Monica: The thing to remind ourselves about Canadian equities in the Canadian market is that we have these really high quality companies that I think are often overlooked, but probably worth a bit more work or probably want to keep an eye on.
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Ingrid: Hi everyone and welcome to TDAM Talks. This is Ingrid MacIntosh. And on this podcast sitting here enjoying a double-double because we are getting ready to talk about investing in the Great White North. We're going to be focusing on the Canadian stock landscape. Joining me today is Justin Flowerday, managing director and head of equities here at TD Asset Management and more of a rookie guest, Monica Yeung, lead portfolio manager of some of our Canadian equity funds. Today we're going to be talking about the driving forces in the Canadian market, similar emerging opportunities and themes. And we'll talk a little bit about the great conversation around Canadian productivity. We're going to end off as always with our rapid-fire session, talking about three hot topics. So make sure that you stick around for the full show. So welcome, Justin and Monica.
Justin: Great to be here Ingrid!
Monica: Thanks for having us.
Ingrid: Okay. So Justin, I was coming at you with the big view here. So we're getting through the first half of the year. How are markets shaping up?
Justin: Shaping up pretty darn good. Ingrid, When you look at using round numbers, we'll talk about Q1. I know we're a couple weeks into April, but we'll be at Q1. The S&P 500 is up 11%, The TSX is up 7%, EAFE is up 6%. These are really, really good returns in a very short period of time. And we do need to remember that these come on the back of what was a really strong year last year where you saw the S&P 500 up 26% and the TSX up double digits as well. And so, you know, going through the quarter, I'd say the big debate in the market is, look, are these gains sustainable and is this rally going to continue? And it really comes down to a belief of ... has all of the investment that's gone into AI - has that generated a sustainable economic environment where we're going to see higher productivity growth, where we're going to see sustainable GDP growth, margin expansion, which will lead to good earnings growth, or is this last leg of the cycle really just kind of FOMO and people, people looking to catch up and feeling left behind and putting money to work later than they should have? And so that's… that's the debate that's going on right now.
Ingrid: I want to sort of expand on that a little bit further, because you mentioned AI’s driving force, but also, you know, the whole narrative around rate cuts, When will they start? How do people that go? How fast will they go? We're recording this podcast today just after the Bank of Canada's latest April announcement and also seeing some U.S. CPI data. Can you talk a little bit about that? And also you were talking about some of the market drivers. So as we look at that rate environment and some of the moves, I think there's probably a story to be told on, you know, even more cash money coming back into the market depending on how these things play out.
Justin: Right. So I guess maybe I'll start on the CPI print in the U.S. this morning. And it really came in a little bit hotter than people expected. 0.4% month over month versus expectation for 0.3%. And and all that means is that it makes it more and more difficult for the Fed to begin the rate cutting cycle. And if you remember going into this year, there was an expectation that the Fed would cut seven times in 2024 and you moved through Q1 and then moved down to six and then five. And then, you know, a few weeks ago is three after today's announcement on inflation's two cuts, two cuts for 2024 is the expectation today and so I guess markets where you've gone in anticipating for rate cuts in sectors that have been looking for rate cuts, there's probably a little bit of a pause and a wait and see there. But what it does mean is that the economy is running hotter than expected and this is a really good thing for general employment and incomes for people who are looking to to spend. And so GDP growth will probably come in decent as well. With respect to the money on the sidelines, I think is there's no question that there still is a huge pile and you have seen some money flow in. You've started to see flows into equity mutual funds and balanced mutual funds. And so investors are starting to participate a little bit more. I think with this rate cut and the fact that Bank of Canada's on pause of five probably means we’re in a bit of a wait and see period.
Ingrid: You've talked about the U.S. in Canada, would you say, especially given the tone of the bank account this morning, that if we had higher expectation for cuts earlier in the year, similarly that outlook is getting less aggressive?
Justin: Yeah, I think that's a fair statement. And you know, we'll get more data in the coming weeks which will talk a little bit more about, you know, what the employment picture is looking like.
