Introduction

[Short video of a stock market chart arrow moving in an upward trajectory with upbeat music play in the background. Magnifying glass appears and becomes the “o” in Sherlock’s Clues. Full title comes into focus, Sherlock’s Clues – Insights on Investing & Economics with the investment philosophy below “Investing Success: Powered by Process, Fueled by Discipline, Rewarded by Patience.”]

 

[Aaron Sherlock, dressed in a suit, is sitting in his office]

 

[Speakers: Aaron Sherlock and Greg Valliere]

 

 

Aaron (00:11)

Hello and welcome to another episode of Sherlock's Clues. As always, I am your host, Aaron Sherlock. And on today's episode, we are going to talk tariffs, trade, and the global economy. I have with me today special guest, Greg Valliere. Greg is the chief US strategist for AGF Investments and brings with him over 40 years covering US policies, in particular, the Federal Reserve. Good morning, Greg.

 

Greg Valliere (00:38)

Good morning. Great to be with you.

 

Aaron (00:40)

We had a little failure to launch with some technical difficulties earlier this week, but I think we have things pinned down now.

 

Greg Valliere (00:47)

Great.

 

Aaron (00:48)

So for the listeners out there, Greg is based in Washington and he's currently in Canada, in Toronto. Assuming you're having a day of meetings there to talk about all the things happening in the world these days.

 

Greg Valliere (01:00)

It's been quite a stretch. Living in Washington, DC for the last 50 years has given me a lot to talk about, but the last few weeks have been just extraordinary.

 

Aaron (01:10)

You certainly have a storied career. Maybe before we dive into the details, give the listeners a little bit of a background on where you came from, what you accomplished over your 40 years and how you landed at AGF.

 

Greg Valliere (01:23)

Well, my grandfather was born outside of Montreal, hence the French last name, and the entire family moved down to New England, to New Hampshire, 100 years ago. So I'm a native of Northern New England, lovely spot, but long, long winters, which I guess you just have to get used to in this part of the world. I've been a good friend of Kevin McCready for...

 

several years. Kevin is our CEO and our chief investment analyst and he's great. Really, really sharp guy and he brought me on board. I was honored. He brought me on board to AGF seven years ago and I've had a blast. It's a great company and I have had so many incredible stories to cover. Political stories that have been just remarkable over the last several years.

 

Aaron (02:08)

Would you say the last seven years have been slightly more complex or interesting compared to your previous, say 30, 35 years?

 

Greg Valliere (02:18)

Yeah, it's been quite a ride. You've got to say this has been highly unusual. Our political instability in the US has been depressing. And in particular, I've got to say, Aaron, the US-Canadian story is depressing. I have always viewed Canada as fabulous country, great people, beautiful country. And here we had Donald Trump picking a fight.

 

with Canada and it is unlike anything I've seen in my career.

 

Aaron (02:48)

Well, to some of the listeners out there that don't know this, I'm a dual citizen. My father's from New England and my mother is from Canada. So I have relatives on both sides of the border and get to talk with them frequently over what's happening. And it doesn't seem like too many people are terribly pleased, even stateside, with how Canada is being treated currently.

 

Greg Valliere (02:56)

Yep.

 

Yep. I agree.

 

Aaron (03:10)

Well, I think that's a natural lead into the first topic, which I think we should cover is the elephant in the room. And that's a review of the tariffs which have happened. saw liberation day come and go. We've seen the art of the deal and its workings and the impacts which it's rolled out through Canada and the rest of the world. Would you mind just recapping that a little bit and maybe sharing a few of your thoughts, particularly on the impacts?

 

Greg Valliere (03:18)

So, yeah.

 

Thank

 

Aaron (03:40)

For Canada?

 

Greg Valliere (03:41)

Well, I would start by saying it's hard to know what to believe anymore. It's very, very frustrating as an analyst. I know a lot of policymakers. I know a lot of the issues, but they change all the time. I Donald Trump and some of his top advisors have said one thing in the morning and they said another thing in the evening. And this was quite dramatic during April. It's not quite as bad now.

 

I think that Trump and his advisors realized that they were so strident on going after Canada and many other countries that it really did have a negative impact on the financial markets. And I think that the markets have thrown at Trump a real lesson that you can't confuse the markets or the markets will get their revenge.

 

So first and foremost, I think the markets have won this battle, at least for now. Do we continue for a long time without a deal? I doubt it. I think as we get toward the end of the summer, there will be a deal. Trump seems to be getting along with Carney a lot better than he ever got along with Trudeau. So I do think we'll get something done, but it's not imminent. I think Trump has so much on his plate.

 

It could be well into the second half of this year before we get anything done.

 

Aaron (04:54)

Yeah, and you mentioned that it's so hard to believe what you're hearing on the news. It seems like there's a constant evolution with everything. If you can call it evolution, maybe that's a little too polite. Now you did touch on there potentially being a trade negotiation between Canada and the US or some sort of agreement by the second half of the year, but maybe let's touch on the trade balances between Canada and the US. It seems like this whole tariff tirade was based around

 

trade deficits with other nations. Canada, export a lot of our goods to the US. So maybe could you unpack that a little bit?

 

Greg Valliere (05:28)

Yeah, complicated issue. I would say that there are some legitimate complaints on both sides. I would say that there is a case to be made that Canada does not contribute to NATO as generously as many other countries would like to see. That's been a persistent issue between Trump and Canada. There have been issues on auto parts and trade going back and forth between borders. There's been an issue of

 

illegal immigrants going north into Quebec and other parts of Canada from the US. So there are a lot of issues that have to be resolved. But my sense is that this is not as personal a fight as it was with Trump and Trudeau. I think they genuinely did not like each other. I think Trump can get along with Carney a lot better.

 

But I wouldn't hold my breath on getting a big new contribution to NATO. That's going to be a sticky issue.

 

Aaron (06:22)

Well, once upon a time I was a military reservist and I know that almost 20 years ago, people were discussing about how everything was deteriorating and falling apart in the Canadian Armed Forces back then. It doesn't sound like things have improved much since then. I think the rest of the world got a bit of a wake up call with the Russia-Ukrainian conflict, particularly Europe with that massive package that Germany was proposing to roll out. I think the US was kind of the world's police.

 

Now other countries are being forced to stand on their own two feet. We can argue the merits of that back and forth. But touching on Europe, what do you think the implications of this trade war are for more Western European countries?

 

Greg Valliere (07:03)

Great question. I think that much of Western Europe has capitulated. I think they realize that there are a lot of issues where we're going to have to become more conciliatory. So that probably is a good story. But again, that will take a while as well. I the first sign of real progress, as you know, was the deal we had with the UK. And I thought that was encouraging.

 

And I think there'll be a lot more deals to come. But it's important to note that most of these trade deals take months and months and months to resolve, maybe longer, maybe a couple of years. These trade deals give you the worst ice cream headache that you've ever had in your life trying to figure out how to get these done. So we could be talking a year from now, right here, and they still would be sort of the same.

 

There would be some compromise, things would be moving along, but I would be reluctant to say we're going to get trade deals done anytime soon. They're going to take a while.

 

Aaron (08:01)

Okay, so we're kind of touching on the future outlook as to what these tariffs could do to international trade. Maybe let's backtrack and discuss how we got into this place a little bit. Just going back too many years to my university economics courses, as economies and countries develop, they turn away from manufacturing and more towards consumption-based societies.

 

The US moved away from that post-World War II and kind of offshored most of its manufacturing when it had strong ties to China because they had cheap labor costs. Do you see there being an ability to walk that back significantly or is this just to try to nearshore or bring manufacturing back to friendly nations for key components that are more essential to industry and essentially semiconductor business and technology companies?

 

Greg Valliere (08:32)

Yeah.

 

I think there's real anxiety in the Trump administration over the enormity of the U.S. budget deficit. And Trump feels that the deficit can be virtually eliminated through tariffs. I would say that is very dubious. Hard to make the case, in my opinion, that we're going to eliminate that. And I would worry more that we'll get inflation.

 

and we'll get slower economic growth, both in my country and in Canada. So I feel that Trump, for his entire life, thought that we should have trade protectionism. Again, I think it doesn't make a lot of sense, and all it's done is create uncertainty.

 

I mean, you and I have been doing this for so long, we would have to agree that the one thing the financial markets don't like is uncertainty. And that's what we have now with tariffs.

 

Aaron (09:41)

Well, you can't plan around uncertainty. can either downsize, make efficiencies. If it's negative uncertainty, if it's positive uncertainty, well then you can plan, or sorry, if it's to the upside, you can plan for expansion. If it's to the downside, you can look at cutting back and making things more efficient. If it's uncertainty all around, things are paused. You can't do anything with uncertainty.

 

Greg Valliere (10:03)

I think in the administration, there's a coarseness that has been very disappointing in terms of how the US has treated Canada. I think that you'd have to look at all that Canada has done with the US, sending firefighters to Southern California last year, defending us in various wars.

 

over the decades. The U.S. and Canada was a really truly special relationship and to see this ingratitude right now is quite disappointing.

 

Aaron (10:32)

I wanted to touch on one thing you just mentioned there and that was inflation. That's kind of been the word for the past several years. We just had Walmart come out and say that cost of things is going to rise. We had Home Depot say that they're likely not going to increase prices. believe Walmart sources over 70 % of its goods in Southeast Asia or China. And Trump said he doesn't want them to raise prices. He wants Walmart to eat the cost increases.

 

Walmart runs on razor thin profit margins, their net income margins and the low single digits. If you get your cost of goods rising by 35-45%, there's not much that you can do but pass that on to the consumer. What are your thoughts on that and the impact on some of the major retailers?

 

Greg Valliere (11:02)

Yep.

 

Yeah, my thought is that we're going to see higher prices. We're just at the beginning. We're in chapter one of a 12 chapter novel. And I'd say we're now in an environment where companies will not eat it. mean, Donald Trump is not a dictator. He can't say to US businesses, you have to eat these cost increases. And I do think prices will go up.

 

Certainly for autos, that's the most blatant of all the examples of how Americans may have to spend an extra $4,000 $5,000 for a new car. And I think that has a trickle-down effect for all of the auto parts manufacturers. This is going to slow economic growth, in my opinion. I'd like to think that Trump will...

 

will change once again. He's been very fickle on the subject, but we now are in the environment where, again, we're at the beginning of an inflationary period, and I do think that will persist for a while.

 

Aaron (12:16)

Okay, so we've touched on a lot of the high level issues here. When we start to look at the economy and dissect that, what does it look like for employment? We've obviously seen the headlines come out that consumer confidence is wavering a little bit. had disappointing employment numbers in Canada here where we lost, I believe, what was it? 31,000 manufacturing jobs directly linked to the tariffs. What do you see happening in the United States?

 

Greg Valliere (12:43)

Well, we have, I have to be fair here. We have, even I've been critical of a lot of Trump policies, but I've got to say the US labor market is astonishingly resilient. Our unemployment rate is, I think, 4.4%. We see in many parts of the US an acute labor shortage. I have friends in California who tell me they can't find workers. They can't find anyone to fix the roof, to do gardening.

 

there's a real shortage of labor. And I think that the US labor market will stay pretty good. The US economy is growing moderately, probably growing at, I don't know, one and a half percent, maybe a little bit more. But we're not in a recession. And a year ago today, there were many experts, including Lawrence Summers.

 

the former treasury secretary in the US who said incessantly that we were headed for a recession. Every day he'd say we're headed for a recession. Well, here we are now in the middle of May, a year from then, and we still don't have a recession. I think we're gonna have slow growth, but again, the US economy is remarkably resilient.

 

Aaron (13:52)

What are your thoughts on the immigration policies? know you mentioned some of the more of the labor oriented jobs, whether it's farming, construction, gardening. Do you think that's going to have an impact on that? Because I know that we are hearing anecdotally from farmers across the US they can't find labor to help them with their crops.

 

Greg Valliere (14:12)

Yeah, it's a good point. And I think that will continue. At some point, I think there'll become a realization that we have to be more sensible, more moderate on this. They cannot continue to throw people out of the country in sectors where these workers are crucial. There's gotta be a balance and we don't have that right now.

 

Aaron (14:33)

Okay, so we have

 

currently relatively stable inflation. It's been declining since the beginning of the year. We haven't quite seen the price shock. We have full employment What does that mean for the Fed? The Fed seems to be put into a bit of a pinch right now where you have Jerome Powell looking and saying, well, we have a tight labor market. We might have inflation coming back if these costs are pushed through to consumers. What do you think the outlook for potential rate cuts is?

 

Greg Valliere (14:39)

Not that.

 

What a thankless job Jerome Powell has. That's a rough job that he's got right now. He has to balance so many conflicting interests. I think that he has been sincere in saying that we don't know right now. It's still going to take a few more months to see where the economy is headed. And therefore, he is unwilling to make any policy move precipitously.

 

I think that there's very bad blood between Trump and Powell. They don't get along. They don't like each other. And I think Trump would love to fire Powell. But he knows after all of the rhetoric in April and March and April, he knows you can't go after the chairman of the Federal Reserve. The markets get nervous to hear a president going after the Federal Reserve. So I think Powell

 

As the economy maybe settles down a little, I think that Powell may be able to have one or maybe even two rate cuts between now and the end of the year. Maybe a rate reduction in late summer, early fall. Maybe another rate reduction in late fall, early winter. I think two is the most we can hope for. I'll take it. But for now, here we are in May. I think it's still too soon for Powell to...

 

to make any decision until he gets more data.

 

Aaron (16:19)

I completely agree and I think Powell's done a very good job over his tenure. I believe he was appointed by Trump in his first term, was he not? And now Trump's coming back and insulting him, essentially saying he wants to take over the Federal Reserve. There's a separation between the two. You cannot have someone in government running the Federal Reserve. Looking at some of the breadcrumbs as well, today the housing news just came out.

 

Greg Valliere (16:26)

Yes he was.

 

Exactly.

 

Aaron (16:45)

that the US April home sales fell to its lowest level for the month since 2009, just after the great financial crisis. I'm looking at that saying, all right, is it consumers being kind of paralyzed with fear? Is it 7% 30 year mortgage rates? Is it not having enough certainty about what's happening in the future? Or is it a combination of all of them? And if you get a couple of rate cuts and you get down to the

 

We'll say mid 6% to high 5% 30 year mortgage rates. Maybe you see the housing market unlocked, but we all know the housing market contributes substantially to the US economy.

 

Greg Valliere (17:23)

Yeah, and I would add one other factor, Aaron, and that is Trump over-promised. Trump said, we'll get the inflation rate down very quickly. We'll keep the economy in great shape. You we'll end the war in Ukraine in one day. And he made absurd promises. And I think the American consumer was expecting to see a rapid improvement, and we haven't seen it. Inflation has gotten a little bit better.

 

But it's not great. It's not where the Fed wants. The Fed, as you know, looks at this indicator called personal consumption expenditures. And PCE has still been a little too high for Powell. So I think that Trump has over-promised. And that is one of the reasons why Trump's job approval rating is mediocre.

 

Aaron (18:11)

All right, I agree with that and we could continue down this thought process, but I did want to jump on the China conversation. I know that that's the biggest trade deal which they're looking at. I know that there's been a 90 day pause now. Do you think there's any sort of resolution or is this just kicking the can down the road?

 

Greg Valliere (18:19)

Sure.

 

I am not an optimist that we're going to get a resolution. I think that there's great antipathy toward China in my city, in Washington. Both Democrats and Republicans are suspicious of China. There's almost, as I say, almost unanimity that China doesn't play fair, that they spy on everybody. They are not transparent on things like COVID. They want to...

 

expand in the South China Sea. And the list goes on and on and on with what China has done. I don't think there's going to be looking at a conflict, an armed conflict. I think Xi has too much on his plate to even think about that right now. But I don't see any big breakthrough on trade. I think that's going to last for a very, very long time. Trump is hard to read on China.

 

He says, always Xi is a good friend of mine, we'll get a deal done. But I think he likes to say that, making people think that better days are here to come. But we're a long way away from any kind of meaningful resolution of US-China trade issues.

 

Aaron (19:30)

All right, we've covered a lot of topics outside of the US. I think I'd like to switch gears to what's happening inside their own house. And that's with their deficit spending. We've currently had some issues with that. What was it? The US currently was spending at a 6% of GDP deficit, which is essentially 6% stimulus to the economy. It impacts everything from inflation as well as GDP and other expectations. Would you mind unpacking that?

 

Greg Valliere (19:39)

Yep.

 

It's a tough one. It's a very tough question to deal with Aaron. And first of all, the deficit with all the spending cuts that we've gotten in the last few months from Elon Musk, who has made a little progress, he's sort of nibbled at the edges with all of these cuts. It's it's barely made a dent in our U.S. budget deficit. The deficit continues to rise in this fiscal year that ends on September 30. The deficit will probably be over one trillion dollars.

 

And we're now at 36 trillion total U.S. debt. That is not sustainable. There has to be some really tough action, but I haven't seen it. The politicians are terrified of taking action that could cost them their next election. They don't want to do anything too provocative, too courageous that would anger the voters. So I think the deficit will continue.

 

unfortunately to rise until the politicians are willing to get tough on Social Security, Medicare, defense spending, maybe a need for some tax hikes. I give Trump credit. He raised the issue on taxes of taxing the wealthy. The Republicans were incensed. They were stunned that he would say that. But there's going to have to be something dramatic, either taxing the wealthy or going after these entitlement programs like Social Security.

 

because the status quo is not working.

 

Aaron (21:22)

was just about to ask you if you had any thoughts as to where they would cut. Most people don't even want to talk about Social Security or Medicaid. The Elon Musk conversation as well. What did they come out and promise? $2 trillion worth of savings. The last numbers I heard were $50 billion. Is that about what you had heard?

 

Greg Valliere (21:29)

Right.

 

Yeah. Yeah.

 

Yeah. I mean, it's nothing to sneeze at. I would take it as a holiday gift from anybody. But I think that there's no courage on the part of the politicians to really go at this. If you were to ask me for a really optimistic scenario, I would say maybe we get economic growth a little stronger than we've seen. Instead of one and a half, good Lord, if we got two and a half.

 

That would make a difference. It would reduce the deficit by a lot. It's something that could start to make me a little more optimistic, but I don't see, in fact, after all this angst that we've seen over the level of budget cuts in the last few weeks with Trump demanding budget cuts, with the House demanding budget cuts,

 

We're arguing over a budget deal that still will leave us with an extra trillion in deficits in this fiscal year.

 

Aaron (22:31)

Politicians like to spend, they don't like to save. Now, if you would mind, could we turn our attention to Canada? I know we just had a recent election. We just had a delay in the Canadian budget, so we don't even really have a roadmap for what our outlook is. Do mind sharing your thoughts on that?

 

Greg Valliere (22:34)

Exactly.

 

Yeah, I don't follow that as much as I follow the US, I must confess. But I think Canada is not in as bad a shape as the US. I think one thing that Canada has that the US doesn't have is tremendous natural resources, coal, oil, things like that. But I see in your country also an unwillingness.

 

to go after the deficit. No politician in either of the two countries wants to really take off and cut the deficit because they will not get re-elected.

 

Aaron (23:24)

fiscal austerity does not get you reelected. Greg, we could talk about this stuff all day long. I just wanted to give my listeners a little snippet of what's happening between the US and the rest of the world and touch on Canada here. We're coming up on time and I would like to thank you for joining me. I know you have a busy schedule in Toronto with I'm sure many hedge funds and large institutions to talk to after this.

 

Greg Valliere (23:27)

No.

 

Well, this has been great fun. I've enjoyed the dialogue and you obviously really, really know what you're talking about. So to that regard, it's refreshing to hear anybody in this milieu talk as intelligently as you. So I've enjoyed it greatly.

 

Aaron (24:05)

Well, I'll thank you very much for those kind words. To all the listeners out there, if you want to learn more about anything economic between Canada, the US, and the rest of the world, you can go to my website, which is aaron.sherlock@cibc.com, or you can Google Sherlock Wealth Management. I'd be happy to talk more about it. Thank you.

 

Greg Valliere (24:25)

So long.

 

Outro (24:25)

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Sherlock's Clues Podcast (Ep.13) - Infrastructure Investing in Turbulent Times

 

[Aaron Sherlock sitting in his office, wearing a suit]

 

Aaron (00:11)

Hello and welcome to another episode of Sherlock's Clues. As always, I'm your host, Aaron Sherlock. And on today's episode, we are going to get an update from the infrastructure expert himself, Andrew Maple Brown. Andrew was on my webcast last year. For those of you who hadn't listened, we are going to get an update on what has transpired over the last 12 months. But a brief background on Andrew, he brings with him over 20 years of infrastructure investing.

 

and he is co-founder and managing director of Maple Brown Abbott listed infrastructure. Good morning, Andrew.

 

[Andrew Maple-Brown appears, and he is in office]

 

Andrew Maple-Brown (00:45)

Good afternoon, Aaron.

 

Aaron (00:46)

8 AM right now in Australia. I appreciate you taking the time out of your schedule to have a conversation with me.

 

Andrew Maple-Brown (00:52)

And thank you very much. Really appreciate the opportunity to get to speak with you.

 

Aaron (00:55)

For the listeners who hadn't seen our first webcast, I am a large supporter of global infrastructure as a non-correlated asset class across most of my portfolios. So I thought I'd take the time to talk with Andrew to get an update on what's happened in that asset class. I'll pass it over to you, Andrew. Could you maybe give us a little background on Maple Brown Abbott and then we'll get into a few more of the talking points.

 

Andrew Maple-Brown (01:21)

Yeah, absolutely Aaron. So, Maple Brown Abbott was actually first started by my father as an Australian equities firm with his partner back in 1984. So, the firm's been going for over 40 years now. The history with the List infrastructure business though is a bit more recent. Myself and my partners started it in 2012. So, our business is effectively a boutique within the broader boutique. The infrastructure business is majority owned by myself and my partners.

 

and our investment team. And as I said, it's been running now for a bit over 12 years.

 

Aaron (01:56)

So you come by it honestly, you were born into it.

 

So I guess I'm talking to the foremost expert then. Maybe you could give us a little reminder as to the Maple Brown Abbott process. How you look at investing in infrastructure and then maybe define infrastructure a little bit because I know in Canada people just think pipelines, power lines and utilities.

 

Andrew Maple-Brown (02:18)

Yeah, absolutely. So our starting position is that we believe that infrastructure deserves a strategic asset allocation within a portfolio. We believe that because we believe it has differentiated investment characteristics. Specifically, it's the low cash flow volatility and the natural inflation linkage that the asset class can provide. If those characteristics are important to investors as we believe that they should be, we believe it's critical that they're focused on

 

throughout the investment process. So in terms of the assets that we're looking to invest in, we're looking to invest in assets with the strongest combinations of those two characteristics. So low cash flow volatility, so defensive investments and natural inflation linkage. So the opportunity of what we're looking at, about half what we look at are regulated utilities. So we invest in regulated gas, electricity, water companies.

 

about a quarter of transportation assets, so investing in toll roads, airports, railway track, and similar assets, and the final quarter assets subject to long-term contracts, so assets like pipelines, renewable assets, and telecommunication towers. So there's quite a broad range of assets and certainly a very large opportunity set globally, very significant value and very large in

 

investment needs going forward. So a very large and growing asset class for us to look at.

 

Aaron (03:36)

I can certainly attest to a couple of points you made there with regards to reducing volatility, low volatility in cash flow. certainly does complement a portfolio made up of publicly traded equities when markets get more volatile. That's how I certainly use it within my practice. Now, it does seem like the infrastructure space is evolving. It seems like electrical utilities are certainly getting a little bit more

 

attention than they did before. They are predominantly regulated on the consumer side of things. Maybe touch on that a little bit and we can get into a few more of the, we'll say, more interesting topics that have arisen over the past 12-24 months.

 

Andrew Maple-Brown (04:15)

Yeah, absolutely. And I think that's one of the, I suppose, the exciting things about working in an asset class like infrastructure is that it is so essential for society. And we are dealing with some of the really important thematics of our time. One of them, as you touch on, the electric sector has actually got a couple of them. Decarbonisation, I'd argue, is a huge,

 

investment thematic and the electric utilities are in the middle of that and very happy to talk about that. But the other ones obviously around AI and data generally, communications generally and infrastructure assets are incredibly important for that. In relation to AI in particular, data centers are extremely energy intensive and so have very large electricity demands and that's seeing some really exciting opportunities.

 

within the regulated electric utility space, particularly within the US. Just to give you one example, Meta recently announced their largest data center ever, which is down in Louisiana. This data center is absolutely massive. It's costing about $10 billion to build. At its widest, it's about one and half miles wide. So just a huge footprint. But that has a really significant impact.

 

on the electricity needs of that region. So the investment opportunity is extremely significant as a portion of its rate base in the specific utility in which it sits. It's about 20%. So it's going to grow that company by about 20% just by that individual data center announcement by Meta.

 

So the magnitude of these investments is obviously very large for the tech companies and for the data center owners, but it's also extremely large for the electric utilities, which are tasked with providing this reliable energy that's required in order to supply those data centers.

 

Aaron (06:01)

Well, just looking at my notes here right now, the size of this facility that Meta is constructing is 4 million square feet. That's spectacularly large. Some of the knock-on impacts, 500 direct jobs, 5,000 construction jobs at its peak. It's going to consume, was it 2 gigawatts of electricity?

 

Andrew Maple-Brown (06:21)

a lot.

 

Aaron (06:22)

According to the back of the napkin math, is what? One and a half million households worth of electricity.

 

Andrew Maple-Brown (06:28)

Correct.

 

Aaron (06:29)

That kind of infrastructure and power generation certainly doesn't come on overnight. Maybe we got ahead of ourselves a little bit, but let's dive into it. What kind of trends are you seeing in the infrastructure space? We might as well continue down with the electric utility conversation.

 

Andrew Maple-Brown (06:43)

Yeah, I mean, it is broader than the electric utilities. I think that the world is rapidly, or has been realising and continues to realise that the size of the investment need across our various asset classes, whether you're talking water companies in terms of replacing pipelines and the importance of protecting that precious resource, avoiding leaks and so forth.

 

Whether you're talking roads, urban roads in particular continue to become more congested and so the investment need in terms of widening or tunneling and so forth is very large. On the electric utilities, yeah, there's several themes driving that and it really is, without wanting to get too excited, it's a renaissance in that sector. The growth is quite astounding.

 

Electric utilities or utilities generally are normally constrained in the amount that they can grow really due to the amount that the customers can afford. Typically growth in demand is quite subdued. The electric industry historically has seen growth well under 1 % per annum. And so if your load is only growing by that amount then it's difficult to grow the asset base without bills becoming unaffordable.

 

bills regulators generally are seeking to keep bills bill increases below the rate of inflation The big change here though is is that you're seeing a massive increase in demand from from you know from particularly from the data centers right now  but if you look further into the future, there's there's other drivers as well. There's in the US or North America generally It's on shoring of manufacturing is very positive

 

but then you've also got the electrification of transport firstly, but also electrification of industrial processes and potentially residential and commercial. And so there's multiple drivers of demand which is going to result in electricity demand growing well above historical levels, we believe for several decades and that's really providing or enabling

 

this significant increase in capital expenditure in an affordable manner, which is so crucial. So the need for investment is never ending and the need for investing has only increased partly through providing for this increase in electricity demand like the Meta data center, but also very much around the transition of the network as it looks to decarbonize the retirement.

 

of coal plants, which are generally largely depreciated, so have a pretty low current value within the rate base and replacing them with new generation, whether that's renewables or gas or into the future nuclear. But it's also investing in the grid, enabling this more intermittent energy to be provided in a reliable manner requires more transmission, more batteries, a more complex distribution grid. So huge investment needs.

 

which can now be affordable because of this demand growth. So it's an exciting time for the electric utility sector in particular.

 

Aaron (09:40)

Well, you touched on two different angles of which the infrastructure space as a whole will need additional funding. One is the maintenance capital and the other is the expansionary capital. These publicly traded entities are coming to market with billions of dollars they're looking to spend into these data centers, which certainly must be putting some tailwinds behind these infrastructure businesses, particularly utilities.

 

when it comes to updating their legacy assets, which they have, and upgrading the grid, because as we hear every day on new source XYZ, we need more electricity, or sorry, we need to upgrade our grid to handle the load we're putting on it. So it seems like it's coming from multiple different angles, which is usually a pretty good place to be if you're a utility.

 

Andrew Maple-Brown (10:25)

Yeah, absolutely. And I suppose the follow on, if I can ask a question for you, then what does all that mean for us as shareholders? And I think it's exciting for us as shareholders. Historically, the utilities may have been able to grow their asset base in an affordable manner for customers at sort of 4-6% type rate based growth. So the rate base was growing at sort of 4-6%.

 

That would have required a little bit of equity issuance. So historically, utilities used to have a nice dividend with probably sort of a 4-5% growth rate. What's happening today is the rate base of a lot of these companies is growing in the high single digits, 9-10% type numbers. And that's not for one year, that's for their five year forecast. And on our estimates, we'll continue a lot longer than those five year forecasts.

 

If you're growing your rate base at say 8 or 9%, you may need 2-3% of equity issuance, but resulting in earnings growth of sort of 6 to 8%. And that's what we're seeing most of the product, average US utility these days, was historically used to have an EPS growth rate of 4-6% is now showing a sort 6-8% growth rate. Still with a nice attractive dividend.

 

But that's been sort of the change in the utility sector from just being a dividend payer with a modest level of growth to still being a dividend payer, but now being quite strong growers across the market more broadly.

 

Aaron (11:58)

Another benefit for them more recently is declining interest rates. know most of them have long-term locked-in termed-out debt, but people are looking forward. They're saying, few interest rates have come down some. It is an interest rate sensitive sector. That is just another cherry on top to the investment thesis. Let's dive in a little bit as to where we are in the infrastructure cycle.

 

I know we just talked about the need for all this capital to be spent. Let's look at where we've been in 2024, how it's evolved over the past five years. Like you said, things certainly have changed and potentially entering a new era and where the category is going in general.

 

Andrew Maple-Brown (12:46)

Yeah, absolutely. And there's this, I suppose, multiple facets to that question. So I'll try to do them justice. In terms of the underlying assets, I'd argue that they've performed as we would have expected. Infrastructure assets, they're not companies which typically provide you earning surprises. And if they do provide significant earning surprises, then they probably don't meet our definition of infrastructure.

 

So probably shouldn't have been included in the first place. And I'm very pleased to say we haven't, I can't recollect any such significant surprise. So the companies themselves continue to have stable, predictable cash flows and earnings. And that's exactly the types of companies that we're seeking out. In terms of how they perform, in terms of investments,

 

The last 12 months or 2024 was a good year for global equities generally. Growth continued to be robust. We didn't see the recession that people feared. so global equities generally performed strongly. In that environment, infrastructure would typically be fine, but it doesn't.

