Transcript
Hello, and welcome to the Download. I'm your host, Dave Richardson, and it’s always exciting when we have our favorite market statistician, head of Canadian Equities at Phillips, Hager & North, Scott Lysakowski. Scott, welcome back.
How are you doing, Dave? Thanks for having me.
I'm great. I know you get a little upset being portrayed as the Stat Boy, but you do know the numbers inside out. It's pretty impressive.
Well, according to the University of Toronto, I do have a Bachelor's of Science in Economics and Statistics. I barely passed, but I've got one.
Wow, I didn't know that. That's news to me. So, you literally are Stat Boy.
I'm a qualified stats guy, yeah. Don't ask to see my transcript, but the degree is valid.
Wow. So that's pretty impressive. The other thing that's impressive is, we always do a little pre-preparation— we don't just want to show up and have nothing to say— and you came in today and you said, Dave, I've got a lot of meat on the bone for this podcast. You've just been in some meetings where you're talking a lot about investment strategy more broadly, but what you wanted to do today was bring it back to Canada, because there's just some trends that you see if we look back in history that make a case for how Canada might be a pretty good place to be investing in the next little while.
Yeah, that's right. So we had our quarterly strategy review sessions with a bunch of members from GAM across all asset classes and geographies, and a good discussion it was. A lot of it is framing the outlook for the next 12 to 24 months but also to bring in some bigger picture themes and ideas that we should be thinking about and translating to clients and expressing some of these views or contemplating whether we should be expressing some longer-term views into our portfolios and figuring it into the overall strategy of the firm. So it's a bit of two time frames that we're thinking in. And I was giving the presentation on the Canadian equity markets and highlighting some of the strength— I think we've talked about on the podcast before— or the relative performance in Canada versus other equity markets that we saw in 2022, which was a down year for most equity markets. But Canada fared relatively better. So that was good for Canada. And then just putting that relative performance in a longer-term context, as we both know that Canada has relatively underperformed, particularly the US market over the last ten years. And there has been some pockets of outperformance of Canada, but they've been very brief. So trying to think about: are we on the precipice of some more continued relative performance or strength for Canada? There's a couple of things that come out of it and I'll include some of the stats. More on a short-term basis, Canada was down last year. So, what's the likelihood or is it possible to have two back-to-back down years? We're off to a fantastic start so far this year. So being down, given the January effect, it probably seems not very likely. Back-to-back down years in Canada have occurred, but they're fairly rare. And typically, after a down year in Canada, you're looking at forward returns for the Canadian equity markets in the 11 to 14%; 11% on average, median 14% returns, which is better than the long-term average. And then in terms of drawdown, in terms of entry-year volatility, a little bit less than the long-term average, around 15%. So typically, the drawdown in a year following a down year is in the 10% range. So that sets up for a fairly decent outcome in Canada, which we could see from the start so far this year.
Now, we should mention something about stats. Someone who went to university and studied stats, in their degree description, understands what a 90% chance means. 90% means that 90 times out of 100, it's going to happen. It’s a lot out of 100, but there's still a 10% chance that it doesn't happen. So these are things in stats that you're using to guide and look. You've got to dig deeper to identify that there's actually something behind that stat, going into a particular period. We were talking before about December, and you mentioned December is a really great month seasonally. Normally, December is fantastic— but December 2022 was not so great. And you talk about the January effect. So the January effect is that, typically, if markets are up in January, they tend to be pretty good for the year, they tend to finish the year up. Of course, 2022 was another year where January was pretty good and then we fell off. So what's interesting about all of this is that these are just other data points, these are other tools you can use along with deep analysis, which Scott and a professional investment manager is going to do to identify how to overweight and underweight different areas, sectors of the market and pick specific stocks.
