and more dominated by a small number of stocks. I think I saw a stat the other day that Microsoft and Apple are 15% of the S&P 500, which is quite astounding, to have two stocks be that large of a very large market. So we start thinking about the equal weighted S&P 500, and what that does is it just removes some of that big bias that the big stocks have on some of the metrics, whether you're looking at performance or valuation or what have you. And the equal weighted S&P 500 is flat on the year as well. So it's not so much a problem with Canada. I think it's just a problem with all the stocks outside of that small number of stocks in the US. That said, Canada has lagged the US greater than 10% year to date. That's probably in the bottom decile in terms of relative performance. So not that ideal of a set-up, but I think we were mentioning, I was out seeing some advisors and clients over the last couple of weeks, and one of the pieces of good news I was trying to impart with them is that while September and October tend to be seasonally some of the worst performing months of the year, November and December are often the best performing months. And heading into November, we were not just flat on the year, we were down by a few percent. And then of course, we know that month to date has been volatile, but the TSX is up 4.5% just in November. And here we are. Today is November the 9th. So, lots happening. Hopefully that's a good sign to come that the seasonal patterns will hold, and we'll get a nice push into year end and some strength in our market.

Well, we've talked a lot over the last three or four years that we've had you on as a guest, and we've had other guests on who have talked about the idea of a commodity supercycle. And we certainly saw in the bounce out of COVID when you had lots of demand for what ended up being relatively scarce resources. And we can talk about how hard it is, all of a sudden, to flip a switch and produce more copper, because that's not what happens. But you haven't seen that follow through on commodities. Is it simply the forecast that people have for an economic slowdown or a recession? Or does it run deeper than that? And then is this supercycle that we talked about still something that we should be looking at, which, again, will ultimately make Canadian equities more attractive? And coming from a point right now where they're even more attractive because of the lower valuations?

