Hello and welcome to The Download. I'm your host, Dave Richardson. Unusually today, we have two guests. We normally just bring you one guest, but today it's a two for one. It's a very special appearance by these two because they've just been recently appointed the co-heads of North American Equities at RBC Global Asset Management, which is a really big gig. Remember, if you follow the podcast and listen to Stu's days, Stu used to have that job. Now it's Sarah Neilson and Irene Fernando. Or Irene Fernando and Sarah Neilson. Because I'm not sure who you want me to say first. Although I'm guessing, knowing Irene, Irene would probably prefer it if I say her name first, right?

No, actually.

Whatever works.

You're very flexible. That's just you, given how powerful you are. And so I think that begs the first question, since we cover many, topics on the download, not just investing. I think a lot of people who have listened to your appearances in the past and seen this rocket ship ride you've had in your career, going from when we've had you on the first time, about four years ago to now, basically running everything. What career advice do you have for young people in the investment industry and joining the investment industry? Or looking to join the investment industry out there. How do you get on that rocket ship?

Great question. I would say, always be curious. That's honestly been, I think, the key to our success and mine for sure. Be curious, take on any role that you're given and run with it, see what you can learn and keep asking questions. And I think that's been a really big strength.

Maybe I can add, I think ChatGPT is making things different these days, but I think hard work goes a long way. And I find even looking at my own son, he wants things to be ready, to go always the next day. Patience and hard work. I think those are the good old tools that I think deliver over the long run.

Well, I know I threw a curve ball right out of the gate. And all joking aside, I just can't think of two people that are more deserving of all of the responsibilities that you've been given. Curious and hard working is exactly the way I would describe both of you. And so much a part of what makes a success. I think that is one of the keys as I do these podcasts with all kinds of amazing investment managers around the world, that curiosity and that tenacity, that hard work, and patience as well, which is so important not just for professional investors, but for all investors. You do that hard work, but you've got to have that patience to let things happen over time. Your son's a great example, and my kids are the same. We want it now, and the whole world seems to want everything now, tomorrow. What's the next get-rich-quick scheme? But real wealth is built through patience, having the right strategies, asking the right questions, being curious, and putting those right strategies in place, and letting them play out. And again, you're both perfect examples of that. So thanks so much for joining us today.

Thank you. We're happy to be here.

Yeah, it's great.

So it goes without saying, you had a phenomenal year, and markets had a phenomenal year in 2024. What are your thoughts on the previous year? And then maybe as both of you, I think, are going to take a somewhat different role, talking about what we can look forward to in 2025.

Yeah, you're right. Last year was an extremely strong year for markets. Even the TSX, it gained 18% last year. And while it lagged the S&P 500, I think that was a pretty good result for a market that isn't dominated by technology. Technology is definitely the theme of the year, last year and the year before. So when we look at the big drivers of performance last year in the TSX, technology definitely was a major one, but then also financials really recovered, and that was a massive driver as well as materials and energy. Last year, we saw earnings for the TSX grow roughly 6%. And so really, we saw the valuation multiple improve on the market last year. That accounted for about half of the performance. So we look at that and we think, looking forward, what should we expect for the TSX? And the market's thinking probably 10% earnings growth next year and another 10% the year after that. So while analysts like to be a little bit optimistic, looking at two years, I think that's a pretty decent setup for earnings growth. And relative to the S&P 500, I think the consensus number is 13% EPS growth. So not bad for the Canadian market as a base case, we'll just highlight. There's a lot of moving parts in the background to consider for sure. And the biggest contributors to that growth will be materials, pretty strong gold prices being reflected as well as industrials. But financials and energy make up roughly 45% of the earnings pool of the TSX. So Irene and I spend a lot of time doing bottoms-up EPS analysis and understanding where the earnings could work. And look at the financials, they had a great year last year. And even looking ahead, the banks could see another 7% earnings growth. And that's with an expectation that the economy in Canada improves a little bit with rates cuts happening, and we get through some of this credit loss drag we've had on earnings. I think maybe by the end of next year, it's expected to possibly peak, again, on a base case, assuming the economy does get some boost. And energy, we're thinking it grows modestly, but that's better than last year. And if commodity prices stay flat, it's actually a decent setup for energy companies. They have a lot of free cash, and the pipe companies still grow earnings at a pretty reasonable rate. So we'll wait. I think in the next few weeks, we'll have earnings stats from the Q4. So wrapping up 2024 and looking into what to expect for 2025. We'll listen to the guidance outlook for the companies, and that will really help solidify the expectations. But I think it's a pretty okay setup for the TSX from here.