Ingrid: The I think the last thing that I saw Justin was, you know, sort of a 50% rate cut probability now in June. So that's waning a little bit. And even our own TD Economics is expecting July. So we shall, we'll just have to wait and see and be data dependent, as we always are. So I'm going to turn to you now, Monica. You've been a top analyst at TDAM for a number of years and now you're the lead PM on our dividend income fund. Tell us a little bit about you. Tell us a little bit about that transition.
Monica: Well, I have to say, Ingrid, 17 years at TD, but first time on the podcast, so...
Ingrid: Well, it sounds like that one's been a call to me there, but of course we'll have to do more! To be fair, you've not been around a lot the last little bit. Maybe talk about....
Monica: Oh, that's true. Yes. I recently returned from maternity leave, so maybe backing up. I've been at TD my whole career - 17 years, started first at TD Securities in the investment bank. I was advising companies on M&A in corporate finance transactions, did that for a couple of years, and then I moved into TD's in-house corporate development M&A team. So really interesting time. It was the middle of that, the great financial crisis, and I was helping the bank actually acquire other banks in the US. So really got a firsthand view into the banking sector and the financial sector at a really critical time in the economy. And then I joined TDAM in 2017. The rest is history. I started off as an analyst covering financials and telcos. I moved into a co-head of research role after my first maternity leave, had a second child shortly thereafter, and then upon my return for my second maternity leave, came in and took over as lead PM on the TD Dividend Income Fund.
Ingrid: And that is brilliant. That was good.... go ahead, Justin!
Justin: Yeah, I was just going to mention, you know, Monica has been tied in to that kind of Canadian dividend pod for quite some time working very closely with Doug and the team for a long period of time. Just, just being a sounding board and has been named on funds now for I think a couple of years now pre the second maternity leave. So there has been an alignment there for for a few years.
Ingrid: And beyond your impressive background across… across many areas of TD, I learned as we put the headphones on for the podcast today that you've got a bit of a backstory in breakdancing, but that is one we'll do for another day.
Monica: I missed my chance to be in the Olympics, but you know...
Ingrid: You’ve got to pick your path...Monica, speaking of which, let's… let's continue on that theme around the Canadian market. So what are the areas - in the context of what we're talking about, rate cuts, productivity, etc. - what are the opportunities you see in the Canadian market? Like what's exciting you right now?
Monica: So I think Justin laid the stage in terms of the US being probably in a stronger economic position than maybe we thought with better economic data, employment data. Canada's kind of on the other side of the picture, we've seen a pretty notable increase in employment with the last number going from 5.8 to 6.1. Inflation's been a bit weaker and so I'd say we're probably on the front leg or closer to the later innings when it comes to the rate cuts. So in terms of sectors that we're looking at, certainly top of mind would be the Canadian banks, really important sector, 20% of the TSX. And so we always have our eyes focused on this. And on one hand, I think in the context of fairly anemic growth in Canada, it's easy to overlook the sector because you can kind of think of banks as levered plays on the economy. On the other hand, you have to really be forward looking and look beyond this year into next year and also put the valuation. So this year we're expecting flattish growth of the banks. But if we think we are in the later innings of this story or the cycle that it should stand that provisions are peaking, we know that banks are being very aggressive around expense controls and then loan growth is normalizing. So expect that within some amount of time, whether it's 12 or 18 months, banks reverting to their historical growth pattern of 5 to 10% earnings growth, plus a fairly juicy dividend up.....
Ingrid: Yes, and I think that's a really important point because I think as an equity analyst and PM, you think about where a stock is relative to other stocks and you think about where it is relative to historic multiples. And, you know, I meet with investors all the time and I tend to think about it in terms of the alternatives where we see so many people investing. And I think we're getting to a point now with the dividend yields on the banks and you can look at all the money that's sitting on the sidelines in GICs and is it's actually very compelling story. Can you talk a little bit about that?
