Hello, and welcome to the Download. I'm your host, Dave Richardson, and it's time for a visit from our very own Captain Canada, Scott Lysakowski. Scott, you didn't like being the Numbers Guy, so how about Captain Canada? Because I know you're a big Canada fan.

That's right. I'll be Captain Canada. Sounds like a big role to play, but I'm up for the challenge.

Well, I know you're out there cheering for the Vancouver Canadians regularly. A season ticket holder. And I'm sure you're a big fan of the Canucks.

I'm still a diehard Leafs fan, fortunately. And then I was on the tank for Bedard for the Canucks. Clearly it didn't do it. So hopefully that means they're turning things around.

I'm pretty excited because my beloved Denver Nuggets are in the NBA championships for the first time.

Dave, you definitely have an eclectic sports affiliation portfolio. I don't know many people who are diehard Denver Nugget fans.

There's not many because they have a legacy very similar to the Vancouver Canucks, which is to not ever win. But for a losing team, when they win, it's exciting. And let's segue that into Canadian markets because for much of the previous decade, US versus Canada, US always wins. But we saw that shift up a little bit as we come out of the pandemic. But we got the potential where some of that is going to stall. We were together about a month and a half ago. I was watching you do a presentation, and there were a lot of really great positive signs around Canada. But we look at the month of May— you just mentioned before we got on—, Canada is down about 3% this month. Not that anything else around the world is doing particularly well, but what the Canadian market is made up of is struggling in this environment and may continue to struggle. Why don't you talk about the makeup of the Canadian market and why you may see Canada struggle in the short term. And then we'll come back to why we get so excited about Canada longer term.

Right. We've talked about the composition of the Canadian market many times on this podcast and that it's quite different than the US market or even the global markets. Canada has a lot of exposure to what we call cyclical sectors. Energy, commodities, financials would count into that, industrials, etc. And that's three quarters of the market in Canada. If you compare that to something like the US market, it's probably only a third of the US markets. The US market is much more broadly diversified. It has more exposure, particularly today, to things that are more higher growth; technology, healthcare, consumer, communications, media, etc. So that has implications for the Canadian market and a relative performance versus the US market particularly has ties to the economic cycle. When we were presenting to clients a few weeks back, we were sharing the message that investors today, particularly Canadian equity investors, need to think in this two-time frame. And it's a bit of a good-news-bad-news story. Starting with the bad news is that in the short to medium term— and I call that maybe 6, 12, 18 months—, as we are on the doorstep of an economic recession slowdown, whatever the flavor is, that is going to weigh heavily on these cyclical sectors. That term cyclical means they're more tied to the economic cycle, and so therefore, if we are heading into a recession or a slowdown of some extent, you're going to see that pressure on the cyclical sectors, commodities, financials, and you're already starting to see it as we know that the stock market is forward looking. It's starting to contemplate what does an economic slowdown mean for things like consumption of commodities. And we talked that the commodities stocks and sectors had a really strong couple of years. But if we look at it on a year-to-date basis, we're seeing copper is down, iron ore is down, oil is down, natural gas is down a lot. So we're seeing some of that concern about commodity demand in an economic slowdown start to present itself in the commodity prices and of course the stocks even lead the commodity prices. So we're seeing that play itself out. You could argue that if we actually go into a recession or something more significant of a slowdown, there's likely to be more downside. So the short term is somewhat negative for Canada because of that cyclicality and that exposure to things like commodities and economically sensitive sectors. Financials— I won't steal Stu’s day's thunder and talk about bank reporting—, but banks have been under pressure. They're very cyclical thinking about credit and the credit cycle and their exposure to the economic cycle. So that's really weighed down on Canada. While we had a really nice run of relative outperformance, which we've talked about many times— the discount that the Canadian market trades at relative to the US and the strong relative outperformance that we saw last year and even to some extent the year before—, we're giving some of that back today. You talked about how it's been a rough month for Canada. It's down 3 to 3.5%. S&P 500 is only down 1% and the Nasdaq is actually up. And if you look at it on a year-to-date basis, the TSX is up 3%, which is roughly maybe a little bit behind the S&P 500, but the Nasdaq is up close to 20%. So there's a lot of bifurcations happening in the market and that relative underperformance for Canada is presenting itself today. Now that's the bad news. The good news is more of a longer-term thought and this more fits into our time frame. We're very mindful of the short and medium term, but the real investing opportunities exist in capturing some of these longer-term cycles. And this is something that we probably talked about. You heard this word, regime change, being thrown around at the beginning of the year in a number of places. It was all over the financial press. Talking about this idea that we're in a very different regime change is referring to the interest rate environment. For the last decade, we had very low and falling interest rates and that had a dynamic of what drove leadership in stocks and sectors and markets that were outperforming. And now we've reset that and we're in a much higher interest rate environment. And who's to know if we're going to be rising from here, but the structure of interest rates is markedly different than what we saw over the last ten years. And if we look out over the next ten years, we are potentially heading into an environment where maybe it's not high and rising interest rates, but we're not in that low and falling environment anymore. And that has important implications for leadership amongst stocks and sectors and then of course, markets. And then tying it back into Canada— and this is the message we were sharing with investors over the last couple of weeks in our presentations—, as it relates to the commodity cycle, these are very long-term cycles. So I think about economic cycles are shorter term in nature even though an economic cycle would take on average three, four, five years to play out from recession to recovery, back to recession again. These commodity cycles are very long-term capital cycles. The investment cycles for the stocks tend to match the capital cycles for the underlying industry. So if you're in the commodity sector, the capital cycle is about the amount of time it takes to invest the capital. Whether you're building an oil sands plant or a copper mine or any significant new supply of a commodity, the amount of time it takes to invest the capital, to build the project, bring it online, and then recover your capital and then earn a return on that capital, that's a multiyear and perhaps a decade-long type of investment cycle. And that drives the relative performance cycles of the stock. So we are coming out of a decade-long period of underinvestment across most commodities. As we move into a period or an environment of somewhat scarcity— that's what we saw, those high and spiking prices that we saw over the last couple of years across a number of commodities—, we're heading into that period where we've created the scarcity and we need to have a higher price to incent new production and new supply to be brought on. And that plays out really well for Canada. The exact picture of how it plays out as it relates to which commodity, it's hard to tell. We're obviously in the midst of an energy transition, so the types of commodities and the types of investment may look different over the next 10 to 20 years than it did over the last 20 years in terms of which commodities are being invested, which commodities are leading or lagging. But the important thing is the amount of capital that needs to go into the ground in the commodity sector— whether it's copper, lithium, gas, oil— is significant. And then of course, we have the energy transition conversation about carbon capture, net zero, etc. That's going to require a lot of investment. So that significant amount of investment will be beneficial for the Canadian market. You have a lot of that capital, economically sensitive sectors that will benefit from that in our market. Over the longer term, that sets up for a good news story for Canada.