Well, I'm sitting in my office in the Azores here in Portugal. I'm doing a lot of bottoms-up analysis on Portuguese wines. I found a fantastic spot to get access to some wines we can't get in Canada. So I'm glad you like the bottoms-up analysis approach as well. One of the things, as you make those comments, we had Stu on last week for his weekly appearance, and he was talking about, particularly as we look at Canada, and we've had the silliness around the idea of the new president suggesting that Canada could become the 51st state and couldn't survive without the US, which is somewhat true, but certainly not in the terms that he describes it. Negativity around the Canadian economy, negativity around the housing market, obviously all the political issues. And he posited that maybe when you just got so much of this stuff, all this bad news happening all at once, that's usually a bottom in terms of the negativity around the market. Do you share that sense?

A good rule of thumb is to always look for things where they are today. Are they getting better or are they getting worse? So I think the scenario analysis approach that we take here on the team really lends itself well to understanding that dynamic. Because you can just say, well, my base case is 10% earnings growth times some average multiple, and off I go. Instead, we try to really figure out what is reflected in the stock prices today and try to envision the future. Look at the Canadian dollar. That is pretty weak. A lot of bearishness is in that number. Can it get worse? Well, maybe in the worst-case scenario, it could. But in the best case, I think a lot is already reflected in that number. You can go through different variables including housing, including GDP growth, including hour rates. In instances where we see increased uncertainty in the market, what we like to do is widen the range of outcomes a little bit. If we look where the TSX is trading today, it's around 15.5 times, which is by no means expensive versus the history. You could say, well, it's reasonably priced. Even if market is too excited about 10%—maybe it's 8%, if we shave off some excited forecast—it doesn't sound like such a bad setup. Also, another thing I like to look at is the inverse, meaning what is your risk premium? You take your earnings yield minus where your 10 year is. And TSX right now is giving you 300 basis points risk premium. If you compare that to the US, it's exactly zero. You do have a bit more cushion here. Yes, we are always aware that our economy is not as exceptional as the US and that we do have these cyclical drivers, but I think we capture it through that range of outcomes. In times of uncertainty, we make it wider, and when things are a bit more clear, we narrow it down. The path, I think right now, because of uncertainty, maybe it's a little more wider than it was before.

I'm so glad you brought it up in that way. And nothing against the US. As you say, there's an exceptionalism to the US economy and the US stock market that we have to acknowledge. But I just feel that so many people, so many investors have just thrown their hands up in the air with relation to Canada. We had Phil Langham on a podcast just a few hours ago on emerging markets. We're going to have David Lambert on talking about European equities and just this focus on US, US, US, and this small group of technology stocks in the US. And that's really the only place I need to invest when, again, as the markets have moved, the way you're actually rewarded for taking risk, it really tilts towards some of these other places, and Canada would be one of those examples.

Yes, that's exactly it. And I know there are things about Canada that we should be worried about. And when you look out and you say, well, what was the uncertainty last year? Well, we really worried about the renewal of mortgage rates. We really worried about the US election. We lived through those already, and the prices that we see today should reflect the reality of those outcomes. Now we need to think about the future and what are we worried from here on now? You've listed a few things, and I think one thing we're really watching is the unemployment rate. The economy was already weak. I'm not sure if it's going to get much weaker because we are cutting rates. We do expect at least four cuts next year. We'll go from 3.25 to 2.25 or 2.50, who knows, but somewhere there. That should help the economy. That’s not negative, that’s stimulative. On the other side, we have less immigration. For the Canadian employment, that’s also good because your denominator is not growing at the rate they used to grow. Those are the two things we're really mindful of. They flow through our main sectors we wanted to talk about, especially on the bank side.