Yeah, it's a good point. It's a good question and something that we've been spending a lot of time on, and particularly when we're out presenting to clients and advisors and planners, one of the key messages we try to impart, the challenge for investors to think in different time frames. And that's really hard. It's hard for the market too, not just the average investor. Professional investors and broad market participants struggle with it as well. The market can really only focus on one thing at a time. Either we're going into a recession or we're going to have a soft landing. But it's really important to think in multiple time frames. And the reason why it's important as it relates to commodities is that commodity cycles are typically long in nature. This is a bit of a rule of thumb, but it's helpful to give some insight and perspective and put some context around it, is that investment cycles— different parts of the market have different investment cycles; different industries have different investment cycles— they tend to match the capital cycle, the underlying capital cycle of the business. And for commodities, the capital cycle is quite long. If you thought about the idea of building a copper mine or something like that, it would be easily a decade-plus-long exercise in terms of finding the resource, getting the permitting, securing the financing, doing the actual construction, bringing the production online, recovering the capital costs and then earning a return. That could be a 20-year process. Lots of things can happen along the way in the economy, even locally, within those environments. The capital cycles tend to be long, therefore the investment cycles tend to be long. The reason why I bring that up in response to your question «are we in a supercycle?» is I think that the shorter-term cadence of market cycles or economic cycles confuse us as it's wrapped inside the longer-term investment cycle or capital cycle for commodities. And so I don't know if this is something I would conclude with a lot of conviction, but you could almost say that all commodity cycles are supercycles. They just take a really long time to play out. So you ask the question, if it's a ten-year supercycle, you might have three or four economic cycles in there, which would have some volatility in the commodity prices because again, they're highly economically sensitive, so you would ask the question «are we in a supercycle?» several times in the longer-term cycle. So I don't know if that lands or resonates well, but it's a framework that I, even as somebody who focuses on this as a professional daily, have to remind myself, because the market can be too focused on the here and now. So where are we in the capital cycle for commodities in general? All the commodities are a little bit different. But if we were to generalize— and these are multiyear, these are ten-plus year cycles— I would say that we're just coming out of the oversupply/underinvestment from the last cycle. So you spend all the money, you bring in all this new supply, you crush the price, the weakness in the commodity prices, and just the experience of spending a bunch of money and then having the price crash leads to underinvestment. So, there's been no incentive to invest in commodities for a number of reasons, mostly because the returns from the last cycle ended poorly. And then of course, you have the emissions overlay as it relates to some of the more carbon intensive commodities. And so, you've had a number of things to say that the producers weren't incented to invest in bringing on new supply. So we've come out of that underinvestment cycle. If you think about it, global mining capex peaked in 2012, and global oil and gas capex peaked in 2014. So that's ten years ago when the peak of the last dollars was spent. We've had ten years of underinvestment. And then the next phase after underinvestment is what we call the scarcity. So you've worked through all that excess supply, demand is chewed through it, and now you've created scarcity. And it's basically what we've experienced over the last couple of years with the pandemic. But you've also had supply shocks and shortages. So you've seen high and rising commodity prices leading to inflation, which is causing putting upward pressure on interest rates and volatility and price, which is what we're seeing today. And so we're just coming out of underinvestment into the scarcity phase, and we haven't even gotten into the next wave of capital investment. You're seeing some capex tick up off the pandemic lows, but that's just because we couldn't get outside to spend the money, and of course the uncertainty. You've seen it tick up, but we're nowhere near the previous peaks, whether we're talking about mining or oil and gas. And there's a couple of reasons to drive that. The price required or the risks around spending that capital have gone up. Whether you're talking about inflation, labor costs, steel costs, all the input cost of building a mine, or just future demand uncertainty. If you and I were running an oil company and we had this project where we could bring on a significant source of new supply, and we thought that it would take us a few years to build it, and it would take us a few years to get our money back, and then the profit, the excess return, would happen in years five through ten or twelve. And there's a lot of uncertainty about what the demand picture is going to look like for some commodities out five to ten years. And so we're a little bit reticent to put billions of dollars of capital to work. The way I reflect that into the financial framework is that the returns required to compensate commodity producers for that risk have now gone up. And as a result, the price required for them to earn a return is now higher. If I just think about oil, the one I have in the top of my head, historically, if you wanted to earn a 10% rate of return on an oil project, you would need roughly $70 to earn a 10% return to bring on. So we're north of 70. Oil has been volatile, but it's been north of 70 for some time now, and you're not seeing a lot of new capital dollars getting spent. If we were to factor in some of these risks, whether it's emissions risk, environmental risk, inflation, you need to be compensated for uncertainty around future demand. If we were going to use a 15 or a 20% return, then you would need oil prices in the 80, 90, even $100 range. And we've seen them tick around there for very short periods of time, but not long enough for the folks sitting around the boardroom table to say, yes, we should go ahead with this project. So that just means it feels like there's going to be continued upward pressure on commodity prices, which has an inflationary impact that we need to factor into other parts of the market. But in order to incent that new supply, I think that we're going to need to see some higher prices. So it's a long cycle and we're still in the fairly early stages of it, and we need to keep that in mind, especially as we wrestle— this is the message I was leaving with some of the people we were presenting to over the last couple of weeks— the near term risks and reality of an economic slowdown offset by the long-term opportunity that presents itself in Canadian equities and resources and commodities, etc.

Yeah, I was with some advisors this morning, and I often do this when I'm out with them, I put up a chart of the S&P 500 since 2009, which is where we come out of the global financial crisis, and the S&P 500 bottoms out at 6.66%. And then I've got two parallel lines that run at a 45-degree angle and capture the run from 2009 until the beginning of COVID. And if you just step back and look at that line, as a trend, it is a very consistent upward trend. However, along the way, there are several significant pullbacks where there was either a bit of a slowdown in economic growth, or the perception that economic growth was about to slow, or maybe interest rates had moved up or a little bit through different periods. The main thing to look at is the long-term trend. So it was, for lack of a better term, a supercycle in the broader equity market, certainly a secular bull market or long-term bull upward-moving market. But along the way you have some pullbacks. So as attractive as some of these stocks look, because of their valuation, and when you got into the middle of COVID where oil was at minus $40 a barrel, or basically nobody wanted oil at all, so you had to pay to just store it; a point where nobody wants to touch energy stocks at all. And then you see the reversal once you come out and that demand spikes up, there's no supply, and that kicks you into a new cycle that, again, could go for a very long time.