Scott, from a supply standpoint, as much as that investment is needed in that sector— even if your view is that we are moving into a transitionary or transitory period (one of our favorite words of the last couple of years)—, is that money going to be available to invest and to build to the extent that we have through previous cycles like this? Because there's just not an appetite to invest into businesses that may not be producing or need to produce at the same level in 20, 30, 50, however many years the transition goes?

Yeah, that's a great question and an important observation. And that explains how we ended up in that spiking commodity price environment in the last year or so. The prices before we had that big price spike about a year ago were high enough to incent new supply. And if I think specifically about oil, we were in the 60-70 range, maybe even upwards of 80, prior to the events of Russia and Ukraine, which caused the prices to spike. That signal was not actually being received by the producers, and there's a number of reasons why. One is the long-term nature of the capital cycle. If we were running a large oil company, we'd see the oil price and we'd say, well, the oil price is actually telling us something. It's giving us a signal that the price is sufficiently high enough that we can invest in some of our projects to bring on new supply, and the economics would make sense. The problem is that's a ten-year investment cycle to put the money in, bring the project on and get your money out and then earn a return on that investment. If we're sitting around the boardroom table saying, if it's a ten- or an eight-year type cycle, what's demand going to look like in eight to ten years? We don't know. The other thing is that the cost structure is different. So there's two elements. Well, there's a number of elements that go on the cost structure: the actual cost of the labor and the materials and the steel that go into the ground. And the other one is that project, when it comes on stream, is going to have a carbon cost potentially on it in eight to ten years. So you need to factor that into the equation in order to get compensated for those. So there's a lot of risks and uncertainty around these decisions. And just like an investor, if you're taking on more risk, you need to be compensated in form of return. I'll just use oil as a simple example, but historically, an oil company would think about their cost of capital returns or the minimum return required— and it would be in the 10 to 12% range—, so they would think, okay, this project costs us X, so we need a commodity price of Y to earn that 10 to 12% returns. But now that we've added these risks to the equation, the companies are saying, well, I would like a higher return. And so typically, the cost curve at the 10 to 12% range was probably in the $60-70 range. But when you take that 10 to 12% and say it's going to be 15 or 20%, the price required to earn that type of return is in the $80-90 range. So you add that to the equation. And then the final piece is that the shareholders of these large oil companies are screaming at them to say, give us our money back. We don't want you to grow production, we don't want you to do acquisitions, we want you to buy back stock, pay special dividends, grow your dividend, pay down your debt. So all those things are swirling around and that's why there's maybe been on the margin some small incremental inklings towards increasing capex. Not so much for growth production— it was actually just to shrink slower and without naming specific names, there was a very large global super major who came out and said, we are not going to decline our production as fast as we originally said; we're actually going to maintain a flatter production profile. So it's not actually growing, it's just on the second derivative growing by not shrinking as fast. So we haven't seen that. And when we think about it— we shared this, we had a great schematic of the long cycle and the different phases of each cycle—, we're just in the scarcity piece. That's phase one. You've come out of underinvestment, you're into scarcity. The next one is when the companies start investing again and of course they're going to invest too much. The pendulum always swing the other way and we'll get into that oversupply. But we are nowhere near that. We're coming out of underinvestment. We've created the commodity scarcity and we're moving towards the reinvestment phase, but there is nothing of significance to tell me that we're well into that phase just yet. So it's still fairly early days.

