Hello, and welcome to the Download. I'm your host, Dave Richardson, and we've got our old buddy, our old coffee pal, Scott Lysakowski, here with us today. And Scott, you're actually in Toronto today instead of Vancouver.

That's right. In town for our quarterly strategy session. I was really worried about the humidity and that my West Coast softness was going to be disrupted by this warm weather. But it's actually pleasantly nice outside. I'm surprised and happy that I'm not sweating in my suit as I walk around downtown Toronto.

Although they can't see it, your hair is kind of frizzy. You don't look as sharp as you normally do when you're out on the West Coast.

I'll chalk that up to an early start and still being on West Coast time on a long day.

There you go. Well, you think you've had it hard. You know what my double header is today? I had a dentist appointment this afternoon, and tonight I'm going to the Barbie movie.

Oh, wow, you got your pink shirt on?

Not really sure what's going to be more painful, but there you go. Have you seen the Barbie movie yet?

I have not seen the Barbie movie yet. I have two young kids. I think they're a bit young for it. Once we get through recording this podcast, I'm going to a Jays game this evening. Looking forward to that.

Say hi to my daughter when you see her. She's at the game as well. She looks like me with long hair and no beard, I should make that clear. Okay, well, let's get into it because you are doing a big presentation tomorrow about Canada in your strategy meetings, so it's a perfect time to catch up with you. And you're going to start with a review of Canada in the first half of the year. And if we're looking at Canadian markets, not a fantastic first half, but how does it really stack up when you look at the numbers?

On its own, not so much for the first half, but maybe near the end of July, or even if we look at it year to date, Canada is up roughly or just over 8%, which is pretty good for half a year. I think where you would be disappointed is Canada's performance relative to other equity markets. The S&P 500, year to date, is up 18% or something like that. So Canada has really lagged behind. And of course, the Nasdaq is the big performing market, up over 30%. Maybe in absolute terms, it's a decent result for half a year, but relative to other markets, it's been a bit disappointing. The drivers of that relative performance— and we talk about it all the time—, is the composition. The best performing sectors so far this year have been technology. Canada's tech sector and the Canadian technology stocks have done really well. I have Canadian technology stocks up 50% year to date, at least to the middle of July. But the US has a lot more technology stocks or has more exposure to technology sector and US tech stocks have done better than Canadian tech stocks. And then even though Canadian energy stocks have done better than the US— we just have more energy in our benchmark—, the relative underperformance has been somewhat disappointing, but understandable given where we are in the market cycle. And it hasn't been until recently where we've seen some of these— I'm often referring to them as the cyclical parts of the market. Canada has lots of energy, financials, materials, industrials. Those sectors have really lagged. When we look at the year-to-date performance, energy is down, and the financials and banks in particular have been chopping around a little bit. Having some of that exposure in Canada has hurt and it hasn't been until recently that we've seen a little bit of life in the lagging parts of the market. So I think, probably the last time I was on, we talked about the narrowness of the breadth of the market returns, that has resolved itself to the upside as the rest of the market's been dragged up. And now we're starting to see that bleed into Canada where you're seeing energy stocks act a little bit better; the oil price is acting a little bit better. So that's helpful. Interestingly, when you look at the relative returns of the TSX versus the S&P 500, the first six months of this year ranks amongst the worst six-month period of returns of Canada versus the US. You would like to think there's some mean reversion to that trend. You know me, I love to look at the stats and the numbers, but really the data is inconclusive. If anything, when the forward six and twelve month returns when we're in these bottom deciles actually is still negative looking back in history. So it's not a clear pattern. We'd hope to see some mean reversion, but the relative underperformance could persist for some time. So that's maybe a little bit disappointing.

I guess that would be in line with what we've talked about a lot on this podcast with Stu Kedwell, Sarah Riopelle and Eric Lascelles, and others; it's more likely than not that we have a recession or at least a slowdown in the western world and a slowdown really all around the world. So going into the future, that slows down the demand for the commodities, the things that Canada produces and that the world wants, and the prices go down. So that's going to be a little bit tough on the stocks. And then on the financial service end, a recession is never good for banks, but when you have a situation like Canada, where you have a group of very large banks that really get a lot of impact from the Canadian economy— or the Canadian economy gets a lot of impact from them—, that's tough on that sector. And that's about 50% of the market. And there you go.