 

doesn't see as much upside in strong markets as you'd expect from global equities. So the sector did lag slightly global equities, but I'd suggest still had a positive, or certainly had a very positive year from performance, still had a very acceptable level of performance. In terms of when the sector typically outperforms, it's obviously in the more challenging environments. 2022 was a clear example of that.

 

global equities had a significant fall really around in particular inflation concerns and the inflation protection inherently within infrastructure assets positioned in very good stead. So whilst 2024's performance numbers were considerably stronger than 2022 for infrastructure, 2022 was pretty flat. On a relative basis, 2022 was a very good year relative to global equities.

 

Aaron (14:55)

In Canadian dollar terms in 2022, your mandate was up mid single digits. So we don't need to give out specific details, but yes, very strong when you're looking at markets which are down double digits.

 

Andrew Maple-Brown (15:06)

Sure.

 

yeah, our sector is always difficult to describe from a performance perspective, because in absolute terms, last year was was was the stronger year. But in terms of relative terms, yeah, last year lagged a little versus global equity. So so depending on your perspective, yeah, from my perspective, 2024 was it was it was a totally, you know, was was an absolutely acceptable year.

 

In terms of, think, the third aspect of your question was really about how the sector is evolving. And firstly, as I mentioned before, we're absolutely seeing huge demand for further infrastructure across pretty much all of our existing sectors.

 

So the existing sectors are seeing, continue to see very strong growth in the investment needs on the existing assets. In addition to that, there continue to be new areas of investment that get people question as to whether they should be viewed as infrastructure assets. And one example I'd give for that is probably data centers. So data centers has obviously been a very large area of investment in recent years.

 

And a number of people would include that then as within a definition of infrastructure. Back to what I said about our process, our approach is very much focused on the assets with the strongest combinations of low cash flow volatility and natural inflation linkage. Because our view is that the reason you hold an infrastructure investment is because of those differentiated characteristics.

 

For us data centers, having looked at them very closely, don't exhibit those characteristics. To us, they are more like industrial property. So whilst they may be very good investments, the rent is much more based on market demand and supply. Whereas infrastructure assets, we're typically investing in genuine monopoly or duopoly assets, which have stable predictable

 

pricing or have pricing power enabling that stable predictable pricing and very stable demand structures as well.

 

Aaron (17:01)

Well, I watched a few of the REITs that are tied towards data centers and when the DeepSeek news came out, they certainly did not perform like your traditional infrastructure investment. For those of you don't know, DeepSeek was a competitor to ChatGPT out of China and it certainly turned the market upside down for a few days.

 

Andrew Maple-Brown (17:22)

Yeah, yeah, absolutely.

 

And just to expand on that, we actually wrote a white paper on the data centers. And again, not trying to trash the data centers. There been some extremely successful investors into that space, but they don't have the characteristics that we're looking for. And we went back and looked at the rentals achieved over the last 10 years. And whilst the rentals for data centers have gone up a lot over the last couple of years, for the preceding five or so years, they actually went down.

 

quite a bit. So a much more cyclical type asset which for us is a more general equities or a rate type investment, not an infrastructure asset.

 

Aaron (17:58)

sure we could keep talking about data centers, AI and electricity demand tied to that. But there's other topics to cover here. For instance, decarbonization of the grid. Would you mind going down that and discussing how that's evolving? Then maybe we'll dive into the outlook for that area.

 

Andrew Maple-Brown (18:15)

Yeah, absolutely. Decarbonizing the grid, obviously, there are different perspectives around the world in terms of how quickly that should occur, but pretty well, globally, we're seeing a transition of the grid. And part of that is economics as well as decarbonization goals. So renewables, onshore renewables,

 

in most markets do provide an extremely competitive form of generation. The opportunity, we believe, is huge. Our expectation absolutely is that the world will continue to look to shut down coal as quickly as possible. The investments that are required in order to enable that and even more so now that electricity demand is growing.

 

So it was a huge investment need when electricity was flat, but from an electric utility perspective, doing it in a reliable and affordable manner at the same time whilst electricity demand is growing, the size of the investment has just increased. So in terms of what that looks like, our expectation continued, retirement of coal continued.

 

investments in onshore renewables pretty much as fast as they're able to be delivered and they have been delivered slower in most markets than people were expecting and hoping. A result of that is more investment into new gas, the combination of renewables coming on slower and at the same time electricity demand growing. Batteries, further investment in batteries although the batteries, it's becoming more apparent I'd argue that the batteries

 

don't solve the reliability issue, particularly as the renewable penetration gets higher. So we really need technologies with longer duration storage. And that's also putting a greater focus on nuclear in terms of having carbon free generation, base load generation, which nuclear can do so well. The challenge with nuclear is building new nuclear in its existing traditional form.

 

is extremely expensive and you saw that the US completed Vogtle of the last 12 months which is the first completed new nuclear in the US since the 1980s. The cost of that was multitudes of what had originally been expected when units three and four of that plant were initially planned. So the hope for nuclear is really SMRs, so small modular reactors. Can that make nuclear affordable?

 

But regardless of how the technology develops, the investment need into the new generation and also into the transmission and distribution networks is massive and very exciting from our perspective.

 

Aaron (20:42)

I'm very glad you brought up nuclear because it seems like it's the elephant in the room that no one wants to address. People look at the disasters which have happened over time and they get scared away from it. Several nations in the EU have moved away from nuclear, much to their detriment, I would argue. It does seem like it is the way forward and the small modular reactors certainly seem like they're quite useful, lower cost and easier to

 

put in strategic locations.

 

Andrew Maple-Brown (21:10)

Yeah, absolutely. I think countries like Canada who have existing nuclear are extremely fortunate. Nuclear, from my perspective, is a fantastic form of energy generation. The only problem from my perspective about nuclear is the cost of building new nuclear and that's what the recent large reactors, or at least in Western countries,

 

have been extremely expensive. Vogtle mentioned, Hinkley at the moment, has been built in the UK. huge cost overruns, huge delays, time overruns. The cost is arguably prohibitive. So we really need SMRs to come to fruition. I know there are other reasons people resist nuclear, but from my perspective, if you have nuclear, you keep it running as long as you can and you expand if you can.

 

But new nuclear, we need to find a way to build it cost-effective effectively.

 

Aaron (22:04)

Well, I think we're looking into the future here now. And on that note, maybe let's touch on the outlook. know over the past few minutes, we've talked about the outlook for several of these different areas, but maybe let's cover a couple of different topics. Where do we see the infrastructure class going over the next 12 months? What do you think the economic outlook could be and any sort of macroeconomic?

 

facts you want to drop in there as well.

 

Andrew Maple-Brown (22:29)

Yes, certainly. It's always difficult predicting what markets will do over the short term. From an infrastructure perspective, we feel very comfortable. We feel that the valuations are certainly not stretched, that they're fair and we see some good opportunities within individual companies. We believe that the significant interest rate movements have already happened.

 

And as you referred to earlier, that can be a headwind, particularly when real rates increase. So if it's because inflation is increasing, that is generally fine for our infrastructure assets because a lot of those companies have their revenues linked to inflation. So there's an offset. But when it's real rates rising, that is the more challenging scenario for infrastructure assets. But our perspective is that rates have already reached

 

What we see is longer term normal rates. They're very similar to the bond yields that we utilize within our investment models in valuing the companies. And certainly, if the world were to hit some challenges and there's plenty of potential risks out there which could cause that, we believe that defensive nature of the instructor assets.

 

would put it in very good stead. So yeah, no specific concerns from our perspective in relation to the asset class and generally view it as being pretty well positioned in the current environment.

 

Aaron (23:48)

You echoed most of my thoughts there. Infrastructure is a core holding across all of my portfolios for just the reasons you had mentioned. its a hedge against inflation. its lower volatility. its a non-correlated asset class or lower correlated asset class to publicly traded equities and performs well in times of volatility. Myself personally, I do believe that interest rates might

 

see a little bounce around, but we're not going to see the same kind of heights that we had a couple of years ago. On that note, I guess we could wrap up. I'd like to thank you for joining me, Andrew. I know you've got probably a busy day ahead of you. To all the listeners out there, if you want to learn more about global infrastructure and how to position it in your portfolio, please reach out to myself at Aaron.Sherlock@cibc.ca, or you can Google The Sherlock Group to get in touch with me.

 

Thank you.

 

Andrew Maple-Brown (24:36)

Thanks Aaron.

 

Introduction
Short video of a stock market chart arrow moving in an upward trajectory with upbeat music play in the background. Magnifying glass appears and becomes the “o” in Sherlock’s Clues. Full title comes into focus, Sherlock’s Clues – Insights on Investing & Economics with the investment philosophy below “Investing Success: Powered by Process, Fueled by Discipline, Rewarded by Patience.”

Aaron (00:10)
Hello Giuseppe, how's it going today?

Giuseppe (00:10)
Hello, just sent you another call today.

How about how are you, Aaron?

Aaron (00:14)
Good, good. For the listeners out there, Giuseppe is a familiar face. try to bring you on every quarter to unpack the complex world of macroeconomics and we certainly have a lot to dive into today.

Giuseppe (00:26)
Without further ado, we've got we've got quite a long list of things to cover here, But maybe we'll start off with the topic du jour that is tariffs

Aaron (00:27)
Without further ado, we've got quite a long list of things to cover here, but maybe we'll start off with the topic du is

Giuseppe (00:34)
You know, we hear what the markets are saying. We hear what the news is saying. Probably more hectic and volatile than what's actually happening. But in terms of tariffs, like the threat of tariffs, and I know we discussed this before, the threat of tariffs is real. That the impact to economies generally are negative. Economic theory is going to say tariffs are bad for the economy in general. And I think we're seeing it a little bit in the market reaction of this in the U.S. and globally.

But I think, you know, we all think this in terms of what the U.S. government is trying to do is use tariffs as a negotiation. Obviously, you know, if I think about U.S. centric, they want to be, you know, the leaders across the board is obviously a threat from China. There's threat globally. And so they want to bring back manufacturing. They want to bring back jobs. They're trying to do what they think is best for their economy.

One of our economists here at CIBC Asset Management who worked for the Bank of Canada, who's actually our head economist, extremely intelligent individual, he kind of modeled out what the tariff scenario would be globally. So if tariffs hit globally, what's the potential impact? And so in terms of economic growth, the economy that's hit the hardest is China.

The economy that's hit the third highest is the U.S. And the economy that's hit the fifth hardest is Canada. So in essence, if Trump continues with tariffs, and this is tariffs continue and stay on for a longer period, let's say 6-12 months, in terms of North America, the U.S. is the one that's the most hit economically. And I think markets in general have kind of reacted to that. That's why you've seen this.

know, March this decline in U.S. equity markets, they're pricing in, okay, what's the impact to earnings and earnings growth? We've got this stellar performance in U.S. equities, right, for the past decade here, minus COVID. And so, you know, investors are concerned and they should be. Do we think that, you know, tariffs, say Canadian tariffs, Mexican tariffs, tariffs in Europe are gonna be...

Something that's that's long term no, we don't think that we think that this is more of a negotiating tool to open up the USMCA and negotiating tool to restructure some trade deals and to win off some of the reliance that Some economies had towards China. So I think that's that's thinking. Yeah

Aaron (02:49)
So you just.

just wanted to jump in. You

mentioned the USMCA, which was the last trade agreement that Trump had negotiated in his previous term. And he said that was a tremendous victory and it was the best deal ever. Now he's coming out and crumpling that up and just throwing it in the garbage. Uh, maybe touch on that little segue here.

Giuseppe (03:16)
I laugh just in the sense that we've to remember that everything Trump does or doesn't do is tremendous and amazing. And we've to take that a bit with a grain of salt.

Aaron (03:24)
Those are very polite words.

Giuseppe (03:26)
Yeah, exactly. So, you know, like Trump is doing what he thinks is right. The USMCA when it was negotiated, we unpacked that when it was negotiated, we re-impacted it as a reminder in November when he did win the election. Yeah, there were some things that were better for in terms of trade deals for the U.S., but largely the changes were marginal. And so he takes that as a victory. That's fine because negotiating these big deals are extremely difficult.

There's a lot of levers, a lot of individuals involved. There's a lot of repercussions on different markets. So any negotiation to these deals can be seen as a victory. Was it a tremendous victory for any one deal? In economic sense, no tariffs, free trade across the board is the best for economic growth in theory. So I think it goes back to his posturing, posturing to say, we're the biggest economy in the world.

We don't need anybody. You absolutely don't need anybody, if you think about energy, you've been leveraging Canada and using Canadian energy to profit not only Canada, but also the U.S. So it's been mutually beneficial. And I don't see that going away. It's been too beneficial for both economies.

Aaron (04:31)
Well, I find that an interesting point that you just brought up where cheaper Canadian resources or where resource rich have benefited the U.S. When people think about tariffs, they think that it's going to be detrimental to the U.S. Well, U.S. has been buying cheap oil from Canada. Trump says they've got enough lumber in the U.S. Well, they've been getting a significant portion from BC and our massive forests in Canada for a very long time.

Giuseppe (04:51)
This way, we will have this process again.

Aaron (04:56)
I've heard this said from a other economists, we're complements to the U.S., not competitors. We provide them with the goods and services they need to then create the products for their own population. it's almost contradictory what he's trying to say that we've been taking advantage of them. It's almost like they've been taking advantage of a lot of our natural resources and maybe we have had some trade policies in place which benefited Canada and were protectionist mainly in our agriculture space.

think this is a good lead into clearing the air on Canada. You hear the headlines in the U.S. saying Canada has been taking advantage of the U.S with their own tariffs for years. Could you touch on that a little bit?

Giuseppe (05:34)
And I think you're bang on there. Like the tariffs that we have in place, they're also like a tariff, say for dairy industry. There's an amount that has tariffs for us to protect certain industries. And just think about COVID, COVID where, know, pre-COVID, we're talking about globalization and post-COVID, we're saying, okay, well, for national security, we need to come back to manufacturing certain goods for ourselves.

And so that's Canada's rationale that was always Canada's rationale for certain industries. That being said, in terms of trade, it's been mutually beneficial. And you can argue it's been somewhat more beneficial to the U.S. when we're talking about some of our energy and minerals materials. Like you said, lumber, for instance. I go back to energy because oil is traded, is sent to the U.S. at a discount. And then they refine and then they export.

And so when I think about the goods that are being exported to the U.S., a lot of them, yeah, it's raw material, but also a lot of them are intermediate goods. And so where you get the most bang off of your dollar as an institutional, as a corporation is really that finished good. Who's been benefiting from that finished good? Well, the U.S. has. So not to say that Canada hasn't, we have as well, because we're providing raw materials, intermediate goods. But the U.S. is the one who largely benefits from that.

at the finish good stage. And so that's not talked about, right? As a politician, what they do best, right? And they're gonna position themselves so they're have a specific posture to make themselves, you know, right? Or look more beneficial and let people, others less beneficial. I think that's what Trump's doing right now. Not to say that he's wrong on all counts. I'm sure there's deals here where there's a middle ground. But I think the concern is that you've got a world where

tariffs slow down economic growth. And so we're just coming back from an environment, really high inflation. know, people are renewing mortgages, it's getting tighter on the belt. Unemployment starting to take up in the U.S. and starting to take up in Canada. So there's that concern. but maybe we kind of pivot here into interest rates in the Bank of Canada. Well, globalization has the benefit of providing

Aaron (07:29)
Well, globalization had the benefit of providing

lower cost of goods. You were able to export your labor and manufacturing to areas with cheaper lumber. Now, or sorry, not cheaper, cheaper labor, not lumber, my mistake.

Giuseppe (07:34)
lower cost of goods, you were able to export your labor manufacturing to areas with cheaper labor. Now, or sorry, not cheaper, labor, cheaper.

Bringing that all back home. That's not necessarily going to be the same. It's not the same cost. That's correct. So there is a definite inflationary period with tariffs with deglobalization.

Aaron (07:46)
that all back home, that's not necessarily going to be the same, it's not same cost.

Giuseppe (07:59)
So the de-globalization effect, if we do buy into this theme, that's more of a, I would say a longer term inflation impact, where you have the impact and it remains for a longer term. Tariffs from some econometric models that we look at, and this is not proprietary to us, it's across the board, we're looking at a two year impact on inflation. And so we don't wanna bring this word back that we kind of...

transitory. We don't want to say that word because, you know, that was the 2020-2022 that didn't end up being transitory. But there is forces that can potentially increase inflation, talking about tariffs, de-globalization. But there's that growth component. The growth component across the board was weak in Canada, was weak in Europe. We talk about rates being cut. That's going to help.

economic growth, but when there is weaker growth, prices normally come down as well. And so what we're thinking, you know, what can expect in the U.S., at least in terms of growth is you've got these past five years of really exceptional above trend growth in the U.S. That expectation is that it would come down. So you have this counterbalance effect. You've got increased inflation because of tariffs. You got the counterbalance slower growth.

We got the counterbalance where a good chunk of inflation was also coming in the last few years due to tight labor. Well, unemployment's coming back up. Doesn't mean that we're in a dire situation. We're just going back to a balanced situation. I want everybody to be employed. I want everybody to have jobs. But there's a healthy number where unemployment makes sense for the economy so that the labor market isn't tight and prices don't start to skyrocket because of the labor.

I think we're in a world that we're just getting back to a balanced situation. Here in Canada, that's where we're seeing unemployment ticked up. It's not necessarily a bad thing, it's just a renormalization back to what we've seen in a normal environment.

Aaron (09:46)
I think those are all some pretty interesting points. Going back to my economics 101, it was cost push inflation or demand pull. You think that we're going to see maybe cost ratchet up a little bit, but demand perhaps moderate some due to slightly weakening economy.

Giuseppe (09:46)
I think those are

was cost push inflation or demand full. And you think we're going to see a cost rise a little bit, but demand perhaps moderates some due to slightly meeting the

demand. That's absolutely right. And I'm sure your economics teacher were impressed that you were listening in your classes. But yeah, that's exactly it.

Aaron (10:12)
Ha

Giuseppe (10:14)
At least a U.S.-centric story where growth is going to come down. think Canada's growth is a little challenging in the really short term, there's a positive outlook, minus tariffs, but there's a positive outlook going forward in the next 12 months in Canada. So central banks, think in Canada, Bank of Canada, cutting rates, I don't think they had a chance to. They saw inflation coming down. That was their window. So cutting rates to increase growth over the next 12 to 18 months.

That's normally the lag when rates are cut or increased. There's normally a lag 12 to 18 months relative to the economies. So I think the Bank of Canada did a fairly good job still cutting. We saw that earlier this week. We expect continued cuts. But another thing that's happening that, you know, where there's a lot of stress in the Canadian economy is real estate, right? We talk about these housing prices supply that's limited. And so we look at

not necessarily as a forecast, but as an indicator, we look at permits, how many permits are given out for construction. And so that number skyrocketed in the past six months. And so what happens after permits? Well, construction happens after permits. And so we're expecting that the government of Canada has been doing a lot of work there to help increase the supply and reduce the potential inflation impact that we've had over the past few years.

due to the real estate market, due to rents, due to housing. And so an increase in construction, because it's a big chunk of our, know, sizable chunk, it will help once again increase that economic growth on

Aaron (11:45)
I heard a statistic a while ago that 30% of the GDP in Canada touches the housing and construction market. Not that 30% is made up of those segments, but 30% touches it. That's a tremendously large part of our economy that we absolutely have to support.

Giuseppe (11:47)
All right.

Yeah, and that's probably right around that that's I wouldn't be surprised if it's that much like obviously look at housing What are the what are the? The materials that are needing the labor that you need, you know, there are the the the resources and so Looking at a standalone doesn't seem big. But when you look at all the components

terms of piecemeal, it's quite sizable in terms of economic activity. We think about China, how they've stimulated their economy over the past two decades. It's been through real estate and infrastructure. know, obviously they it a little bit differently, but regardless, you see how that propelled that economy. And so not to say that Canada is going to be the next China. That's not what I'm saying here. I'm just saying that construction real estate does benefit the economy in a positive way.

Aaron (12:50)
Okay, so we did lean into the interest rate conversation here a little bit, centered around Canada. The U.S. just this week came out and said they're holding rates steady. They had an inflation print that wasn't as severe as we would expect, but tariffs really haven't shown their teeth yet in the economy. What are your thoughts on the Federal Reserve and what they're going to do with interest rates?

Giuseppe (12:51)
you

Yes.

Yeah, and I think it's the big question that we're all asking ourselves, or we keep asking ourselves, obviously, you know, when we're talking about rates or even on the bond market, everything is relative to the Fed and the U.S. bond market. And so when we think about Jerome Powell's comments this week, you know, he keeps talking about growth. His concern is growth. And so what's the mandate for central banks? And again, I might have said this in other calls, but

The two things for central banks is to keep inflation low and make sure unemployment is at that balanced level or low. And so you've got these two pillars now that, okay, inflation is coming down, but it's still elevated. Growth is coming down. So the reaction is that unemployment might take up. And so if the central bank, if the Fed is expecting inflation to stay sticky or they're put in a tough place because they can't cut rates.

And so the sentiment from Powell was more on toward tilted towards growth, which, you know, over the past five or five years, we've talked about more. He's talked about more about inflation. The fact that he's talking about growth kind of signals that, there might be cuts coming sooner than the market had priced previous to his comments. And so we saw that in the market, the market wasn't pricing many cuts. Now they start back pricing some cuts later on in the next 12 months. So there is there is a potential for rate cuts in the U.S.

It's not a slam dunk because of, you said, like you mentioned that inflation factor that's somewhat elevated partially due to tariffs, but we can see a reversal in terms of Trump, in terms of tariffs in Canada, on Mexico, once a deal is negotiated potentially on Europe as well. I don't see a reversal in China. know that, you know, Trump is talking to Xi Jinping, so there may work out a deal. again, I don't see.

tariff is completely being eliminated from China. Maybe it's summer reduced or there's a target or some sort of negotiation there. But I do see a tariff elimination in the next three to six months for Canada, for Mexico, and a negotiation of the USMCA.

Aaron (15:07)
I absolutely echo your thoughts on that. think that Canada provides the raw goods and materials. Mexico provides the agricultural support for the U.S. You can't tariff both of them and have a presidency who promises inflation to be low and stable, all while having an independent Federal Reserve. I'm not envious of Jerome Powell heading that. He certainly had quite a gauntlet to run over his tenure.

With that said, seems like Europe's had a little bit more of a cohesive thought when it comes to inflation and what their banks are doing. They're starting to look at it a little differently.

Giuseppe (15:42)
Yeah, exactly. obviously, the Europe area is a little bit different if you're talking about specific countries, but broadly, they too have cut rates. But economic growth was, you know, post this last German fiscal announcement, but economic growth in Europe was weak and it is still relatively weak. And so what's the stimulus for renewed growth in Europe?

Fiscally, there hasn't been many fiscal packages and the fiscal package that would come out would be out of Germany, which is exactly what was announced. And so this huge fiscal package that Germany announced a few weeks ago, we can't understand that because that's a huge package. And if it gets ratified and then happens at that huge level, the growth in Europe can be surprising. We saw equity markets, international equity markets.

outperformed U.S. equity markets in the first quarter, or as of right now. And so if we still see this momentum going and we see Germany kind of reviving the European Union or Euro in general, that could be huge, huge tailwinds for them.

Aaron (16:38)
If haven't just outperformed North American markets, they've crushed them. They're double digit positive. U.S. markets are in correction territory. I think part of that is a mean reversion. Europe's been ignored for so long. Valuations at some point in time do matter. You can't continue to ignore them forever. I do think Europe has some tremendous businesses over there as well. U.S. isn't the only game in town and people are just catching on to that.

Giuseppe (16:39)
They haven't just outperformed North American markets, they've crashed them. They're undoubtedly doing positive. U.S. markets are corrupting too.

Yeah,

think you're on like we talked about by valuation I think as as fundamental analysts, you know, that's the core of what we do We're looking we look at all these ratios. We look at fundamental analysis with evaluations and we say okay. Well international equities have been cheap

Canadian equities have been broadly fair value, slightly cheap. U.S. equity is extremely overvalued. And so as a portfolio manager, it's okay, when do you pull that trigger? And so I think the missing word is catalyst. You can have a valuation or an economy or a country or a currency or a stock that's undervalued for an extended period of time and you're waiting on that catalyst. I think that's what we got in Europe.

We got that catalyst. This is the catalyst that, you know what, one, the market's been wanting, but not really expecting because it just hasn't happened. The fact that it was somewhat of a surprise, I think, market participants' didn't expect it we're happy to have that and say, now there's a rationale to get back into international equities. There's a catalyst there for future growth.

Aaron (18:05)
Absolutely. Future growth as we've learned certainly benefits from printing what 500 billion Euro defense packages. Shifting gears a little bit. What do you think the outlook could look like from let's start with the Canadian viewpoint then move to the U.S. and back to Europe and then maybe wrap it up with a global view.

Giuseppe (18:11)
billion.

Yeah, so I think if we start from the Canadian, think broadly over the 12 months, we're positive. Obviously, like tariff talks can always derail that view. But I think there's a positivity in Canada. think cutting of interest rates is going to help when there's this, know, a lot of remortgages right now happening. So there are higher prices, but I think the fact that rates have come down, it's going to be somewhat helpful.

Aaron (18:46)
How many more forecast interest rate cuts are there for the Bank of Canada this year?

Giuseppe (18:51)
Yeah, there's two to three right now. Yeah. For the next 12 months. And so economists come back and forth, back and forth. A lot of it's going to wait. You know, if you're on the tariffs are going to be longer, you're to have more rate cuts. Tariffs are going to be shorter. It's going to be less rate cuts. Right. That's pretty much the end of the game. When we look at the U.S., we're still thinking about positive growth in the U.S. It's not about negative growth. It's positive growth. It's just below that trend growth. And so

Aaron (18:52)
Okay.

Giuseppe (19:15)
the U.S. has been way above that trend growth. And so we're expected to come down closer to 2%. And so that might, that reaction is gonna be towards, you know, the risk asset, which is U.S. equities. If we do see inflation stickier, then once again, like we talked about, Jerome Powell is in a really tough situation. It's not always gonna be the best for the bond market or the equity market, to say.

Still positive growth. We're not saying that we're going to see this huge decline in U.S. equities. I don't expect that right now. I know soft landing is what we said in the past or what we've heard in the past. That's what we're expecting. We're not expecting a recession right at this point in time anywhere. We're just moderating the growth. We're going back to more of a balanced global growth.

Aaron (20:00)
Well, didn't the Federal Reserve just come out and cut its

GDP forecast for the year from 2.1% to 1.7%, which is still quite strong. It's still in that 2% band that they want to see. But people are so used to seeing recession thrown around in the news these days.

Giuseppe (20:04)
See you guys later.

Yeah,

think that's the reaction, the individuals react to say, hey, slower growth means recession because it's been always strong growth for the past little bit here. So I think it's just a renormalization right now.

We follow a couple of indicators that help us assess what future economic growth is going to be, and then obviously related to markets. And so there's some more pessimistic views. And it's tough because that's always related to tariff talk. And so as fundamental investors, yes, tariffs are for us used as scenario analysis. We don't know what exactly is going to happen on tariff. And so to model tariffs and actually take action on it right now,

We're a bit more cautious because Trump can come April 2nd or April 3rd and say, oh, okay, you know what? We negotiated with Canada, the border's secure. We've got a better deal. Tariffs off the table. So it's trying to assess the impact on tariff and making a high conviction decision on it. It's not, I would say it's probably not the best approach. Once you have that higher conviction, then you can take action.

But right now it's somewhat hearsay. It's all up in the air. It's volatile, just like the stock market has been this year. Well volatility provides opportunity in my world. guess we're going to get some more certainty on your world, when is D-day April 2? Yeah, around there, yeah. I forget if it's 2nd or 3rd, but yeah. So in terms of Canada, the U.S., what do you think happens for Europe and the world as a whole?

Aaron (21:32)
Well, volatility provides opportunity in my world. I guess we're going to get some more certainty on your world. What is D-Day, April 2nd?

So we've covered Canada, the U.S., what do you think happens for Europe and the world as a whole when it comes

to these tariffs and what Trump's trying to accomplish with them?

Giuseppe (21:57)
I want to kind of ask you about Europe.

That's another risk factor. so, you know, that was also a positive catalyst this year for international equity markets to say, okay, if there is a ceasefire, if there's, you know, this end resolution that Trump has promised between Russia and Ukraine, that could be also positive for international equity markets.

I think that there's still going to be continuation in terms of conversations on how we can get that war resolved. I think once again, that stimulus package is huge for that European economy. And then I think there will be some sort of deal between Europe and the U.S. we're hearing, know, Mark Carney and

European leaders talking and so maybe there's another deal with Canada and Europe. And so that's all without saying there will be some political volatility this year. You know, if there is a snap election that, you know, was in the news yesterday. So keep in mind, it's going to be a busy year. I love to have that crystal ball. I'm sure you do too. But that's why we do what we do. That's why we're on markets, you know, almost 24/7 here, just trying to assess, dissect what's happening in markets and respond accordingly.

Aaron (22:59)
Well, I think if there's anything positive that comes out of this, pushes other countries outside of the U.S. to work together, to put our differences aside and say, okay, how do we benefit and how do we build a stronger relationship? trying to put a positive spin on things. With that said,

Giuseppe (22:59)
Well, I think if there's any pause that comes out of this, it pushes side and the other side to work together. Putting our big, big eyes, how do we benefit from this? trying to respond to

Aaron (23:17)
Giuseppe, we've covered lot today. We've covered tariffs, inflation, further trade wars, geopolitical issues, global economies. Is there anything else that you think we should cover right now or is that about all you wanted to talk about?

Giuseppe (23:18)
Aaron, I think we can go on for the full day talking about different topics, but I think for today, think that's enough for today and happy to come back on next quarter.

Aaron (23:40)
Alright, well, look forward to that. For all the listeners, if you want to learn more about how to position your portfolio for tariffs or geopolitical events, please feel free to reach out to myself at aaron.sherlock@cibc.ca or you can Google The Sherlock Group. Hope you have a good day.

Outro (23:40)
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Introduction
Short video of a stock market chart arrow moving in an upward trajectory with upbeat music play in the background. Magnifying glass appears and becomes the “o” in Sherlock’s Clues. Full title comes into focus, Sherlock’s Clues – Insights on Investing & Economics with the investment philosophy below “Investing Success: Powered by Process, Fueled by Discipline, Rewarded by Patience.”

Aaron (00:10)
Welcome to part two of my conversation with Ghislain Maillet from JP Morgan. Just a quick refresher, Ghislain has 25 years of experience in the financial markets and recently joined JP Morgan. Good afternoon, Ghislain

Ghislain Maillet (00:24)
Good afternoon, Aaron. Happy to be here.

Aaron (00:28)
To refresh listeners who might have missed part one, do you mind giving us a little bit of background on your experience, who you are, and who JP Morgan is?

