Transcript
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 and North, Scott Lysakowski. Scott, happy New Year. Hope you're doing well.
Thanks, Dave. Happy New Year to you, too. Good to see you in the new year.
Did you have a good holiday season with the family? You've got young kids, certainly younger than me.
Yeah, we had a nice break. We tried to do some skiing. We got some ski days in but my family got hit with all the various viruses and colds that were ripping through British Columbia and Vancouver. So we managed to squeeze a few ski days in between sick days. But it was nice to take a bit of a break and recharge, spend time with the family. How about you?
Actually, for the first time in ages, we were healthy, and we didn't go anywhere. So it was kind of a boring hang around. But I think you know, and the listeners know, I travel about 150 to 180 days, or about half the year. So a couple of months sitting at home and certainly a couple of weeks where I'm not working is always a nice break. One of my kids is at university and the other one's a teenager, so she's out and about on her own. So to get some time to hang out with the family is always nice. So we enjoyed it.
That's good. We're battling this arctic outflow here in Vancouver. We're quite lucky in Vancouver that while being close to the mountains, we get to enjoy some of the benefits of the winter sports and the snow. But in the city of Vancouver, it doesn't get cold very often. So even minus ten is a bit brisk for us.
Is that what you got out there? I didn't realize that. I know Calgary and Edmonton, or the Midwest is really cold, but Vancouver is cold, too?
Well, we had a minus 20, and at the top of Whistler Mountain it was minus 50 with the wind one day. I'm a diehard skier, but that's a bit too cold for me.
Well, that is winter in Canada. And that's what we're going to talk about today, Canadian equities, and take a look ahead. We'll look a little bit back at 2023, but then try and piece together what we think is going to happen or is most likely to happen through 2024. Scott, when you look back at 2023, what really strikes you about that year from a Canadian equity investment perspective?
Yes. When you look at the Canadian equity market, the TSX was up 11.8 or just under 12% for the year, which on the surface looks like a pretty good year. I think the average annualized return for Canadian equities is somewhere around 7 or 8%. So just under 12% is a pretty good result. But I think there's a lot more to the story than just the headline number. I think the one that probably sticks out the most is that while 11.8 or just under 12% is a pretty good return for Canada, it did lag the US market. The S&P 500 was up just over 25%. And actually, Canada lagged the US by what might have been the largest margin in the last ten years. So quite a bit of another year of underperformance for Canada. I usually would attribute it to the composition of the markets — and maybe there's an element of that that's worth noting — but I think what's really important — and it's a topic that's been fairly widely discussed throughout the year — is just that it wasn't so much that Canada lagged, it's really that most of the returns in the US came from a handful of stocks. So the top ten stocks in the US, which now account for about 24 or 25% of the market, contributed 70% of the returns for the S&P 500. So that 25% was really driven by a small number of stocks. And so when you back out those stocks, whether you look at the S&P 500 x the top ten, it was about 11 or 12%. You can think about the equal weighted S&P 500 — where every stock has the same weight —, that was around the same, maybe a little bit higher. Or if you looked at other global markets like the MSCI World x-US, it was around 11%. So while Canada did lag, the headline broad market in the US wasn't so much a problem with Canada itself. It was more of just that the top ten stocks really drove most of the returns. So that's one interesting thing to point out. The other thing to point out is that 11.8, or that 11 to 12% returns, that all came in the last two months of the year. So as of October 31, the TSX was flat on the year. And so you had all of the returns coming in the last two months. So there's a couple of things that's probably worth highlighting. One, we think about the market. What was going on in the first part of the year and what happened, what changed in November? And we always talk about the stock market as very complex and nonlinear and dynamic, and it's always balancing out the various scenarios and continuously reweighting the outcomes. But it also can be quite myopic and can really only focus on one scenario at a time. So while there's many things that can happen, many scenarios that can play out, the market gets intensely focused on one outcome. And I would say, generally speaking, for the first ten months of the year, the market was focused on a scenario of rising inflation, higher interest rates, central banks that were not yet accommodating — they were still in that restrictive mode — and concerns around a