Yeah, and it could go two ways. You could have the scenario that you're talking about, or what feels like is being more broadly discussed in the market, and maybe the stock market is starting to discount this scenario as a whole, that idea of a soft landing or no landing. I'm not an economist, so I can't predict these types of outcomes, but if the market is going to continue to discount this soft-landing type scenario, you could actually see some lagging markets and some lagging sectors start to participate. The big concern that we had around Canada was that just the amount of exposure we have to the more cyclical components of the market, and if we were to have a recession, things like energy and banks and industrials materials would not do well. And if we are going to have a soft-landing scenario, you could see the market saying, okay, well, if we're having a soft landing and there's no recession, then those more cyclical or economically sensitive parts of the market could do better. The other thing that we talked about the last time I was on, is how Canada looked cheap, but the estimates really hadn't started to reflect some of these concerns. And then, of course, through the course of time, that's starting to get reflected. So if you look at the estimate revisions for the TSX down slightly, which is directionally good, what's more important is that for those more economically sensitive parts of the market, the estimates are down more significantly. So I think, as a whole, TSX earnings are down. The estimates are down maybe 3%, which is not a lot, but that's probably a ten plus percent swing from where they peaked out maybe a year ago. And now, when you look at the estimate revisions for energy, down 13% in the last six months, banks down 8%, you're starting to see the estimates come down. The stock market stocks are forward looking, as we know, so they start to do that first, and then the estimates come down after. So we're getting to a place where the TSX does look relatively cheap or reasonably valued, especially when you look at it relative to the US. And we've seen those estimates come down. So that's a bit of a better set up for us that, whether we go through a mild recession or a soft landing, we are setting up for a better risk reward. Now, I would say when we think about our bottom-up forecast for the market, we still have the risk reward. The downside to our bear case, which would be a recession— call it garden variety or just more of a standard recession—, we're still showing downside to that bear case. I don't know which one is going to happen. That's why we deal in scenarios. But there is still some downside to a bear case around a recession. But if the market is going to assign a higher probability to either a soft landing or a no-recession type scenario, the returns to the upside are pretty good as well. So the risk reward is somewhat balanced upside to downside, and there's probably decent returns that would all be caveated by the fact that we don't have a recession. Now, the tricky thing is that if we looked back into whether the earlier part of this year or really the big opportunity in the late fall, the market was discounting more of a recession type scenario than we are today, so even though the estimates have come down, the market's gone up a little bit. So if you want to get upside returns from here, you actually need the soft landing or you need the no-recession scenario. So the risk reward is not terrible, but it's not super attractive. So we're somewhat a bit neutral and still our ability to predict recessions is not great— or predict no recessions is not very great either. So we just live within that scenario analysis and look at the risk reward.

Yeah, you've seen the multiple expand a little bit, reflective of that thought that you may have a soft landing. And earnings revisions, although down, have probably not come down as much as you would expect or think that they would were we in the midst of a recession. So it's been one of these odd, very disrespected rallies in the stock market. But when we look at actual earnings and again, just to provide some perspective on your comments, as we shift gears and we're going to take more of a specific look at the energy sector, you've seen some of the reports over the last couple of weeks from some of the large producers, at all ends of the production line of energy, you've seen a lot of those earnings come in 30% to 50% down year over year, which looks awful, except to say that the earnings that you had a year ago were just not there. There was no possible way they were going to be sustained. Or we'd be talking about a really severe recession because you'd have to have $125 energy prices over an extended period of time to do that. With that, we've seen a bit of a comeback in oil prices and natural gas prices, across the whole energy spectrum. What are your thoughts about energy from here?