Yeah, that's right. And thanks for bringing up my forecast from the December podcast that falls under the «hot takes exposed». I did note that December is the best performance month on the calendar, and we were down 5%. So the stats are just used as a historical guide. We know that history doesn't repeat, but it often rhymes. About the stock market, there's lots of data and lots of history tied to it. So we could use these statistical patterns to help us particularly take away some of the noise and perhaps emotion of what's happening right in front of us and build the framework. But you're right, we need to map the statistical analysis or the numerical piece to what's happening fundamentally. And that actually ties into the discussion we had at the strategy sessions around how Canada's relative performance versus the US— or versus other markets— can play out. And so when we're talking about the one year forward, that's one view, but then we take a step back and think about how has Canada performed relative to the US particularly? It's often the market we compare ourselves, the US. How does that look over longer periods of time? And that's where you start to see some evidence present itself that these are long-term relationships. So Canada has underperformed the US for close to a decade, going back to the 2011, post financial crisis of 2010-2011 time frame. It has really underperformed. But prior to that, we had a period of ten plus or ten ish years of relative outperformance, if you recall coming out of the tech bubble and in the early 2000s, that sort of China-demand-led commodity story was really a big driver of relative outperformance of Canada. So Canadian relative outperformance tends to come in clusters. It tends to follow a good year, or it follows another strong year. So that helps build the mosaic. And then, of course, looking at these long-term relationships is helpful. There's a couple of things we can use to build in. What is that fundamental backdrop? The discounted valuation still holds true. We've been pointing to this discounted valuation for some time, and I think probably in the last year or so, we probably have been speaking to it that the valuation has discounted. It has been trading at a discount for a number of years. But what happened in the last one-to-two years is the discount got so wide and so we were trading at close to a two-standard-deviation discount, again, in the stats term. And typically, when you are at greater than one-standard deviation, the forward relative returns are quite positive. So that's helpful. We've talked about that before. But then, also mapping the relative performance of Canada to what we see in more of the macro backdrop. If we think about long-term relative returns of Canada versus the US, and we map that to inflation cycles, there tends to be positive correlation. So when we're in a periods of rising inflation, Canada tends to outperform the US. And then also, that ties into the commodity backdrop. When you're in a period of rising commodity prices, Canada tends to outperform. So that sets the stage for potentially a more prolonged period of relative outperformance to Canada when you start building in some of these macro data points.
Yeah. Now we always have to point out— as we have many times before when we talk about the Canadian market relative to other markets around the world— that the Canadian market itself, the composition of the Canadian market— if we look at the TSX— is weighted much more heavily than other markets around the world to those commodities, energy, mining and financial services. So you're creating an environment in the background which you can analyze from a fundamental basis and say, hey, this is an environment that is typically pretty good for banks. And it's an environment that's pretty good for commodities and commodity producers. And that leads you to those scenarios which tend to last for around a decade, and historically, the pattern we've seen is that that elevates the Canadian market above not just the US but a lot of markets around the world, just based on composition.
Yeah, that's something we've talked about many times. If you add up financials, energy, materials, industrials in Canada, it's about 75% of our market, relative to the US that's maybe about a third, maybe even less than that, 25 or 30%. And those sectors typically are viewed to be cyclical and more economically sensitive, but also benefit from a rising interest rate environment, rising inflationary environment, especially when you combine rising inflation, rising interest rates on the back of rising commodities. Those sectors would do better. That's three quarters of our market versus the US. The sectors that do really well in a declining interest rate environment are the more growth-, longer-term-, longer-duration-type sectors: technology, health care, consumer, which the US has plenty. That's two thirds of their market. So the sector composition will really drive that. The other thing to think about in commodities— and this helps to build the mosaic of these longer-term performance trends— is that the length of the relative performance trend relates to the length of the investment cycle underlying these markets. So as you would know— and perhaps the listeners would know—, commodities are very long-cycle investments. If you're going to build a copper mine, it's going to cost billions