Ghislain Maillet (00:38)
Well, originally I'm a New Brunswick boy from Kent County. I did my bachelor's in accounting at the University of Moncton I did a master's in economics in Europe and Paris. I joined Fidelity Investments in January 2000 and I've spent 24 years and seven months there. And four months ago, I joined JP Morgan to lead off their efforts to, well, JP Morgan has been in Canada for 43 years or so.

dealing with institutional clients, they finally decided to open up their doors to the retail market, but via financial advisors and portfolio managers such as yourself, Aaron. So they got an old wolf to help them put JP Morgan on the east of Canada map.

Aaron (01:23)
Like I said in the first part, I don't think old is quite right there yet. It looks like you have many years left. But I'm very happy to have JP Morgan's mandates on my platform to provide access to my clients with.

Ghislain Maillet (01:29)
I hope so. I hope so.

while we are equally thrilled about this partnership. For sure.

Aaron (01:42)
Well, so we covered a lot of the macro outlook in our last conversation. Macro is always very fun to talk about, taking the big picture of what's happening in the world economically. And now we're distilling it down towards how to make actionable investments. Would you mind talking me through the JP Morgan process? And I know you do have two mandates here with myself at CIBC with Gundy.

One is a JP Morgan US Core and the other is US value.

Ghislain Maillet (02:14)
Okay, well let's start with what we believe is our advantage. So the beauty of investing via an asset manager like JP Morgan Asset Management is that for one, we take advantage of tremendous advantage of scale. So we manage over $3.5 trillion, of which a trillion of that is in equities. And that gives us the ability to hire more analysts, do more research, have more access

to the grand majority of portfolio managers and asset management firms out there. Basically, think of it this way. JP Morgan is the largest financial institution on the planet in terms of market cap. If we call up a company because we're interested to invest, you can imagine that we're going to get a call back. But after that, it's these equity professionals you see at the bottom left. These equity professionals are not like

People that comment on news, no, they're the one that actually analyzes the business in great detail. So what sets us apart is that since we're growing fast, we're already big, we are one of the rare firms that are actually growing our research capabilities in a world where a lot of firms have abandoned even the objective to beat the markets and they go more passive and they get rid of analysts.

We're in a world where pretty much five companies in the world are growing their research capabilities, whereas hundreds of others are either stagnant or on their way down in terms of research capabilities, in terms of equity analysts. So we're definitely proud of that. And the other thing I'll say about these people is that

People don't leave JP Morgan. A lot of the analysts, and if you ask Aaron for some information, you can see the actual full list of analysts directly involved in those two SMA mandates only available at ICS, CIBC Wood Gundy today. They're a large team and the average analyst experience is over 20 years. So highly tenured.

very experienced, specialized in their sector, and they've gone through the market cycles. They've seen new management takeover companies. And that brings a form of wisdom to these stocks that helps them see through the noise. So we're quite proud of the research organization, that's for sure.

Aaron (04:59)
I certainly enjoy hearing stories about equity research getting the support it deserves. I'm certainly biased given my equity research background.

Ghislain Maillet (05:08)
That's right.

The other thing I'll say is that we're getting into the nitty gritty here, but most firms you become an analyst to grow your way up to become a portfolio manager. And that is a path that is available at JP Morgan.

But they have another path called career analyst. So if you really love, if you have an analytical mind, you really love your sector, whether it's healthcare, consumers, technology, and there's many others, you want to specialize for the long term, we allow our analysts to earn as much money as a fully diversified portfolio manager, which gets all the spotlight. And that's how we've kept our people. Independently which

path they want to take.

Aaron (05:54)
They certainly are two different skill sets. Well, without diving into that too deep, could you touch a little bit on the research process at JP Morgan? I know we have two mandates in particular we're going to speak to. They are going to differ some, but could you give us a high level view as to how the research process looks and whether there's checks and balances in place when you're adding or subtracting positions to either portfolio?

Ghislain Maillet (05:59)
Hehe.

Absolutely. for one, the end result of the work of an analyst that is assigned to cover, let's say 15 stocks or 30 stocks, and if it's smaller stocks, maybe 40, 50, but it doesn't go much more than that, is to give them a rating from one to five or the quintiles. Rating number one would be the most attractive stock. It's a combination of, well, the most important factor.

that determines if a stock's gonna do well. There's many factors, but the most important one is profits. Because if you're gonna be a business, if you're gonna own a stock, you're gonna become a business owner, there's nothing that adds value to your business than more profits. So getting the three-year earnings outlook is one of the biggest job of all of our analysts. It's not to say the short-term profits are not important, they're just less important. And that could sound...

counterintuitive because the the media especially the specialized media and finance What about the next quarter? Are you gonna get the quarter or not? It can be noise Sometimes there's signals in there. That's a catalyst for a turn, but usually it's noise We try to look at three to five years normalized earnings. What does it look like? But it gets a lot more detailed than that and then their style so there's we are a whole

research organization split in three. We have analysts in a growth team. These are people that are going to look at technology. They're going to look ahead. They're going to look at what is coming. They're going to look, they're comfortable buying stocks that are more expensive because they usually come with a high growth rate, making them more expensive on the stock market. We also have a team completely the opposite, which is the value team. They want a deal. They want

some kind of inefficiency in the market, or let's say a great business that just went through some, bad event, a temporary bad news that got its stock down and there's tremendous value today entering that company because those problems that are plaguing the stocks are temporary. These are value analysts, a value analyst and a growth analyst and you've been an analyst before. They're two different beasts. So we keep them nice and apart.

So they can do their respective type of analysis. And in the middle, we have another team called Core. Now they'll inspire and they will leverage the work from both the growth and the value and everyone has access to everyone's research. they're kind of the type of analysts that kind of sits in the middle, or they work more in small caps or dividend names. So we've organized our teams like that. After that,

The factors that goes into picking stocks, profits most important, but then there's a long list after that. But at end of the day, it's better understanding the health of the company you cover than everyone else. So that when news hits, you have a better understanding if that news is pertinent or just noise. And that can keep a firm into a position just by discriminating, that's noise.

that's important. Especially when we like a company long term.

Aaron (09:36)
Well, I find growth analysts are, they're the eternal optimists. They're the ones who wake up on the sunny side of the bed every morning. Value analysts have a healthy amount of pessimism is what I would say.

Ghislain Maillet (09:41)
true.

I would agree. And we want both. We want both working. Because the optimist will see a trend coming down that the value person might not even think about. But the value people that are often naturally skeptic will find maybe problems in the balance sheet, might find problems in the structure. So I like the fact that

We have a culture of value analysts and they excel at that. We have a culture of growth tech type of analysts and they excel at that. And we've got a team in the.

Aaron (10:25)
Well, show me a short-term timeframe and can show you someone who's got reasons to be pessimistic and optimistic. Show me a long-term timeframe in the investment world and if you're not optimistic, I don't know what stock chart you're looking at.

Ghislain Maillet (10:40)
Good point. Good point. Good point.

Aaron (10:44)
Now that we've on the research process, discussed a little bit about how you distill some of these ideas down in various teams, maybe let's focus on defining the two mandates that we have, the core and the value, speak to kind of how each one of them views the markets and the differences between the two.

Ghislain Maillet (11:01)
Okay, so core, as it suggests, can be a core part of a US equity portfolio. So its benchmark is the S&P 500. That's not a benchmark that's easy to beat. We're quite proud of the historical returns, which you have access to if you want to share it to anyone. But basically...

Aaron (11:21)
Well, alert

to the listeners, over the long-term timeframes, you're ahead of the S&P 500 as well as during the short-term timeframes. If you want to talk about the performance returns in more detail, reach out to me.

Ghislain Maillet (11:35)
Yes. Well, thank you for that. We're quite proud of it. And we're also quite proud of the fact that we believe it's durable in a sense that it's the people in process that generated that past return. Those same people are there. That same process is still working for the future. So the core is meant to be complete, meaning you'll get the best ideas from the growth guys, the optimistic, the techies, the looking ahead, the artificial

Intelligence teams the mag-7 right so that doesn't mean you're have every one of those mag-7s But because they're a big part of the index we'll never ignore them there's certain companies at certain times can be underweight and overweight, but basically We're gonna look at them and dose them appropriately based on conditions, but on the flip side We're not gonna let go of all the other stocks

in the American stock market that doesn't make the headlines, which are maybe on the value side or what we called GARP, growth at a reasonable price. So it's meant to be complete for one, style agnostic, so you get both growth and value. And third, core can sound boring to some people, it's not, it's concentrated. So basically right now we're sitting on 52 positions. So...

Look at the S&P 500 and there's way more stocks than what's just in the S&P 500. And we look at more companies than just the index. We look above and beyond the index. But we're going to pick roughly 50.

Aaron (13:10)
think that's a good segue to pop up one of your slides that speaks to index concentration levels, we haven't seen in decades now.

Ghislain Maillet (13:22)
It's impressive how the US stock market is no longer diversified. So what you're seeing here is basically on the top right, it's the weight of just the top 10 stocks, which is just shy of 40% of the whole American stock market. So on the left, you have their difference in valuation. So if you just look at the top 10 companies,

They're trading at 30x their profits. If you look at the rest, under 19x earnings. So yes, the American stock market is expensive from a historical perspective, but it's a story of two markets. There's the 10 biggest companies, which are arguably quite fantastic in terms of businesses, right? That doesn't mean they're all great investments all the time, but they are great.

businesses to have gotten to that kind of rich valuation. But I would argue that it's a good time to to re diversify or the very least rebalance and to take a look at the 490 names outside or at the bottom or the the rest of the S&P 500 where you have valuations that are a little bit more inviting. And and the other thing I would say is that there's something healthy happening in the stock market.

recently in 2024. Like 2023, the biggest companies were doing all the work. It was a concentrated leadership of stocks that got them to be this concentrated. Recently, we're seeing more and more companies participate at a rally and looking ahead estimates for earnings based on street estimates. And we're kind of in line with that as well. The 490, they're starting from a lower profit level.

but they're growing faster in the next two years based on estimates that is. Whereas the 10 biggest companies are starting at a higher profit level. They still do well, but they don't grow as much. So sometimes it's the earnings direction or the second derivatives of earnings or who's growing faster that ends up being the leadership.

I think if some of you made some good returns by being very exposed to tech or just the index which is now very exposed to tech, this is a great timing to re diversify. Core does that. The value mandate which we haven't touched on does that even more.

Aaron (16:08)
Like you mentioned, there can be fantastic businesses out there, but you just don't love the shares because either they're priced too high, they're too volatile. They don't see the same kind of liquidity that you'd like to see.

Ghislain Maillet (16:20)
And that's the thing with both a concentrated S&P 500 and the top of that concentration being expensive. High valuation doesn't mean we're gonna have a bad year, right? Expensive stocks could be the best performing stocks next year. It does make them fragile to bad news. But I would argue, don't look at the market as the S&P 500. Look under

the S&P 500 and you can find value.

So that kind of brings us to the second mandate. The second mandate that's available exclusively through CIBC Wood Gundy as of the 27th of January is the value mandate or a value, US value equity. This strategy is meant to focus on companies that are not too expensive. So this is led by this value team. But one thing's for sure.

don't it's not to be confused with what's known in the industry is deep value, which leads us to buy, you know, mines and commodity stocks, which could be good investment sometimes for sure. But basically, what what defines or the way we build a value portfolio is we actually start with quality. We're not going to buy a company just because it's cheap. If it's of a less

if it's not a quality business, they will easily pass the test of time. So we start with a first filter of analysis which defines the quality of a company, the durability of their profits, the low cyclicality of their earnings and their growth, the visibility of their success looking forward. So these are all qualitative measurements and with that we create a universe of quality businesses and from that filtered universe, then we look within that universe and

What is cheaper within that? What is value within that? So quality first, value second, and you're left with a basket of companies that JP Morgan has selected that are trading today or the last report was the average P/E was 16.5x That's quite a bit less expensive than the S&P 500. So it's a way for value investors out there or anyone that wants to like read diversified or rebalance to pull the other way.

Aaron (18:45)
Traditionally value has lent itself to businesses that are more mature, more durable business models. Maybe the growth runway is not as long as some of these other up and coming businesses. But with that, you generally have return of capital to shareholders through dividends, share buybacks, in volatile markets, generally perform much better. I do believe through the

2022 downturn your mandate was single digit positive?

Ghislain Maillet (19:15)
Yeah, it did resist to that bear market. now that particular bear market was, you know, coming from a position where interest rates went up a lot. When interest rates go up a lot, let's say we relive an inflation event in the future. It's not impossible, right? And that would force central banks to raise rates. Value does a whole lot better in that environment. Whereas, but if the opposite happens,

let's say inflation that's trending lower, keeps going lower, and let's say inflation stays polite and interest rates can come lower, then I would argue the growth side might have a tailwind. But more importantly, you should be diversified in both styles.

Aaron (19:58)
I couldn't agree more. Having all your eggs in one basket might seem like good idea in the moment, but in my experience, everyone has a high risk appetite when markets are trending upwards and it's a much lower number of investors who have the same risk appetite when markets are trending downward. So, pairing growth with value is a long-term winning approach.

Ghislain Maillet (20:20)
I would agree and core does that. So the core mandate I would argue is more complete. That said, you you need to consult Aaron for all of these questions, which are quite personal, but there is a lot of people out there that made a lot of money with growth stocks and now they got new money to commit. I would argue, you know, if you're not comfortable paying your taxes on your gains, which you shouldn't let the tail wag the dog.

You know, you shouldn't be afraid of paying your gains to rebalance. if you're not going to do that, at the very least, your new money, I would argue, should be committed more on the value side. Just to rebalance. But that's personal situations.

Aaron (21:01)
My job to have those conversations with clients to figure out what their risk return profile or appetite would look like. And it seems like we're driving down the conversation around outlook here know we touched on our last conversation on the macro side, what the outlook could look like. Let's just put a different spin on that. What kind of outlook do you have for each one of these mandates, whether it's the growth mandate.

Ghislain Maillet (21:16)
We jump right back into it.

Aaron (21:25)
or sorry, the core mandate or the value mandate.

Ghislain Maillet (21:29)
Well, we remain constructive on US equities on the backdrop that it's the best economy in the world. Not to say stocks are always correlated to the economy. They're not, but it is a healthy backdrop that the US economy is pretty much the strongest economy in the world. Second, we've already seen a lot of deregulation that is to the benefit of businesses in the US, which has more wiggle room to do more things, to be more aggressive.

to invest in their future. And that could be a creative going, looking out. that's, that's positive as well. Now it's hard to say which one will do the best because it depends on factors like interest rates that are hard to predict. But in the fullness of time, I think the core mandate is probably the most complete mandate that can better

allow investors to participate to the massive level of innovation we see from the US. Like artificial intelligence, the American market is highly innovative and the core will expose to these growth companies.

as well as the best ideas of the value. It's against our rules to say what we expect in terms of rate of return. But the whole process at JP Morgan, the people that are tenured and stable around that are paid towards one goal, to outperform in a durable way the S&P 500. So we're happy when

It's not going to happen every year, but through every rolling three, five year period, when we've added value over the S&P 500. So that will be the barometer of our success, is the value creation above the S&P 500. Value, we expect more stability. We accept less cyclicality. We want it to be smoother. We want...

value investors to be comfortable in this. We want it to be less interest rate sensitive, but we also want it to outperform its benchmark, which is different. It's the Russell 1000 value. So we compare apples to apples.

Aaron (23:44)
All right, we have everyone back now. We had a little technical glitch. We were just getting into the value mandate. I'll pass it back to you Ghislain land to continue on that thought process.

Ghislain Maillet (23:55)
Right. So the value mandate that is for now exclusive at CIBC Wood Gundy is meant for value investors. So it promises or it aims to achieve a few things. First of all, it wants to beat its benchmark from a performance standpoint, but its benchmark is not the S&P 500. It's the Russell 1000 Value. So it has done that successfully in the past. The same team is still there for the future.

It's better suited for people that for one are value at heart. They don't like to pay too much for acquiring a business. And that's the mindset of the managers and the analysts of that team. It's also appropriate for anyone that wants to diversify, that maybe has too much exposure to growth technology and the concentrated parts of the S&P 500 wants to pull the other way. Obviously value styles can be less volatile, less cyclical, less sensitive to interest rates.

Offering generally a smoother ride is another defining benefit of this US Value strategy available through ICS.

Aaron (24:59)
I like what you told me about the value mandate. The growth is fairly self-explanatory. Value, there's a lot of different subcategories. Like the Warren Buffetts used to say it's like getting the last couple of puffs out of a cigar. the, I like to say some value investing is like holding a hand grenade. You just never know when it's going to blow up, but you feel like you're getting a deal at the time.

Ghislain Maillet (25:20)
that's not what we would want them to think.

Aaron (25:23)
No, it looks

You're trying to pick up businesses at a cheaper valuation that have a durable business model and a moat, not necessarily something just because it is undervalued. Sometimes there's a reason it's undervalued.

Ghislain Maillet (25:37)
Right, and we're very wary of value traps and we are not deep value where it's all about paying as little as possible relative to earnings. It doesn't matter what you pay, if earnings are not going in the right direction in the future, you're not going to like the experience, quite likely. So as mentioned before, for us it starts with quality businesses that have all it needs to pass the test of time, can grow, even if it doesn't have to grow as much as some of these

growthier stocks and from that quality basket which one are the most attractively priced or sometimes just misunderstood. There is a growth story within this company but the market has a caught on to that. Other times to be honest it's like a great company that goes through a temporary bad period that is often when value investors initiates positions.

Aaron (26:30)
I think that's actually a pretty good way to summarize things. like to focus on quality and earnings, whether it's value style, core or growth. On that note, I think it's a good time to wrap up. Thank you very much for joining me today, Ghislain you have been a wealth of knowledge.

Ghislain Maillet (26:47)
so much for the invitation and more than happy to come back on the show.

Aaron (26:52)
To all the listeners out there. If you want more information on either one of these investment strategies, please reach out to myself at aaron.sherlock@cibc.ca or you can Google The Sherlock Group to get in touch with me. Thank you very much.

Outro (26:53)
Upbeat music begins to play in the background while CIBC disclaimers are displayed.
[This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2025.

The views of the commentator and/or guest speaker(s), do not necessarily reflect those of CIBC World Markets Inc. This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed. The commentary is for informational purposes only and is not being provided in the context of an offering of any security, sector, or financial instrument, and is not a recommendation or solicitation to buy, hold or sell any security. 

CIBC Private Wealth consists of services provided by CIBC and certain of its subsidiaries, including CIBC Wood Gundy, a division of CIBC World Markets Inc.

If you are currently a CIBC Wood Gundy client, please contact your Investment Advisor.

Aaron Sherlock is an Investment Advisor with CIBC Wood Gundy in Saint John. The views of Aaron Sherlock do not necessarily reflect those of CIBC World Markets Inc.

The CIBC logo and “CIBC Private Wealth” are trademarks of CIBC, used under license. “Wood Gundy” is a registered trademark of CIBC World Markets Inc.

Clients are advised to seek advice regarding their particular circumstances from their personal tax and legal advisors.]
 

Introduction
Short video of a stock market chart arrow moving in an upward trajectory with upbeat music play in the background. Magnifying glass appears and becomes the “o” in Sherlock’s Clues. Full title comes into focus, Sherlock’s Clues – Insights on Investing & Economics with the investment philosophy below “Investing Success: Powered by Process, Fueled by Discipline, Rewarded by Patience.”

Aaron (00:11)
Hello and welcome to another episode of Sherlock's Clues. As always, I'm your host, Aaron Sherlock. And on today's episode, we are going to talk macroeconomics. I have with me Ghislain Maillet from JP Morgan. Ghislain brings with him 25 years of experience in the financial markets with various global firms. Good afternoon, Ghislain.

Ghislain Maillet (00:33)
Good afternoon, Aaron. Happy to be here.

Aaron (00:35)
How's it going today? I see a little snow coming down in the background.

Ghislain Maillet (00:38)
more than snow if you see the camera shaking it's the wind there's a there's a storm we're just outside of Quebec at a cottage but hopefully you can still hear me hear me all right

Aaron (00:50)
Loud and clear. Well, we just had a little snow squall here myself and a lot of my listeners come from Western Canada, so they deal with their fair share of inclement weather themselves. Well, you work for JP Morgan. JP Morgan seems to be making more of a push or presence into Canada as of late. You joined the team recently. JP Morgan is the world's largest bank by market capitalization.

I'm sure most people know the name Jamie Dimon as well. Maybe give me a little background on yourself, how you landed at JP Morgan and some interesting facts about your new firm.

Ghislain Maillet (01:25)
Well, for one, I'm from New Brunswick. So originally from St. Charles, Kent County. I did my bachelor's in accounting in the University of Magda, did my master's in economics in Paris. Then I started working at Fidelity in January 2000 at the peak of the bubble. So went through roughly three market cycles with Fidelity. And then when I heard

that JP Morgan was coming to Canada to deal with advisors such as yourself. I could not, and I knew, I know the guy we started Fidelity together who's leading this initiative. So eight interviews, months and months of discussions. September 3rd, I started at JP Morgan. And I think we're gonna make, we're definitely gonna make ourselves a place here. That said, JP Morgan's been in Canada.

dealing with institutional clients for 43 years. So we were already here. But the way New York sees Canadians, they see it as the Maple 8s, the eight big pension funds. That's pretty much who JP Morgan deals with until we opened up this division.

Aaron (02:38)
You dated yourself there for a second. You don't have enough gray hair to have started in this industry in 2000 and ridden through the tech wreck and the GFC.

Ghislain Maillet (02:41)
Yes.

well, maybe the wonders of modern video technology, but they're there and they're coming. But yeah, it's been. Yeah, so this will be this actually a couple of days ago was my 25th year in the business. And I was happy because when I joined JP Morgan, that meant that I'm taking charge of covering all of Eastern Canada. So I looked at

Brunswick and which brokers were there and I was pleasantly surprised to see that most of the brokers that I had the pleasure to deal with from 2000 to 2012 are for the most part still there. So for me it's happy to be back covering the Brunswick but I'll be doing it based out of Montreal.

Aaron (03:35)
Okay, well, I think we're going to lean on some of your experience and knowledge and let me take a little look back as to where we've been over the past, we'll say five plus years, how we got there, maybe touch on how we actually have achieved a soft landing. We didn't get the recession that everyone was forecasting a couple of years ago and how our economies have evolved. As quick as the markets change, seems like businesses as well as

individual economies in different pockets across our countries have learned to evolve with an environment which is never static. Could you maybe touch on that a little bit?

Ghislain Maillet (04:15)
Yeah, well, I think if you take this window, which you're proposing of last five years, it's great to showcase how adaptive companies are to changing conditions. It starts with a shutdown. Honestly, as much as you've been in the business long time, so have I. When at first thought, when I was realizing, okay, we're going to shut down all the boutiques, we're going to shut down all activity, we're to go home and we're going to hunker down.

thought it could have been messier. That said, all of a sudden, central banks started to be accommodative to the point where a billion dollars used to be a big number and all of a sudden, a lot of numbers were starting with the T for trillion. So the ample to infinite liquidity that was provided by not just the Fed, by pretty much all central banks, kind of liquefied all problems.

to help us weather that shutdown storm. Then inflation showed up. Then the central banks turned around and raised interest rates, restricted liquidity. So kind of live in the opposite scenario. Again, companies did a great job adapting there, unfortunately passing on inflation, unfortunately from a standpoint of a consumer, of course. But that said, companies had to adapt. And then lastly, if you bring it back to the last couple of years,

We were able to bring back inflation close to 2% without having for the U.S anyway, a meaningful recession or actually no recession at all. Canada's different picture though. What's the last couple of years have brought forth for Canada and U.S is an economic divergence. Because a few reasons if I want to keep this one short. The mortgage market in Canada is...

very different than a mortgage market in the States.

Aaron (06:16)
locking

in a 30 year mortgage in the States when rates were 2-3%, you never need to look at renewing it again. That's got to be the dream. But the knife cuts the opposite way. 30 year mortgage rates are now over 7%.

Ghislain Maillet (06:24)
That's right. So.

making paralyzing the real estate market for people to stay where they are. But at least their interest cost burden has barely gone up, whereas Canadians has gone up a lot. Add to that more recently, last year, another 20 plus year for the American stock market. There's a wealth effect in the U.S that is fueling consumer confidence. For example, $12 trillion of added wealth to U.S consumers in the last 12 months. Add to that.

the labor wage increase, the salaries have gone up faster than inflation in the U.S. for 20 months in a row. in summary, I'm amazed how companies have adapted. We haven't even talked about this AI wave that's also, you know, have created a lot of enthusiasm and investment. But the point is, it could have been worse after COVID and after inflation, after interest rate hikes.

to find ourselves where we are today. It's not perfect and we have things to talk about looking ahead. But one thing's for sure, we had all kinds of reasons to get rid of stocks or to be afraid of being a business owner, but yet it did quite well in retrospect.

Aaron (07:47)
Well that's just, we're just summarizing unintended consequences after solving a major problem. I don't think ever getting the answer 100 % correct right out of the gates is going to, it's not feasible. So whether it's inflation or interest rates, having to deal with those over the next, we'll call it 36 months, that's much better than having to shut down the entire economy.

Ghislain Maillet (08:09)
Hmm, right. Correct. Correct. The only thing is that when it comes to JP Morgan's views on inflation, it's and looking back at what we just went through this big spike up in inflation and it kind of went down as fast as it went up. We would love to think it's a one and done. We hope it's a one and done. And we're back to the type of inflationary regime that I've been in for all of my career.

characterized by two things. It's inflation was low and it was stable. Our base case though is that we are in an inflationary regime, which is not to say we're going to live the 70s and the 80s again with like rampant inflation. The demographic scenario is different. There's all kinds of things that are different. But whether we point that de-globalization, climate change, X or

lack of fiscal responsibility that's globally present and all kinds of other factors, we are of the school of thought that what will define inflation in next 10 years is a little less low than last 20 and a little less stable. So that shapes the way we build portfolios and in some parts differently than before because

We think right now it's pointing in the right direction inflation, but things could happen and we had an election. Might be a topic for later, but it could change.

Aaron (09:51)
Well, that's a good summary of where we've come from over the past five years. Maybe give us a bit of a snapshot as to where we are today. At this point in time, things seem fairly stable, like you said. Interest rates on the decline, inflation declining. We've got relatively full employment across the board. Wages are rising faster than inflation. Things seem like they're almost in a bit of a Goldilocks zone here right now. Can you give us a few more details around that?

Ghislain Maillet (10:20)
Well, for the U.S. it is looking quite great. In fact, if it was left alone, you know, if we would just leave it to its course, we see a normalized economy after everything it's gone through. We're not even taught like our predictor for recessions at JP Morgan for the U.S is that 15% probability. It's never zero. 15% is actually the lowest it gets. So you've got a healthy consumer.

that's willing to spend. You've got a government that, independently, who would have won the election is generous, meaning like the blues spent a lot, the Reds in our view is going to spend a lot despite their best efforts. A fiscal deficit when a government spends more than it collects in taxes is actually a form of stimulus for an economy. It's actually a form of stimulus for our business, the asset.

business because if there's more money coming into the system and there's not more stocks, there's not more real estate, there's not more great companies, it technically helps. The point is, status quo for the U.S is looking good. It's looking good. If it remains status quo. The only thing I'll say, which I think is worth saying, parts of the American market are quite pricey. So if you're looking for deals,

Aaron (11:36)
I'm like...

Ghislain Maillet (11:49)
in the best companies in the world, you will not find any. That could change quickly, but it's a fully priced market, especially the greatest companies in the world.

Aaron (12:01)
Well, that's why diversification is usually your friend. I love a lot of businesses. Sometimes I don't love the stock because of valuation purposes. I noticed you've placed a caveat a couple of times speaking about the U.S. saying the U.S. is very strong. There certainly has been a divergence of economies around the world. We're seeing Germany show consecutive years of negative growth. UK is in some trouble. Asia has some troubled economies.

Canada has its own issues here, whether it's your productivity or a declining GDP per capita. Maybe give us a 10,000 foot look at that.

Ghislain Maillet (12:43)
Well, the U.S remains the, economically speaking, the envy of the world. You name them a lot of regions. Each of these regions have their own catalyst. China is on a huge overhang of a real estate market that pulled most of the weight economically and now is in some ways deleveraging. They're trying to make that as least painful as possible.

They finally started stimulating, if they really start stimulating the Chinese economy to get it going again, it won't be easy because they've tried twice now. But they could try harder and they could put more money at play. That's a big piece of the global economy and that could be a positive impulse. Canada, you've said it. We're in a recession per capita. The productivity problem is structural. It's going to take time to heal.

We're sensitive to interest rates or our cost of interest have gone up. We don't have the same wealth effect and our salaries aren't going up as fast. So that's creating a deviance before this threat of tariffs. it's Europe. could point to very heavy regulated countries and companies that don't adapt as fast as American companies that were able to adapt.

to many changing events in the last couple of years. that could be one thing. But the beauty of being a Canadian is that, yes, it's important to look for international diversification, but with Canada and U.S alone, you can build the majority of the diversification needed for a portfolio without looking too far. that's a convenience factor of being in Canada for sure.

Aaron (14:35)
Well, I do think there are still some of those cheaper names that are outside the North American borders. Like you said, the U.S is relatively fully valued. There certainly are some more value propositions outside of these borders. You did touch on a couple of things when it came to the presidential cycles as well as tariffs. Maybe let's dive into that for just a couple of minutes. I know we could probably take a university course on this, but would you touch on the current political landscape?

Ghislain Maillet (14:41)
Definitely.

Aaron (15:04)
in the United States and a lot of this saber rattling around tariffs.

Ghislain Maillet (15:08)
Obviously, numbers of headlines relating to Trump is in many ways overwhelming. Obviously, when you're managing money, you focus not on what can bring up certain emotions or values, but mostly what's important for the economy and the businesses that we own or we want to own. And it comes down to four things. Starting with the positive.

From the standpoint of a business owner, deregulation is a big one. If you're taking away the speed limits, if you're taking down a number of rules, or if someone wants to invest in the U.S. and the government's going to pave the way with very little obstacles to make it happen, that could create a pretty powerful impulse of investments, business activity, deal making.

It attracts capital towards the U.S. It attracts confidence. So now deregulation can have consequences long term. You've been in the business long enough to have lived through 2008, which was a function of deregulation from the 90s, right? Clinton deregulated the financial industry. Certain rules disappeared, allowing them to take more risk.

Unintended consequences could come down the road for many reasons, but short term, the deregulation aspect of the four things that Trump's working on is quite positive if you're an American business owner or anyone owning American businesses. The other one, which is tax cuts extension. So in the first Trump presidency, they put together the the tax cut and job act.

and he wants to extend that. It's not a given. Even if controls the House and Senate, he needs every vote out there. But it's likely that he's able to get to the finish line. That's fine in the sense that it's good for being a business owner because the tax rate is not going to go up. But it would add to the deficit, which is another form of stimulus, which is a good news.