So why don't we start with the banks, given that we just had the discussion about interest rates. Obviously, a very interest rate sensitive and economically sensitive sector. For the Canadian banks, if we look at 2024, I don't recall a much better year in terms of the performance of Canadian banks stocks. Is that repeatable? As again, you'd argue almost conditions are getting better, and markets look ahead. They were looking towards these better conditions that were going to be in place in 2025. But are you still pretty optimistic about the sector?

Let me just backtrack and say that when you look at the 2024 performance, Sarah mentioned that TSX delivered 18%, and if you look at the banks, they were slightly lower, at 16% something. But I always want to remind unit holders and any investor in banks is that you really should be looking at banks on a total return basis. When you compare TSX performance versus the bank group performance on the total return basis, including the dividends, they did better by very small amount, but they did do better than the TSX on the total return. You always start your year knowing that on average today, you'll get 4.5% yield from your bank. Even if nothing happens, you get the 4.5%. If you keep compounding that, that is magic. It keeps working. All you need on top is another 4 or 5% earnings growth and there you go. You get your 8%, and you can double your money every 10 years. We love that setup. But as you said, a 16% performance, can we repeat that? There was definitely some re-rate in the bank stocks. Although the earnings did not grow so sharply, it was only between 5 to 6%, we did have change in the sentiment because the mortgage renewal risk was in the back mirror. We are now, the way I describe it, at that peak provision for credit loss level. Our base case calls for improvement. Maybe not this quarter, maybe not next quarter, but by the end of 2025, I expect improvement in that line. In 2026, I think it's actually a significant decline that will be a tailwind. As investors, as an analyst, when we look at it, we almost look through 2025 into 2026. Once you do that, banks don't even look that expensive anymore. They price in line with history at around 11 times. One thing I want to bring up is that they did experience significant pressure on the revenue line from high cost of deposits. That is a beating. If we expect another 100 basis points cut from the Bank of Canada, that is another tailwind that they should experience over the next year. Putting it all together, what did we worry about last year? It seems like those headwinds are going away. We had mortgages; we're not worried about that. We had risk on capital. A lot of banks were issuing extra shares to make sure they have enough capital. Now, some of them are buying back stock. That's a complete reversal. I just attended a bank conference that RBC hosted this week, and I have to say that the presentation from the CEOs were, I would say, borderline bullish. It's hard to say. You're like, well, GDP is not great. But guess what? They are looking forward to capital markets revenue. They will be recovering from years of sluggish activity. They expect more M&A, more IPOs, they expect monetizations for private equity players, and as well, they expect good wealth earnings. So all of that combined, again, maybe you shouldn't be jumping up and down because it is not cheap as it was. It's not nine times earnings anymore. But there are a few things you could be excited about.

I know the CEOs were not jumping up and down because bankers are not excitable people.

They were, on the inside.

I know lots of bank CEOs, and they're not excitable people. So if you're saying they're bullish and excited about the prospects, then that's really interesting. By the way, we're going to link to Stu Kedwell on a podcast, maybe about six months ago. We'll try and get the exact episode number for you and put it in the posting of this podcast. And by the way, if you don't want to miss the description I'm talking about that Stu gave on loan loss provisions and what they mean and how they're related to future earnings and the prospect of a bank, then subscribe to the podcast. We'd love you to subscribe. Follow, depending on where you get your podcast, and give us a five-star review. That's only two and a half stars each for Irene and Sarah, so it's an easy five stars. It should be 10 stars with the two of you on today. But one of the things I wanted to ask you about on the Canadian bank side—and then we'll move into energy and materials—but I remember growing up and buying bank stocks and investing in bank stocks 30 years ago. There was almost a thought around Canadian bank stocks that every bank is the same. It doesn't really matter which one you buy, just buy a basket of stocks. They've evolved into becoming quite different businesses with quite different prospects. And again, if we look to last year in particular, quite different return outcomes across the major banks in Canada. So how do you navigate? I think back to an old dividend fund back 30 years ago, the decision is to be overweight or underweight banks, and then you just spread yourself out across it. Now, you're not going to have as much success unless you're making some calls on one bank versus another. So how do you manage that within the portfolio?