of dollars. It's going to take you ten years from discovery, permitting, design, approval, construction, bringing it on stream. So that's a very long capital cycle and a very long investment cycle. And that maps to the length of these relative performance cycles. I think people are aware that we've come out of a period where capital has not been flowing into commodities. We’ve had a big period of— you probably heard this term— underinvestment, whether it's in the oil and gas sector or in the mining sector. And that really ties in with these long-term performance trends. The amount of capex that's been spent— whether it's oil and gas companies—, in the resource sectors, peaked around 2012. So that again ties into that ten-years. The capex peaked in 2012 and the relative performance peaked around the same time. We're exiting the period of underinvestment, and we are in the midst of the period of scarcity, where that decade of underinvestment is starting to present itself— and we’ve seen it in the last twelve months—, where demand is starting to improve, whereas you haven't even added any new supply or meaningful supply in the last number of years. And demand is starting to improve and you're starting to get that scarcity. How it presents itself is in higher and more volatile commodity prices. And I think if you looked at 2022, that was a very good illustration of that, obviously spurred by the events of Russia and the Ukraine. A big spike up in a number of commodities. But it's highlighting that these commodities were in that scarcity part of the investment cycle. High commodity prices, volatile commodity prices, leading to increased inflation and interest rates. And so, we're in that moment right now, but it's still a long cycle before you start to see the increased investment. On the margin, you might see small increments of new investment in commodities. For example, some of the big major oil and gas companies, as they're reporting their year end and looking into the year ahead, we're starting to see them increase their capital spending just a little bit, and mostly just to make up for the past couple of years— especially through the pandemic— of significant underinvestment. So some of the even bigger global super majors are shifting some of their capital from the sidelines to at least maintaining their production levels. But we're not seeing the big capex announcements, the large projects. And we use that saying that history doesn't repeat but it often rhymes. The next cycle of investment for commodities may not look like the last cycle. So we may not be building large oil sands projects, but we may be building lithium mines and other types of big commodity related investments. This all ties into this longer-term view, which has implications for Canada, but also has implications for other asset classes. When you look at the relative performance of commodities versus things like stocks— this idea of rocks versus stocks— as an index, the commodities have underperformed the S&P 500 for the last ten years, culminating with the pandemic lows, with energy like oil going negative in that brief moment. But since then, we've seen a big relative outperformance. We're now into our second year of relative outperformance of commodities as an asset class versus stocks, which may or may not get people by surprise. And so that's something that we really need to pay attention to. And then particularly— I think I've talked about it—, we have to separate these two time frames. One is the shorter, more near term time frame. But wait a minute, Scott, if we're heading into a recession, that's not going to be good for commodities, which is true, but that would be the 12- to 24-month view. Where you would have that commodity or economically sensitive correction in commodity stocks, Canada relative to the US. We could see all those things have a minor correction. But the bigger picture, the big decade-long or multiyear relationship, is pointing to a longer-term period of out- or strong performance, potentially, for commodities relative to stock. So these are all the things that we're swirling around and putting into our forecast. But you need to marry those two together and understand the interplay between the two.
Yeah, it’s such an important point when we're talking about something like commodities. And again, the time it takes to build more capacity into the system. So just think of where the oil price went from the depth of COVID, when oil was priced at minus $40 a barrel— you literally had to pay someone to take it off your hands— to when we run into the middle of 2022 and we're close to $130 positive a barrel. And then you're sitting there going, okay, so the price has bottomed and come out, and you decide to make that investment. It's going to be a long time before you see any production coming out of that investment. So some of that production comes online, comes online, comes online slowly, and eventually you've got enough. Then you have a recession, the price drops again, and you go through the remainder of the cycle, because then you've got too much capacity at the other end and it just goes back and forth and back and forth. And despite the fact that, as you would say, everyone knows this, because they're planning with such long cycles, it's so hard to get it right. Which is why you always have these kind of boom and bust cycles in those sectors.