Yeah, and we share some of these longer-term charts when we're comparing Canada to the US, because Canada has underperformed the US this year. And outside of a few bright years here and there, it's been disappointing for ten years. But if you pull up that chart of Canada versus the US going back 50 years, it goes in these ten-year waves, it's not just an oscillating chart that ping pongs back and forth, it's these ten-year waves. And then when we try to line up what's the macro environment that would be supportive of Canada outperforming the US on a relative basis, it rhymes with things like we're seeing today. So Canada tends to do better than the US when we're in an inflationary environment. Canada tends to do better than the US, not surprisingly, when we're in a rising commodity price environment. And these are really hard things to predict, especially the future is very uncertain. And clearly in the next 6 to 12 to 18 months, the economic future globally is uncertain. But when you marry all these pictures together and understanding these different timeframes, you do create that backdrop where the conditions for Canada to perform relatively better than the US are presenting themselves. And that's the thing we keep in the back of our mind when we're thinking longer term. Because that's really how we invest, really long-term thinking. We have to be aware of what's happening here and now, but we want to be understanding where we are in these broader market cycles and making sure we're positioned accordingly and not getting too caught up in the noise that's in the current moment. The other message we leave with investors is that volatility creates opportunity. It's unpleasant even for a professional to go through volatility. Volatility just means stocks are going down, and that's never fun. I got a little sticker on my monitor on my desk that says «volatility creates opportunity». When you're down in the dumps of a down day in the market, I always say, where are the pockets of opportunity? And where can we position ourselves? If you're thinking about these longer-term cycles, which is where a lot of returns are captured, you could use near-term volatility to position yourself accordingly to capture some of these longer-term trends. And that's the mantra that we've been doing. It's hard because I don't have a view of a bullish or bearish. I think we've been saying that the risk reward is improving in Canada and there's a longer-term cycle opportunity that we could be participating in. But we have to be mindful that Canada is also very cyclical and that if we do go through some economic weakness in the near time, that underperformance could persist. But we would be using that to capture an opportunity for the long-term cycle.

There's an example of where that volatility creates that opportunity. And then one of the other things we were talking about that is somewhat unique to the Canadian market is the idea of the dividend yield of the broader Canadian market, and then what that income does for you and how you think about that as a manager, in terms of where you're taking your positions, particularly as interest rates are moving up or down. And Canada provides a really interesting investment opportunity from that perspective, doesn't it?