If you're a business owner, the economy is going to be well stimulated. But the economy in U.S is strong enough that it's more at risk of overheating than any kind of recession for now, unless some kind of catalyst happens or some kind of event. But short of that, we're afraid it could be a little too much stimulus. So that's something to watch out for. And that's before we talk about the two.

that are really gathering the headlines. One obviously is tariff threats and the other one is restrictive immigration. In all honesty, as much as tariff is stealing the show because Canada is in the target, just like Mexico, China and many other countries, Colombia was added to the list for a short period of time this weekend, we're actually afraid of overly restrictive immigrations for U.S. because

The U.S is a service economy. I'll get back to tariffs, but the U.S is a service economy. Therefore, a large part of its economy is sensitive or its inflation calculation through time is sensitive to labor wage. So the cost of an employee. And one of the reasons inflation came down is that the job market was healthy and most of those jobs were filled by people that are not born in the U.S. you now you can't change that all of a sudden in couple of months.

despite the photos of people getting deported, which, you know, that's something. But if the numbers get big enough and sustainable, and if it's hard to bring in talent, whether it's low-skilled on the farms, which we really need, or highly skilled in these data centers, which tech companies really need, and a lot of different positions in the middle, that could be tough. And that could add to reasons why inflation could come back.

On tariff? Now, we're gonna get clarity in a short while. It's coming. So next Monday is February 1st. So we'll get, or sorry, it's coming this week. But basically, we're gonna get clarity on that. My impression, because this is recorded before Trump makes his announcement. The last announcement was probably 25% and I think February 1st.

Aaron (19:32)
You

Ghislain Maillet (19:56)
Here's what a consensus of opinions from JP Morgan. One thing I hear a lot, the bark's probably gonna be worse than the bite. Because tariffs, from a common sense perspective, is like a company going on strike. The employees can threaten to go on strike. It could be a good tool to get a couple of candies, better conditions. But as soon as you go on strike, everyone starts to lose.

And the longer you stay on strike, the more you put the whole thing at risk. So it's a horrible idea in many ways. Hence why we think he's probably more comfortable talking a big tariff talk. He will do something. If he does absolutely nothing, then, you know, wow. I don't know if you want to add to that, but I think he'll do something. But the first thing I would say is that probably far less than what he's been proposing.

think we have a chart on this on what he's actually proposing. It's like bringing us back to the 30s. All of a sudden, that kind of shock would be way too

Aaron (21:07)
pull up that chart you're referring to here right now.

Ghislain Maillet (21:11)
As you do that, I'll go into a second thing about tariffs. yeah, there it is. So this is the effective tax rate or the average tariff rates on U.S goods coming into the border. know, so globalization has pulled that down through time. And then there was the first mandate of Trump, which you can see, you know, right, around 18, where some of his tariff wars started taking effect. Then it came back down.

And then you have what's proposed. There is no way the system can take that all of a sudden. So his headline comments are quite likely not going to come true. What is likely in our opinion is that Trump will be Trump. And if you study his version of the art of a deal, it's hit first. Get up on the table, put him in a weak spot, then make your asks. Get whatever you want, not necessarily think win-win.

win-lose is okay with an America first policy. So with that kind of approach, that's a good way to get bring everyone to the table and extract wins.

Aaron (22:22)
Well, I find it so interesting when he's talking about sweeping tariffs through Canada and Mexico, two largest trade partners, or sorry, the U.S. is the largest trade partner with each of us. Canada provides a substantial amount of energy to the U.S. By putting a tariff on us, energy costs are going to go up. Energy is a broad sweeping input cost to everything. You cannot control it. It's not tactical.

I don't think that that would be a very sensible idea for him to do. And on the flip side with Mexico, what's the other thing everyone needs every each day? Food. There's an enormous amount of food that's imported from Mexico. You put tariffs on that, you're going to cost the average individual more money at the grocery store. In Canada, more at the gas pump. You're not going to make a lot of friends with that kind of policy.

Ghislain Maillet (23:15)
And that brings us to the third point. It's going to be tough to keep in place, whether he uses a negotiation tool or he really thinks this is smart and wants to put this in place for the long run. The longer he keeps it, the tougher it's going to be, especially against all of his promises of getting eggs cheaper in the grocery stores. So be careful.

overreacting to headlines, especially knowing that markets tend to look forward. And market tends to stick on things that are permanent and things and tends to look through things that are likely more temporary than permanent. That's the other thing. So it might be worse than the headlines. Sorry, it might be less than the headlines. And it's likely not permanent. That said, if you invite me back on the show in a couple of months, we'll get

We'll get clarity on this.

Aaron (24:15)
Well,

maybe let's wrap this section up here with just discussing investing around political events. I profess long-term investment with discipline, process discipline and patience will serve you better than shooting from the hip when you see a headline. Navigating the political waters is nearly an impossible task. But what we just talked about at the beginning of this.

was businesses are very well equipped now to manage an evolving environment or business climate. Maybe touch on that a little bit.

Ghislain Maillet (24:52)
Well, I couldn't agree more than it's trying to predict geopolitical events and how they could affect market is a very hard proposition to get right often because basically you have to be right three times. First of all, you can be worried about a certain risk happening. the first variable is will it happen? Because everyone has opinions and, you know, there could be a lot of noise out there, but what will actually happen is the first variable.

Two is when will it actually happen? Because let's say someone could say, well, I'm convinced China's building an army to take over Taiwan, and that's going to be World War III, and blah, blah. Then OK, well, if that's in 10 years, then you're taking action on this today on your portfolio, you're probably outplaying yourself just on the timing aspect. And three, you've got to be right on its effect, right? Because if you're right on the risk, and let's say you're right on timing, and right there, that's improbable. But let's say you got these two right.

You could get the effect wrong. The first win of Trump's, the first Trump win, a lot of people were convinced the market was gonna go down. We saw the opposite happening. When people started talking about World War III, they wanna sell everything, go to cash. The stock market was up tremendously towards, during World War II, because a lot of money came into the system and not everyone was at war at the same time. All that to say is that,

It's hard because there's a lot of bad news out there and I get it and it brings emotions and money can be emotional. But at the end of the day, don't forget, you're not buying shares of a country somewhere that's in trouble. You're buying shares of businesses. So ask yourself the following questions. Are people showing up? Next time you see a bad news and it's concerning as a human, ask yourself these questions.

of the businesses I own, who's not gonna show up to work because of what I read? And of the businesses I own, are they gonna still sell their products? Like are consumers, like basically ask yourself the question, what are, you read a bad news, horrible, what are you gonna do for the rest of the day, rest of the week, rest of the month? I would argue, you're still gonna go do the grocery store, you're gonna pay your phone bill, might put some gas or put the charger on, might plan a trip, maybe not the same place where you're.

reading the headlines, life has a tendency to go on. So that's why as much as we're playing by too much geopolitical bad news, you can kind of see the markets not necessarily focusing on that as much. And I invite investors to do the same.

Aaron (27:38)
Well, media outlets play on our emotions. They know that bad news sells more papers than good news. So that's why it's front and center every day. I think this is actually an excellent segue to move into part two of our conversation. This was our macro overview. We are now gonna dive into some thoughts around investment strategies and how to take advantage of these volatile times. So if you wanna join us in part two with myself,

Ghislain Maillet (27:41)
Definitely.

Aaron (28:08)
and Ghislain Maillet you can do so. It'll be up shortly after this episode. As always, if anyone listening to this has any questions on what we've discussed, please feel free to reach out to me at aaron.sherlock@cibc.com or you can Google The Sherlock Group Thank you very much.

Outro (28:09)
Upbeat music begins to play in the background while CIBC disclaimers are displayed.
[This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2025.

The views of the commentator and/or guest speaker(s), do not necessarily reflect those of CIBC World Markets Inc. This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed. The commentary is for informational purposes only and is not being provided in the context of an offering of any security, sector, or financial instrument, and is not a recommendation or solicitation to buy, hold or sell any security. 

CIBC Private Wealth consists of services provided by CIBC and certain of its subsidiaries, including CIBC Wood Gundy, a division of CIBC World Markets Inc.

If you are currently a CIBC Wood Gundy client, please contact your Investment Advisor.

Aaron Sherlock is an Investment Advisor with CIBC Wood Gundy in Saint John. The views of Aaron Sherlock do not necessarily reflect those of CIBC World Markets Inc.

The CIBC logo and “CIBC Private Wealth” are trademarks of CIBC, used under license. “Wood Gundy” is a registered trademark of CIBC World Markets Inc.

Clients are advised to seek advice regarding their particular circumstances from their personal tax and legal advisors.]
 

Short video of a stock market chart arrow moving in an upward trajectory with upbeat music play in the background. Magnifying glass appears and becomes the “o” in Sherlock’s Clues. Full title comes into focus, Sherlock’s Clues – Insights on Investing & Economics with the investment philosophy below “Investing Success: Powered by Process, Fueled by Discipline, Rewarded by Patience.”

Aaron (00:11)
Hello and welcome to another episode of Sherlock's Clues. As always, I'm your host, Aaron Sherlock. And on today's episode, we are going to discuss emerging markets. I have with me guest, David Jauregui. Was that too bad or was that all right? Excellent. David is a client portfolio manager with institutional global firm, Lazard. He brings with him a wealth of experience on the emerging market front. Good afternoon, David.

David Jauregui (00:25)
That was perfect.

Good afternoon, Aaron. How are you?

Aaron (00:42)
Good. I find the emerging market space very interesting and I'm going to be leaning on you heavily to help unpack some of these questions. But before we dive into things, would you mind just giving a little background on Lazard? Because I know you were founded in the 1800s. Could you kind of give us a couple of minutes as to where Lazard started and where they are now.

David Jauregui (01:05)
Sure. Just really quickly on myself, client portfolio manager, like you said, with Lazard Asset Management. I've been in this role for almost a decade. Other roles, other firms that I've worked that include PIMCO and UBS. I grew up on the West Coast of the US in California, but I live on the East Coast. I've lived here for more than 20 years now. And not only do I have a professional connection to the emerging markets, but I also have a personal one.

Both of my parents are from Bolivia in South America and my wife is from Brazil. For Lazard Asset Management, you're right, we were founded going back to the 1800s, actually last year, 2023. We just celebrated our 175th anniversary, but the roots really take shape with the Lazard brothers coming from France and moving.

to the United States, New Orleans in 1841. They set up by a variety of businesses, but most known for dry goods or selling fabrics, clothing accessories. They eventually moved west for the gold rush that took shape in California. And by the 1860s is when they started officially pivoting into financial services at the time, extending credit to customers and then ultimately converting themselves into a bank.

for formally launching the asset management side of the business much later on, but the roots are deep, as I quickly alluded to. So, you know, that is a bit on our background. And again, we just celebrated our 175th anniversary across our offices last year.

Aaron (02:52)
It certainly is quite a storied history and I know you do have offices that span the entire globe. Where are you based out of today? Is it New York?

David Jauregui (03:01)
I am in New York, that's where we are at 30 Rockefeller Plaza, so where the big Christmas tree goes up and where the ice skating rink is featured in very prominent movies like Home Alone. That is where we are and that is where the majority of our emerging market team colleagues are based, but we have offices around the world and a presence around many offices across the developed and developing world for both.

sales and marketing and on the investment management side as well.

Aaron (03:34)
Now why I'm particularly interested in speaking with you today is emerging markets is something that evolves much more quickly than developed markets. What we're going to discuss today certainly isn't my parents BRICS acronym. I'm sure things have moved substantially away from that. And the emerging markets really is a space that isn't followed as well. So stock selection

and certain risks do come into play more often than if you're investing in the TSX or the S&P 500. But with that said, I'd like to lead into defining emerging markets, how it's evolved over time, and then maybe touch on what drives the emerging markets, whether it's economic expansion, US dollar, interest rate policy. Could you

Dive into that a little bit. I know you could speak ad nauseum about it, but give us a little high level.

David Jauregui (04:29)
Sure, so emerging markets can be classified as really developing parts of the economy. And probably one of the easiest ways to quickly identify which country is quote unquote emerging markets or developing is to lean on our index providers. One index provider that we use for our portfolios to benchmark is MSCI. There are other, certainly other,

index providers, but the classification that an MSCI or an index provider would.

assigned to a country is how we use to quickly identify which country is officially quote unquote in the benchmark and has their own companies in that specific country. So MSCI emerging markets index, the broadest standard index has 24 country markets that would include, as you mentioned, your BRICS, but certainly other countries that have evolved along the way and have been included and graduating from perhaps frontier markets

status into emerging market status. Similarly, there are countries that have left the emerging markets index. So we really rely on MSCI first to make that classification, but you can use other data providers like the World Bank, pretty much anywhere that is not a developed market.

safe to say that it can be classified as developing. At one time, many European countries that are in the developed market index or indices today were developing or emerging. So it is something that continues to evolve as the asset class evolves, and certainly the index providers as well as ourselves do take notice of that. One thing we also do just really quickly in terms of going beyond what an MSCI index provider does is that at a firm like ours, at Lazard,

Just because a company perhaps is traded, its security is traded on a developed market index or in a listed and developed market country, perhaps the US or in London, we don't exclude that. We want to make sure that we understand where the company's assets are based, where the revenue is derived and

for us internally so long as a majority of the business's assets or its sales come from.

from the emerging market region, that to us makes it by DNA and that is part of our investable universe. So we also include companies that may be listed again in certain developed market countries, but are very much in nature and background and operations. So to your other question in terms of what drives the emerging markets, whether it's economic growth, whether it's interest rates, whether it's the US dollar.

I'll give you that cop -out answer and say it's all of the above or it depends and it often depends depending on the market environment and what we see. But certainly economic growth does play a role in this, in the attractiveness in sometimes the performance of the equity markets in the end. There's been a famous study now, you know,

more than a decade ago where just because a country or region is growing from a real GDP growth perspective fairly quickly or with relatively high numbers doesn't necessarily translate into a high attractive equity price performance. It's not always one for one.

One thing that we're seeing from a economic growth perspective that is making the case for today is that that economic growth premium that investors can expect from what you get in the emerging market world from a real GDP growth perspective over and above that of the developed world is moving back in EM's favor. The past decade after the global financial crisis just really bottoming out at the end of COVID.

the growth premium that was there in was moving away from It was moving more in favor of the developed world. Well, that is moving back in favor of the emerging markets. And really the period that for many investors is that they can recall is during the 2000s, post China joining the World Trade Organization in 2001.

And really heading into this, you know, what is historically referenced as the commodity super cycle, the BRICS that you were referring to when many commodity sensitive countries did very, very well. And that lifted their not only their economic growth, but there are many of their their countries.

leading company stock price performance. And that's when did as an asset class phenomenally well. And that EM to DM economic growth premium was moving very, very high and very wide in EM's favor. That reversed over the past decade, but we're starting to see that the reverse come back into EM's favor. So what I'm trying to emphasize is that these periods can move in cycles where of course can be in favor then out of favor. And then what we think is

happening now is more of a case for going forward, but certainly interest rates in the dollar, you know, those are top of mind today with where global monetary policy is. And now everyone is trying to get a sense of where the Federal Reserve here in the United States will go, when will they go, how much will they go? This can has been kicked down the road really since last year, continues to be kicked down the road into this year. And it seems to be more of a

a tail end of 2024, but more into 2025 that we're seeing for expectations of a rate cutting cycle. And certainly Central Banks, they're...

To a certain extent, they take their cue from what the Federal Reserve does, but many EM central banks have already begun to cut rates.

So I know I just said a lot there but I think I answered what you just asked there.

Aaron (10:55)
Ahem.

It was good and we'll touch a little bit more on this at the end where I'll get your opinions on the outlook. But back to the interest rate cutting conversation with EM countries were the first to raise interest rates when they saw inflation because this is nothing new to them. They're much more sensitive to inflation. So, they raised rates much quicker. Now, they're starting to bring them back down, but we'll unpack that here in a few more minutes.

Now I'd like to switch gears and talk about the Lazard process a little bit. The EM space certainly is quite broad. I know that China used to be a major player in most EM portfolios and it still does have a significant weighting. That could be a little different. Could you walk me through Lazard's investment style, thesis, your research process?

because the EM space certainly is an area that's not covered as in -depth as most developed nations. So research really plays an important role because you touch on that and then check some balances on when you decide to add positions or cut positions.

David Jauregui (12:10)
Absolutely. So in terms of our different styles and perhaps strategies that we offer, we're blessed to have many different flavors of ice cream and solutions for our clients and partners out there. So we don't have just one EM strategy or product that we sell. We have a...

we're probably best known for is a relative value strategy that just crossed 30 year anniversary. And we have also a

growth at a reasonable price strategy. We have a core strategy.

So we have a variety of different mandates that we run, but at the center

of all this, we have a very fundamental process across our active strategies and really guided by the investment research, the level of detail that our research analysts embark on. I mentioned the majority of our emerging market analysts are based in New York, but we have offices globally. We have large platforms across the US, across the international side, and of course various other...

offices where analysts may be based, just because we are perhaps have more analysts in.

you know, in New York or in London, doesn't mean that they're, you know, that's where they stay permanently and running the portfolios and look at the businesses. We're very much traveling in this post -COVID environment, even probably more so going on the road, visiting businesses, visiting clients, and traveling almost in a SWAT team fashion where portfolio managers, research analysts, perhaps even a macro specialist or a member of the emerging market debt side will travel and collectively

visit companies, economists.

authorities in various countries to get a sense of what the outlook is for, of course, the businesses, but the macroeconomic outlook for the country as a whole, the political environment, the regulatory environment, and then bring it back to our home base or headquarters and, you know, of course, share our information globally with our colleagues and try to make the decisions for each individual mandate that we run and that this applies to. So from a checks and balances to your question in terms of how do we go ahead and decide

you

whether to initiate a position or add to it or exit a position or trim back. And a lot of it will depend on, of course, the individual business drivers. So being very close to what drives the business, where it's upsides, what are the potential derailing factors that can get in the way of that thesis playing out. So very much having a buy and sell discipline for each strategy that we offer and a process, more importantly, a process that we follow

and want to stick to, especially as we've been kind of alluding to emerging markets can be very volatile. And without a process, it can be tough to gauge and catch, you know, almost at times catch a falling night, but sticking to a process, rooted in fundamental analysis, really powered by our research analysts globally is something that our PMs really rely on, our portfolio managers really rely on to help make these investment decisions and guide

the portfolios and hopefully deliver that experience that the client signed up for at the beginning of the partnership with them.

Aaron (15:47)
So for instance, with your relative value mandate, what kind of turnover should someone expect with that portfolio over, let's say, a three -year period?

David Jauregui (16:01)
So I will give you a bit of a it depends answer again. In over the past decade where emerging markets were underperforming versus developed markets and where growth as a style was outperforming value, very difficult environment for value in EM and of course our portfolio.

also faced its challenges from being in that space EM value. During that time where we couldn't find as many attractive value opportunities within the EM space, the turnover was much lower than it is today.

Again, bringing it back to our process and what guides us and how we buy and sell or add and trim positions. So during that period for value being challenged, lower turnover. Today, over the past three and a half years, you've seen value and EM do much better.

So for us, that's been a great market environment for our relative value strategy. It's done very well. It's capitalized on this value recovery.

price targets have been hit much sooner and much quicker than the prior decade where value was challenged. So the turnover has increased as more names have become more attractive, as more names have hit their price targets. So we've either trimmed or exited these positions. So just a bit of a comparison between some of the style environments that can help shape what the turnover ultimately looks like.

Aaron (17:41)
Okay. Thank you for that. And I like the saying inaction is action itself. Sometimes when you're looking at the investment world, sometimes doing nothing is the best approach. With that said, I'd like to touch on thematics. Do you have any themes, any particular sectors or countries out there that you think could have some tailwinds in the near and medium term?

David Jauregui (18:09)
So we tend not to invest by themes. Our sector and country weights are a residual of our bottom -up investment process. That said, and going back to how I mentioned, we have a variety of emerging market flavors for our clients to invest in.

Broadly speaking, most of our strategies tend to be more exposed or overweight information technologies. So within that, of course, semiconductors and how excited investors are for the long -term.

outlook for AI, for artificial intelligence and generative AI and what that could mean for a variety of different industries that we use or that are emerging or that will emerge. And certainly emerging markets do play a role in that AI infrastructure supply chain. So many businesses coming out of Taiwan, South Korea, even parts of Southeast Asia exposed to semiconductor testing and packaging

That has been where a lot of the outperformance has come from, a lot of what has been driving the MSCI Emerging Market Index from a composition perspective. So broadly speaking, that's where our teams have really liked to be positioned in, where they have a good portion of the portfolios capital invested. At the same time, for the past...

few years, just given the higher interest rate environment, higher policy environment globally, you mentioned central banks were the first to raise rates compared to the developed world. Banks within financials have certainly been an area that many of our teams have liked and that have held for the improving net interest margin outlook. So within information technology, financials, I would say that those are the sectors where we

are most exposed or most overweight in the portfolios.

Aaron (20:16)
So, would it be fair to just summarize this in a nutshell that you are agnostic to geography as well as sector agnostic within reasonable boundaries?

David Jauregui (20:28)
I mean, it depends on the strategy. I would say that's really the case for our value strategies, our GARP strategy. Our core strategy would be a little more sector and country benchmark sensitive, just given that it's core -like and tends not to deviate too much from the benchmark. But our style solutions from a value and growth perspective, those have a little bit more flexibility.

Aaron (20:55)
Thank you. Now, my favorite part of the webcast is the outlook. I know we touched on it a lot beforehand, but I'd like to touch on your thoughts around the global economy. Interest rates and inflation, we already talked about it. This is an easier question to answer now than it was, let's say three, six months ago.

And I know we could talk at length about this, but if we could keep it to three or four minutes, that would be great.

David Jauregui (21:22)
Absolutely. So I mentioned earlier in our conversation about the improving economic growth.

outlook from an relative to develop market perspective. So that is certainly improving in the emerging markets favor. And with that, we talked about, as you mentioned, the outlook for monetary policy and inflation and the dollar. So certainly fast forward to the end of this year and heading into next year, it'll be a more supportive monetary policy environment for the asset class. We discussed that EM central banks have already begun, many of them

already begun cutting from an earnings growth perspective, one thing we're seeing, of course, is still lagging the developed world. Your developed market index of choice is outperforming the emerging market index. But one thing we're

we're trying to emphasize to our clients and partners that perhaps most don't appreciate is that from an earnings growth outlook perspective, the earnings growth is moving back in EM's favor this year and into next year. You're already seeing higher EPS growth figures broadly across A lot of that is being driven by...

Asia, so markets like Taiwan, Korea, but other parts of Asia. And so that is something that you're trying to emphasize because stock prices can often follow earnings growth movement and moving higher over the next two calendar years is something that we think investors should take notice of.

profitability perspective, so return on equity. That is something where EM ROE, return on equity, has lagged, developed market equity for a number of years. To the extent that we can see that profitability gap begin to narrow, where we're not saying that...

EM profitability should trade where developed market profitability is. We're just saying that that gap is a little too wide. And to the extent that some of the improvements can begin to show and come through and slowly chip away at that gap, that is a case to help in addition to the earnings growth, in addition to the economic growth, in addition to some of the other points you mentioned on monetary policy. That can help narrow what we know is

you know, has been true and that everyone I think understands EM is cheap and trades cheap to develop markets. We are arguing that it's too cheap and that the valuation discount also is too wide. Currently, depending on the valuation metric you use, whether it's price to earnings, whether it's price to book, whether it's versus MSCI World, versus the S&P, you know, that discount that trades at is north of 30% or is wider than

and 30%. The longer term discount is closer to 20-25%. So we're not saying that should trade just as expensive or with the same P/E multiple that the developed market index trades with. We just think that the valuation discount has gotten too wide for some of the more improving metrics that we've seen.

across the region.

Again, just bring it back to my initial conversation.

24 country markets in the MSCI Emerging Markets Index. It's very easy to say that as a whole will trade one way, but there will be differences in nuances across regions.

and across of course those countries. So it's a market where we think you need an expert, you need an active manager that is well -versed in this and travels extensively in this region to help guide and shepherd your portfolio and your allocation.

Aaron (25:23)
I completely agree with your thoughts on having an expert and having an active manager to try to mitigate some of those downside risks as well as capturing the upside. But with that said, I'd like to thank you for joining us and end this interview to all of the listeners of this webcast.

If you have any more questions on the emerging market space or how to allocate within your portfolio, you can reach out directly to myself at aaron.sherlock@cibc.com or you can Google the Sherlock Group to find out more. Thank you.

Outro (25:24)
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Short video of a stock market chart arrow moving in an upward trajectory with upbeat music play in the background. Magnifying glass appears and becomes the “o” in Sherlock’s Clues. Full title comes into focus, Sherlock’s Clues – Insights on Investing & Economics with the investment philosophy below “Investing Success: Powered by Process, Fueled by Discipline, Rewarded by Patience.”

Aaron (00:11)
Hello and welcome to another episode of Sherlock's Clues. As always, I'm your host, Aaron Sherlock. And on today's episode, we are going to dive into macroeconomics. I have with me today, repeat guest Giuseppe Pietrantonio. He is our in-house economics expert and client portfolio manager of our multi-asset currency group. Good afternoon, Giuseppe.

Giuseppe (00:34)
Hi Aaron, nice to be back.

Aaron (00:36)
Before we dive into the details, I would like to you kudos. I've had you on a few times already this year and you've been pretty spot on with your predictions of where the economy was gonna go, where interest rates were gonna go and where inflation was gonna go. But maybe things get a little bit tougher from this point forward, but I would like to give you a little bit of praise upfront.

Giuseppe (00:56)
Thanks for that. We try to get it right. That's not always the case.

teams than

of inflation.

Obviously that's been the big theme in the past few years and I think I would split this up in terms of what's happening in Canada versus what's happening in the US. In Canada we've seen a big deceleration in inflation but we do expect that to continue coming down. There was a bit of a threat to this reinflation or this stickier inflations coming up this staying up this summer. I think that was largely due to the labor structure of Canada versus the US.

If you think about the labor structure in Canada, there's a lot more unions, bigger unions.

And so when you're thinking about inflation dynamics and what we've seen in the past few years, how that flows to the labor markets and how that flows to unions for unions on average, it takes a little bit longer. And so that's why we probably saw a little bit stickier, a little stickiness this summer. That's largely behind us. There's still some few big large unions that are still negotiating their salaries, but a lot of that is behind us. And so that coupled with the amount of debt in terms of consumers,

in Canada in terms of growth prospects in Canada, at least for the short term, the expectation is that inflation will come and actually go beneath that 2% level between now and the next 12 months in Canada.

Aaron (02:30)
Well, everyone who's holding a mortgage is certainly hoping that we start to see inflation roll over given the Bank of Canada further evidence that cutting rates is the correct thing to do. And I would like to touch on your topic of unions and inflation. I'm sure you've looked at the data across Europe and they're starting to say that inflation could be stickier or actually pick back up due to union negotiations in European nations.

Giuseppe (02:58)
Absolutely. Europe is very similar in the case of the added component in Europe is the regulatory framework across the board. And so things happen very slowly in Europe across the board, whether it's with unions, whether it's with pension reforms, whether it's whatever the European Union is trying to achieve. And so if I can switch a little bit there in terms of Draghi wrote a report earlier this year or a couple of months ago talking about

productivity in Europe, how productivity has lacked for decades. And so what the European Union needs to do in terms of fiscally to support the economy, inflation will come down in Europe. It's just growth is the factor that's very, very challenging right now in Europe. But the problem in generally is when you want to do a large fiscal program or you want to do structural trains within the European Union, you do have to consult

each of the heads, each country. And so to get all countries to align the same vision as you can expect is quite challenging. There are some challenges at least for the near future in Europe, that's for sure.

Aaron (04:10)
Well, maybe we'll touch on the economic side of things a little bit later in our conversation, but I'd like to continue driving down the inflation topic here, particularly with the US. We did see a little bit of an upside surprise in the US. Would you mind unpacking that a little bit? Canada seems to be coming down and the US seems to be flatlining and maybe potentially increasing.

Giuseppe (04:31)
Yeah, so what you saw is that you saw over this summer a really strong deceleration in the US. A deceleration in Canada, but not as strong in the US.

And so now the latest print today was kind of somewhat more elevated. I think the trend regardless in both economies is downwards. Are there risks for more inflation in the US in aggregate? Maybe, but I think there's still this downside trend that's going to happen. When we get into the election risk, maybe we'll talk a little bit about how that can impact inflation over the next at least few years depending on which candidate.

comes to the eventual president of the US.

Aaron (05:15)
Okay, so trending downwards, generally good for inflation. You don't want it to jump down drastically or jump up drastically. That means there's been shocks to the economy. With inflation trending down, hopefully we're going to see central banks start to moderate interest rates a little bit further.

What are your thoughts on Canada? And then we'll move to our cousin south of the border.

Giuseppe (05:31)
What are your thoughts on Canada? Yeah, in Canada

Largely, I think Maclem has talked about this. think the Bank of Canada has talked, they're committed to cutting rates. That's why they did the jumbo. And so the amount of debt is what's concerning, growth is what's concerning in Canada. If you talk about a lot of developed markets, central banks, they've changed their rhetoric. It's less on inflation, more on growth. So the concerns are growth.

I think if I've been doing this for 13 years in asset management and so when we do listen to central bankers, whether it's in, or probably developed markets, the Fed, back of Canada, UK, a lot of times it's backward looking. This is what happens so we have to cut or there's some sort of stress in the environment. There's a credit event, okay, let's cut now. Whereas in 2024, it's almost like, okay, we're not seeing, we're seeing a little bit of slow growth, but there's some...

some indicators that aren't doing as well, still positive, still very well, let's look ahead, let's start cutting now for the future. And so that's something that's changed in terms of the rhetoric of central banks globally. And so that's what I think the Bank of Canada has done. I think they understand that the population is over indebted, the real estate market was very, very hot.

There's a lot of big mortgages which are the number one expense for most Canadians. so rate cuts are needed to make sure that growth doesn't decelerate.

Aaron (07:05)
Well, one thing that I do like to point out regularly is the Canadian average debt to disposable income has now peaked above what the US debt levels were in the great financial crisis of 2008.

Giuseppe (07:19)
That's correct. so the expectation is that hopefully there's an increase in payrolls in Canada.

Canadians make getting more money, renormalization from inflation, and so that Canadians eventually pay down that debt. Rates come down, so it's less of a burden for Canadians on average. But you're absolutely right, we are one of the highest indebted countries globally. If you look at real estate markets, we're one of the highest, or overvalued real estate markets as well, globally. think Sweden might be the only one that tops us right now.

So I think the Bank of Canada is in a tricky spot where you don't want to cut rates too much and then have this re-acceleration. When rates cut, there's still an amplitude for individuals to get more mortgages, spend money, companies to refinance and be more indebted. But that interest expense comes down. So they're in a tricky spot to say, okay, well, we do have to cut to make sure that there's not this deterioration in growth. It's just the how much is what we're trying to evaluate.