I'm glad you brought it up. You're right. Last year was probably one of the most drastic years in terms of performance and bifurcation of returns in the bank land. We have really six large banks. The difference was nearly 50% if you chose the wrong one. I think there's obviously many factors that play into it, but I think in my opinion, there is one that really culminated this year. It was the result of long-term capital allocation decisions by the banks. It was so obvious when you dig into why the stocks performed and didn't perform. The common thread was the decisions that those banks have made in the last decade or more in terms of their capital allocation. Either it was deployed in a country where maybe the thesis of making money didn't play out. Either you went abroad, and you didn't execute the way you were supposed to, or it was just a bad acquisition. Deployment of capital and the allocation of resources, I think, is always one of the most important things as a role of a CEO. I think that it’s their contribution and their footprint that determines what the bank will look like 10 years from now. Right now, what we're seeing is the actions of maybe decisions that were made even 10 years ago because at first, they look fine, and then mistakes, they start compounding and compounding. And I think that was on display this year, and it was really interesting to watch, and I've learned a lot.

Yeah, it was a silly comment about the excitability of bank CEOs, but what's not a silly comment is that a bank CEO makes a difference. As you say, that prudence, that calmness, that patience, the important decisions about where they're going to make long-term investments. And these are huge investments when we're talking about big Canadian financial institutions. Canadian banks are big on a global scale. So these are huge decisions that are being made. So that leadership is critically important. And it's interesting that you point that out as perhaps the main reason why you saw that differentiated performance across the different banks.

It really highlights that importance, because those are regulated entities, they need to run with specific capital requirements, and they need to carry capital. Carrying excess capital often was viewed as, no, you got to use it. I think CEOs are changing their minds. They love having excess capital for that optionality. They do not want to miss that best deal or the best opportunity they were waiting for forever. It did come about this year and it was HSBC, and only one bank was really ready to act. We know which bank it was.

Yeah. So let's transition over to Sarah, and we'll talk about energy and materials. And I'll transition with, is it just important for a bank to select the right co-heads of North American equities? Is that an important decision for a bank to make, too, Sarah?

Yeah, it's extremely important.

So a little bit above CEO, but not as important as a podcast host.

Yeah, that's right. In the ranking, we're somewhere in the middle.

So Canada, you have your banks, and then there's the stuff you dig out of the ground, or chop down. That's the Canadian economy, right? So Irene's got the banks, and you've got all the other digging stuff. What do you think is going to go on over there? And what are the prospects for that part of the Canadian economy?

Yeah, you're right. It's super important to the economy as well as the market how mostly energy fares. And I spend a lot of time on that. I've spent more than a decade focused on energy. And to start, when we're looking ahead, we try to think about what's going to happen to the commodity prices. And again, thinking in a scenario mindset, super important. But at the end of the day, it's sometimes best to think, okay, how will these stocks fare if the commodities are flat from today? And then understand where the leverage is and the risks are if we're wrong on the commodity, either higher or lower. So I'll start just thinking, crude oil has many tradeoffs or puts and takes right now, as it always does, but it feels extremely elevated right now. Inventories are bloated in some areas of the world and then lower in others. Geopolitics is, I would say, fairly heightened at this point. And even today, we're seeing increased sanctions being imposed globally, which could really impact supply. So that's somewhat of a bullish outlook for crude oil. At the same time, demand remains somewhat muted. And especially when we look in China, it's not been a stellar outcome. So I think that coupled with the fact that there's excess supply sitting in the Middle East in OPECs hands, and that will provide a limit to any upside to prices. So lots of puts and takes. So I like to say, let's assume it's flat for the year, and where would you like to invest. And I think when you think about the Canadian energy sector, it is really leveraged to crude oil prices. And these companies, if I assume prices are between $70 and $75 WTI, which is the North American benchmark, these companies make a lot of free cash flow. And the business models have evolved. I think in the past, Scott Lysakowski has talked about that as well on this podcast, but balance sheets are extremely strong. The free cash flow generation has been wonderful for the last two years, and most companies are committing to put 100% of free cash flow back into shareholders' hands, either through dividends or increasing share buybacks. And so even if prices don't grow and they only grow production modestly because they're quite disciplined, that per-share accretion helps make this an investible segment right now. I will say the political regime in Canada has been somewhat of a hindrance to investors for looking at oil. The regulatory burden and uncertainty has held people back somewhat. And I think as we look ahead into 2025, we've got a lot of political change coming. And so that could bring some more certainty to the regulatory outlook for these stocks. And that could be maybe a positive. I'm not going to call that yet, but it's something we're definitely considering.