recession. And as a result, a market like Canada, with its cyclical exposure of energy and financials and materials, really didn't do a lot, because the market was very concerned about a recession. So that affects the economically sensitive sectors. And then that rising interest rate. The other parts in the Canadian market, whether it's telecom, utility stocks, real estate stocks, even financials, to some extent, were really concerned about that rising interest rate environment. So as a result, in the first ten months of the year, the TSX did chop around — it wasn't a flat line — but it was basically flat for the first ten months of the year. Now, we've talked about it in the past, seasonally, November and December tend to be the best months of the year and actually contribute close to half of the returns for the TSX, whereas this year they did all of the returns. So you have a seasonal element. But most importantly, it was a shift in tone, a shift in language, a shift in outlook of central banks in the early part of November, saying interest rate hikes are now on hold, and the market starts looking forward, thinking about the next wave of interest rate cuts. And of course, that swings everybody. You heard that saying, everyone's tilted on one side of the boat, and now we shift over to the other side of the boat, and the market started to consider the other scenario or one of the other scenarios, and that's being a soft landing, an economic recovery, and the potential for interest rate cuts. And so there's two things that play out there. One is the interest rate function is sort of that discount rate. It really drives the valuation mechanism of the stock market. And then that economic recovery, that's really the earnings profile. So the market got less concerned about a recession and more optimistic about a recovery, a soft landing where earnings weren't hit as much. And then the prospect of potentially lower interest rates, which would help support higher valuations. And that really drove most of the returns in November and December, and really that composed the entire year's returns for the TSX. So an interesting roadmap of the year where the market was really focused on one aspect, and then switched its mind and focused on another outcome. And that really had a big driver on returns. And all the returns came in the last two months. So you had to be there for those last two months.
You had to be there. I liked one of the comments you make, which is that last year, you could have just gone away, lied on the beach, played golf, gone skiing, do whatever you like to do and not pay attention at all. You'd pick up your statement for last year, you'd go, wow, my Canadian stocks had a great year, not knowing that they did nothing for ten months and then had a great last two months. And that says a lot about the way you should be thinking about investing anyways, in terms of not trying to time the market, but putting your money in the hands of a great investment manager and then going and doing what you love to do and let them do what they love to do and what they're great at doing.
Yeah, we often talk about time in the market is way more important than timing the market. We hope that our clients, while they may be interested in financial markets and follow along with our commentary and what we're doing, we take great pride that they've entrusted us with their life savings and retirement savings so that we can look after it and they can look after themselves in retirement, enjoying the good life, traveling and golfing and skiing, as you mentioned, or looking after their families and working hard in their jobs and building up their savings. This idea that everyone wants to be a great market timer, that sounds interesting. If you stayed on the sidelines for most of the year and nailed that timing perfectly with the central banks and put all your money in at the end of October, you'd have done really well. But we know, especially, even as professionals, that's really hard to do. Especially when you're trying to predict these macro-outcomes and behavior of central banks. It's incredibly difficult to do. So we really lean towards that idea of being fully invested, and every once in a while these stats come out and they're worth sharing. This is for the S&P 500, but the story is very similar for Canada. If you're fully invested over the last 30 years in the S&P 500, you would have earned a return of around 8%. That's pretty good. Now, that's time in the market. You're fully invested, you're enjoying your life, you're golfing, you're skiing, you're hanging out with your family, you're traveling, you're working hard, and that's the return you get. Now, if you try to time the market but you miss out on the five best days, that return goes from 8% down to 6.5%. And if you miss the ten best days, which is pretty easy to do, you're down to 5.5%. And if you miss the 20 best days, which is a month — and we said that a lot of those returns came in November — then you're down to 3.5%. I often like to think about the rule of 72, which is that idea that you