Yeah, and I think you bring up a good point that the earnings for energy companies are down 50%. There was a large super major that reported their earnings this morning and I think they were down 70% year over year. So that's a lot of it that is commodity driven. And so while the actual earnings year over year are down, the results are exceeding analysts expectations. So that's the most important thing. And I think in the past when we've talked about whether it's the energy cycle or commodity cycles in general, we have to understand that these are very long-term cycles in nature. The last time I was on, I was talking about how the investment cycle for these stocks matches the capital cycle. If you're building new oil production or building a new copper mine, it takes a long time for that to occur. And so there can be lots of volatile moves up and down through these investment cycles. But the commodity cycles and resource cycles tend to be long in nature. And within those cycles, it's actually quite normal to have interim drawdowns of the 30% to 40% type range, which is what we've seen. If you think back to a year ago or just over a year ago, oil prices peaked around early June of last year and since then we've had a fairly significant drawdown and they're starting to recover. And the stocks did the same. So a couple of dynamics at play is that the stocks have corrected. Again, going back to the analysts estimates, the estimates have come down. One of the things we track is the consensus forecast for different commodities relative to the futures curve. And so what happened was, when oil prices spiked up last year, the analysts took their numbers higher and then corrected down. And then of course, the analysts are much slower in chasing that number down, but that gap has closed considerably. Now we have oil prices around $80 for WTI and the consensus forecast is roughly the same or maybe just a little bit higher. That gap is closed. The expectations for the analysts have come down to match the commodity. So yes, the commodity is down a lot year over year, but the estimates are more in line with what's happening right now. So that's good for the go forward; will companies exceed expectations or not?

I guess the other factors in terms of the stocks as well, which has made investing for you in this sector— and we'll get to the climate concerns because that's always at the back end of this; so don't anybody leave unhappy because I'm throwing the positive investing in the sector, before we talk about the focus on climate and the transition in energy—, but a lot of these companies are doing a fantastic job of paying dividends or paying back to their shareholders either through dividends or buybacks, right?

Yes, the discipline in the sector has been quite astounding really. If you think back over the last number of years, the energy sector and resources in general have a relatively poor track record of being disciplined around their capital spending. And again, this is not great podcasting, but there's a chart that we like to show that shows the last time oil was around $80. The companies were spending significantly much higher levels of their cash flow on building new projects, bringing on new supply, and actually taking on more debt and issuing more shares to do it. Now we've seen the oil price correct and normalized to these 80 levels. And the amount of capital that the energy companies are spending has gone up a little bit. Part of it is just making up for some maintenance and some projects or spendings that they probably should have done through the pandemic when oil was extremely low. So they're making up for it. Also, some inflation has worked its way through. So if you see charts of oil and gas capital spending or investment, it's gone up, but it's still significantly below its peak from ten years ago. And then of course the rest of that cash flow has gone to share buybacks, dividend increases, special dividends and debt reduction. A couple of other thoughts. The companies are being more disciplined and then you mentioned to it there's a new feature or a new issue to address in the energy sector and across all commodities in fact— but energy is at the forefront of it— is on emissions. And a lot of the oil and gas companies have repositioned or reset their forecast for oil and gas production growth and set as a priority emission reduction over new supply growth. So that's had a couple of implications. One is on the oil price because you're not bringing on new supply even though demand is still quite strong. And two, around how the companies are behaving. We often get the question— talking about energy transition because our economy is so exposed to the oil and gas sector, to the energy sector—: is energy transition a negative headwind for Canada, for the Canadian energy sector, for the Canadian stock market and for the economy as a whole? And I think there's a view— and it might be misunderstood, or my view might be slightly different— that actually Canada is really well positioned to participate and benefit from energy transition. And there's a couple of pieces to it. One is the companies themselves; all the Canadian— I shouldn't say all, but a lot of the large Canadian— oil and gas companies have set net zero targets. So that's quite ambitious given the level of emissions that they generate today. But they have set net zero targets. It's a long way out. I think they set 2050 as a guideline, but they are moving towards this target of being a net zero producer of oil and gas. And then the next piece is that when we think about energy, capital spending, the next 10 to 20 years is going to look drastically different than the last 20 years. So the next energy cycle is going to look very different than the last energy cycle. The last energy cycle, if $100 billion was spent, it was spent on building oil sands mines, drilling shale wells, building new pipelines, gas plants. The next decade, the next 100 billions of capex that's going to be spent in the energy sector, there'll be some oil and gas upstream production, but a lot of it's going to go towards carbon capture, sequestration, LNG export, improved efficiency, emissions reductions. If we include all forms of energy, including electricity, renewables, etc., then you'll see a huge increase in a broad definition of energy capex or capital spending. You'll see that increase over time; it's just going to look a lot different than it did over the last energy cycle. So I actually think that Canada, just because we have exposure to the oil and gas sector in our economy and in our markets, but the fact that the companies within that sector are very focused on being an active participant in energy transition— whether it's building out renewables, building out the sort of the bits of infrastructure that's required to get to net zero—, that's going to have a positive implication for our economy because that's going to put people to work, there's going to be lots of engineering work to be done, equipment is going to be required. So that capital spending doesn't often happen without a return attached to it. So that'll be great for investors, it'll be great for banks lending money to these companies. It'll be great for employment and all the secondary effects on the Canadian economy. So I actually think the energy transition is not a headwind for the Canadian economy and for the Canadian stock market. I actually think it's a huge opportunity. So that's something, I think, that sometimes gets misunderstood by the market.