Aaron (08:26)
Well, that's the million dollar question. you get that one right when we talk in a couple months time, I'll, I don't know, I'll send you a gift card for a nice dinner out on town.

Giuseppe (08:36)
Hahah

Aaron (08:37)
Maybe let's move over to the US and then maybe touch on the ECB a little bit. In the US, we did see a jumbo rate cut and with the inflation print do you think there's any pause given to another rate cut in the US or do think they're going to continue down the same path that Canada is?

Giuseppe (08:49)
I to present a short video of the hall that is to the right of the webinar.

Yeah, and I think that's a great, great question because, you know, we came out of July, August, right? July, August was softer employment data, Japanese carry trade, market volatility, risk assets went down. So equities had tough time. so bond participants are pricing significant rate cuts, right? Though there's a deceleration, got to cut, cut, cut. And so August finished.

August is over and we kind of go back to a little bit of using rationalization or using a little bit more logic saying, okay, that was, let's say there's one print. Is it a sustained trend? Is there's a sustained, you know, potential for slowing growth in the U S well, as more data came out that, that, that theme where that, that was kind of like rebuffed. And so the amount of rate cuts that were priced into this, this year starts to eliminate and get extended to next year. And so with this inflation data from today,

That same thing is going to happen. still them. I still expect the next meeting 25 basis points. And then a little bit of a pause to see, okay, how that market or how the market absorbs that. We've got to remember that every time there is a rate cut or a break hike, whatever, whatever the decision is, economists are predicting that it takes roughly six months, six to 12 months to really impact the economy. And so once again, forward looking central banks like the Fed, like the Bank of Canada.

They're doing this now for six months down the road. And so at a certain point of time, they're going to have to pause and say, OK, what has been the impact of all these cuts? Has it been pro-growth? Is there a reflation story that's going to? Those are the two things that they're focusing on. What's happening on unemployment? Is unemployment still a low? And so in the US, has been, Canada still has been relative to historical norms. So you can argue that both central banks have done a good job at least this period of time.

Aaron (10:52)
It is interesting in the Eurozone how they've gone from almost negative interest rates to just creeping over that hump. To those listeners out there, you generally don't want to have negative interest rates. You want to have moderately positive interest rates. Do you think they're going to go back to a zero rate policy or do you think they're going to try to hang on to those rates that they're sitting on right now?

Giuseppe (11:14)
You know, you ask any investor, do you want to get paid for investing in any set asset, right? And so if you're in Europe and you're getting a 0 % interest rate, how much are you getting paid versus the US versus other counterparts, Canada versus Australia? And so is Europe attractive? It's not attractive. And what are the prospects for growth in Europe? What are the prospects in general? And so not to say that, you know, on the equity side, there's companies that grow. Yes, there are.

You're saying in terms of the bond market in Europe, it's just not as attractive as other markets. And so when you think about capital flows, it doesn't drive too much in terms of having allocation to euro bonds, for instance. Do I expect rates to stay at zero? Once again, we talked about productivity issues. We talked about growth issues in Europe. And so the only way to stimulate the economy is to keep rates lower, do a huge fiscal package.

change some structure underlying structure within the European economy. Potentially loosen regulations. That's not the sentiment. That's not what the euro area at least has signaled. They're not pro to deregulating. They're not pro to agreeing, everybody agreeing to a specific fiscal package. So those are the challenges that we see in Europe overall.

Aaron (12:39)
Okay. And the first two topics, the inflation and interest rate conversation naturally drop out of employment, which leads into economic activity. Employment in Canada seems to be cooling some. We haven't seen major job losses yet, but the employment makeup I find very interesting to look at because it seems like it's becoming more consistently driven by government jobs or part-time jobs or the hourly

The work week that's put in has been shortened. So there's lots of things which going into that, which is going into that data pool, which I find very interesting. I'm certainly not qualified to speak to it. So I'm hoping to pass that question over to you to have you break it down for me.

Giuseppe (13:25)
Yeah, absolutely. And so I think when you look at the employment numbers, there's nothing that alarms you right now in terms of Canada. The fact that the number of hours worked has come down a little bit. It's not enough of a signal in terms of magnitude to signal any stress in the market. I wouldn't say that the labor market is hot, but it's not cold either. There's still jobs availability, but there's still large enough workforce. We're coming from a period of time where we had a significant amount of

of immigration, right? And so that also pushed for that amplified the employment or the tight market per se. In terms of also jobs, in terms of supply chains renormalizing, for instance, we need to get goods out. We needed more individuals working in the work field. So we're able to use them immigration to fill those jobs, which is good. So, but at a certain point that starts to cool. Are we at that level now in Canada? You can argue that we're at a

at a decent level in terms of employment across the board. Do we track part-time workers versus full-time workers? Absolutely. Once again, there's a seasonality effect. In the summer during holidays, there will be an increase tick in part-time workers. And so you have to normalize that when you're looking at that data. And so once we do normalize that seasonality, I would say there's largely further.

time being, again, that can change very quickly, but for the time being, there's not many risks in terms of the labor market in Canada or the US.

Aaron (15:01)
Okay. And the most recent economic data coming out of Canada is pointing to a unemployment rate, which is almost back to its normal range above kind of your 6-6.5% Is a lot of that driven by our immigration policies and as those individuals become integrated into the marketplace and find jobs? Or is it something which is a better explanation for it, I guess?

Giuseppe (15:22)
Thank

No, I think that that's been the bulk of it, right? So you have individuals that are now joining the workforce who weren't part of this calculation. Now they are part of the calculation. So unemployment ticks up. Once again, there's still a multitude of job markets. We also look at how many jobs are being posted relative to months prior, quarters prior. So those numbers, they have come down, but they're still strong. And so when we think about

This renormalization, think, once again, those levels are not, in terms of historical norms, they're not high. We don't have a high inflation numbers. We're more on the low end than high end. And so think the economy in general is still running slightly below potential. We think that's the case for the next few months. But over 12 months, if you think about a 12-month framework, if the Bank of Canada continues, once again, it's all mixed up with rates as well.

If the Bank of Canada continues reducing interest rates, that's going to propel growth, that has the chance to further reduce unemployment, but I don't think it's going to be anything significant in terms of the labor.

Aaron (16:34)
I want to touch on one point you just talked about there was labor market productivity. Particularly in Canada, hear that griped on some that our productivity is lagging behind. A few minutes ago, you mentioned that European productivity isn't quite where North American productivity is. The US just seems to be springboarding ahead of the rest of the Western world. Is there any particular reason for that? And maybe define labor market productivity to the listeners.

Aaron (17:01)
in general that there might not be an economics expert.

Giuseppe (17:01)
Thank

Yeah, so I think in terms of productivity, you're absolutely right. Canada has lagged It's not something new in terms of one dollar invested. How far does that one dollar invested go?

And so if you think about technology that's been over the past 50 years, biggest factor that's increased productivity across the world for the most part. In Europe and Canada, it's been two decades where our productivity has lagged in general. The biggest reason is largely because we compare ourselves to the US. And productivity in the US in terms of automation, in terms of AI more recently,

has been able to propel their GDP. Think about also, you

The structure in terms of capital or doing business in the US, it's very easy to do business in the US. There's a lot of capital and everybody wants to be invested in the US because they've shown time after time that they're able to propel, they're able to grow. You have a company in the US for the large part has been more successful than most places in the world. There's a lot of investors in terms of capital, there's less restrictions, less regulations.

And so when you compare that to, let's say, a Canada or Europe, in terms of building a business or a company, you're most likely going to have more opportunity to benefit from that ecosystem in the US than in Canada. And so that being said, you've got that better ecosystem in terms of technology. You also have the place where investments or enhancements in technologies are the forefronts.

And so we've seen that with, you know.

phones, we've seen that with AI, we've seen that with automation generally. Asia has done the same and you can argue that, but in terms of regulatory framework, it's much easier in terms of regulatory framework to the business in the US than anywhere else in the world, arguably, but for the most part.

Aaron (19:13)
I completely agree and echo everything you say there. It seems like the US is the epicenter for innovation. Anyone who's highly innovative and most businesses want to be in the US. And this naturally leads us to global economies. Where do we see things going? I know this is a four-year university course we could dive into here, but just high level, where do you see North America going over the next six, 12 months?

Giuseppe (19:42)
So in terms of North America, once again, largely dependent on what happens with central bank policy. And so our expectations that rates will come down. Canada's slowing growth, let's say three months, and then reaccelerating over 12 months span. Growth in the US, actually, we expect growth in the US to slow. And that's just because it's been so hot for such a long time. And so it's not a negative growth. It's just

below trend and so what their trend is or what their neutral rate for instance, just to go beneath that. In Canada, once again, rate cuts are what's going to propel the market. That's what we expect. That's what we've been talking to clients about. And so we're starting to see some of that in terms of the reaction when the Bank of Canada's cuts has been very positive. On our corporate bond side, our equity side, some of the companies that we've been

talking to not myself per se, but some of our colleagues in Toronto, there's general, there's much more positivity than there was, let's say, six months ago in terms of their economic conditions. There's still concerns, obviously, because of geopolitics. think that's the biggest concern, the overhanging concern that we have globally because of the world that we're living in in terms of wars. once again, we just dealt with huge supply chain issues. And so what a potential escalation in war.

results in for businesses around the world.

Aaron (21:13)
Well, when I speak with clients and we talk about declining interest rates, I generally say it's good for the consumer. It's good for you. And what's good for you is also good for a business. They're just the corporate citizens. That means they can spend money more easily. That means their balance sheet is easier to finance. So it's almost what's good for one is good for the other. On that note, I would like to transition over to a slightly more topical note and that's elections in the US.

Aaron (21:43)
It is something which everyone's trying to cover. Everyone's trying to forecast and predict. I know that economists were hoping that central banks wouldn't cut interest rates before the election because that could be viewed as trying to skew individual's thoughts around who's going to be in power. Could you just touch on that a little bit? I'll make one statement right out of the gates. Elections are generally irrelevant to the long-term return to the stock market, but everyone wants to speculate around them

Giuseppe (22:14)
Yeah, so I would fully agree with that comment as you know, Aaron. I think what central banks have done a good job is for central banks to be the finance credible, they need to be independent from governments. And so I think Powell has done a good job with that over his tenure. think in Bank of Canada generally for larger part has done a good job. And so showing that you're cutting rates not because...

not because of an election, just because of potential growth risks in the future illustrates, this central bank is credible. That's not a political game here. It's really looking at what's their mandate. Their mandate is to make sure inflation is coming down to 2% and make sure unemployment is at a sustainable level. And so if those two things are achieved for a good chunk of the central banks, they've achieved their mandate, regardless of who's in power politically.

And so once again, I think a lot of that was the media coming out with this, maybe political candidates on one side or the other also feeding some of that information. It's obvious that, you know, politics in general or individuals within politics, they do want to be able to have their imprint in terms of central banks because they want what they think is best for the economy. Once again, the job of central bankers to be independent and to make sure that they're independence is credible.

We've seen that in Turkey, we've seen that in Romania, we've seen that in large parts of Asia, where when you're not credible, you'll have a huge depreciation in your capital markets and currency as well. So credibility is very, very important for central banks globally.

Aaron (23:55)
Regardless of what political party you support, you generally want the economy to do well. Everyone just wants to say, my party is going to do better than the incumbent. So I completely agree with everything that you said and thanks for backing up the fact that elections are generally noise. On that note, I think we're at time here right now. I'd like to thank Giuseppe for joining me. I'd like to thank all the listeners. If you have any questions on any of the macroeconomic topics we spoke about,

happy to answer your questions. You can reach out to me at Aaron.Sherlock@cibc.ca or you can Google The Sherlock Group and get in touch with me that way. Thank you.

Giuseppe (24:39)
Thank you

Outro (24:40)
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[This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2024.

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Introduction
Short video of a stock market chart arrow moving in an upward trajectory with upbeat music play in the background. Magnifying glass appears and becomes the “o” in Sherlock’s Clues. Full title comes into focus, Sherlock’s Clues – Insights on Investing & Economics with the investment philosophy below “Investing Success: Powered by Process, Fueled by Discipline, Rewarded by Patience.”

Aaron (00:11) Welcome to another episode of Sherlock's Clues. I'm your host, Aaron Sherlock, and on today's episode, we are going to dive into dividends and income producing securities. I have with me today, Peter Hardy. He is a vice president and senior client portfolio manager with American Century Investments. Welcome, Peter.

Peter Hardy (00:33) Thank you for having me.

Aaron (00:34) Peter is a VP with American Century. He joined in 2008 and brings with him a wealth of investment experience, particularly around income generating securities. I'm going to pass it over to Peter here for a second just to give a little background on who American Century is. And then we'll dive into a few of the topics we're going to discuss today.

Peter Hardy (00:55) Yeah, American Century Investments is a $240 billion asset manager. Offices around the world, but headquartered in Kansas City, Missouri. So we say we're on Main Street as opposed to Wall Street. And, and we have an expertise across the board in fixed income growth equities. But the team I work for is known for low risk value investing and income investing alongside of that. We manage about $40 billion, all told in U.S. value securities. And one of the interesting things about American Century is our founder started the firm in 1958, but then decided after he and his wife and daughter had contracted cancer to donate the bulk of his wealth to a medical research endowment,

that it's set up to do basic research, to understand genetics and humanity. So our primary owner is the Stowers Institute for Medical Research, and they do, through our profits, we fund them, and they do primary research to uncover questions about humanity. For instance, last year, they discovered a pathway for amyloid formation.

That can result in cures for Huntington's disease, dementia, Alzheimer's, Parkinson's disease. So we say we have profits with a purpose, meaning that not just are you investing with an investment management company, but we have this greater benefit to society that pervades in what we're doing in our culture.

Aaron (02:47) What I like to tell clients and prospects is the two most important things in your life are generally your wealth, your health and we'll tack family on there as well.

Peter Hardy (02:57) Yeah. So we can cover two of those for you.

Aaron (03:03) All right. Thank you for the introduction and a little bit more information. I knew that you did have some charitable roots at American Century, but thanks for the further details on that. Speaking of details, I'd like to start off by defining what dividends and income generation is in a portfolio. I know you can speak to a handful of investment professionals and everyone has their own definition of what that means.

Would you mind touching on that a little bit to start us off and then we'll get a little bit more detailed.

Peter Hardy (03:36) Yeah, so when you're investing in equities, which we are, there's two forms of your return. One is price appreciation, and one is income that the security generates. Income is the only certain part of that. Prices can go up and down. And so people look at income as an important consideration in investing.

Diverge on how they look at income some equity income managers may look for absolute levels of income get the highest yield you can but we believe sustainable income that isn't subject to change or go down based on a company's financial wherewithal so some companies that pay high dividends can't sustain those and so we look for as opposed to just a high level of income, we want to couple income with the sustainability of that. We do that because it helps us in generating higher returns. Dividends constitute about 35 to 40% of the total returns of stocks over time. And by focusing on sustainable income, amongst other things, we can improve the risk adjusted returns. So how much volatility or how much our portfolio goes down when things are bad of an equity investment.

Aaron (05:14) I'd like to bring up and back up to one point which you made there is a sustainable dividend because there are dividend traps out there. When I speak with some clients they say this has a very attractive yield. Often times when I look at that it's usually 5, 6, 7 percent and we both know the reason why dividends at that level is either the companies returning all of its cash to shareholders or the share price

has dropped drastically meaning there's rougher times ahead for that company itself. Finding that balance of an attractive dividend yield versus a sustainable business is of paramount importance. With that, I'll ask you to touch on a payout ratio. Maybe speak to that as well because that is something which I like to focus on when looking at sustainability of a dividend.

Peter Hardy (06:08) Yeah. So the payout ratio is the portion of a company's earnings or cashflow that they're paying out in the form of dividends. The higher the payout ratio, the less, the more susceptible that it, that dividend is to be, to being cut. Or put another way, the less flexibility that a company has in maneuvering in order to pay that dividend.

So to your point, many high payout companies that have high dividend yields, the market is saying that dividend yield is likely unsustainable. But we do the work to determine which companies have sustainable dividends, even if they have a high payout ratio, and which companies don't. But that's why we're focused on dividend sustainability and not the absolute level. What you do want as value investors is a company whose stock price has dropped for transitory or non-fundamental reasons that caused the dividend payout to go up, or the valuation to be, excuse me, the dividend yield to go up, and the valuation to be more attractive correspondingly.

Aaron (07:30) Okay, thanks for adding some more color to that. I feel like we're driving in the direction of talking about the American Century process. If you could walk us through some high level thesis research process and some checks and balances or disciplined investment approach that you have because I know you're certainly not overnight investors and you have a very rigorous investment screen and process which you put every company through.

Peter Hardy (08:01) Yeah, so we've been together as a team for 30 years and we've been doing this process since 1994. And the way we arrive at dividend sustainability isn't to look at dividends first, it's to first understand the characteristics of the business and we look for high quality businesses. Everybody says that, but our specific definition is we're looking for companies with high financial high returns on capital, they make more money than their competitors and other businesses in general, they're more stable in that return profile so that the earnings don't go up and down as much given economic cyclicality and then we make sure they have clean balance sheets, low degrees of leverage and sustainable franchises. Quality as a starting point gives you a company that

outperforms over time with lower risk. And because that has superior financial productivity, because it makes more money, it has a better ability to pay dividends and increase their payout ratio over time. Alongside of that, what we do is look for attractively valued companies. So we avoid risk, not by looking at what a company's best case value could be, but what a normal value could be. And more importantly, and this is how you frame up when the dividend yield is attractive, we stress test the business prior to investing, to understand where the company's finances can go in a bad environment and therefore where the stock can go in a bad environment. So that downside belief is critical in protecting on the downside. Then we layer in dividends. So we seek a dividend yield advantage, and then

utilize that yield to further augment returns and reduce volatility. I'm sorry you were gonna ask a question there.

Aaron (10:08) I just thought it was timely to hop in and just touch on years of volatility and how quality businesses do perform in those times. Usually when there's volatility in the market, you get a flight to safety and that's generally in companies which have low earnings volatility or low earnings variability. I'll just touch on two timeframes in particular, which I'm sure you're proud of. 2008, when the great financial crisis happened and Canadian dollars, you were positive.

As well as in 2022 when broader markets were down mid to high teens, you were also positive in that year just because you were able to mitigate some of that volatility on the high growth names.

Peter Hardy (10:51) Yeah, that's the crux of our process. We believe in kind of winning by not losing in many ways. Downside outperformance is more powerful than upside under performance, but also we couple very well with more aggressive growth type managers in arriving at a total portfolio that is less volatile, participates in the upside, but also protects on the downside. I should add, those periods of market volatility also occur with significant dividend cuts, and we really haven't been exposed to those companies because of our views that cut their dividends during bad times, which is important. If you're going to invest in income, you want that income to be there. And thus the sustainability, when things are bad becomes the most important consideration.

Aaron (11:48) I appreciate you touching on that as well and saying you pair very well with a more aggressive style of management because the old adage of diversification and not having all your eggs in one basket certainly does help as well. Move on to another topic here and I'm sure this is part of your day-to-day job is what areas are you seeing potential tailwinds for? Headwinds and …

Are there any general thematic or sectors which you do like or dislike? Because I know being from the dividend oriented investment world, there are going to be some sectors which you just cannot look at.

Peter Hardy (12:30) Yeah, there's certainly a lot of names that don't pay dividends that we can't participate in or whose business models are such where we don't believe in the sustainability of their return profiles and definitely in the future. That said, you know, one of the reasons we pair real well with growth managers is right now we're identifying attractive dividends.

In areas outside of the Mag-7. So there's a high degree of concentration and performance associated with a select few names. Those are growth names. As value investors, we're gravitating to other areas. So where are we going? Well, we've been invested in and increasing our weight on underperformance and consumer staples in healthcare.

And why are we in those areas? Well, first, you have had increasing interest rates. There is the potential for economic slowing, and these are the least economically sensitive businesses that there are. Second, and when I say we want higher yields because of transitory or temporary reasons, both these sectors have been negatively impacted by what we're calling the GLP-1 bubble.

GLP ones are a class of drugs, weight loss drugs, think Ozempic and the market has ascribed detriments to these sectors. So the stocks have somewhat languished, making them more attractive. Even though they're fundamentals, their earnings have been good. The belief is that you and I aren't going to eat as much on a go forward basis because we're going to be on. Ozempic or GLP1 drug of some sort, and it'll reduce our appetites. But we think that risk is overstated. And that's on consumer staples side, like food companies. On healthcare companies, the belief is, you know, we're not going to have the same need for medical services in the future. So a variety of healthcare companies, whether that's diagnostic companies or medical device companies like, make hips and knees aren't going to see the same usage. Well, hips and knees are a disease of longevity. If you lose weight, you actually become more active and live longer. So the need for those probably goes up in the future as opposed to going down. But we're finding a variety of the names in those two sectors. Another sector would be utilities. Those...Utilities just produce power that's used in the grid for homes and businesses around the country. Those stocks are higher yielding stocks, have very sustainable yields. Their payout ratios may be a little higher, but they get a regulated return on capital. So they are one of the least economically sensitive assets and they've gone down because of rising interest rates, which makes very little sense to us.

Additionally, all three sectors have been left out of kind of AI fervor. Utilities actually benefit from AI in that they produce power for these data warehouses. So we think the market is not ascribing a correct valuation to those names. But all told, those are three of the most stable, sustainable dividend sectors that you can have. And because they've underperformed, we've been increased our weight in all three.

Aaron (16:24) Yeah, and I usually describe those three sectors as the have to haves, not the want to haves. And when you get any sort of constraint or pinch on your wallet, if there is some sort of economic slowdown, you're going to spend on the have to haves. Your comments on the utility space, I completely agree with. As long as we continue down the electrification path, they're just going to become more important. And, the inflationary pressures that are put into place, the price of copper, the price of all these metals which are going into producing these utilities is going up. Their hard assets should generally be inflating in value as well. I completely agree with everything you've mentioned.

Peter Hardy (17:06) Yeah, that's the irony to us. The have to have stuff is really attractively valued and the nice to have stuff like for instance, cruise lines were up over a hundred percent, you know, at a Apple handset that costs you a thousand dollars, you may not get as many of them in the future in a bad environment, specialty retailers, where, you

 know, have nice to have stuff, not have to have stuff. All that has, has gone up substantially and these have to have sectors of underperformed making them more attractive, but that's the irony of the current market environment. Nice to have, is doing well from a stock price standpoint. Their dividends aren't sustainable. Have to have is done poorly and their dividends are sustainable.

Aaron (18:03) Now, I know the mandate which I use in client's portfolios is predominantly based in the U.S. or domiciled within the U.S. Do you have a preference globally with where you like to look for companies? I know the U.S. certainly has some preferential regulations versus the rest of the world, but is your scope global or do you have certain constraints?

Peter Hardy (18:25) For this portfolio, we have constraints. We can invest a portion outside of the US, and we tend to kind of hedge the currency risk there. But we're global as a team. We manage a couple of global portfolios. And when I mentioned quality, we're not confining ourselves to businesses in the US when we're looking at quality businesses. But that being said, U.S. has many advantages from a depth and breadth of market standpoint. Certainly in certain sectors like banks, the U.S. banks have some of the best backdrops from a demographic and capital and return standpoint versus say their European or Japanese peers. But we're not constrained and

We will go where valuations lead us, for instance, in energy companies. If you're going to look at Exxon and Chevron, you need to study Royal Dutch and Total. And so we've got investments in some of the integrated oil companies that are overseas. We've found some industrial businesses in the US. Many of those nice to have industrial type businesses are expensive. but in Europe they're cheaper, so we have some of those.

Aaron (19:52) I'm going to switch gears here to the outlook, the million dollar question, which is impossible to answer, but everyone wants to hear what your thoughts are on it. That's the global economy. I keep saying that trying to time things around an economic cycle is an impossible task. There was supposed to be a deep recession by this time this year. It hasn't happened yet. Interest rates and inflation. Looks like inflation is starting to moderate. Last but not least, the election cycle. We do have a lot of excitement coming up in the US and in Canada here. I generally view it as being irrelevant to the marketplace outside of falsehoods and promises which aren't going to be kept, but I'll put that on the table as well.

Peter Hardy (20:39) Yeah. So one of the interesting things for Renaissance CIBC, who we sub is a fund for, we, we had a call in 2016 that I had to do with a Canadian publication on the U.S. elections. And so it was the day after Trump was elected and nobody knew who was actually going to be elected.

But the belief was then, and I use this on kind of politics first, and then we'll go to the harder question, but I use this to say it is noise. So I'm glad you said kind of irrelevant, but banks and energy companies rallied under a reduced regulatory thesis post Trump election from November of 2016 to the end of the year, they were up almost 25%, both sectors. Fast forward through Trump cycle and 2020, what were the two worst performing sectors, energy and financials. So these things tend to be not based on economic reality. What we do is try to understand the underlying valid economic impacts. Tax cuts were one. That caused us to have to revalue a lot of companies based on their cashflow potential. And so that was real. In this election, if Trump were to be elected, there is a belief that there will be continued tax cuts and that would cause valuation or ascribe a valuation improvement to many companies based on their improved cashflow. 
But I say that to say, a lot of what occurs from an election standpoint doesn't really result in any change in underlying economics. So that goes into your second question. What does result in a big change to underlying economics? Interest rate policy, central bank policy. And what we are seeing is that in spite of the rise in interest rates, we're not seeing corresponding economic slowdown. And in the US in particular, you're not seeing inflation abating to the same degree that the Fed had anticipated. So that's resulting in a belief that rates will remain higher for longer, or there's not going to be as many interest rate cuts. That said, what becomes the issue is the sustainability of debt levels and the ability of asset prices to remain high in the face of higher interest rates. So companies that have high levels of debt, those debt costs are going to go up and it's going to decrease their earnings profile. So that is embedded now more for the future.

Certain asset classes that have relied on easy money for their valuations like private equity or private capital that will also result in a pullback there and that could impact the valuations of stocks it certainly has impacted the valuation of bonds, but higher yield bonds could go down go, you know be pressured So I say that to say the higher for longer environment likely puts more pressure on equity valuations, less likelihood of this trending up market that we've seen here at the end of 2023 and 2024, and more muted and volatile returns. Now, I could be saying that because that's where we do well, but I do believe that is the likely scenario, lagged impacts of interest rate increasing. Leading to reduced returns for equities and other asset classes into the future and creating some form of volatility.

Aaron (25:03) Well, that's why pairing you with a more growth oriented portfolio, you're hedging your bets some, it's almost layering in portfolio insurance to a certain extent.

Peter Hardy (25:14) Yeah, I think people call it rose colored glasses or glasses half full versus glasses half empty. We have growth teams here and they're very good at what they do, but we think they have the rose colored glasses on at all times and we'd say the glass is 48% full versus has 48% of liquid in it. We tend to think of ourselves as realists.

Aaron (25:40) Be sure you're not an economist because they always seem to talk about 40% probabilities. They never cross the 50% line.

Peter Hardy (25:48) No, you kind of got to understand economics, but your point in the beginning about when it comes to calling the economy or interest rates, I think everybody's gotten it wrong every year. We have a strategist we use and when it comes to forecasting oil prices or interest rates, his quote is, nobody knows nothing.

Aaron (26:16) On that note, I think we'll end it here. Thank you very much for your time, Peter. I'm sure we could continue on for hours at length. I'm hoping to get you back on at some point in time in the future. For all the listeners out there, if you want to learn more about American Century, in particular American Century US Large Cap Equity Income, you can reach out to myself at my email which is aaron.sherlock@cibc.ca or, google the Sherlock Group and I'd be happy to discuss how to place that within your portfolio. Thank you and have a good day.

Peter Hardy (26:51) Thank you.
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[This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2024.

The views of the commentator and/or guest speaker(s), do not necessarily reflect those of CIBC World Markets Inc. This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed. The commentary is for informational purposes only and is not being provided in the context of an offering of any security, sector, or financial instrument, and is not a recommendation or solicitation to buy, hold or sell any security. 

CIBC Private Wealth consists of services provided by CIBC and certain of its subsidiaries, including CIBC Wood Gundy, a division of CIBC World Markets Inc.

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Aaron Sherlock is an Investment Advisor with CIBC Wood Gundy in Saint John. The views of Aaron Sherlock do not necessarily reflect those of CIBC World Markets Inc.

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Introduction
Short video of a stock market chart arrow moving in an upward trajectory with upbeat music play in the background. Magnifying glass appears and becomes the “o” in Sherlock’s Clues. Full title comes into focus, Sherlock’s Clues – Insights on Investing & Economics with the investment philosophy below “Investing Success: Powered by Process, Fueled by Discipline, Rewarded by Patience.”

Aaron (00:11)
Hello and welcome to another episode of Sherlock's Clues. I am your host Aaron Sherlock and on today's episode we are going to talk value investing. I have with me today KC Parker. He's a portfolio manager and research analyst from Canadian institutional money manager, Beutel Goodman. A little background on KC. He joined Beutel Goodman in 2006 and prior to joining Beutel, he was a senior partner in an Ottawa based technology firm. Good morning KC.

KC Parker (Beutel Goodman) (00:40)
Good morning, Aaron.

Aaron (00:41)
Thanks for being here with me today. I know that you're based in Toronto, so not a drastic time zone difference. My listeners will notice that I've got people from all over the world on the call, so it is nice to have someone in Canada.

KC Parker (Beutel Goodman) (00:54)
That's great.

Aaron (00:55)
For the benefit of the listeners here, would you mind sharing a little bit of background on Beutel Goodman? I know you're coming up on a 60th year anniversary here.

KC Parker (Beutel Goodman) (01:03)
WHA -

Yes, and I apologize my dog's gonna run away. There we go.

Aaron (01:10)
That's quite all right. We love dogs on Sherlock's Clues. I've got two of mine out in the living room right now sleeping.

KC Parker (Beutel Goodman) (01:16)
OK, but he's gone now, so it'll be quiet for the rest of the time. And it was a bit distracting. But yeah, so Beutel Goodman was founded in 1967 by three individuals in Montreal who defined value in their way. But I can say Beutel Goodman was absolutely founded as a value firm. Those three individuals are all somewhat famous today. And they

They all went their own different ways. So none of them or any of their descendants or anyone else is involved in the firm. There's no equity owned by them. Two of the names remain as part of our company, which is great because it just sort of, you know, it pays sort of homage to, I mean, the founding of the firm as, you know, sort of value roots.

The firm today is probably the largest or second largest independent institutional money manager in Canada. And that was not an area that they found exciting, but we find it very exciting. And we've been growing and we've been expanding our strategies and with partners like CIBC and, but also in the US. So it's really exciting. Now, I think it's important that what is value, I think this is...

no one defines value the same way. So if it's okay, I would maybe explain how we define value.

Aaron (02:39)
Yeah, I think that's an excellent segue because like you said, your firm generally focuses on value investing. And I know when I went through university, we were running screens based on Benjamin Graham and the Intelligent Investor, but no one's going to public libraries to comb through documents these days. It's at your fingertips with the good old fashioned internet.