take your rate of return, and you divide it into 72. Hopefully it's not too early for some math for our listeners, but you divide your return into 72, and that's the number of years it takes for you to double your money. So if you're fully invested, earning that 8% return, you're doubling your money every nine years. For a young guy like you, Dave, you got quite a few doublings left in your lifetime, right? So you want to stay fully invested, you want to capture as much of that as possible. And if you miss out on, say, the ten best days, it now takes you 13 years to double your money. And if you miss out on the 20 best days, it's now taking you 20 years to double your money. So while you're thinking you're doing the right thing by trying to time the market, you're really missing out on this great opportunity to compound returns over time. And that's the power. There's still lots of uncertainty, but we're kind of working our way through this market cycle, this interest rate cycle, the economic cycle. We're working our way through it. So when you think about inflation rising and central banks doing their thing of increasing interest rates, that has an impact; it could have an impact on the economy, it could lead to a recession. It may or may not. We don't know. I wish I knew. I always say even for Eric Lascelles, his crystal ball is better than mine, but it's certainly not perfect. And so the ability to predict those things is really hard. And as we move through it, the message that we've been sharing with clients is that while the G in GIC, that guaranteed return, which people felt comfortable with, especially when they have a 4-5% return attached to them, that was really helpful for clients and for investors as we work through a period of uncertainty. But as we're moving through this period of uncertainty, I think it's an important time to shift from that G of «guaranteed» to a G of «growth». So this idea of putting a plan together, speak to your advisor, speak to your planner, have a plan of getting fully invested. We know there's a lot of cash on the sidelines, and that's understandable; people want to protect their savings, protect their retirements. But I just walked you through the benefits of being fully invested. So now is the time to start shifting that cash from the sidelines and getting to more of a fully invested so you should capture that compounding of returns.
Well, the great thing about being an investor is it's never an «either or». You can own GICs, you can own bonds, you can own stocks, and that's part of having a diversified portfolio. And those higher rates certainly do help people who want to be more secure and who still are looking for income off their investments. But I was just doing some quick math while you were talking about the difference in returns from being fully invested versus missing those top 20 days, and it's the difference between just a little bit more than doubling your money over 30 years to having your money increase tenfold. That's your 100,000 to a million dollars, if you just stay invested. Then if you can diversify and find a way to drive returns a little bit higher than that, well, then you're really doing well. But as always, when our super smart guests go on a soliloquy and start talking about what they're thinking about for the year ahead, some questions pop into my mind. One of the things that I've meant to ask Stu, but I'm going to ask you instead. On the Magnificent Seven. Or you talked about the top ten stocks in the US and how much they led. But we've heard about these Magnificent Seven stocks, these incredible big companies that drove returns in the US. And those seven stocks really is what drove the US. If you take those out, as you said, basically the US returns were what everybody else did last year, which was pretty good, but it was really good if you had these seven stocks. When I think of Canada and all the potential that's in Canada — and I was thinking about this when I was watching the Research in Motion movie. I don't know if you watched it. If you've not seen that movie, I encourage you to watch a nice Canadian production. It's pretty good to support what's going on here at home. But I remember that company. I remember that stock. My brother went to Waterloo — he's an engineer there — at the same time as the people who founded Research in Motion were putting that company together. And that's just an amazing Canadian success story. The BlackBerry was in the hands of people all over the world until the ultimate collapse of the company. But I walk around the neighborhood, everyone's out walking around and they're wearing Lululemon. That's a Canadian company. We’ve got Shopify. I'm listening to other podcasts, and there's advertisements for Shopify. Where is the great Canadian? Where's the Magnificent Seven of Canada? Why don't we have a Magnificent Seven that comes in? It seems like a stock or two will pop up here and there over time and surpass some of the banks and big industrial or cyclical companies. But why don't we have that Magnificent Seven somewhere in Canada?