Monica: Certainly, when we think about or talk about rate cuts, often top of mind would be bonds. We also talk about bond proxies like the telcos or utilities. But actually it stands to benefit other sectors as well. And I think of banks being one of those because if you look on average, they're yielding about 5%, now. That's fairly juicy compared to where we think rates might go if we do see rate cuts. But on top of that, you have to remember that if you have money in a bank and banks are kind of levered to the economy, they grow in line with the economy. That capital that you have should grow over time and over the long term if you are kind of a long term investor.
Ingrid: And from a relative valuation perspective they are still attractive right now ...
Monica: Banks are still trading at discount to historical Price/Earnings multiples, historical price to book multiples...
Ingrid: Are there other sections of the Canadian economy that you'd want to ... err ... the Canadian market landscape that you want to talk a little bit about what else is exciting you?
Monica: One area that we're looking at quite a bit are the rails. So two big ones in Canada, CP [and] CN, in 2023 was a challenging year for them because they had labor strikes, there were forest fires and then we had this inventory destocking cycle. And so as you look forward to 2024, a lot of those factors are normalizing. And so it should set out for a much more constructive year. What we've heard from management teams is that volumes have bottomed already, we're past the bottom and that it's really a revenue story at this point.
Justin: You one thing I'll mention just on the rails, I mean, the good news for for a lot of these sectors is that everything that we talked about two, three years ago related to COVID and supply chains and all the issues the global economy was having, I mean, we're beyond that. It's no longer in this story. It's no longer being discussed. And so that is the one nice thing when you think about a lot of these industrial companies and a lot of the transports is we're operating in a somewhat normal environment. I mean, we do have issues that come up and, you know, the Red Sea is one in the Baltimore Bridge is one, but in general, it's just nice to be beyond all the supply chain issues that were plaguing us a couple of years ago.
Ingrid: And it's funny. And, you know, you talk about the Baltimore Bridge situation. I remember the words we used in (the) COVID (pandemic) , but, you know, the sort of the transient supply chain issues and the transient inflation. And that turned out to be really, really sticky. But I think those ones truly are a little bit more episodic where you can see a beginning and an end and, you know, it's just got to work its way through the system. I want to turn back to you, Justin. I know that's been a real narrative and you quoted some headline numbers around market performance, but there's been this narrative that just a handful of stocks have been driving market returns. And your team, I don't know, has… has really bought into that narrative quite so much. Can you talk a bit more about that?
Justin: If you look back at 2023, you know, it really was a story of the haves and the have nots. And we talked about this, I think a couple times last year. And, you know, seven stocks, the seven largest companies in the U.S. generated something like 75% returns for the year and everyone else generated something like 13% returns. And so it really was and I think it was a podcast that you named “A Tale of Two Cities,” and that really was it this year, I would say at the beginning of January, we were looking at it and it was the same old story. And then towards the end of January, something changed, and you just started to see signs of things broadening out. And then I'd say if we looked at our portfolio today and if Monica looked at the stocks that are doing really well in her portfolio, Damian Fernandes and Ben Gossack, across their portfolios, they'd be looking at companies in industrials and companies in energy and companies in materials. A lot of these companies have blasted through all time highs and are making, you know, fresh highs every single day. And so it is interesting because, you know, you still Nvidia still she gets a lot of the headlines but beyond Nvidia, it's no longer the 'Mag Seven' that's driving things forward.
Ingrid: The ones that had the really pure revenue line tied to the AI revolution you now string the productivity piece start to kick in right?
Justin: Absolutely
Ingrid: Talk a little bit ... I started to go down this path now on the conversation on productivity. And the Bank of Canada has warned that, you know, weak productivity and some low business investment are going to become a real challenge for the Canadian landscape. We've heard recently, you know, announcements around large federal investment in AI. Can you talk a bit about that story in Canada?
Justin: Look, Canada has an opportunity here. We have what I would call a legacy platform in AI in Canada, and it revolves around a lot of the educational institutions and the research they've done. And from that you've had spinoffs of private companies that have been funded by venture capital, by the government.
Ingrid: Or acquired by large entities like ourselves...