KC Parker (Beutel Goodman) (03:02)
Yeah, I think that's actually a really interesting point you made in the sense that everyone has almost equal access to information, both because it's just like the data is readily available to every professional manager instantly. And so really it comes down to, I think, what people define as a good business or not, and also a question of timing. So I think the largest advantage we have, and I will still define,

defined value, but I think this is very important, is that if there's a company that is going, like a very well run company in a good industry, but it's going through a significant challenge, maybe there's like some sort of temporary regulatory sort of overhang, maybe it's a cyclical downturn in their end markets, you know, management change, all these different little things that can be happening. The incentives in the industry are such that very few firms could take advantage of that. So, whereas,

Our clients know that we are very long -term investors. If you see us buying a new stock, it is very likely that that stock will underperform the market for the first year, maybe even two years. I mean, we're not making a call on when that stock will start to add value relative to a benchmark. We are making a call on the industry structure, the company's positioning within it, the balance sheet. Are we aligned with management?

But most importantly, the valuation, right? And so we think one of the easiest ways to lose money is if you pay too much for a business. So that's, I think, one important aspect. But the second one is for us, cheaper isn't better, right? So if you have a pretty terrible business and it's trading at six times earnings, for us, that's expensive because it's a terrible business.

Aaron (04:55)
I generally define those as value traps and things to avoid. They look cheap, but they're really a trap underneath it all.

KC Parker (Beutel Goodman) (04:59)
Yes.

Yeah, absolutely. So we're just looking to, as I said, almost arbitrage our ability to take a long -term view and to not worry about getting the timing right. Whereas many other firms, if they invest in a stock and it blows up in the quarter or the year, their boss is on that person or the client is saying, what are you doing buying this thing for me like it blew up? Whereas our clients, full disclosure, we have...

conversations that this is how we invest, don't be concerned when you see the new stock that we're buying, it's underperforming. Because they've also seen it in action, where the stocks that underperform and are hated, eventually those become great stocks and almost stock market darlings. And that's when we will be selling them. Because, yeah, so I don't want to get too ahead of myself. So maybe just if I could spend a little bit more time on the value part.

I'd say that there's four elements that we look for in a business. So one is valuation. So I think it should just be at a... The multiple that we pay is such that we should be able to hit our hurdle rate without using aggressive assumptions. So our hurdle rate is a 50% total return over three years. And there's a lot of ways that people can fudge this if they want, but we keep each other honest.

So if I find a business that's 18 times earnings and I say, if I just assume 10% revenue growth and all kinds of margin expansion and it stays at 18 times earnings, then we can get our 50%. And no one on my team will let me get away with that. And similarly, I will not allow anyone on our team to get away with that. So we can buy stocks that are, I mean, 15 times earnings sometimes, because some businesses do grow more than others. And so,

You know, we don't put the same growth assumptions and everything on every stock. It's very specific to what industry are they in and what's reasonable. Because we don't want to lose money. That's the number one thing. We know that good businesses will make us money. What we don't want to do is lose money. And as I said, if we use aggressive assumptions or pay too much, then that's the surest way to lose money. So valuation is an important pillar. Number two is the balance sheet. Like we don't like playing with matches.

A business that has way too much leverage is not interesting to us at all because it can just take a small change either in the market or somewhere else. And then all of a sudden, I mean, it's completely unownable. So balance sheet is not negotiable. Number three is return on capital. In a way, that's almost a truth meter. So we say we only buy good businesses. And you can't tell from the multiples that we pay whether that's true. But what should come out,

is that if you compare our portfolio's ROE to the market, you should see that our portfolio is cheaper than the market, our portfolio has less debt than the market, but somehow the ROE is higher, which is a little bit counterintuitive because normally, obviously, if you use leverage, that gooses an ROE. But we buy businesses that actually have less leverage but have higher ROEs. So I like to call that the truth meter, as I said.

And then the fourth one, which is somewhat qualitative, highly judgmental, and the trickiest one is management alignment. And so we spend a lot of time before we even start doing a deep dive on a stock and we say, okay, let's look at the current management team. How are they paid? Right? How has that changed through time? What are the incentives? What have those members of management done in their past lives? Let's talk about the board of directors. Let's also look at the industry that they're in.

And are they competing against rational players who also have the appropriate incentives? So if I can just pause on that for a second and say, well, what are appropriate incentives? I mean, the base salary, you're not going to spend a lot of time on that. The annual bonus, again, it's not that important. I mean, it's more the long -term compensation that we spend most of the time discussing. And so a company that is paid on revenue growth, just

Aaron (09:20)
Mm -hmm.

KC Parker (Beutel Goodman) (09:26)
not even organic revenue, but revenue growth, that's going to probably not end up in our portfolio. So there's no perfect compensation sort of metrics. There's good enough and there can be slightly better. So metrics that we would look at would be a TSR component, which is a total shareholder return relative to some benchmark. Return on capital is very important for us.

but is also how you define these things, right? It's never just the number. So, you know, we've seen companies that say, you know, returns are very important. We keep hearing that from shareholders and our current return on capital is six. And if we get it to six and a half, then, you know, we get, you know, three times our base or something. And you say, that's a terrible return on capital. You should get nothing. You should be fired. Right.

So as I said, there's a lot of debate internally before we actually move forward with writing up a stock on those four elements, but especially the alignment. So anyway, we ended up on a bit of a tangent, but I think it's what sort of definitely differentiates us.

Aaron (10:32)
Well, value investing grows like any other style of investing has this different flavor depending on what firm and who you're talking to. I did like that you touched on a couple of things when it comes to research. Coming from the research world myself, garbage in garbage out. You can make anything look as good or as bad as you want. It just depends on who you're trying to pitch it to. So having conservatism in your thought process, I think is a good thing.

KC Parker (Beutel Goodman) (10:56)
Yes.

Aaron (11:02)
The next thing that I would like to highlight and we won't talk to specific numbers is in 2022, your general portfolios when it comes to equities were actually flat to up in a year where the markets were down significantly. So you're investing in more stable businesses which have positive cashflow and strong balance sheets that don't feel the cycles of the markets as much. With that, maybe we'll try to hop into a little bit more detail on

Beutel Goodman process. I know we touched on it a little bit before talking about some of your return hurdles, but maybe talk about how you would add a company to a portfolio. And I know it's easy to buy a company. It's hard to sell and having sell discipline is just as important so you can crystallize any sort of those gains. Like you said, if the company's turning into a business, which is on the front page of every other investor's portfolio or mind,

probably time that you're going to be moving away from it. Could you touch on that a little bit?

KC Parker (Beutel Goodman) (12:05)
Yeah, and I think that absolutely our investment process, i .e. the thing that governs how we buy stocks, how we size them, and how we exit them over time, it's our secret advantage. But the funny thing is that everybody knows what it is, but nobody else can follow it, because that entails buying things that are out of favor, holding them despite that.

And then when they are completely working, when they're the top stocks in the index, sell them. No one can follow that because, I mean, they're human, right? Like who wants to sell a winner? Who wants to buy a loser? And I would say, oh, we do, right? In both counts, right? So if we take a step back, it is very difficult to get a stock into the Beutel Goodman portfolio. If it's OK, I'll maybe sort of talk about the life cycle of a stock.

in a Beutel Goodman portfolio. And so if I have an idea, I will do what's called a one -pager, and it will be a single piece of paper, two sides, whatever, and I'll give it to everyone in the group. And it's my job to know the people that I work with, know the things that they look for, because otherwise I'm just going to have to come back and do it again. So it'll present the basic thesis, some of the...

parameters in terms of assumptions that we would use, maybe multiples. I mean, we don't know for sure at that point, but it's all preliminary. Industry structure, risks, how management's paid. So we present that, the whole team, all the analysts get together and we have a discussion. And any one analyst can kill the idea right then and there. And about half of the names that are presented die, which is actually a pretty high hit rate because we all are investing the same way, but

You know, someone might think, well, I'm not going to pay as much attention to that risk as I want to because I really want to write up this name. Well, there's seven other people to say, yeah, you're not paying enough attention to that risk, right? So I think that's a high kill rate. But either way, we have discussion around it. If everyone is on board, then that analyst disappears for whatever it is, one to four months, does a full memo with model, talks to management, does whatever the person needs to do to be fully comfortable.

Then we come back, we review the whole memo, maybe we tweak some disclosures, some assumptions, etc. And once it's a go, then we meet as an entire company. So everyone in client service, the Canadian equity team, I mean our whole team, and we present the name. And just for everyone to sort of understand why are we buying this thing that's out of favor and invite Q &A.

And at that point, if the stock is still at a 50% total return over three years, which means it meets our hurdle rate, we can then initiate a position which we would always start at a minimum 2% because we think that if a name belongs in the portfolio, then every name deserves to be a substantial weight. We're never going to buy a stock that has a 50% total return, but we say, well, it's a little riskier, so we're only going to start with a 1%.

That is not a thing we're going to do. That's the same thing as saying it doesn't belong in the portfolio. So all names warrant a 4-5% weight eventually. So we buy the 2%. Typically, if it's a US name, it'll go in the US fund. Every global strategy that we have can participate at that point if they choose to. You go forward, maybe the stock underperforms. It's down 10%. Maybe some global funds will then buy it.

probably the US fund will continue to add to it. And then this is where it gets interesting, at least from my perspective, which is that, again, we have really simple rules, which I think govern the biggest risk is the fact that we're all human, you know, greed and fear. So if the stock, when you buy a stock, there's two fixed prices. The first fixed price is what's called a downside price. If the stock at any point goes through this downside price, which is fixed for the duration of owning the stock.

then the first analyst effectively loses that stock and it goes to a second analyst who then has to do a downside review. And they come back, they present the downside review to the whole group, and it's almost like a one -pager all over again, which is that if that analyst thinks we should continue to hold it, anyone can say, I disagree, here's reasonable reasons why we should exit. And so...

At that point, the idea has to fight to stay in the portfolio. I can tell you that there's a very high live rate, if you want to call it that. So stocks will go through downside. It's not often that the story has devolved so significantly from our original thesis that we sell it.

Aaron (17:09)
Do you ever see times when the stock declines for no reason and you take it to the committee and you come away from that and say, maybe we should add more to the position because it is cheaper now or is it just on a watch list until it starts to perform better?

KC Parker (Beutel Goodman) (17:26)
Oh, absolutely. We will absolutely add to it if it's underperforming. But we're not allowed to add to it after it goes through the downside price and until we've met from the second analyst who's presented this person's view. And then if we all agree that this is a go, it's the same as before, only cheaper. So it's very likely that we'll actually add to it. And then it goes back to the original analyst, except now there's a new downside price and a new target.

Okay, so that's managing that fear. And the reason I bring it up is because, you know, different people react in different ways. If you have a torpedo, if you have a stock plummeting, some people might just say, oh my god, we have to sell that, right? But you can also have the reaction of just double down, double down, double down, like, just piling more money, bad money after bad money, right? And so we want to avoid that, right? So it's a very simple but formalized way to make sure that the story is still on track, right?

Now on the upside, we also want to manage that. So as I mentioned at the beginning, every stock has a target price. That target price is also fixed. It doesn't matter if it's a pharma company and they come out with a weight loss drug that you can just like inject like, you know, through nasal spray. Like it doesn't matter. Our target price stays fixed. When the stock hits that original target price, it's not a time to cry. It's a time to celebrate for a few reasons. One is that

we have high hurdle rates. If a stock is hitting the target price, it means it's done very well. And so what happens is the trading desk automatically trims a third of the position in every portfolio that holds that stock. And I say, like for me, that's like Christmas in the sense that now we have extra money in the strategy and then we can go add to the stocks that haven't performed well. So as I said, most people wouldn't want to sell their winner.

I am personally excited as everyone else on my team are because now you get to add to those names that have lagged. After we trim the third, the original analyst will review the name, present, re -present it to everyone with the new upside. And at that point, if there's, if it's fully value, we'll exit. If there's still good upside, we'll just hold the position and hope that, you know, maybe it underperforms or that type of thing, right?

And so the whole portfolio process is really governed by the total return, which is informed by the target price for each individual stock.

Aaron (20:04)
Okay, very interesting. I appreciate you going into more detail on that. I'm a sports guy myself. The way I like to look at it is, Beutel is trying to pick Tom Brady with the last pick in the draft and hope he develops into the superstar that he became later on in his career. Maybe in his golden age, trade him off for some new draft picks.

KC Parker (Beutel Goodman) (20:25)
I mean, or Moneyball, right? Like, absolutely. Yeah, that's a great analogy. But the difference is that we're not going to, if we're, you know, we're not going to pay a lot on the idea that Tom Brady becomes the Tom Brady, right? That's the difference. But no, it's a great analogy.

Aaron (20:43)
Alright. Now, I would like to shift gears a little bit and get a little more focused on some sectors or thematics which Beutel Goodman generally invests in because I know your screening process would naturally eliminate some sectors or some areas of investment because you are value investors. It generally comes with companies which are cash flow positive, pay dividends. Could you touch on that a little bit more and maybe some

KC Parker (Beutel Goodman) (20:47)
Of course.

Aaron (21:12)
geographies which you naturally gravitate towards.

KC Parker (Beutel Goodman) (21:16)
Well, yeah, I mean, so every company that we invest in has free cash flow. I mean, that's not an option. Now, not all of them pay dividends, but many do. I'd say more than 80%, probably, maybe even 90% pay dividends. But that's also just a sign of it's a strong company in a more mature industry. So they have more cash than they need. So they return to shareholders, right?

Now, in terms of almost, I'll call it almost bias. So I'll start with some of the maybe the industries and geographies where, you know, it gives us a little bit more pause traditionally. So we would say that if there's any element of a macro call, then probably that entire sector is off limits. I mean, that's sort of a number one, right? So I'll give you an example. I'm I am a huge energy bull, like one of the few kind of like it was a very lonely, dark days.

five years ago when everyone was convinced that starting next week, every vehicle around the world was going to be electric. I mean, it was preposterous. No one spent five seconds just actually thinking about it. But despite that, we don't own any energy or not in the traditional sense. Go ahead, sorry.

Aaron (22:29)
Well...

I was going to say, I know we spoke before, my background is in energy equity research as well as investment banking. And I look at the names and some of them look mighty cheap, but the way I like to refer to any sort of natural resource based investment is it's usually up on an escalator, but down on an elevator when there's any sort of cyclical headwinds.

KC Parker (Beutel Goodman) (22:38)
Yeah.

Yes, so we would, if there was a way that we could know that the oil price would remain within a particular bound for a three to five year basis, I mean, I think then we would have a big weight in the energy sector, right? But the problem is that there are so many almost, you know, black swan trap doors on both demand and supply.

And it's just one of them. And then it's like, whole thesis down the drain. And it's like, that's not how we invest. So we feel that way about energy companies and almost the entire energy sector. We feel that way about mining. It's the same thing. It's like, OK, I mean, sure, electrification, copper. But really, we're going to buy something that's entirely dependent on the price of copper. That doesn't feel right. We can do better, and we do. Another area that we stay away from typically,

is life insurance and frankly the banks. And it all comes down to kind of a simple idea, which is that these companies are not really sort of masters of their own destiny, right? If you're a bank, you have these market rates and you have extreme regulatory oversight. And so you use a tremendous amount of leverage to try and eke out...

pretty terrible ROE and hopefully, you know, the regulatory environment, hopefully your underwriting standards and the economy, all of these things line up, right? That's a horrible setup. We're trying to present the 25 most interesting companies we can find in every sector and geography around the world. I just don't think a bank can typically make that short list.

Aaron (24:46)
On the bank side of things. I know I work for one wonderful place to work. However, I view a bank as the company which provides you the capital to go then buy the thing that you really want. The company who's producing the excellent good or service which you're willing to spend money on the bank is essentially your source of funding.

KC Parker (Beutel Goodman) (25:07)
Yes, yes, which is kind of a commodity if you think about it, right? I mean, if you need a mortgage, I mean, you'll just take the company that is going to give you best rate, really. And so it's a bit of a problem. But that's OK. Now, we have owned banks here and there in the US, like as one example, when JP Morgan, the whale, if you remember the whale back in the early sort of 2010s, we actually bought JP Morgan on

the fear that the market had over the whale trading. And so we have owned banks and we will own banks, but it's an area that typically, if you open up the portfolio, don't be surprised if there's zero banks, that's all. So I would say banks, utilities, real estate, mining, and energy, all for the same reason, which is that they're not in control of their destiny. Areas that you would typically find us overweight would be...

The consumer sector, so consumer staples, consumer discretionary, also healthcare and industrials. We think those are really interesting sectors. And, you know, normally there's a handful of great companies that we can invest in there. If I flip to sort of a regional perspective, I mean, we don't have anything in emerging markets. We haven't had anything in emerging markets for a very long time.

And it just goes back to the idea that if we have 25 stocks, it's very difficult for a company that is in a region where there is very difficult governance sort of set up. Typically, that company is heavily reliant on its own market, which is not very diversified. Right. And so there's too many calls within that. And and you rarely have good returns in valuation and balance sheet. So it's just like.

I mentioned the four things at the outset that we look for. You can usually go zero to four on most emerging market stocks. So you're not going to see them in our portfolio typically. And then also if we talk geographically, if I'm going to generalize, companies in the US are typically more kind of shareholder aware as opposed to stakeholder aware.

And it's not because they're nicer people, it's because the CEOs make obscene amounts of money and they really want the stock to work. And so it's more likely that you'll get alignment. It's more likely that they'll shut down bad businesses, you know, just really do the best thing for shareholders because their paycheck relies on it. But it's actually changed a lot. As you said, I've been doing this since 2006 and there's been a bit of a revolution in the Western world.

Aaron (27:45)
Hmm.

KC Parker (Beutel Goodman) (27:55)
So while a lot of European companies, you know, and sort of Japanese as well, are still very stakeholder driven, we're actually okay with stakeholder driven. We don't think it's shareholders at all costs, but we think that you have to run the business appropriately and you have to be awake and say you're a public company, right? Go ahead.

Aaron (28:16)
Would you, just for the audience's benefit, define stakeholder versus shareholder for us?

KC Parker (Beutel Goodman) (28:21)
Yes, that's a great point. I mean, I I I would say that if you consider a society at large, then there's different groups within that which would be stakeholders. So if you're, let's just say, company X. So you have employees. If you treat those employees well, not too well, but appropriately, you will probably be a better run company. You will probably be able to take market share from competitors, etc

You've got your community, you know, you've got society at large, there's government, there's suppliers. I mean, you've got all these different groups of individuals, which is effectively your ecosystem. And if you treat any of them in a kind of inappropriate way for what you could call supposed to be like global stewards of capital, in the long run, that's going to hurt you. Right? I mean, if you if you hurt the environment or the community, if you

take advantage in an almost like illegal or, you know, unfair way to employees or suppliers in the long run, you're going to lose your competitive advantage. So that, so we think stakeholder approaches is valid, but you have to be awake. And what I mean by that is, you know, your public, you know, the shareholders own you. Yes, treat everyone well. But if your stock is really inexpensive and you have net cash, it's inappropriate.

for you to sit on it. So we spend a lot of time engaging with companies in all jurisdictions because, don't forget, we're buying companies that are out of favor for some reason. And sometimes the reason is that they're not being run optimally. And so we feel that we have to get involved in a very discreet, non-public way and explain to them that this is how the market will value you, like with a higher multiple.

Aaron (30:20)
Thanks for sharing a little bit of light on that. I guess boiling it down, you're focused predominantly on the Western world, both North America as well as developed Europe and maybe tiptoeing over to developed markets in Asia being Japan.

KC Parker (Beutel Goodman) (30:35)
Yeah, Japan, Singapore, Australia, yes, at the current time, yes.

Aaron (30:40)
Okay, perfect. Now, we're running out of time here, so I would like to finish up on the impossible question and that is the outlook. I know you're bottom-up value investors, so you generally don't spend too much time looking at potential future headwinds. But if you could just humor me with a few of your thoughts on what the global economy is looking like. I know if we had a…

Listened to all the experts from this time last year. We were going to be in a deep recession. People were expecting multiple interest rate cuts this year. I'm not sure if we're going to see that. And then we are coming up on an election year here right now. I know by and large it's irrelevant because either party makes promises they cannot fulfill, which generally drives optimism. But if you have some broad thoughts on that, I'd appreciate you sharing them.

KC Parker (Beutel Goodman) (31:31)
Yeah, I mean, that's tough. As you said, you did say humor you. So we have no official view on any of those things. And the reason is that we're smart enough to know that we can't know. And so whenever we invest in any company, it has to be able to survive all ranges of outcomes. So I mean, you mentioned the global economy. If we're buying a company that's cyclical,

and we're not at some economic trough, then we're probably going to build in a recession. And we're going to look and see how has that company done in recessions in the past. Or a company that might be interest rate sensitive, we're going to say, if rates are 200 beeps higher or 200 beeps lower, are we still interested? And if the answer is no, then it's not a buy. So just I want a caveat that I love talking about these things because it's almost like talking about sports, where it's fun to talk about.

but nobody really knows, right? And so specifically, the global economy, look, I think that this is just my personal view, because we don't have a company view, right? I think that there's a lot of building pressures in terms of global tensions, persistent inflation. And there's a lot of areas where, if you look at particular end markets, we're higher than we would

normally be and so I believe in mean reversion. So I think there's a lot of factors, any one of which can create headwinds for the economy. I think we're long overdue for a proper slowdown, like a proper recession. You know, many people who are running money haven't even lived through a recession, which, you know, I would say the last like classic recession might have been the early 90s. Okay, the 2000s a little bit.

It was pretty brief. It was mostly consumer, etc. People get confused and they say, oh, like 2008. It's like, no, no, that was a global financial crisis. That's different than a recession. In a recession, stocks go down, they get cheap, and the banks don't come along with throwing money at everyone and then you're saved. That's not what happens. So I think the risk I worry the most about is the central bank overconfidence that they can just

It's like a puppet show and they can apply the exact amount of precision to every part of the global economy to make it. And it's completely out of their, I mean, it's for the most part, completely out of their control, right? Like if you take auto insurance as an example, which is very persistent and ongoing inflation, how on earth can central banks impact auto insurance inflation? They can't, right? So I think that, I mean, I think there are a lot of risks out there.

And I think the biggest thing I can say is that most of the market is not priced for anything going wrong. And a lot of things can go wrong. You've mentioned some. And so it's shocking to us because the market right now is a combination of two markets. We feel that most of the market is a combination of the two.

Aaron (34:41)
you

KC Parker (Beutel Goodman) (34:53)
of the dot com bubble, like in the sense that valuations are very high. We're not saying there's bad businesses, but the multiples that you pay matter. But then at the same time, a lot of businesses like healthcare and things that touch the consumer are almost 2008 cheap. So it's this weird dichotomy. So it's not saying be cautious on the market. It's saying be cautious about debt risk, be cautious about the valuation you pay.

because there could be a very large lesson in finance theory that's about to land on people. We think we're very well prepared for the finance lesson. We think we'll get an A+. But it might also not happen. So...

Aaron (35:38)
Well, I appreciate your thoughts on that and it is a difficult topic to even try to wrap your arms around. What I view the biggest risk is people's personal emotions and getting either too married to something or staying away or trying to time the markets. Like you mentioned, you try to take away any sort of personal bias that your internal portfolio managers have by having a committee view things. So I think understanding your own

KC Parker (Beutel Goodman) (35:56)
Oh yes.

Aaron (36:08)
personal biases and your own emotions is the number one risk to try to eliminate right out of the gates.

KC Parker (Beutel Goodman) (36:16)
So if I could just follow up to the comment you made about 2022. So if people are nervous about the markets, then you can say, not every portfolio is the market. And so I mean, 2022 was a good example of if you were out of the market, you actually would have missed a slightly positive year, right? And I just want to say, one time as an exercise, I looked at the market peak for the S&P 500 in the year 2000. And then I looked.

12 months forward and I looked at all the constituents at the time and said, what was the 12 month return for all the stocks in the S &P 500 from that time, i.e. a market peak and then a significant crash? And there were dozens of companies that actually had double digit positive returns in that 12 month period, even though the market was down significantly. So I would say,

Price matters. You don't have to make a market call if you pay the right price.

Aaron (37:22)
I agree. With that said, we're running out of time here. To all the listeners, I would like to thank KC for taking his time today to speak with me about the Beutel Goodman value investing process. As always, if you have any questions, you can email me at aaron.sherlock@cibc.ca or you can Google the Sherlock group at CIBC Private Wealth and reach out to me there. Anyway, thank you very much.

KC Parker (Beutel Goodman) (37:48)
Thank you much.

Outro (37:48)
Upbeat music begins to play in the background while CIBC disclaimers are displayed.
[This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2024.

The views of the commentator and/or guest speaker(s), do not necessarily reflect those of CIBC World Markets Inc. This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed. The commentary is for informational purposes only and is not being provided in the context of an offering of any security, sector, or financial instrument, and is not a recommendation or solicitation to buy, hold or sell any security. 

CIBC Private Wealth consists of services provided by CIBC and certain of its subsidiaries, including CIBC Wood Gundy, a division of CIBC World Markets Inc.

If you are currently a CIBC Wood Gundy client, please contact your Investment Advisor.

Aaron Sherlock is an Investment Advisor with CIBC Wood Gundy in Saint John. The views of Aaron Sherlock do not necessarily reflect those of CIBC World Markets Inc.

The CIBC logo and “CIBC Private Wealth” are trademarks of CIBC, used under license. “Wood Gundy” is a registered trademark of CIBC World Markets Inc.

Clients are advised to seek advice regarding their particular circumstances from their personal tax and legal advisors.]

Introduction
Short video of a stock market chart arrow moving in an upward trajectory with upbeat music play in the background. Magnifying glass appears and becomes the “o” in Sherlock’s Clues. Full title comes into focus, Sherlock’s Clues – Insights on Investing & Economics with the investment philosophy below “Investing Success: Powered by Process, Fueled by Discipline, Rewarded by Patience.”

Aaron (00:10)
Welcome to another episode of Sherlock's Clues. I am your host Aaron Sherlock and on today's episode we are going to talk energy and in particular oil and gas. I have with me today David Szybunka He is a senior portfolio manager with Calgary based institutional money manager Canoe Financial. Hi David, how's it going today?

David Szybunka (00:31)
Hey, doing pretty good. Thanks for having me.

Aaron (00:34)
Thanks for joining me today. David's got a wealth of experience in the energy space. He's got 17 years of experience in the capital markets world as well. David, I'll pass it over to you to give a little background on Canoe Financial, who they are and why it was founded.

David Szybunka (00:51)
Yeah. So Canoe got founded back in 2009. And we're one of Canada's fastest growing independent mutual fund companies. And when we founded this thing back in 2009, 2010, it started with the EnterVest Closed End Fund, and that was used to launch an open -ended mutual fund business. And so when we started, we had a small energy fund, a couple other funds. And you fast forward to today, we have international equities, fixed income, energy, balanced funds, you name it.

And this is really good for our clients as Canoe's broadened out. The brand's gotten bigger as we think through across the country. We now have 21 sales guys, multiple managers, some sub -advisors on some of these products. But we're super proud of what we've built here over the last decade in a bit.

Aaron (01:38)
I always do find it nice to speak with an independent firm as well. A lot of the money management firms are sub -owned or owned by another institution. So you have more autonomy and with a smaller core team, you have more concentration as well.

David Szybunka (01:55)
You got it. Like I didn't really touch on it, but all of us here that work at Canoe, we are owners of the business. And so we are tied to it. We're incented to grow the business. That's really good when you can have that type of alignment. These are the types of stocks and companies that I invest in and we're kind of putting our money where our mouth is to.

Aaron (02:12)
It's the structure which I think makes the most sense. It aligns everyone on the same side of the table. With that said, I'd like to hop into a little bit of history lesson in terms of where oil and gas was. I know that for myself, this is a very interesting topic. I spent the first part of my career as we were discussing earlier in Calgary, Alberta covering the energy services space in equity research.

wasn't necessarily a very fun time to be looking at that space from 2013 -2014 up until about 2017 -2018. It seems like we've started to get some legs. Could you just give a bit of a background on where energy was, let's say a decade ago and how it's changed to even today?

David Szybunka (02:58)
You got it. I think this is really important to touch on and I'll go back even more than a decade ago. I would just say, look, these energy cycles tend to last 10 to 15 years, 10 to 15 years up, 10 to 15 years down, 10 to 15 years up, 10 to 15 years down. They ebb and flow like that. They don't come and go and end after two years. You get volatility within those bigger picture cycles where you get checkbacks. but you always end the commodity cycle with the capital spending cycle.

That's how it always ends after multiple years of capital spending. When you come out of a very depressed period in that down market where it's really, really bad for multiple years, you tend to bottom commodity asset classes in general, over call it a decade long of generating minus 9% annualized returns. So.

That is a very dire period. If you just think through you being an investor, making minus 9% for 10 years in a row, people are done with the sector, if you will, by the end of it. And then on the contrary, when you flip to the other side, they tend to end after plus 9-10% annualized over a decade. And some years you're getting a lot more than that. Other years will be less than that, but through the cycle, that's how it goes. So historically as you're kind of four or five, six, seven years into the cycle,

companies, investors, they start to forget what they went through in those dire times. And that's what then starts to spur a capital spending cycle. The capital slowly starts coming back. And then historically, as it relates to energy, the companies are in grow, grow, grow, spend, spend, spend, raise money, accelerate growth projects, etc. A theme that's present this cycle that has never been present in prior cycles is a theme of decarbonization.

This is a theme happening across the globe and this is going to make producers walk, not run. It's going to provide anxiety for investor capitals to come back racing like they used to. I think there's going to be pools of capital that never come back to conventional energy because they've just decided that they will never invest in hydrocarbons. And then I think there's other pools of capital that will chase performance. But all of this in a mixer to me is really, really good.

We're in an age of restraint. I always get asked, are we in a commodity super cycle? I don't think we're in a commodity super cycle, but I actually believe we're in a super cycle of energy profitability for the conventional energy sector because it has a governor on it, because they're constantly looking over their shoulders, because we're all being told that we need, we're going to drive EVs in the coming years because refiners don't want to go and build new refiners, but we keep using the products of diesel and gasoline.

This is setting the stages for a super cycle of energy profitability. And I think this cycle is actually gonna take longer to play out because this capital is not gonna flow back. The producers aren't gonna step on the gas like they have in previous cycles.

Aaron (05:59)
I think that's a very good point talking about discipline. Pain creates discipline. The capital discipline that a lot of energy companies had to employ over the past 10 years is remarkable. Looking back when I was covering the space, it would be nothing for these companies to have two, three, four times cash flow in terms of debt on their balance sheet, debt to cash flow. Now, balance sheets are virtually squeaky clean, very little debt.