Yeah. You talk to the leaders of these companies, the executive teams. And I spend a lot of time in Alberta, as I travel across Canada, I end up bumping into more of the employees. And you talk about that discipline in terms of the way the energy companies. This is all over the world, but I think Canada really gets a particularly big gold star for they're really committed to managing the businesses in a more disciplined fashion, which you talk to, and very clearly understand the need to be in front of this transition, but there's an opportunity for them to lead that transition as well and take that understanding elsewhere. And it's another way for them to grow their businesses as you move forward.

If their goal of being a net zero producer of oil and gas appears to be fairly ambitious today, that's our job as engaged shareholders to speak with the companies and get updates of what they are actually doing and holding them accountable to these plans. But I agree, there's a significant opportunity for these companies to not only survive and be sustainable over the long term, but it's actually going to have positive follow-on effects to the economy and will be good for the Canadian stock markets as well. We talked about that long-term relationship of commodities versus stocks, and we've just gone through a really strong period over the last ten years of stocks outperforming commodities and there's had a number of effects that follow on from that. A lot of it is underinvestment. The commodity companies, the producers, unsure about long-term demand, unsure about the cost that's required to bring on new supply, they've been underinvesting over the last ten years. The rubber is starting to hit the road on that. And as we move forward, we may be heading into a period where we're going to actually need to reinvest. It might be a different form of reinvestment. I talked about the last energy cycle. The next energy cycle is going to be very different from the last. And so maybe we're doing carbon capture and renewables and charging stations and copper and lithium as opposed to oil and what the previous cycles were focused on— coal, etc.—, so things that were part of the last commodity cycle may not participate in the next commodity cycle, but these cycles tend to work in long-term fashion and we potentially could be on the doorstep of a fairly long cycle in terms of commodity prices, resource investment. And I do think that's going to be good for Canada and the Canadian market.

Yeah, I mean, what's exciting for Canada is we know one thing, it's a big place and we got a lot of this stuff. It's relatively hard to get at or has been hard to get at. Technology keeps improving and so we're going to be able to, as we move forward, get at some of this stuff— not necessarily oil, but other things that are going to help us in that transition. And that's going to be good for the Canadian economy, as you say.

That's right. Hopefully it's good for the Canadian economy, good for the Canadian stock market, good for our clients’ portfolios as well.

And you know what's going to be good for you tomorrow, Scott? I'm coming downtown to buy you a coffee. We're going to go back to one of our old haunts. We'll get a nice espresso and maybe a cooler drink for you so you can manage the heat.

I might have to do a cold brew, something like that. Cold brew in the afternoon. The time difference catches up to me in the afternoon, so I'll be ready.

Perfect. Well, I'll be there for you. And thank you for joining us today on the Download.

Thanks, Dave. Thanks for having me.