Justin: Or acquired by larger companies. And one of the things that's happened, though, is we haven't yet built out, you know, this pure play AI public company. So a lot of really good things happening in the private sector. When I think about the benefits of AI to the Canadian economy and Canadian markets and companies, I don't think it's… it's necessarily going to be a revenue generator.
Justin: What I'm looking for is - things more related to how can companies become more productive? How can AI over the next, I'm not just talking 6 to 12 months, I'm talking 6 to 12 years, help companies expand their corporate margins by becoming more and more efficient.
Ingrid: Maybe, Monica, let's…let's go a little deeper on that - like where in Canada? Where do you see the opportunities coming out of this, like this macro trend, really?
Monica: Justin's absolutely right. I think in Canada, we're not going to be the in NVidia’s or Microsofts of the world. That's not our role. But I think AI has a big piece to play in terms of the cost story for a lot of Canadian companies. So take for example, banks. If you think about AI, where it can help, it can help on the margin in terms of fraud detection, underwriting, credit evaluation. That's not necessarily a revenue generating opportunity, but it can certainly make the bank a lot more profitable. Another example would be the retailer. So you think about the retailers in Canada being the grocers or the dollar stores, for example.
Monica: AI can help in terms of inventory management and their working capital. That's a huge benefit as well.
Ingrid: So beyond the trends then from an AI perspective, is there any other things in the Canadian landscape, Monica, that maybe people aren't thinking about or aren't worrying about that You know, you keep top of mind when you think about our Canadian equity mandates?
Monica: So when I think about the conversations that we've had with advisors over the field, the thing about always comes up are banks and energy. And that makes sense because 50% of the market are in those two sectors. But I think the thing to remind ourselves about Canadian equities in the Canadian market is that we have these really high quality sectors or high quality companies that I think are often overlooked, but probably worth a bit more work or probably want to keep an eye on. And so a few examples of that. One would be waste management. We view as just a high quality industry because it's highly fragmented. It's an essential service. It's a very .... small cost but high need. So every municipality needs waste collection, but it's small relative to the overall budget. As a result, very strong pricing power. They're pretty durable growth. They kind of grow GDP plus. And then on top of that, they're consolidating the industry. So easily, kind of double digit growers. Another example would be dollar stores. So we know that consumers are pinched in this economic environment. So whether it's dollar stores or discount grocers, we've seen this trend of consumers trading down. So that's a huge tailwind. But also as you think about the value proposition of dollar stores, at least in Canada, very different in the US, but in Canada, typically the largest chains are within a kilometer of most Canadians.
Monica: They offer price points that are 50% below Walmart or Amazon. And so that's been a huge kind of secular tailwind where we continue to see these dollar stores opening up.
Ingrid: And I think it's a really interesting story because often we when we look at investors, we've been advisors books. Often our advisors are holding, you know, the classic Canadian securities that you've spoken about, the banks, the telcos (telecommunications), the utilities, but really being invested more broadly in funds is giving you access to some of these really high quality, high growth sectors that aren't typically what you'd be thinking of, and you're getting that really diversified. So I think that's really that's a really useful insight. I want to pivot, as we always do, to the Rapid Fire section. And no, you don't get away with a one word answer. You got to give me a little bit of a theme here, but I think, you know, when we put these together, we're trying to get to the topics that really matter to people that are truly affecting people's lives in their portfolios. So, Justin, first to you. Let's talk about Canadian housing.
Justin: Okay. Canadian housing.
Ingrid: Not enough of it.