But another example, Sarah, of where it likely couldn't get any more negative than it is right now, whether you agree with the policy or not, in terms of the actual impact it has on the companies, it couldn't be a whole lot harder. So that the change likely comes the other way to make things better for those companies in terms of their ability to execute their strategies.

I think you're exactly right. And I think from the producer side and from the infrastructure side, I think things cannot get much worse. So I think incrementally better will be positive for the market. And I just want to take a minute to talk about another important commodity in Canada, and I think an important year for it, is natural gas. It improved extremely last year. I think in Canada, our gas prices were close to zero for a period of time. I hate to dwell on that, but it looks like things, again, from saying the worst is possibly in, they're better now. And when we look ahead, this cold snap we're having here in North America—and lucky you, Dave, you're in Portugal, so you don't have to experience it—polar vortex isn't fun, but it's fun for natural gas inventories. It starts to draw them and the prices respond accordingly. And while that's maybe a short-term noise impact, when we look at other drivers of demand and support for maybe a bottoming in natural gas prices, it's increased LNG exports in US. Finally, LNG Canada, the West Coast plant that is expected to come on sometime mid-year this year, and that will start to draw demand out of the Canadian basin. We think that's probably a nice catalyst as well as it provides investors a certainty of where the bottom is in that supply and demand balance. It’s nice to see a big project in Canada come online this year. It will be a big positive in that sense.

And then also, south of the border, we'll get into some of the negative potentials of the policies coming out of the new administration in the US. But one of the first projects that was cut when Biden became President was the Keystone XL pipeline. Trump is talking about opening that project back up, and he seems to have a strategy. I believe the policy that's going to be embarked on is referred to as «drill, baby, drill». And last time I checked, that would generally be favorable to the industry. I may be misinterpreting it somehow. So is that policy change in the US going to help the Canadian industry, or do we need more out of Canada? Or could, when we start to talk about tariffs and America first and that, will that offset some of the potential positives? How do you see that playing out?

Yeah, great question. Again, back to these puts and takes, some of those things are positive. More pipelines would be positive. Keystone XL, I'm not sure it comes back in its previous form, but if we can get excess capacity crossing the border or off the West Coast, that would be wonderful to just put a relief valve in the industry. Drill, baby, drill. Well, it's nice to say, but I don't know. Producers, like I said, have a lot of discipline, and they'll need a price signal to really want to drill. And increased drilling means increased production, and that will drive prices lower. So it's a bit of a balancing act there. On the tariff side, for sure, that would be a 25% tariff on Canada. On exports, that would be hugely impactful and negative for the energy sector. I think it's $166 billion dollars is what the value of the exports for just energy to the US, and that's 4 million barrels a day we send to the US. That's 25% of their refining capacity that relies on Canadian energy. So a tariff on that would be quite detrimental to their energy outlook. Trump has said that he really likes low oil prices and low energy costs. If he tariffs four million barrels a day of the oil that's coming into the US market, almost certainly that would have an impact on driving gasoline prices higher in the US. And we've heard a lot of chat lately that we may have some retaliatory tariffs and things that we do from a trade basis that would only exacerbate that even more. So lots of moving parts in that sense. We have outlets. We have the TMX pipeline now, and that's great to have that running and not quite full. So there is more exports we could do from that pipe should we have more tariff noise. But I think that we have a good place to negotiate, given we're so important to that market.

Well, yeah. And just that example of how much oil we send, how much energy we send south of the border makes it highly unlikely that we get to a 25% tariff there or a 25% tariff across the board. It's likely much more targeted, but the threat of it is certainly already having an impact in Canada, at least discussion around boardroom tables. And how do you really see that play out, the impact of the tariffs across Canadian investments, Canadian companies, and how do you manage for that inside of your portfolio?