That's a great question, Dave, and I actually don't think we have enough time to fully answer it, because as you're walking through it, I have so many thoughts and so many beliefs, and I don't think I have the magical answer for you. I would say a couple of things. One, we always talk about that, it's almost like when we back out the returns of the Magnificent Seven, it's almost like they don't count. They certainly count. These companies, they don't call them the Mediocre Seven. They call them the Magnificent Seven because they are truly incredible businesses in terms of innovation, the products or the services they provide, the amount of growth, whether it's industry growth or the market share, the profitability. The profitability of these companies. I'm certainly not the expert to talk about Internet and technology stocks and comparing, but everyone says all through the tech boom of the early 2000s, those companies were not profitable. These companies, these Magnificent Seven companies, are incredibly profitable. They have extremely strong businesses. And when you combine them, even when you look at the returns they've had, they're not actually that unrealistically valued. If you just thought about the concept of a stable business with strong market share that's growing. If we go back to the old dividend discount model, K minus G, you have a fairly low discount rate and a high growth rate, that's going to result in a stock that has a fairly high valuation. I don't want to take anything away from the Magnificent Seven. So I want to say that first. Secondly, why doesn't Canada have these? That is a fantastic question. I wish we had more. And there's a broad answer, and I'll try to keep it quite simple. Canada is endowed with a very large resource base. We know that. Oil, copper, fertilizer, grains, uranium. The list goes on and on. We're quite fortunate to have this huge land mass with a relatively small population. A huge land mass that’s buried beneath the surface. There are all kinds of resources, and that's really been the main driver for our economy for decades. And so our economy is wired to be resource centric, which I think has been beneficial to us. Sometimes challenging, because commodity prices go up and down. The industries that we support tend to go up and down as well. And then, of course, we add in the complexity or the additional issues that extracting resource from the earth now has an emissions component. So some of our key industries are now facing greater scrutiny around the emissions that they generate. So that's a challenging dynamic. I don't want to lay blame, but I think the government could be more supportive of innovation. One of the things that we are quite proud of as a country is our immigration policy and attracting new Canadians to our country. We have this large landmass that we're happy to share. That's a big driver of our economic growth. And we're attracting people from all over the world who bring an immense amount of skills and knowledge. And hopefully what we could do is we can use that as the next great resource — human capital, human knowledge, intellectual property — and bringing those to Canada and supporting what we already have. We have a lot of smart Canadians here. You talked about Research in Motion. Even in a microcosm, the stock went up, the stock went down, we switched out our BlackBerry for iPhones, and that's the way innovation goes. But as a result, there is a technological hub in Waterloo now. So that has created this little ecosystem. We have to remember that while our population is growing, we're still one 10th of the US. So we can always look south of the border and compare ourselves to the ecosystem that exists in Silicon Valley. Our ecosystem would pale in comparison. However, the one thing that we have is lots of really smart people. It seems like on the surface, and some people may believe that it's not happening fast enough, but we have a government that is aware of and in support of new developing innovation, new technologies, new ideas, new concepts, so that hopefully, over time, we can come up with our own Magnificent Seven over time. We're just not quite there yet today. So we are endowed with the cyclical sectors and the resource-driven economy. The one thing I would say — you asked the question, so you put a quarter in me and you ask a question like this and who knows how long we can go for? — technology doesn't only apply to devices and apps and Internet related things. We've probably talked about this before, but everyone says the resource economy is dead and we need to move to technology. I don't think it's that cut and dry. And actually, I think the opportunity is far greater to apply technology to the resource sector. And we can do this to help get emissions down. Because at the end of the day, we need energy. It's going to come in different forms than we've consumed in the past. We're going to need copper, we're going to need steel, we're going to need fertilizer, we're going to need uranium. And so our energy consumption is not going to end. Our energy consumption is going to change. And some of the biggest opportunities in the energy transition, I think, come from technology. Investment in technology. And that's where I think Canada can create its own innovation hub. I you think about decarbonizing energy, traditional oil and gas production, that would be an incredible opportunity for Canada. And maybe one of our Magnificent Seven companies comes out of that sort of dynamic. So I'll try to keep my answer as brief as possible. I think I've already failed in that. But I think the idea, the concept of technology doesn't just apply to things that we do on our phone, it applies to all sorts of industries, and in particular the resource and the extractive industries. The emissions intensive industries are screaming for investment in technology to make those industries much more sustainable going forward. So I think there's a huge opportunity for Canada in technology applied to a number of areas, including resource and the extractive industries.