Justin: Yeah, that's well, that's the long term issue. And look, we we've been spoiled in Canada as homeowners. People who have owned homes have seen significant appreciation over the last couple of decades. And, you know, last year, for the first time in probably 15 years, you saw the value of your house decline. It wasn't a huge amount in most cases. I think, you know, low single digit depreciation in the value of your home. But it was a little bit shocking and you could sense the panic entering the psyche of the homeowner, the good news is earlier this year, we haven't seen a continuation of the panic. We've actually seen some firming. And it's a result of the expectation that the Bank of Canada will cut rates and it'll make that affordability piece a little bit easier. I mean, the big tug of war going forward and it'll continue is going to be supply demand imbalance and not enough homes for the population that we have and the folks that continue to to come into our country against the affordability and affordability is dictated by real incomes and interest rates. And if interest rates start to head back down and we see a re-acceleration in the economy, the real incomes can be held up as well. And so longer term, you know, I would expect housing to continue to pace along with GDP-type growth. But this year in particular, I think the fluctuations will be dictated by Bank of Canada and interest rate cuts.
Ingrid: Yeah. I certainly think, you know, for our demographic, when we bought our houses, we were actually at a much higher rate environment, but our houses were a fraction of the price back when we did it as well. And you know, I've got four kids in their twenties and thirties. One of them is on the property ladder and I quite frankly don't know in Toronto how the rest of them will ever get there.
Ingrid: But...
Justin: I'm terrified...
Ingrid:... of money going into the markets.
Justin: I've got three kids and I'm terrified.
Ingrid: …we've got two sides. Let me tell you all about it. There's only one way to keep that from happening. Let's talk, Monica, now about the Canadian consumer debt, the financial stress with that.
Monica: So one word answer is it's flashing yellow. It's certainly an area of concern. And I would say it's so keep in mind, a lot of that debt is investment, so debt being in homes. And so when we think of that, we often think of loan losses with respect to banks. That's not the area that concerns me and for a few different reasons. One is that if you look at the average Big Six Canadian bank, these homes are held at 50% loan to value. So Canadians have a lot of equity in their home.
Monica: Secondly, 40% of those mortgages are insured. So by CMHC, for example, where it does concern me is on the margin the impact to Canadian consumer spending. So we talked earlier about this trend of Canadians trading down. Well, there's only so much you can trade down to if rates continue to be high, if inflation persists. And so I say flashing yellow because it's an area that we're watching.
Ingrid: Yeah. So, you know, we're all going to feel it individually. But, you know, from a market perspective, it's not it's not a red hot button yet. Okay.
Ingrid: Last one. And just you're going to love this question, our love affair with GIC's over the last year.
Justin: Ah, Yes. And we'll go into the conversation I had with my father two years ago and he didn't listen to me. But GICs, in a way, it's a similar conversation to the to the housing piece, because once again, we're in this 15 year period where we could guarantee rates, We could get a guaranteed rate of 1% or 2%. And then all of a sudden we see the fives flashing in the fours flashing, and maybe, you know, you could get the six flashing as… as the guaranteed rate on a GIC. And I get it. There was a there was appetite for that. There was fear...
Ingrid: Well, the psychology was that it was happening at a time when the bond market had readjusted, which meant even in the most conservative portfolios, you were seeing negative returns. And if I look at my statement and see red and I see somebody offering me 6% to the good, I totally get it, too.
Justin: Absolutely. And so, you know, there was obviously a huge appetite and GICs have been gobbled up, You know, I think one of the big questions is going forward, what, you know, how does this play a role in your portfolio? And and look, I'm going to leave all that to the advisors. But what I will say and and what I do continue to to kind of advise to my folks is if you're looking out beyond a few years, you want inflation protection because it doesn't look like inflation is coming back to 0 to 1% anytime soon. And the asset classes that are going to be able to protect that erosion in your purchasing power are probably not GICs. It's probably some combination of equities and fixed income and probably alternatives. And those are the types of asset classes where you're going to generate returns that are going to allow you to gain in excess of a...
Ingrid:... a Real return, as we say.
Justin: A real return.
Ingrid: And I think that's the pieces appealing of the rates are in a world of 3-4% inflation. That's actually not going to get you where you need to be in the long run. Justin, Monica, thank you so much for your time today. It's great to have a little focus on the Canadian market. I know, Justin, you went a little broader in North America. We can't go without it. But thank you both for being here today.
Justin: Thanks for having us on Ingrid.
Monica: Thanks, Ingrid.
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