Hello and welcome to The Download. I'm your host, Dave Richardson, and I’m always excited to be joined by our guest today, Scott Lysakowski, Head of Canadian Equities at Phillips, Hager & North. [Scott is an] investment manager in beautiful Vancouver, British Columbia. Scott, how are you doing today?
Great, Dave. Thanks for having me. How are you doing?
I'm doing great. As we talked on a previous podcast with you, one of the reasons I love spending time with you— and I have spent lots of time over the years, it's always fun when we get out to B.C. because it's so nice out there— but you're always looking for interesting little tidbits that help frame investment decisions and help investors to start to think about the way they want to invest. We've had a year where markets have been very strong in the first half. So we have some investors go, “Wow, when markets are this strong in the first half, that means we got to give something back in the second half.” You've been looking at some research that suggests it may be exactly the opposite, or it's not something that you need to worry about. Could you share some of the stuff you've been reading with us?
Yes, of course. You mentioned it's a great start to the year with TSX returns north of 15% in the first half. That causes a lot of people to think, is that too much too fast and are we due for some weakness into the back half of the year? If you think about that 15% in the context of the long-term average, that’s two years of average performance in the first half of the year. This study you're referring to, some research we got out of one of our strategy groups that we follow closely. As you know, we're big fans of the market, and as fans of the market, we like to study history. We know that history doesn't repeat, but it often rhymes. And so, looking back at history can help give us a bit of a roadmap to guide us through the future. What this study did was look back at close to 60 years of history for the TSX and look for instances where we saw returns in the first half of the year north of 10%, and what does typically happen or lead to in terms of the second half. There were 19 periods where we saw returns greater than 10% in the first half of the year for the TSX. 14 out of 19 had a second half performance that was greater than zero, and delivered an average of 4%, which is 8% annualized. So, while we tend to think that the first part of the year was so strong and that we're probably due for some mean reversion in the second half, history does tell us that the back half is likely to see some continued strength, albeit maybe at a more moderate pace. But we should still expect to see some strength. We get the question, well, is it too hot or do we see too much? Of those 19 periods, I think there was about five where the TSX delivered greater than 20% in the first half of the year. In those instances, the intuition is more closely accurate that, yes, it has run a bit too far. And I think three out of those five actually saw negative returns in the back half. We're in the 15% for the TSX, so it's sort of like the Goldilocks. Yes, it's hot, but not too hot. So I would expect to see some continued strength as we move through. As we know, we're in the early stages of an economic recovery coming out of the pandemic. Earnings revisions have been very, very strong. And I expect to see economic growth and earnings growth continue.
So you can still see very good performance in the second half off a somewhat strong first half— or not too strong, just in that right little area— as you suggest. But what about the different sectors? Does the sector performance change, half to half? Or does style? What style is favored to change, half to half? What does history tell us on that?
Yes, the report digs into the sector level. The patterns aren't as clear as what we see from the index level. But what did stick out to me was that within certain sectors, if you saw some leadership in the first half, that leadership may give way in the second half. That would be more in the cyclical types of sectors. For example, we saw great strength in energy in the first half of the year. Historically, when energy has led in the first half, it does not lead in the second half and it gives up some of those gains. Interestingly, what we saw in the first half was industrials. They lagged the broader index, but history would tell us that when they do lag in the first half, they do lead in the second half. So, there is maybe some changing of horses amongst that cyclical group. Within the more defensive parts of the market, what was interesting is that utilities and staples, when those trends are in place in the first half, they continue into the second half. So that speaks to the type of environment we're seeing here today where we're in the early stages of an economic recovery. We've seen that cyclical strength, the economically sensitive sectors, energy, industrials, materials, financials in Canada. Canada has been one of the stronger markets globally. Those sectors have led in other developed markets globally. So, you might still see that cyclical leadership, but the composition of that leadership might change slightly. But I think you see in some of those more defensive type sectors, their underperformance may continue into the second half as well.
So, if history is any guide, it's not necessarily a case where you have to be overly concerned that if we've had a good first half, we can’t have a good second half. A good diversified portfolio is going to give you the advantage to take advantage of what sectors are favored, one over the other. Then I think what would also be a little bit interesting about the market— and maybe we'll get into this on the next time we get together, Scott— is that we've seen these kind of rolling corrections through the market, so we haven't seen any of the major indices across the board have that big 10 to 20% correction. But we’ve seen different areas of the market in particular sectors almost all had some kind of a 10 to 15, 20% pullback at some point this year. So, it's been a very interesting market. Worries have gotten overheated. They moderated nicely and we just sort of slowly drifted higher.
Yes. If we’re tying all the pieces together, we saw a great start in the first half, and history tells us that it is likely to continue in the second half. We are in a seasonal period of volatility in the summer months. So maybe using some of these seasonal periods of volatility to take advantage and continue to build that equity exposure. Within that equity exposure, maintaining that cyclical-type leadership and delivering that into the second half of the year.
Excellent. Well, Scott, always great to hear from you. Always interesting stuff. We'll talk to you in a couple of weeks.