It does. Canada, I'd like to say, is unique, but there's quite a few markets out there that offer attractive upfront dividend yields. But I'll talk about Canada— because if you rearrange the letters in my name, that's what it says. It also compares differently to the US. In Canada, the dividend yield on the TSX, if you bought the broader market, would be about 3.5%. That's pretty good. And if you thought about the long-term dividend growth of the TSX, it would probably be— I'll pick a number— in the 4% range, but it could be a little bit higher in certain parts of the market. You have this interesting opportunity. What's happened with interest rates is that a lot of things have been repriced. The feedback we were getting when we were out doing our presentations over the last couple of weeks is the attractiveness to our clients— and it's not surprising— of a 5% GIC. That makes a lot of sense. People like GICs. I think the thing they like the most about them is the G, which means it's guaranteed. You don't have to think about commodity cycles or supercycles or economic cycles. You are guaranteed to get that. As humans, that's very helpful for us to know exactly what you're going to get. And then what's even more attractive today is that G equals 5%. So that's a pretty attractive opportunity, especially if we're in an uncertain market. But at some point, we will be shifting, as we work through the uncertainty, I wouldn't say to a more certain place, but the economic volatility will at some point be in the rear view. This is not something that I would prescribe to do immediately, but this is something we'd think about over time. Over the next twelve months, we want to be contemplating this: shifting from the G, the guaranteed part of the risk spectrum, out into something a little bit more risky, just because you're going to earn an extra excess return. So Canada, the TSX has a 3.5% dividend yield, which if you looked at the 30-year bond for Canada, it's maybe just under 4%, so pretty attractive. The 3.5% would compare nicely with a 10-year bond yield in Canada. So you get that fairly attractive upfront yield. And then the other benefit is you get the growing income stream or the growing earnings stream of the underlying market. And sometimes it's hard in Canada because there's a lot of banks. What's driving the underlying earnings? Banks, energy companies, commodity companies, very uncertain in today's environment, but the valuation that you're paying for that earnings stream is becoming more and more attractive as we go through. And the other thing is that earnings stream grows. If you buy a GIC, the G is guaranteed, but it doesn't grow. The G stands for guaranteed, not growth. Whereas if you bought the TSX or another equity index, you'd get 3.5% upfront. You get an earnings stream that will grow probably in the 6 to 7% range over time. And the dividends of that 3.5% dividend yield will grow in the mid-single digits over time as well. That's a very attractive return stream if you're thinking about compounding wealth over long periods of time. So that's something that we think about quite a bit. If you dig underneath the hood of the TSX, the parts of the market that have been somewhat upset and have underperformed are the interest rate sensitive. Telecom stocks, utilities, they're interest-rate sensitive just by their nature, the way that the cash flow streams work, and the way that the market thinks about valuing them. So they've come under a lot of pressure, which has created some opportunity in that space. And we just need to contemplate whether we think that the new interest rate environment is being fully reflected. And so that's an attractive pocket of opportunity. But we manage quite a few dividend income strategies. And where we focus our efforts in those funds is, yes, we're going to own the more traditional dividend paying stocks, telcos, utilities, etc. But what we really try to focus on is dividend growth. We're looking for companies that generate a lot of free cash flows. These typically would be good businesses, generate a lot of free cash flow support, an upfront yield that may look like the TSX— maybe a little bit less, maybe it's only 1% to 2% yield—, but they generate a significant amount of free cash flow in their business, they have opportunities to reinvest that free cash flow in their business and grow that free cash flow over time, which would then support further dividend growth over time. When we're looking at yield opportunities in the TSX, we're not reaching for the highest yield. There are some attractive companies that have above-average yields right now that we are looking at. There's the old Warren Buffet quote: there's more money lost reaching for yield than at the point of a gun. What we're really focusing on, if you could give us a reasonable dividend yield and grow that over time, a low yield and a high growth rate actually results in pretty good share performance over time. So while we're looking and taking advantage of some of these opportunities in the more interest rate sensitive, the traditional dividend paying stocks and sectors, what we're really focused is on dividend growth. Having that cash flow stream that grows over time, that's a great way to offset the impact of rising interest rates on the valuation mechanism of dividend-paying stocks. So that's a really attractive opportunity over time for investors to think about moving away from the G in GIC and towards the growth in dividend growth. And the TSX offers a pretty attractive starting point. If you compare that to the US, the S&P 500 would have a dividend yield of about 1.5% versus a 30-year bond, or a 10-year bond, which would be 4.5%. The equity/bond question in the US is very different than it is in Canada, and the Canadian market, I think, competes on a yield perspective quite nicely.

Yeah. And of course, all this depends on your own financial plan, your own risk tolerance, all the things that we talk about in terms of getting the right advice and making sure that you're making the best decisions for you. Scott, always interesting catching up with you. If you rearrange letters in Scott Lysakowski, it spells «always interesting», and I'll have to work on that one a little bit more than the others. But Scott, thanks for joining us. That was fantastic.

Great. Thanks for having me, Dave. Talk to you soon.