It's more of a cash flow game or these companies are starting to implement dividends again, starting to buy back shares, special dividends. They're rewarding people who've stood by them by returning capital to them. I think that's come through some hard earned scars over the past decade.

David Szybunka (06:43)
Yeah, I mean, the structural changes beneath the surface, you brought it up. But it kind of used to be, if you had one times debt to cashflow, you were squeaky clean. As you started to get to two times, it's like, okay, you got a little too much debt. Maybe you should pay some of that off. And then as you approach two and a half, three times, it's like, well, you have too much debt. Today, the average debt to cashflow within the energy sector is 0.5 to 0.7 times, some version of that.

And if you have one times debt to cashflow, you're kind of the redheaded stepchild. That's just like, what are you doing? And so like when we look at our funds, I bet you 40 % of the names we own are sitting on cash. So there's a structural, when you, when you just think through what destroys equity values, too much debt, not enough cashflow. What do we have today? Very little debt, pretty darn good cash flows within the space.

Aaron (07:38)
Okay, with that said, a little bit of a history lesson there. Maybe we'll hop into a few topics that I would like to touch on. You did hit on the cycle, cycles lasting longer, cycles being more gradual now. Can you speak to the potential risk level of this cycle versus previous cycles? Because when I look at the energy space, I used to say it's up on an escalator.

down on an elevator. You never know when it's going to be ripped off, but this one seems to be more stable.

David Szybunka (08:09)
Yep. Well, it's because of that debt structure beneath the service that these companies are actually set up really, really well. But then as you think through this cycle and how we think it's going to play out, look, there's still going to be volatility, but I would try and talk about a couple of different things. I think there's going to be a lot of volatility in the commodity side of the cycle because you're structurally under investing through this period. You're going to at points.

take the price point to levels of demand destruction. We got a sneak preview of that in Europe two years ago, where you physically took natural gas prices from kind of $10 an MCF to 70, right? I was in Europe there with my wife and we were walking around and you went through malls and these places and they shut off the air conditioning, right? You watched refiners and industrial companies shut down because of where you took the price to. And a lot of this still hasn't come back.

When you think about where diesel prices went to, it was the equivalent of $165 a barrel, right? We were all still looking at roughly a hundred, but the diesel price on the product side, you took it to demand destruction levels where people quit driving, right? So that happens in age of restraint where you keep using the product, but then you get these shocks. I think the way to think about the commodities in this cycle, you're going to have periods.

where you get asymmetric upside risk. And then it's going to be followed with downside risk at the same time. But in general, the better quality businesses are going to thrive for where we're going to have these kind of commodities trading in general. Don't get too pinpointed on oil prices are $70 or $80 or $90. Like it's a really good price specifically at a $0.92 or $0.72, $0.73 cent dollar. Right? So that's the commodities.

On the equities, I'll start with what's happening in the debt market right now. In the debt market in previous periods where you sold off the commodity prices, you watch high yield spreads blow out. All debt holders care about is getting their money back. And today, as we've watched in the last 12 to 24 months, you get checkbacks in the commodities, energy or natural gas prices, oil prices, energy high yield doesn't budge.

Energy high yield is at the tightest spreads it's been at in over a decade. Why are we at the tightest spreads we've been at in over a decade? Why aren't spreads blowing out when you get these commodity checkbacks? Because of that debt comment I made. The debt guys know they're at the front end of the line of the capital structures and there's very little debt. This hasn't translated to the equities yet. People are still pushing towards owning up cap type names, large cap companies.

that's where people initially go out of the earlier stages coming out of kind of the doldrums, if you will. And we haven't even really started to see the capital start to flow down to other intermediate type companies yet. This is just starting. And so there still is equity volatility today because there's not enough capital flowing back to the space yet. People don't believe. They're still making trades in energy.

They're not investing in energy. We think we're four years into a 10 to 15 year cycle. And as we progress this through time, I think that equities will have less volatility for all, because of all those things I just touched on. But today it's not that backdrop. The last three years have been three, each in each of the last three years, 2021, 2022, 2023, we have had three checkbacks in each year of 15 to 25%. And this is what shakes people out, especially in the earlier stages of a cycle.

Aaron (11:51)
Investors generally, I find it a little too fixated on the commodity price. Without going into too much detail, a lot of these companies do hedge out their production so they don't necessarily ride the wave of whatever the commodity price is doing at any given point in time. You did touch on a couple of other interesting topics there when it came to the large cap versus small cap and mid cap space. With the large cap names,

They are a little bit more stable historically and have less leverage to the commodity price underlying them. Maybe if you could actually talk on the difference between natural gas and oil producers. You spoke a little bit to natural gas prices fluctuating, particularly with the war in Ukraine disrupting supply in Europe. Maybe could you give a bit of an explanation just on the difference between the two of them and how they can be targeted individually?

David Szybunka (12:43)
I mean, I'll expand even a little bit further on that. Our starting point at Canoe is understanding where you are in the grand scheme of the cycle. Like I told you, I think we're year four into a 10 to 15 year cycle. Could this cycle last longer? I think it could for those reasons of walking, not running like I described. However, we manage the money and our clients' capital in sub -sectors. We don't look at energy like one big thing. We look at it in sub -sectors of energy.

And when we look at subsectors of energy, we specifically look at heavy oil, light oil, services, liquids, rich gas, alternative energy, royalty companies, refiners, LNG, midstream, infrastructure companies. There's all these components of energy that investors always like to just blanket energy like it's one big thing. And there's one thing I've learned in my career is in general,

These multiple nine subsectors, if you will, never all go up and down at the same time. If oil prices are going lower, well, that's an input for refiners. So now they have a lower input and they're producing gasoline and diesel, and they could potentially be making better spreads on that. If service companies are raising their prices on the producer because the market's tight, well, that's negative. The producers good for service companies. All of a sudden we're building out more infrastructure and pipelines.

Now we have multiple avenues to get our product to market. Well, maybe the pipeline tolls need to go down over time because there is the spare capacity. That's good for the producers. That's negative. The infrastructure guys, this is how we invest the capital. We think about the subsectors and we constantly go what percentage of the pie should be in what subsector. And so that's how we invest the capital to kind of just quickly touch on your point. Like there is the crude oil side.

And there's the natural gas side. And just to kind of be very simple on these things, I think we're in an age of structural underinvestment, but I think people get way too fixated on oil specifically as it relates to what are the inventories? Are we in contango or backwardation, which is the shape of the curve? We all focus on these very specific things and...

When we went through the kind of last energy bull cycle in the mid 2000s, you watch the front end of the curve holding in okay, but eventually the back end of the curve, 12 month out crude started to become unanchored. It became unanchored because China showed up at a time that we weren't investing enough. And as much as we're all staring at the front volatility of oil, the last 12, 24, 36 months,

All of a sudden, Russia invades Ukraine, oil prices spike way up, but the back end of the curve is very anchored. All of a sudden we watch again, oil rally this year from $70 to $85, $86. Everyone becomes a geopolitical expert all of a sudden, but the back end of the curve doesn't really move. It was only up 3-4% on the year. We think the back end of the curve will tell you when we have a structural under investment problem, which will always tie to geopolitical risk and all these things.

But that's important to understand that as long as the backend remains anchored and investors don't really believe, like we're breaking record levels of oil demand globally, but investors keep not buying into, we won't need the product as much in the years to come. As long as that's the narrative, you need to be cognizant to where you think these valuations of oil stocks can trade. We're actually seeing the opposite happen in natural gas right now.

where 12 to 24 months ago, natural gas was part of the problem and it's quietly become part of the solution. It's the bridge molecule. Well, of course we're gonna need it to not use as much coal and use more gas. Well, if we're building out more renewables and alternative energy, those are very volatile energy sources. Should we not have a better base load of energy supply? What's exploding in my inbox the last 60 days? This whole narrative around energy tied to AI.

right? Energy demand tied to artificial intelligence. And all of a sudden you're watching people go, well, we're clearly going to need more natural gas. This is an important narrative. We're watching the gas equities slowly start to see their multiples expand. And so this is happening across the surface. I'm giving you all these examples because there's lots to think about when you're investing in energy equities. It's not one big thing.

Aaron (17:19)
So maybe to help the listeners out there, could you nail down just a couple of the key narratives that you're seeing out there? Just to kind of, you know, natural gas, very easy one to tick off. It's no longer part of the boogeyman, you know, terrible for the environment group. They're now, like you said, part of the solution in terms of the bridge molecule. Are there any other narratives which you're seeing playing out?

David Szybunka (17:42)
I'll just try and keep a big picture with that comment because I always get asked by investors. They're looking for one big thing that's going to rerate the sector and it never works like that. It's multiple things that happen over time that slowly changes the narrative and quietly it's okay to invest in energy again. Right? When I was doing my presentations three years ago, I was a lot of the time trying to convince investors that we still were going to need and use hydrocarbons.

And now that's not the narrative. People kind of get it. Well, we're watching energy security issues happen across the globe, right? It starts with Russia, Ukraine. Now you see the Middle East conflicts, Venezuela, all of a sudden, Guyana, these types of areas, China, Taiwan. This is all starting. We've had cheap energy for 15 plus years with low geopolitical risk. We think we're going into a period of elevated costs for consumers.

with elevated geopolitical risk. So this narrative is changing. It's been a version the last 15 years of Republicans versus Democrats, liberals versus conservatives. We think we're going back to us versus the Soviets. There's a new bad guy and the world's dividing. And this is going to make investors think nonstop about energy security. And it's going to become more and more front page news over time.

It's not just going to be about tech and AI, which it is today. So that is happening. We think that's the bigger picture construct. But when I look in my backyard, look, everyone's biggest pushback on Canadian energy has been, well, you can't get your product to market.

And now Canada is quietly getting pipeline solutions with TMX, with LNG Canada. I'm watching the biggest mergers and acquisitions in energy I've seen in my career and in the history of energy

So there's all this mergers and acquisitions happening beneath the surface, which is really healthy for that profitability super cycle that I described, right? So there's all these subtleties happening.

This is called the thaw. We're thawing the sector. We're slowly moving through this. It takes time, but it's happening. The sector's rerating before our eyes. I still get asked, when are the multiples gonna expand? They're expanding. They've been expanding for two years. It's happening slowly. It starts up cap with bigger names, but the multiple expansion is slowly starting for the sector and the sector's thawing and we're in a good spot.

Aaron (20:17)
All right. That all sounds very optimistic. And I always say volatility is a daily issue. It's not something to consider over the long run as long as the fundamentals line up. Now, with that said, maybe could you touch on how Canoe would position or look at adding energy to some of your portfolios and maybe your process or investment thesis around owning energy?

David Szybunka (20:42)
Yeah, I mean, we really focus on those subsectors like I described. If I was just to try and simplify our whole presentation and just some simple points for people to understand, it would be when you look at the market today and energy's valuation of the sector relative to other sectors, there hasn't been this wide of a spread in 30 plus years. Energy's valuation relative to the market. And this kind of ties to its weight in the market.

Energy's weight in the S&P500 is 4%. Energy's earnings are 10%. 90% of the time through the cycle, weight matches earnings. We think energy's weight is going back to 10%, 10% plus. It will happen over time. It will not go in a straight line. Multiple people will get shaken out along the way. But the big prize for energy investors is when that weight goes to the earnings.

this disparent of weight at 4% energy earnings, 10%, it happened in the early 2000s. It happened in the early 70s. It happens at the start of every cycle. And then as you move through it, the weight goes to the earnings. So we think that that's happening. Again, we will manage the subsectors through there. And one key component is we see $56 trillion getting spent in alternative energy. We think we're super naive as energy investors if we're not paying attention to this. And so we look at alternative energy.

We see opportunities there, but we don't really want to leave a bunch of wind to go find wind because it's pretty darn good in conventional energy. So we can put the chips anywhere. And today we are biased towards conventional energy while making select alternative energy investments along the way. But as we go to nine, 10%, 11%, 12% of the S&P 500, and that plays out and everyone loves energy stocks again, we will take our conventional energy weights down and buy more alternative energy.

because there's a multi -year thematic going on there as well.

Aaron (22:38)
We're getting close to time here. I do like to finish on and ask the million dollar question. What is your outlook? And sorry if you hear some dogs barking in the background, some cats moved in next door. But what's your outlook? Shifts in the global economy, interest rates, inflation, energy is usually a decent place to hedge against inflation.

in any sort of regulatory outlook.

David Szybunka (23:05)
Yeah, I mean, sorry, I would say like when we think through like that weight to earnings that I touched on, we think the weight's going to earnings. So I try and always point investors towards thinking in quarters in years, not days and weeks. I can't tell you what's going to happen in the next handful of days and weeks, but we feel like this is a big opportunity. When I talk to investors, they're all treating energy like a trade still.

No one's parking the capital there to ride this bigger thematic out. We're four years into a 10 to 15 year cycle. It's gonna go up and down, but you are getting paid to ride this out. Our names that we own are paying out 10% dividend buyback yields and they have very little debt in the capital structures. So we think we're four years into this bigger picture cycle. We think it will come with some volatility.

But a key ingredient to all of this happening over time is other sectors not working. We could feel the rotation coming from other sectors in 2022 when energy was one of the only sectors that was up on the year. But when I play out this year in the last 18 to 24 months, we've been in this digestive phase after digesting some really, really large moves in the sector. Other sectors have been okay.

We haven't felt this rotation of other sectors not working for the money to flow to other areas of the market. We think that's coming. And it's hard for me to say exactly timing on that, but it's a process. It happens over time. Energy doesn't go from 4% to 10% in two months, three months. It's multiple years. Just like I talked about the energy weight to its earnings. Well, some of these other sectors have really, really high weights with very low earnings.

within the market. And so we think all of this is gonna drive rotation over time. If you believe in a commodity cycle, you also believe in rotation because every single commodity cycle, broader market valuations compress. So this is all gonna happen through time in our view, but we're early. And so I kind of answered that in a bigger picture type way where I do want investors to think in quarters and years, not days and weeks.

Aaron (25:12)
I can't can't that enough myself as well. I do think that we're having a sea change in people's mindsets around energy. Some of the shine has come off of the world moving entirely to EVs. You need to base yourself on reality and how do we get there. It's by looking to steer away from it, like you said, being able to position towards clean energy at some point in time in the cycle. But energy right now seems so remarkably cheap that it would...

It's almost irresponsible to ignore it altogether.
w
David Szybunka (25:41)
And to that point, I think it's important to understand the narrative shift that's quietly happening, right? When you just look at, I'll use the super majors as an example, the super majors, years ago, they were saying we're done with hydrocarbons. We're going to invest in these other alternative energy areas. Quietly. They're all like, well, of course we're going to build out LNG and spend more money on gas. Right. The narrative just on natural gas, natural gas was part of the problem. It's now part of the solution.

Right? But energy in general is going to become more and more topical because of these energy security issues, the world dividing, all these things I've already touched on is going to make investors feel as they're reading the paper, seeing the front page news. I always say to my sales team, price drives sentiment. The higher the stocks go, the more people like them. And that's what we think is going to happen in energy. But the narrative is already slowly shifting. It was very extreme two, three, four years ago, ESG, we don't need it.

Now people are like, well, I like it. I just want it to go in a straight line from an investment standpoint, but no one's pushing back that we're not going to need it. And that's when I described other areas of the market have some pain. You can just see how the capital will flow back in a big way.

Aaron (26:54)
I hope your thesis and narrative is correct. Calgary is a city that's near and dear to my heart. But on that, I would like to wrap up. I'd like to thank yourself, David, for joining me here today and helping to unpack the energy space and share some of your expertise. As always to any of the listeners, if you have any questions on any topics discussed in this webcast or how to position energy within your portfolio, you can always reach out to my email.

which is aaron.sherlock@cibc.ca or you can Google The Sherlock Group and find me on my website.

Outro (26:54)
Upbeat music begins to play in the background while CIBC disclaimers are displayed.
[This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2024.

The views of the commentator and/or guest speaker(s), do not necessarily reflect those of CIBC World Markets Inc. This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed. The commentary is for informational purposes only and is not being provided in the context of an offering of any security, sector, or financial instrument, and is not a recommendation or solicitation to buy, hold or sell any security. 

CIBC Private Wealth consists of services provided by CIBC and certain of its subsidiaries, including CIBC Wood Gundy, a division of CIBC World Markets Inc.

If you are currently a CIBC Wood Gundy client, please contact your Investment Advisor.

Aaron Sherlock is an Investment Advisor with CIBC Wood Gundy in Saint John. The views of Aaron Sherlock do not necessarily reflect those of CIBC World Markets Inc.

The CIBC logo and “CIBC Private Wealth” are trademarks of CIBC, used under license. “Wood Gundy” is a registered trademark of CIBC World Markets Inc.

Clients are advised to seek advice regarding their particular circumstances from their personal tax and legal advisors.]

 

Introduction

Short video of a stock market chart arrow moving in an upward trajectory with upbeat music play in the background. Magnifying glass appears and becomes the “o” in Sherlock’s Clues. Full title comes into focus, Sherlock’s Clues – Insights on Investing & Economics with the investment philosophy below “Investing Success: Powered by Process, Fueled by Discipline, Rewarded by Patience.”

 

Aaron (00:11)

Hello and welcome to another episode of Sherlock's Clues. I am your host, Aaron Sherlock, and on today's episode, we are going to talk macroeconomics. I have with me today, repeat guest, Giuseppe Pietrantonio. He is our in -house economic specialist and client portfolio manager in our multi -asset and currency group. Good morning, Giuseppe.

 

Giuseppe (00:21)

Good morning, Aaron. Thanks for having me.

 

Aaron (00:24)

I think last time we chatted, we followed along a trend of speaking about major macroeconomic topics, inflation, interest, and employment. I think we should continue down the same path. Things have evolved since we spoke last about three months ago. And with that said, the topic of the day still appears to be inflation, but it's certainly come down a little bit. And I think you...

 

Nailed it last time we spoke saying that there would be a slow gradual grind downward. Can you update us a little bit on what inflation is doing in North America and maybe in certain developed countries around the world?

 

Giuseppe (01:03)

Thanks, Aaron. And, you know, we don't always, sir, I don't always get things right, but this one, I think we call it right on, or with the expectation of what we thought inflation was doing is what's currently occurring. So let's rewind a bit before we kind of talk about today's environment. You know, December inflation was coming down on 2023. A lot of rate cuts are being priced into markets. So the expectation that, you know, Bank of Canada, Federal Reserve, we're going to cut.

 

rates. And so we come into the first quarter of 2023 and inflation is hotter than expected. And so I think on our last meeting, the components that I was kind of outlining are some of the things that we're looking at are the services sector, the labor sector. Those are the shelter components. Those are the components within inflation that were stickier than, let's say, these good components. So the goods components, you know, we've

 

toggled over the past few years, where is this transitory word, you know, inflation is transitory, well, inflation was in transitory, but maybe some of the, you know, COVID impacts on the good side were, you know, transitory plus, you know, the big, a bit larger of a, of a timeframe. So they've come down drastically. And now it's really that service component that typically within this and an inflation cycle services do like.

 

And so when we think about how that related to the real world, see your cost of goods come up. You'll go to your employer and say, Hey, I need to raise inflation's higher. And so those are the services that we provide that say, okay, well, so they're typically do like by the time that you get this renumeration. Another component is unions, right? So when, when unions are renegotiating in terms of inflation, it takes a bit more time for them, for union workers to get their salaries, we knew where it are increased.

 

And so that's the lag that we saw over the recent past. And a lot of that has been baked in That was the Q1 conversation. So we expected that this component, the shelter component, the labor component was going to slowly come down. And so recent readings, that's exactly where we've seen this a little bit of not software data, but that slowdown is coming from those components. And so what's the reaction function for central banks when that is?

 

that when inflation is trying to soften a little bit, the reaction is to cut interest rates. And so we need a couple of factors for central banks to cut interest rates. Inflation is one, employment is another one, and growth is another one. So these are broad categories. There may be more, but these are just broad categories. So when I think about, let's say step one, inflation is coming down. Let's focus just on Canada.

 

for the Bank of Canada inflation is coming down, check mark, their goal is to have target, you know, roughly a 2 % inflation target. We look at growth, growth is also decelerating. So that's concerning for the Bank of Canada and unemployment slightly ticked higher in recent, in recent prints. So that's also somewhat not too concerning, but it's something that the Bank of Canada and all central banks are going to, are going to try to minimize or try to limit.

 

unemployment. And so the Bank of Canada in June was positioned to say, okay, well, we've got slowing inflation, growth is not, you know, strong relative to our US comp counterparts. And so we've got this capacity to cut rates. And so let's start cutting rates, let's signal that we've got more room to grow, more room to go. And that's once again, because of this softer growth that the Bank of Canada is expecting. And so for, you know, individuals for people,

 

people within Canada, that's very good for anybody who has a variable mortgage, anybody who's renegotiating their mortgage or getting a mortgage. So the expectation is that rates will come down and that that's going to help economic growth. And that's going to, hopefully we're at a point where inflation is going to stabilize around that 2%.

 

Aaron (05:15)

I find a very interesting look at the components of CPI or inflation and how much of a waiting shelter has in particularly how we measure Canadian inflation. Can you touch on that a little bit? Because I do follow the real estate market relatively closely and I do notice that the long end, we'll call it medium, the long end of the curve isn't coming down. It's the short end which is moving more than your five plus year.

 

rates. Can you touch on that as well as the weighting of shelter in the CPI basket for Canada?

 

Giuseppe (05:50)

Yeah, so shelter is dissected in the number of different ways, whether it's rents, mortgage costs, it's probably the largest sector within CPI services. And so it's a big impact to CPI in total relative to the other components. And so when inflation was staked, your shelter was so important for us to track and to try to get these timbits or signposts because its net impact on the total figure is larger than anyone.

 

And so to dovetail to your conversation why the short end of fixed income curves come down, the way I split the fixed income curve is short end. So three months to let's say inside five is going to be more, more correlated to the central bank policy rate and inflation. Okay. So those are going to be the two factors that are going to create the volatility within the short end.

 

On the long side, inflation will impact central bank policy rates will impact, but not to the magnitude that it will on the short end. And so the big determinants on the longer end is the recession risk. And so if there's no recession, if there's no recession, we're expecting a steep curve or steeper curve, not inverted curve. And so when we think that, historically when that long and has come down is when there's recession risks or a recession.

 

And so that's why we're seeing that short end come down drastically, whereas that long end is kind of come down just a little bit less than what the short end has done.

 

Aaron (07:29)

It is almost good news that bond traders are not running for the hills and expecting a major drop in growth even though it has slowed.

 

Giuseppe (07:37)

That's correct. So I think bond investors, bonds are still, you know, bonds are still back relative to what we've seen in the past 10 years in terms of what you're getting in the yields. And so when we think about some of the solutions on the bond side, you know, there's these, you know, new target maturity funds that only, they buy bonds at a discount. And so what you're getting there is, you know, less of a tax consequence from income.

 

more tax benefits from just the capital appreciation. And so this is the climate where that sort of solution makes a lot of sense for investors because you're getting that discounts and you're being taxed at a lower fraction than you would if you'd be just putting your money into a GIC, for instance.

 

Aaron (08:24)

Well, fixed income certainly has had a rough stretch over the past several years. So if you can buy something at a discount or on sale, that's always a market or an investment which I'm interested in. So we've unpacked a couple of things, spoke about Canadian inflation coming down, a little bit of concerns with the growth and leading to the central bank or Bank of Canada starting to reduce interest rates, which should

 

stimulate the economy more or relieve some pressures on the consumers who are leveraged. Maybe touch on the growth side of things a little bit because I do know that our GDP prints are weakening and being revised downward.

 

Giuseppe (09:08)

Yeah, I think that's a trend that you're seeing a little bit all over the world, minus the US. There's this conversation that we're having in terms of US exceptionalism, you know, this AI theme in the US, productivity gains in the US. And so, you know, the slowdown is not unique to Canada. When we're thinking about Europe, we're thinking about Asia, there's been a slow growth, you know, typically, if I think about China, for instance.

 

GDP growth has double digits and we're in lower single digits. So the Canadian growth is, I think there was a strong growth post COVID. This is more of a renormalization. And so obviously increased interest rates is a burden to companies, individuals as well. And so as you said, as we releverage or as we kind of get some cutting in rates, that's going to help businesses.

 

in terms of re -leveraging at lower rates being balance sheets are going to become a little less, you know, burden for instance. So yeah.

 

Aaron (10:15)

Okay. And you've touched on it a couple of times talking about US exceptionalism or the US being the not following the norm of the rest of the world. What is that due to? You did touch on the AI, their economy is certainly consumption driven. What reasons do you think are behind the US's economy doing much better at performing the rest of the world?

 

Giuseppe (10:42)

So there's a couple of components. Obviously, the US draws on a lot of capital worldwide, in terms of open barriers, very sophisticated capital markets. And so there's always investments within the US. There's always an opportunity within the US. The AI theme, once again, in terms of the US, is where the driver of AI is really the productivity. And so productivity in terms of GDP is one of those factors that can really increase growth.

 

drastically think about innovations over the past 50 years from or even 100 years from combustion engine to internet to AI now, for instance, broadly. And so I think that's what's propelled. Obviously, you can argue that the US value based off of historical ratios is somewhat overvalued. But as we know, the market can be overvalued for a long stretch of time. Sometimes a market's overvalued

 

for a reason and a market's undervalued for a reason as well. And so I think that's where we are with the US. There's a lot of positivity with the US. Growth is consistent. Do we think that's gonna continue forever? Or I think using probabilities? No, I think the US would like that or it's a stable growth. But I don't think that's the expectations going forward.

 

You touched on one point that, you know, in in of policy divergence, you know, the the didn't have to cut or the Fed didn't have to cut in this latest meeting last week because of this growth components, you know. If the US, if the Fed cuts too early, we're going back to this inflation cycle. And so we don't want to see a re -acceleration of inflation like we saw in the late 70s, you know, know, globally.  I think the Fed is being prudent and saying, OK, we still have very strong growth because of these numbers of factors.

 

We don't want inflation to accelerate because we know that that in essence can deteriorate the economy. Let's pause right now. And so that's the impact versus at least Canadian investor is a potential continued depreciation of the Canadian dollar. Right. So the Bank of Canada cut rates, the Fed did not. It's less attractive to be invested in Canada versus the U .S.

 

And so we've diverged from time to time in terms of policies, the Bank of Canada and the Fed. And that has led to a slight depreciation in the currency. These are conversations that we get asked often, how much is the Canadian dollar going to continue to depreciate? Well, the Canadian dollar depreciate for a number of factors. Growth is one of them. Policy divergence is another one. But we do think over the long term, the Canadian dollar will come back to its equilibrium level. That's what it.

 

Canadian dollar has historically done. And so there will be at one point, there will be soft patches of growth in the US because of higher rates, that's just normalization. And at that point, when the Fed cuts, that'll kind of resupport the Canadian dollar in terms of appreciating versus the US dollar.

 

Aaron (13:53)

Okay, I appreciate that. Currency is something that's not talked about enough, but like you said, most of the time it does come down to a mean reverting level or a purchasing power parity between nations. After looking at the growth side of things, naturally what drops out of that is the employment levels or unemployment levels. Looking at Canada and the US becomes more apparent why the growth is where it is and why there is a large gap between the two.

 

Giuseppe (13:56)

Thank you.

 

Aaron (14:23)

In Canada right now, we are slowing down. In this past month, we added 27 ,000 jobs and we made them up all in part-time work versus the US is still having major gaps above forecasts in their job ads. What is driving that and how do the jobs reports reflect actual reality? Because I know a part-time job

 

It still counts as one compared to a full-time job in Canada here. Maybe we're getting a little granular, but add a little color to this.

 

Giuseppe (14:58)

Yeah, so that's definitely granular. And you got to remember that these numbers are going to be revised several times. And so I think it's also, you know, for us as investors, for instance, the revisions are very impactful or they're very important. You know, I think the thinking is, hopefully we can transition some of these part-time to full-time workers. But we can't remember that. Immigration in Canada in 2023 was roughly 3% of the population or

 

depends on time periods, but in the one year period, it was roughly 3% of the population represented immigrants, new immigrants. And so we're in the US, that represented roughly 0.5% of the population. And so in Canada, to fill those roles, in terms of part-time versus full-time, some of those part-time workers are immigrants who've obtained those jobs. And so the idea for the Canadian economy is to transition those over a longer period.

 

to full-time positions, but that's also a reason why we may see an uptake as immigration or individuals who immigrated out of the labor force, the uptake in unemployment is gonna be the result of that to a certain extent. And so I think it's very, very important to look at all the different factors, not necessarily just looking at the top line inflation numbers or the top line job numbers, but understanding the components of it.

 

And once again, also looking at the revisions because the revisions are sometimes quite substantial.

 

Aaron (16:26)

find it interesting looking at Canada's unemployment rate and it's gone up over a full point. It's up north of 6 % and it started the year at 5 % and that's predominantly due to the immigration.

 

Giuseppe (16:39)

Yeah, that's correct.

 

Aaron (16:41)

Now, south of the border in the US, what do they need to see to get their unemployment rate to tick up a little bit to potentially give the Federal Reserve some impetus to start to cut rates or at least give some guidance around it? Because right now they're talking about no cuts. A lot of investors are hopeful that there's some coming down the pipeline. But what do you think needs to come together for us to see a cut in the US?

 

Giuseppe (17:12)

So I think that, you know, in terms of unemployment, the Federal Reserve would love unemployment to just stay at the rate that it's at. I think, you know, we've we've toggled this soft landing conversation over the past year to hard landing, soft landing, no landing. And I think what the Fed is trying to, you know, engineer is this soft land. Is inflation slowly coming down? In fact, unemployment is negligible. Maybe it ticks up a little bit.

 

But the component that I think the Fed is really looking at, they've talked about this within their press releases, Jerome Powell has said this several times, is really focused on inflation, core basket of inflation as well. They've got different metrics to analyze what components they're looking at at different periods of time, whether it's core that eliminates energy and food prices. And so that's going to be the main number alongside growth.

 

to ensure that or to have a rational case to cut rates. If we think about why they haven't done so right now and why the market is not pricing it, it's once again, it's that growth component. And so you'd want to get caught into an environment like the 70s where inflationary accelerates and then you potentially in a position where you will get your economy into a recession. You overheat, you over-stimulate.

 

We've been talking about the monetary component of it, but there's this large fiscal component that's also stimulated growth. Think about the Inflation Reduction Act, the infrastructure bills. These are huge U .S. bills that the U .S. is printing money to support growth or to create jobs within the U .S. And so that's another, I forgot to mention it previously, but that's another big, big, big chunk of resources that have stimulated or propelled growth in the U .S.

 

Aaron (19:08)

Okay, that all makes perfect sense and I'm hopeful that we do have either a soft landing or just slowly coast down in terms of inflation and the overheated job market. We've talked about a lot of things here right now, but I always like to finish on a question put someone's feet to the flames and that's the outlook. You nailed it last time a couple of months ago.