Yeah, I'll start, and then Irene can maybe add on. I think at this point, again, we don't want to be too rash, and we like to understand what those scenarios are and not react to the headlines, but be really clear on where we think the big impacts could happen if the worst case were to happen, and then also if a more moderate case. And recognize, and again, look across our portfolio, see where companies have extreme leverage to these kinds of outcomes, and also look where maybe companies get overly punished for having that exposure, and maybe that's an opportunity for us as well. So energy is one area. There's obviously some of the other materials, potash and uranium would be impacted. Forestry is already heavily regulated in tariff. Those are areas. And then the autos and some of the other consumer stocks would also be impacted. And I know Irene has looked a little bit on the auto side as well. So for us, it's not reacting rashly to a headline, but it's understanding where things could play out and looking where the risks in our portfolio lie and making sure that we are balanced in that exposure and then doing our work. We just both got off a conference call with some people who are really knowledgeable in the government. We have, thankfully, access to a lot of information like that. So it helps us keep up to date. I mean, it's hard to really know what's going to happen or make an extreme call. But we're constantly in discussions with people to make sure that we are up to speed on the next moves.

This ties back to where we started the podcast, the whole idea around you don't predict, you prepare. You prepare by putting in the hard work and being curious about what the impact might be. Don't overreact. Sit back, be patient, because this is going to play out over time. It just fits in with your approach, Irene, in other parts. The automakers, that's one where you may actually see some of the worst-case scenarios actually play out. So what are your thoughts there?

A 100%. I think if anybody tells you that they understand what the impact is, they are definitely lying because no one understands this. Sarah and I were yesterday at the economic outlook for Canada. There were five heads of economic department for the banks presenting, and they kept just making that joke over and over again because honestly, no one really knows. Yes, after energy, motor vehicles and parts would be the second largest sector that would be impacted. But there are also studies that show you that a part that is, let's say, in the Ford vehicle, crosses the border between seven to eight times by the time the vehicle has been manufactured. That's no joke. That's exactly how integrated our supply chains are. Also, if you make an argument that we are definitely running a surplus versus US, well, number one, we are a much smaller economy, so it's not that hard to run the surplus. Number two, if we just stop maybe half of the energy that we're sending to the US and send it elsewhere, that surplus is also disappearing. We need to think about those ways how to really position Canada better in the future. On the auto side, although it's a very big headline, it is really a non-meaningful weight in the TSX. We have three stocks that are really exposed to it and all combined, they're slightly over 1%, so I'll be honest, I’m not overly worried from the risk perspective. I'm mostly worried from the second-order impact. We've talked about banks and the setup that it's variable and that the provisions for credit losses are expected to start to decline. Well, that's not going to be the case if our economy dips into a recession because we have blanket 25% tariff. That's not the case if unemployment surges north of 7%. Those are the things that are reflected in our bear-case scenario. And we do spend a lot of time understanding it. And so I think that puts Bank of Canada in a position of having to cut. They do not have a choice, and monetary support is really required to help our economy to weather the storm. And again, we try to analyze every headline, but we also try to keep it cool and make sure that we take a balanced approach because it's so easy to say, oh, we got to get out of here. Well, as Sarah mentioned, maybe there are actually some good opportunities.

Well, I can't thank you enough for joining us today. While we ran a lot longer than I promised we would run. I took advantage of double the amount of time that I told you we were going to take because it was so amazing talking to you in your role—that is even more important than that of the CFO or CEO—as the co-heads of North American Equity. And again, I think the listeners can appreciate the hard work and curiosity it takes to get to where you are right now. So congratulations on the appointments. Again, so incredibly well deserved. My daughters, they cheered when I showed them the announcement. As aspiring young businesswomen, they love to see women making it to the very top ranks. And again, when it's as deserved as you, it is something to celebrate. So thanks for joining us. And I'm going to try and get you a commitment live in public. You're going to come on more frequently now that you run the planet?

If you invite us, we will come.

It was a good experience, wasn't it? You even laughed a couple of times.

Thank you.

Listen, thank you so much. Thank you so much for all the kind words. And you know what? We are very happy to take on this exciting new role. We're looking forward to more conversations in the future.

Excellent. Have a happy New Year to you and all your families, and we'll talk to you soon.

Thank you.

Thank you.