So some would say— we look at the economic forecast—, that we're likely going into a pretty significant economic slowdown around the world or a recession. But it's a short and shallow recession, so by the time we get towards the second half of next year, we're coming out of that recession, and now all these countries that had been contracting go back to growing again. Demand for all these things goes up. And as you're suggesting, it's not like you can flip a switch and all of a sudden, we've got billions of tons of additional copper coming to market. So that puts some upward pressure on it. And isn't that that next phase of the cycle for this? Or is that too optimistic a view of how things play out from here?

Yeah, it's hard for me to say what shape and size and magnitude and duration the recession will or will not be. That's a mugs game. It’s too hard. That's an Eric Lascelles' question. But regardless of the shape, size, magnitude, duration, the thing about cycles is that they don't repeat, but they often rhyme. There is a recovery component to it. And when we recover, you're exactly right, you can't just hit the switch. If anything, you need to be investing today and for the next several years just to capture that long-term demand that's going to be coming in the commodity space. So that's why I say it's a good-news-bad-news story. The bad news is Canada might suffer in the short term, but the good news is that long cycle is a great opportunity for the Canadian economy and the Canadian stock market.

Yeah. So this is my Supercycle story, Scott. As many young Canadian kids back in the 1970s, I had a Supercycle bike. It was the first really nice bike I had. And I pulled into the local shopping mall, didn't lock it up, went to grab something quick on the way to school. Somebody stole it and I found it a day later. Somebody had mangled it and tossed it off the overpass that we used to walk over the railway tracks and highway to go to school. So my Supercycle, which I was expecting to have for a long time, wasn't a Supercycle anymore. But my neighbor heard the story, and he was very handy with bikes, and took my mangled Supercycle, souped it all up, even repainted it for me. And then I had a really awesome Supercycle that went on for years and years. That's ultimately what we may be able to get out of here. When we talk about the commodity cycle, we had a nice little taste of what a super cycle in commodities feels like and looks like in that sector. Now we're getting that pause as the global economy is slowing down and then you come back, and we still need all this stuff, and we don't produce enough of it. So that's where you get that next phase. And I think that's why you might be optimistic about Canada, right?

That ties it really well. Your mangled Supercycle could be the recession and then the neighbor who tweaks it up. To tie this to the West Coast biking scene, we're going to need a full suspension mountain bike to ride the ups and downs over the next 6 to 12 to 24 months. So there you go.

You're a young guy, you grew up with mountain bikes. I'm of an older vintage where we didn't have mountain bikes. The technology wasn't there as much, and cycling wasn't as big in Canada. But it is interesting, and we will get to Stu Kedwell on the banks because that's the other side of this equation when we talk about Canada. But again, it has been a pretty amazing run in a lot of these sectors. And I know in the portfolios that you manage, you've benefited from being invested in those areas. And now you take a pause, and again, there's no guarantee that this pulls out the way you think, but if you look to a future where there is the next cycle, the next phase of economic growth, that again takes the demand for all of these things up to higher levels. And again, there's just not enough invested in the production over for an extended period of time. So prices rise and that's going to benefit those companies as they manage their production, or at least have shown quite a bit more discipline around managing their increases in production or how they go to market and how they manage their assets and resources.

Yeah, and I think it's an important concept for investors to keep in mind. It's difficult, but I think our listeners are up for the challenge that if we go into a recession, there's going to be some doom and gloom in Canada around commodity prices and the sensitivity of the stocks and sectors to the economic cycle. We always say volatility creates opportunity. That doom and gloom will be the mangled Supercycle chucked off the overpass. And the opportunity will be for young Dave to go to his neighbor and say, hey, can you help me out here? And that's going to be an exciting opportunity for the Canadian market. So like I said, good news, bad news. The bad news may come first. But the good news is the friendly neighbor is there to put the Supercycle back together.

And those neighbors will be huge economies all over the world. Scott, always great catching up with you. I always enjoy our conversations. Sorry for the silly analogy, but I think it works. And I think for a lot of our listeners who are of my vintage, they'll remember maybe having a Supercycle of their own from one of our favorite retailers in Canada and enjoyed that. So thanks for bearing with me and for all the great information because these are important ideas for Canadian investors to understand the uniqueness of the Canadian market and how you need to think about as we go through different cycles, why it might race ahead, calm down, then come back again at a later date. So Scott, thank you very much.

Thanks for having me, Dave.