And don't get me wrong, I knew when I asked the question you were going to go, so I knew I was teeing you up. There's a couple of proud Canadians, though. It's one of these things where we've got so much here, and we have so much coming. The immigration and the growth in population creates such an opportunity for just a boom in Canada, and the opportunity to innovate and create companies that can be world powers. And I'm hoping that we're just at the cusp of seeing that happen. We have talked on your previous appearances on the podcast about the opportunity for innovation in that energy sector. It's not just a device or an app or artificial intelligence, whatever you might say, is technology. We had Dave Lambert on talking about Europe and the innovation there in fashion and creating brands that can charge a premium price because they come up with ideas that people want to pay more for. There's all kinds of different opportunities for Canada to thrive and lead the world. So we're all excited and hoping for that. Right now, we'll just have to deal with this mid-tier podcast that we've got. We're trying to do our part here as well. So let's just finish off with the key question for Canada in 2024. We talk about the concentration or how the Canadian market is structured. So we've got the big financial services companies, we've got these big cyclical companies. We think about where things are going from an economic perspective, where we anticipate things will slow down a bit through this year. But with that comes lower interest rates, and then we emerge from perhaps a short recession or a nice soft landing, and then away we go again. Is this a year where you think Canada closes the gap on some of the other markets around the world? You mentioned that this was one of the bigger years in terms of the outperformance of US versus Canada. So typically that's followed not too far along with Canada narrowing a bit of that gap. What are your thoughts on 2024, given the economic outlook and the makeup of the Canadian market?
Yeah, especially when you're going through this part of the economic cycle where the market is debating between are we going to actually have a slowdown or are we going to have a soft landing? Those scenarios, the market can toggle back and forth, and I don't really know, to be honest. And so we think about both scenarios and just think about watching price and seeing if the stocks or certain parts of the market or the entire market is heavily discounting one scenario or the other, we may shift our exposures accordingly. So the one thing to think about for 2024 is the market. And this is a classic January exercise where the analysts and the companies come out and say, you know what? 2024 is going to be a good year. We're going to grow 7% earnings a year. And we kind of start there. And then as the year progresses, the reality starts to set in and say, okay, well, we're halfway through the year and we're not even close to that 7% earnings growth, or we're way ahead of it. And those numbers tend to get revised. The seasonal pattern is we start high in January, everyone's optimistic about the new year, and then we sort of revise lower throughout the year. So right now, according to the analyst forecast, we're looking at around a 7% earnings growth for 2024. To me, that's a less important number. The way that we're trying to think about it is thinking in these scenarios. If we go into a recession, what does that look like? Well, I think we've talked about in the past, the economically sensitive sectors, they're going to come under pressure both from an earnings perspective and the valuation. And so you can think about some downside there, and those earnings will be down year over year. If we head into a recession, there's no doubt that financials, energy, materials, those earnings will be down. On the other hand, I always say the best part of a recession is the recovery. On the other side of the recovery, you're going to see the earnings come back and earnings growth return. The cyclical, the operating leverage, the economic sensitivity will start to present itself. So while we're aware of both scenarios, the path is uncertain. Do we go and have an economic slowdown? A full recession? Do we have a soft landing? I really don't know the answer. One of the things, a framework we're thinking about is, well, what about not so much 2024 — because 2024 is a bit murky — but 2025? Because if we have a recession, 2024 will be down in earnings, but 2025 will be up. So what if we just thought of over the next two years, we should think about 7 to maybe 10% earnings growth because you have that cyclic and we're coming out of that recovery. So you might get, on average, one year, it's down 5 or 10%, and the next year might be up 10 or 15%. But on average, we're looking at 7 to 10% earnings growth over the next two years. And that's important. When I talked about this idea of shifting from the G of GIC, that guaranteed return, to maybe thinking about getting off the sidelines and thinking about growth. Because if you bought the TSX today, you get a 3.25% dividend yield upfront. That's the same as a Canadian 10-year bond. I'm not a bond expert, but the cash flow streams that come from a government Canada 10-year bond do not change. You are going to get that until maturity. The TSX, on