Yeah. The important thing, and probably the most difficult thing, is to separate the different time frames. The economic cycle, which would be measured in years. And of course, the recession could be months, it might be 12, it might be 6, it might be 18 months. We may not have one. That's the other thing too. Our ability to forecast these types of events is not that great. So we have to think that again, going back to our fundamental framework, thinking in scenarios. What does a recession look like, what does a soft landing look like? And then plan our risk reward and build our portfolios accordingly. A recession would be measured in a year or so. A commodity cycle would be measured in a decade. This is terrible on radio or on a podcast, but some of the charts that I was showing at our presentation this morning were mapping this current economic slowdown/recession correction. In the context of these multi-year-— in some instances, multi-decade-—, investment cycles for commodities, it puts things into context. Like a 30% correction. And one of the other charts that I showed is that point that you talked about earlier. Last year, oil price spiked, a lot of the other commodity prices spiked, then a lot of the commodities are down. I think that we talked about that when I was on in December, that oil was actually down on the year. It recovered a little bit. It's now flat. But a lot of commodities outside of maybe nickel— I think nickel and uranium are the only ones that are up on the year— all the other, copper, oil, gas, they're all down. And so that's something that they can correct 30 plus percent from their peak, but it would still fit. And that would be more of a cyclical. But if you think about the secular time frame or longer-cycle time frame, that would just be actually a minor blip on the long-term investment cycle. So that's something that we need to be mindful of. You have to be very aware that if we do head into a recession, commodities are going to be under pressure because of the decline in demand that comes from a slowdown in the economy. But that investment cycle is a much longer time frame and that needs to be kept in the back of your mind as well as you're seeing commodities to correct. That could be a very positive set up for the longer term.
Yeah, the recession just hides the fact that we ultimately don't have enough supply to meet the demand of the global economy in normal economic conditions. So as soon as things normalize out of a recession, you come back to like, wow, we don't have enough, and prices go higher and you continue along with that secular cycle until you've built enough to supply the world in normal times. And that's where you see that shift. Can I ask you just one other thought, just to finish off, and obviously we need to get you back more often because we always go long. We should have you more often for quicker conversations. But what role does the strength of the US dollar relative to the Canadian dollar play through these cycles or do we see any connection between everything that you've discussed with the two currencies?
It's important, I’m certainly not an FX expert, but it was a big part of the discussion that we had this week around some secular changes. As you know, the US dollar had been quite strong and then has since corrected. This is certainly out of my area of expertise, but they are related. And if you did set up a period of more prolonged weakness of the US dollar, which you could take some of the similar macro data points that we would use to support the commodity or the resource, of that type of investment cycle. Those would be similar data points that we use to support a period of weakness in the US dollar. They're obviously interconnected. And I think when you see the FX team give their presentation on the US dollar, that actually helps— that's another data point that goes into my mosaic—, that would actually be very supportive of strength in commodities. And then perhaps the FX team is looking at my presentation and doing the same. So who knows what came first, the chicken or the egg. But it is something that would actually help— if we did see a period of persistent weakness in the US dollar—, that would be very supportive for commodities. It would be supportive for the Canadian market as well.
Yeah, something to think about for Canadian investors because you almost get a double hit in this cycle where Canada outperforms the US in the market, or the Canadian dollar outperforms the US dollar. Your US dollar investments get hit both ways when you bring those US dollars back to buy Canadian dollars back. As a Canadian you don't buy as many, so you get hurt on that end as well. So these are things to keep in mind in terms of if you are still investing in the US. To think about currency or to keep it in the back of your mind and make sure that the people who are managing your money are thinking about currency. Because as you say, you're having those conversations with your currency experts because that's going to be a part of your strategy as well.
It sounds like a great opportunity to call your financial planner or adviser and have a conversation about how you're positioned currency wise, because I think you're right. And those, the currency discussions, tend to be longer term. They're measured in years, not months. So that's something to be mindful of. It's not too late to have that conversation and make sure you're positioned appropriately for the coming years.
That's a great way to finish up. I watch for the commodity cycle when in Calgary, with restaurant reservations. When I can't get a reservation for months at a mediocre Calgary restaurant, we're near a peak. When I go to the best Calgary restaurant and I'm the only one sitting there, then we're near a bottom. And that's played out pretty well in terms of figuring out the commodity cycle over the years. Not as well founded in real statistics numbers and fundamental analysis as your stuff, but another little trick that I've used over time to identify those things. And Calgary has got some great restaurants, too.
Yes, and we'll add that data point to our barometer, our mosaic. So you let me know if you can't get into the popular restaurants in Calgary and I'll know to lighten up on some of the resource stocks.
Always glad to lend a hand, Scott. So again, thank you as always. We're going to keep to that commitment because I know people love listening to you. We're going to get you back on more often. And thanks for joining us today.
Great. Thanks, Dave.