the other hand, that 3.25% dividend yield is attached to an earnings stream that we think will grow 7, maybe even 10%, if we think about an economic recovery out of one to two years. So you're kind of getting an earnings stream. You get a 3.25% dividend yield up front — that's your initial cash return — plus you get an earnings stream that's going to grow, let's say 7 to 10% a year over the next two years. That's going to drive dividend growth. While Canada is not endowed with these innovative companies, it does have a lot of exposure to very stable businesses that are focused on growing dividends, even though the earnings stream may go up and down. So if you think about a bank or a railway stock or a utility stock or a pipeline company, those companies pay a dividend and they grow their dividend over time. So that 3.25% dividend yield that you get up front is attached to an earnings stream that's going to grow 7 to 10% a year. And then, of course, a dividend yield or a dividend stream that's going to grow about the same 7 or 10% a year. So that's a very attractive investment proposition for our investor, especially today, because of the concern that the markets had about recession and interest rates and the money being on the sidelines. I don't know if we talked about in the past, but 2023 was a record year for inflows into money market funds. Money market ETFs are the new product of this cycle. GICs. And as a result, the index, the prices, the stocks really haven't gone up that much. And the earnings stream grows, which just means the valuation proposition is much more attractive. So while you see you get the same upfront yield in the TSX as you would as a government of Canada 10-year bond, plus your cash flow stream grows with earnings, the dividends will grow, and you're not paying a huge valuation for that. You're actually earning a very attractive spread over that risk free rate, whether you're thinking about a GIC or a government of Canada bond. So it's actually a pretty good time. While the next 12 to 18 months are uncertain in terms of where's the economy going to go, we've actually worked through a lot of that part of the cycle. And yes, it might get worse, which would be a great time to bring up your favorite subject of dollar cost averaging. But also, if you think over the course of time, it would be a great opportunity to start moving off the sidelines and getting fully invested. It may not be 2024 as the year that the earnings recover, but it might. But certainly, over the next two to three years, you're going to get that earnings recovery, as we work through the economic cycle. The valuation you're paying for that earnings stream is very reasonable. It's not super cheap, it's not crazy expensive. And then, of course, you get that dividend yield up front, which is something unique in Canada. The US doesn't have that same upfront dividend yield that is in line with your comparable bond. So I might be sidestepping the what's going to happen in 2024 question, but I just think over the next two years, and it ties into that being fully invested and getting that 8% annualized. This is actually a great opportunity to start moving. If you've stepped aside for a year, let all this dust settle on interest rates in the economy, that's great. Now it's time to get back onto the playing field and shift that G from «guaranteed» into a G that represents «growth» and getting attractive returns in equity markets.
Well, we might lament that we don't have the Magnificent Seven and some of those growth companies, but when you look at a lot of investors in Canada who are edging towards retirements and who are looking for income off their portfolios, Canadian companies, as you say, there is an almost unique opportunity in Canada to get companies of that quality who are that consistent in paying those high dividends. And then again, you still have the opportunity for growth in the stock. So that's one of the things that makes the Canadian market very attractive for Canadian investors. And again, I think we've spent a lot of the last year, maybe even year and a half, talking about the prospects for a recession. The idea that coming out of COVID we move very quickly through an economic cycle, towards the end of a cycle, in front of a potential recession or slowdown. And when you get in the latter stage of an economic cycle, that's typically a period where you're reducing risk in your portfolio, reducing risk in all of your economic decision making. But if we very quickly shift now throughout 2024 to where you're moving into a new economic cycle, having come through that slowdown, that's when you want to start looking at adding some risk to your portfolio. And again, this may be that time that you're starting to look at that. Of course, always speak to your advisor, but that's something that you may want to take a look at. And Scott, here we are at about 35 minutes, so we're a little longer than usual, which just says to me, as we always come down to, we got to have you on more often, and we'll make a commitment to that through 2024 as we try to get a little bit more frequent with the podcast overall. But Scott, thanks for taking the time today. Always a lot of interesting stuff to say, and we'll catch up with you in the very near future.
Great. Thanks, Dave. Thanks for having me.