 

When I have you on in a few more months time, hopefully you nail this one as well, but what are your thoughts on where the economies are going to go and what do you think the next, we'll call it six months could look like?

 

Giuseppe (19:50)

I think this is a period of time where it's triggered than it was previously. And the reasons for that is there's a lot of geopolitical risk globally. We're thinking about elections globally. We just went through South African elections, India elections, Mexican elections. We have a huge election in the US later this year. And so the impact of that is still somewhat unknown. What happens if it's a Biden versus

 

a Trump victory? What's the impact on the global economy? Once again, the US is our largest trade partner. So what's the impact to Canada to a certain extent? If you remember Trump going into power, that was the renegotiation of the NAFTA to, I forget the acronym now, but that put more pressure, upward pressure on prices in Canada in terms of also Trump talking about tariffs and the potential trade war.

 

And so there's a lot of uncertainty. I think, you know, generally, I think that inflation is still going to trend lower. There might be pockets here and there where, you know, you've got these uptakes, but I think the trend is going to continue lower. I see the Bank of Canada cutting at least one at a time. And the reason for that is really because of the slowing growth. And, you know, you've got this housing sector that's pretty much unaffordable for most people.

 

You've got more immigration, you've got less houses. It's not like we're building houses at an extraordinary pace in Canada. And so there's more upward pressure on housing, but there's also upward pressure for individuals refinancing at higher rates. And so what I think is going to happen is that the Bank of Canada is going to maybe have one more cut this year and pause a little bit. I think the Bank of Canada has a lot of restraint in the past year when they've had increased rates. The increased rates, increased rates. Let's pause a bit, see how the economy consumes that.

 

Okay, we've got to increase rates again. Let's pause a little bit. And so it's not just, hey, let's increase rates, increase rates or reduce rates to reduce rates. I think, you know, the bank Canada is very much a war trying to say, okay, what are the, what are the impacts? Is there anything breaking here or is there anything overheating there? I think they've been fairly resound in terms of their, their thinking when they're, when they're moving interest rate policies. Whereas the U.S. if we do continue to see this deceleration,

 

If I'm not mistaken, today's retail numbers were softer than expected in the US. If that continues to happen, well, I do, we do see, you know, at least one cut this year, well, probably one cut this year. I don't really see a case in the current period for more than one cut. A lot of the cuts have been extended to 2025. And so I think that's probably right. One more cut in Canada, maybe two, probably one cut in the US.

 

Aaron (22:40)

What I do appreciate about what central banks are doing is they're not allowing their policies to be weaponized by politicians. You hear a lot of pressure from political figures hoping for interest rate cuts because that does give the population a little boost to help them either spend or it's just consumer confidence as well. But we'll save that for another day. I'd like to thank Giuseppe for hopping on this call again and unpacking some very complicated details when it comes to macroeconomics.

 

As always to any of the listeners or viewers, if you have any questions on any of the topics you can reach out to myself directly at Aaron aaron.sherlock@cibc.ca you can Google The Sherlock Group to get in touch with me. Anyway, thank you.

Outro (23:44)

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Introduction

Short video of a stock market chart arrow moving in an upward trajectory with upbeat music play in the background. Magnifying glass appears and becomes the “o” in Sherlock’s Clues. Full title comes into focus, Sherlock’s Clues – Insights on Investing & Economics with the investment philosophy below “Investing Success: Powered by Process, Fueled by Discipline, Rewarded by Patience.”

 

Aaron Sherlock (00:11)

Welcome to another episode of Sherlock's Clues. I'm your host, Aaron Sherlock. And on today's episode, we are going to talk growth at a Scottish price. I have Murdo MacLean with me today. He's a client investment manager with institutional money manager, Walter Scott. A little background on Murdo. He joined Walter Scott in 2006 and spent the first 12 years of his tenure there, focusing on research in Japanese and US equities. Good morning, Murdo.

 

MURDO MACLEAN (00:40)

Morning, Aaron. Nice to be here.

 

Aaron Sherlock (00:43)

What time of day is it in your part of the world right now?

 

MURDO MACLEAN (00:44)

Just gone about 2:15pm in the UK.

 

Aaron Sherlock (00:48)

For benefit of the listeners of this podcast, I'd like to dive into a little bit of a background on Walter Scott. I know you just celebrated your 40th year anniversary. Could you give a little bit more detail on Walter Scott's extensive history?

 

MURDO MACLEAN (00:59)

Absolutely, yeah, as you rightly say, the firm was established in 1983 by Dr. Walter Scott, a nuclear physicist who went to Cambridge University. He spent quite a bit of time at our predecessor firm, Ivory & Syme, that coincidentally occupied the buildings that we now occupy in Charlotte Square in Edinburgh. From 1985, Walter and a small group of colleagues started investing in global equities and also international equities, global ex-US. And really from that point forward, underpinned by a very sort of stock focused, fundamental focused bottom up research process, we've gone about investing client assets in global international equity portfolios. Initially, I think the client base was largely. Initially, I think the client base was largely domiciled in the United States, somewhat unusually, but given the size of the US market, the time and the relative openness to hiring money managers, that's where the firms were built. Up to this point today, we're being managed around $100-plus billion under management, today the US is still the largest client base, approximately 60-70% of assets. Canada is our second largest client base with about 20% of our assets under management. And across the business it's really split between institutional, so pension funds, endowments, hospitals, universities, things of that nature, and also the fund side of our business where we sub-advise funds, as we do for this one that we're talking about today. Essentially, we don't delineate between the two. So our investment style is exactly the same whether you're a large pension fund or a high net worth individual invested in a fund. You know, I think the things that make us a little different are perhaps that we're based here in Edinburgh and we conduct global equity research from our offices here in Edinburgh. We obviously travel extensively around the world.

 

Murdo MacLean (02:55)

You know, I think the things that make us a little different are perhaps that we're based here in Edinburgh and we conduct global equity research from our offices here in Edinburgh. We obviously travel extensively around the world to conduct due diligence and sort of corporate management teams that we are either interested in or need to invest in. We conduct a team-based approach to conduct due diligence meetings with the corporate management teams that we are either interested in or indeed invested in. We conduct a team-based approach. And in our world, that means that all 20 people on our research team have to be in unanimous agreement before we purchase a new security for a fund, which sets a very high bar for conviction levels. You know, our average holding periods are around 10 years in length, which is very long, I think, I think, in most people's sort of world. In our world, if we the due diligence correctly and we invest in the right sort of business, 10 years is probably the minimum that we're expecting to hold a business provided things go right. So there's a very long-term team-based, high-conviction approach to building portfolios. And the other thing about our firm is just stability. Stability is very high. So as you all know, turnover within the team is exceptionally low. It's a very experienced team today, but the average tenure of the key staff and investment teams are around 10 years also. Portfolio turnover, so the frequency with which the names in your fund will change is also very low. I think the industry seems to suggest that the more you change your portfolio, the more you're being tactical and evolving with the environment. Our view would be somewhat different. If you find the right sort of business, those are the companies that can thrive in all kinds of environments. And so as long as you pay, you already comment about growth of Scottish prices, as long as you pay a reasonable premium or a reasonable valuation, which comes naturally to Scots, obviously, and accept that companies, any company, will have business cycles and accept that companies, any company,  and will have better years than other years. But over the piece, we'll do better than average, then that is the recipe for long-term out-performance, which is obviously what we're trying to deliver for your clients. That as everything that I've just said has basically been in place since 1985. And clients have been with us for 10 to 20, 30 years, really reference the fact that they always know what Walter Scott's likely to be doing in terms of how we're behaving. Markets and the economy might be in apparent turmoil but Walter Scott sticks to its knitting and I think that is a  source of comfort for our clients comfort for all of our clients. So, that might be a little bit out of the question.

Aaron Sherlock (05:52)

No, perfect, and thank you very much. You've certainly had my support for the better part of a decade here in the proofs in the pudding. Could you speak a little bit more to the rigorous research process? I know that you have portfolio managers on flights going around the world almost every single day and you do have a few core tenants and maybe the checks and balances that are involved in adding a position to a portfolio and that it's just not one individual who has a potential pet project and adds it. Could you speak to that a little bit more?

 

MURDO MACLEAN (06:28)

Yeah, absolutely. I mean, as you say, you know, research and learning about companies is the bread and butter of the firm. We really don't do anything else except focus on companies. We don't bother ourselves with looking at indices, sector weights, country weights. What you will get if you invest in the Walter Scott portfolio is the output of that process manifesting itself in around 50 companies, most of which we would consider to be the best in the world. Over 700 company meetings a year. Over 50% of those meetings will be in the company's own backyard. So as you rightly say, we will be on airplanes a lot throughout the course of the year, going to visit management teams in their headquarters, factory tours. You know, I think access is fantastic to top management. Reason being because we are long-term investors. We are the sort of investors that companies like to have as shareholders because we're not what many are, which is very short-term. We're not trying to get companies to change. If you see areas they can improve upon, they will obviously nudge them in that direction, but we're not activists, investors. We are outsourcing the stewardship of your clients' capital to those management teams in the belief that they will do a very good job of growing that capital over the long term. The rigorous process that you mentioned, having lived and breathed it for many years, I think is really key to why the portfolio is as high quality as it is. The individual that comes across the company must first conduct in-depth financial analysis using our proprietary spreadsheet going all the way back, usually over 20 years, to analyze how that business has performed in good years and in bad years. Part of that is establishing whether the company has a profitable return structure or not. And for a Walter Scott portfolio, the companies that we look at must have at least a 20% return on capital and a 20% return on equity to be considered. They must also have a very robust balance sheet. So the average net debt to equity in a Walter Scott portfolio is somewhere in the region of 20 to 25%. Now, when you contrast that with the total index, if you will, that's close to 100%. So we truly believe that a company with strong balance sheet that can generate higher levels of cashflow, higher levels of profitability, and indeed, obviously, higher levels of growth, is really the very best that we can find and we find them all over the world, in different sectors, in different countries. No one country or sector has a monopoly on the world's best businesses. And then once we've conducted that financial analysis, the second stage is to obviously dig into why do the numbers look as good as they do. And it's about the consistency of those numbers, which is really key, not just the magnitude of those numbers. So to seek to understand what it is about this company and the industry that operates in particularly, that has allowed this business to grow at rates and multiples of global domestic product GDP. So that's really the second stage. We look at areas around ESG to work out whether this is the sort of corporate citizen that we believe that you would believe that your clients would want to be invested in. We're not looking for shady management teams here or boards of directors that are basically an old boys club. We're looking for the best people to run the business. And we also look in a lot of depth at barriers or entry around that business, or moat, whichever you want to call it. To be the top of the tree for 10, 20 years, the barriers to entry around your business have to be incredibly high and you need to work hard to maintain those. And so we try to understand what it is about the technology or the market position or the quality product or service that this company delivers, which is enabling it to maintain that leadership position. Because that will be very important going forward as well. And so in order to get a company into the Walter Scott portfolio, you need to do all that work. You then need to convince your regional teammates of the quality of that business. And then you need to convince the entire research team. And just when you think that you've done about everything that you can possibly do, you then have to sit in front of the investment executive, which is five of the most senior members of the firm, and run the gauntlet that then again takes in the curve balls and everything that they can throw at you. And if you can get through that, and that can take anything from a week to six months on some pieces of the company, then the company is considered for efficient. So when we say rigorous, we set the bar very, very high so we don't need to worry about the quality of the business investment.

 

Aaron Sherlock (11:41)

Coming from the research world myself, I can appreciate how much effort goes into understanding both the business as well as the management team and the outlook and it sounds like Walter Scott certainly front loads the work in understanding the business instead of investing first and asking questions later, which is something which I certainly appreciate. And you did touch on a couple of things, which maybe is a good segue into the next area and that's certain sectors or thematics, which Walter Scott sees going into the near and medium term. I know by your process, there's going to be certain sectors which just don't meet the criteria of.

 

MURDO MACLEAN (12:22)

Mm.

 

Aaron Sherlock (12:22)

sustainable cash flow, strength of balance sheet. Can you speak a little bit to that on areas which you like as well as areas where you don't generally invest?

 

 

MURDO MACLEAN (12:39)

Absolutely. So we do start with a blank sheet of paper. We don't have any predetermined biases or prejudices towards any company or any sector. I say that because when you look at the Walter Scott portfolio, we are definitely overexposed to some sectors and underexposed or absent other sectors. But that is the output of looking at companies all around the world in different sectors. We leave no stone unturned here. We cannot afford to exclude anything before we start looking. Over the sort of 38, 39 years or so that we've been doing this, it is true that we have found more names, more ideas in sectors such as technology and healthcare, and the consumer space, and on occasion the industrial space, than we have found in areas such as financials, namely banks. Shock horror for a Canadian audience that Walter Scott's portfolios don't hold any banks. We can, but it's very rare that we have. Indeed, utilities, telecoms, real estate, all of them don't tend to feature highly. The reason being, when you look at companies within those sectors, those sectors where we're underexposed, they tend to be more geared to the economy in which they operate. If the economy is healthy, banks will typically do well, if it's not healthy, appetite for lending or borrowing will decline. Net interest margins will shrink. And the same for real estate. Prices will decline if you are in a softening economy or a stagnant economy. So that removes a major part of the growth tailwinds of those companies. In addition, most of those companies are relatively mature in the markets they operate. Most people have a bank account. Most people have a mortgage. Most people have a mobile phone contract, most people have a house, etc. So there's not a lot of organic growth in those sectors to be had. So you're relying upon the ebbs and flows of the economy in which they operate, which means they're quite cyclical. And we are looking for businesses that are structurally growth businesses, that irrespective of the underlying economy, those companies are being driven by larger forces. So when you consider healthcare, elements such as demographics, the constant innovation going into drug development, or indeed into the development of medical devices, to improve upon historical ways of doing something, or generating a more effective drug, than has been the case in the last 10 to 15 years, or whatever. Technology again, the constant evolution, from desktop to cloud-based, from print to digital, from traditional ways of doing things to augmenting that with artificial intelligence. Those sectors never stop. Because they have technology at their backs, it makes it much easier for those companies to innovate and to move into interesting new markets or create new markets themselves. So there's a lot more scope for growth. And therefore there's a lot more scope for higher returns on that invested capital. Typically, in technology and healthcare areas, you might get one, certainly two, and maybe three companies doing something similar, maybe, at a push three. So the chances of finding a dominant player are high. If you look at banking, or oil and gas even, or there are many players, all of them are basically selling the same product. They're selling the same credit card, the same mortgage, the same barrel of oil, the same bit of iron ore they dug out the ground. And if one of them tries to price it at a premium to the next person, everyone's going to go to the next person because it's the same product. So there's no pricing power there. So there's very little growth other than cyclical growth. There's very little pricing power, which gives them limited flexibility when, say, costs go up and they need to share that cost burden with their clients and that is the contrast really between the sort of sectors that we like to invest in and the sort of areas that we typically have avoided over time.

 

Aaron Sherlock (17:11)

Okay. You certainly touched on a few areas which I've got some more pointed thoughts on as well. And myself coming from the oil and gas banking world, it seems like we were always chasing the low cost producer, someone who could do it cheaper instead of a new idea or something which was potentially different.

 

MURDO MACLEAN (17:28)

I would agree. I don't think the solution for de-carbonisation is necessarily going to come from the oil and gas industry. They are pretty much wedded to what they do. An oil and gas company cannot move into banking, for example, but technology companies, healthcare companies, can really move into adjacent markets quite easily.

 

Aaron Sherlock (17:55)

Yeah, the breadth and use of their technology and scale of it is infinite in some of these situations. And when we talked about the oil and gas side of things, I would like to echo your thoughts on ESG. My general thoughts on ESG are it's been there for a long time. It's just been more topical as of late, but you think about it. If a company treats the environment properly, uh, governance, as well as society, they generally have done well. I'm sure there's companies in your portfolio, which you've held for decades which complied with all of those new rules and regulations which have been put into place, we just threw a three-letter acronym around it now.

 

MURDO MACLEAN (18:32)

Mm-hmm.

 

Absolutely, I mean, that's exactly how we would put it, Aaron. At the end of the day, it is common sense. The whole concept of ESG is common sense. What type of business do you want to invest your hard earned assets in? Businesses that are run properly, businesses that you would want to work for or that you would want to own and not businesses that are governed by shoddy management teams or that treat their staff poorly or that treat their environment that they're operating in, which is finite, currently. So it's really over our time horizon, in 10 plus years, these sorts of things will catch up with the company management teams. So it makes sense to us to consider them, to factor them into our research process. Also, contrary to the narrative out there, it is not more important than another factor that we look at. It is just as important as every other factor, whether it be growth or profitability of a dividend or the growth of the market. ESG is yet just one of a number of areas that you must look at. I think you would be forgiven for believing it's the only thing that's worth looking as out, based upon the narrative of the last few years but high standards of corporate governance are nothing without growth and profitable growth. And at the same time, profitable growth is great but at the expense of managing teams who don't have the best interest, but share a little bit of heart, that might lead to bad outcomes as well.

 

Aaron Sherlock (20:19)

Alright, thank you for touching on that in a little more further detail. Last topic to cover, and this is usually my favorite because it's something which has yet to come to fruition and that's your outlook on the medium and near term. Looking back at history over the past couple of years, we've certainly seen some volatility. 2022 was not a great year in the markets. 2023 things came back despite all the talking heads on TV saying we're going to have a deep recession. We're now into 2024. Markets seem to be doing quite well. One particular area which Walter Scott has been harping on for quite some time, Japan seems to have picked up as of late. Do you have any broad thoughts on the outlook globally, both from an economic standpoint, which leads into interest rates and inflation? Then maybe touch on artificial intelligence a little bit at the end if you wouldn't mind.

 

MURDO MACLEAN (21:05)

Yeah, I mean, you know, I was reading today that it's four years to the day since COVID was classified as a global pandemic, something of that nature, which is frightening how quickly time moves on. You know, and I think we, as a bottom-up stock picker, don't spend a huge amount of time trying to consider or second-guess what the next GDP number will look like, what the Fed decides whether it cuts in June or April or May. Ultimately the businesses that we invest in are well equipped to thrive whatever happens. I think that the overall conclusion so far is that the global economy has managed to escape some of the worst case scenarios that were painted when we saw inflation pick up and interest rates begin to tighten but we're not finished yet. I think the longer the interest rates stay high, the more pressure that puts on the weak. Weaker companies and weaker consumers, which is another reason why we don't invest in weaker companies. They may well look okay when the economy is doing fine, everything will be hidden from sight, but as soon as growth begins to decline, it's more difficult to come by, cost of capital is higher, you will very quickly see as the old adage goes, who’s been swimming without trunks on. So I would say fingers and toes crossed that the global economy continues to muddle through. But if it doesn't, we've got significant confidence in the quality of the portfolio to do a lot better than the average, which is one reason why you wouldn't want to own the index because it's the good, the bad, and the ugly. A Walter Scott portfolio should only be the good or the very good. And that's really a major distinction that we're trying to draw. You mentioned Japan. I mean, it's been a perennial disappointment for many investors stuck in deflation, stagflation for several decades now, very poor demographics, high levels of government debt. All of that said, that's still the same as it is today. What really matters to us is that Japan is still home to some very good companies, just not in the same sort of numbers as you'd find in the United States. So if there are only five world-class companies in the Japan then we're only interested in owning those five. We're not interested in owning the market. It's a very cheap market because there's such a lot of poor quality businesses there. So we don't necessarily get excited just because the Japanese market is cheap. It's usually cheap for a reason. And it's also why very, very good businesses are not cheap and are rarely cheap. You get what you pay for, as we all know as consumers, you get what you pay for. You don't walk into a luxury handbag store and expect a 50% sale. That tells you all you need to know about how luxury that company will be for that brand. So, you know, there is a lot that comes with paying a little bit of a premium, but in the long term it's typically paid off. So I think Japan is getting, the market is getting a little more attention, areas such as a bit of inflation returning, maybe the Bank of Japan starts to tickle rates up. But I emphasize the word tickle. Okay, they're not going to get to 5%. They're terrified of choking off inflation before it gets embedded again. Too many false dawns there. Demographics are unchanged. But the fact that there are some very good businesses in Japan that one can invest in has not changed. And I think we continue to be constructive on that country as a good place for stock picking as we ever have been. You brought up AI, clearly that was the buzzword for last year in markets, it's obviously been around a lot longer than just 12 months. And I think our view is that it is exciting, it is a very potentially transformational tool for lots of companies. But at the same time it's early days. So it's very difficult to equate the amount of hype around a trend or a story to the actual real world applications. Very often hype comes long before we see that coming through in corporate profit numbers and earnings and so on. So I think as it looks today, there's significant exposure across the portfolio to companies that will benefit either from the adoption of AI as a tool to augment their business, better data analysis, better development of drugs, product development and analysis of the customer behavior, or the significantly increased amount of infrastructure spend around artificial intelligence. In the cloud storage, data centers, silicon chips themselves, there is significant exposure to some of the world's best equipment suppliers and manufacturers within that infrastructure chain, that semiconductor chain. So as and when we see tangible evidence that there is money pouring into this, the portfolio will do exceptionally well as a result of that, I think.

 

Aaron Sherlock (26:40)

Perfect. Thank you for that. I thought I would touch on the Japan topic because it is a, you certainly spent a significant amount of your career looking at Japanese equities as well as lived there for a number of years and you're proficient in Japanese as well. I'd like to hear that accent. The way I look at AI and try to talk about it from a very high level is I view it like the gold rush.

 

MURDO MACLEAN (26:55)

Yeah, that's right, that was my degree, yeah.

 

Hehehehe

 

Murdo MacLean (27:09)

There are tons of people flooding into the space. Everyone is talking about it. There are going to be some winners who do hit that vein of gold and figure out how to right size their business, reduce costs, and invent new products. But the ones which are really benefiting right now are the ones who are selling the pickaxes and the equipment to harvest it. Those are the ones like you spoke to, manufacturing infrastructure, as well as the semiconductors themselves.

 

MURDO MACLEAN (27:28)

Yeah.

 

Yeah, 100%.

 

Aaron Sherlock (27:37)

unless there's anything else you'd like to add. I would like to thank you for joining us today, Murdo. If you do have any questions on, oh, sorry, go ahead, I cut you off there.

 

MURDO MACLEAN (27:46)

Thank you for having me.

 

I was just saying thank you for having me. It was a pleasure.

 

Murdo MacLean (27:52)

Oh, thank you for joining us. If any of the listeners have any questions on anything discussed in this webcast, please feel free to send me an email at aaron.sherlock@cibc.ca or you can Google The Sherlock Group at CIBC private wealth to discuss how to position Walter Scott's global and international equity mandates in your portfolios. Be happy to answer any of those questions. Thank you.

Outro (24:55)

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Introduction

Short video of a stock market chart arrow moving in an upward trajectory with upbeat music play in the background. Magnifying glass appears and becomes the “o” in Sherlock’s Clues. Full title comes into focus, Sherlock’s Clues – Insights on Investing & Economics with the investment philosophy below “Investing Success: Powered by Process, Fueled by Discipline, Rewarded by Patience.”

 

Aaron (00:01)

Welcome back to another episode of Sherlock's Clues. I am your host, Aaron Sherlock. And on today's episode, we are going to talk inflation, interest rates, and employment. I have with me today Giuseppe Pietrantonio. Did I butcher that or was that all right? Excellent. Giuseppe is an associate portfolio manager in our multi -asset and currency group. He talks all things macroeconomic. And Giuseppe, I'll hand it over to you to give a quick background on who you are and your experience and then we will dive into a few of the topics.

 

Giuseppe (00:33)

Thanks Aaron. So I've been with CIBC for 12 years, a number of different roles. And so right now I represent the multi -asset and currency team as a client portfolio manager. And so when we think about multi -asset and currency, at least in our view is it's very much thematic global macro view, largely embedded with the economy. You know, let's say our biggest, our flagship is our currency strategies, obviously. If you're investing in different currencies, you need to have that very strong global macro team. And so we also have a global bond, emerging market debt, and a multi -asset team that really the preface or the foundation of this team is looking at economies and trying to find the drivers of financial markets relative to economic data and our intuition.

 

Aaron (01:25)

All right, excellent. Thanks for a little bit more information on that. With that said, we're going to tackle some of the larger macroeconomic trends and something that's been on everyone's mind or their credit card bill is inflation. Over the past several years, we've seen it skyrocket to high single digit, low double digit, depending on how you measure it. But more recently, we saw a downside surprise in Canada. Came in at 2 .8 % in February, below expectations. While the US still remains a little bit hotter than economists are forecasting, there's lots of things which go into CPI or consumer inflation. Can you unpack a little bit of that for us and how the average person should think about it?

 

Giuseppe (02:08)

Yeah, I think for the average person, obviously when we think about inflation, I myself go to the grocery stores or Costco, for instance, and say, oh, those prices are higher and higher every time I come, that bill is getting higher and higher. And so I'm hoping that that bill kind of flatlines right now, trying to relate that back to this lower than expected inflation numbers. And so when we dive deeper into that inflation figure that we saw that 2 .8 that you mentioned in Canada, the component that's brought it down, has been really like good section, the good component of it. And so what we do as investors is think about, okay, well, what's the next level? Is inflation gonna, is this goods continuing, gonna come down or what part of the inflation basket is a bit more sensitive? And so I think we all understand where rates have gone, rates have gone up. Think about our mortgage, the cost to our mortgages are. You know, if we were refinancing or buying a house presently in Canada, it's more expensive than it was three years ago, more expensive than five years ago. And so there's a shelter component within the CPI that it's still sticky. That's the component within the CPI that's remained sticky. Services and shelter. And so you got to think about shelter as two components, obviously home prices, you know, mortgage rates, how much the mortgage costs individuals or Canadians, but also the rental inflation. And so if it's costing property owners more money to hold the house, to have a house and think about, you can think about all the different components and, you we think about mortgage rates, but just think about your insurance bill, right? As prices, as prices go up, well, insurers are also increasing their prices. And so what homeowners have to do is that they have to increase rents. And so you're getting this double whammy, right? You've got home prices that are coming up because of inflation other costs like insurance and you've got rental prices coming up as well. And so that's what's been the stickier part of this inflation report. So we do expect inflation to come down over, you know, medium to longer term. You know, we're not saying the next report is going to come down again, but that shelter component is really where we're focused because it's a large portion of the CPI basket.

 

Aaron (04:27)

And I find some components of CPI have an outsized impact on people's psychology when they're thinking. It's the daily things that you purchase. Sometimes the larger components are the things that you don't go out and buy every day like a house or a car. But one interesting detail which came out in the last inflation print was that food prices started to flatline. They stopped seeing the continuous march upward. Now obviously it's more volatile along with your energy prices, which is why sometimes they're excluded from some measures. But it is nice to see that these large purchases are starting to come down. Now, I know Canada and the U .S. are a little different. We have Canada's got a very homogenous economy versus the U .S. is a little bit different. Can you talk to how Canada and our Southern cousin differ a little bit?

 

Giuseppe (05:21)

Yeah, so I think in terms of we have a lot of similarities and in terms of inflation, in terms of we have the same issues in terms of it being sticky, right? That shelter component in Canada and the US is the component that's a little stickier. But obviously the US has one large benefit to them is that their currency is not pro -cyclical. What I mean by that is that...in any recession or in any period of time where there's stress in the environment, the US dollar does very well. So for instance, if we take COVID as an example or 2022 as an example, when markets did poorly, the US dollar did strong. And so that also helps an economy that imports, because if your dollar is stronger, obviously you can buy more with that dollar. And so it kind of helps the inflation figures come lower than relative to Canada. That being said, I think the biggest dynamic between or the difference between Canada and the US in terms of inflation is that housing component. And so for Canadians, the risk is that five year refinance. So on average, Canadians refinance or not refinance, but we negotiate their mortgage rates every five years. Well, in the US, they have 30 year mortgages that they lock in for 30 years. And so if you were in the US and you had a home and you're able to refinance in 2020, 2021 beginning of 2022, and you've locked in a really low rate for 30 years, well, that's not in five years, you have no issues of refinancing. Those costs are defined, they're not gonna move up. And so that's a little bit of a challenge that we see in terms of Canada where this renewal of rates may keep inflation a little bit higher over long term.

 

Aaron (07:09)

Okay. I think that's a, that's actually pretty good segue into the next topic of conversation around interest rates and maybe a little bit of a fun fact for some of the listeners. I'm, I'm half American. My father was born in the U S so I've got plenty of family members south of the border who have 30 year mortgages set at three, 4%. You don't need to worry about it again. It sounds like a pretty good idea to me, but I'm not the one making the rules at the bank. Uh, onto the interest rate side of things, uh, as inflation goes up, Central banks historically raise interest rates to combat that. Interest rates are used as a mechanism or a lever for them to pull when it comes to an economy which is overheating or an economy they want to stimulate. I know here in Canada, we came from near 0 % to now 5 % and all the prognosticators out there were expecting an interest rate cut by March so far this year. It seems like things have been pushed out a little bit a similar situation in the US with the Federal Reserve. Their rates have not seen this level in a decade and their economy still continues to be strong. What do central banks need to see in order to start cutting those interest rates? It seems like the first round of forecasts have been incorrect so far.

 

Giuseppe (08:26)

And so that's a really good, great point. And so I think the advantage to have, to be able to look at economies globally is that you get to see what different markets or different countries have done, different central banks have done to combat inflation. And so I think about the Canada and the U S one's the last time that we've got, we've had, you know, over two, three double digit inflation. We're looking back at the ninth, at the eighties, right? And so for central banks to combat it in, let's say, developed markets, um, you know, their hesitant, they want to keep rates higher. But if you look at Latin America, Latin America were the first central banks to increase rates. And so in developed markets, Canada, US, Europe, we were kind of saying, okay, well, we don't want to deteriorate the economy. Let's do this slowly. Let's increase slowly. And you can argue that the increase of rates was done too slow, you know? And so what happened is that you did it really slowly at the beginning and then you had to ramp up and so the magnitude that that shock was what was large in a very short amount of time. Whereas Latin America was saying we need to, we know, we always deal with inflation. It's nothing new in Latin America and peripheral Europe. It's nothing new. We got to raise rates right away to come to bring inflation down as quickly. And so globally, what we're seeing right now is very consistent with what we expect to see in the DM. We look at EM markets, emerging markets like Latin America where they're starting to cut rates, inflation is coming down. The goods component, like I mentioned, in Latin America, for instance, is coming down. So they're starting to cut, but it's not a broad -based cut to, hey, let's get back to levels of COVID levels. No, it's, okay, 50 basis points, 25 basis points, and make the market digest that. In the US and Canada, what happened is in the fourth quarter of 2023, you had Powell, chair of the Federal Reserve, talking about, changing his sentiment to be more dovish saying, okay, economy is doing well, inflation is coming down. Let's, you know, we're, we're, we're thinking more and more participants within the federal reserve, the committee you're talking about reducing rates. And so the market got excited. The market got excited and says, okay, well six, there's going to be six rate cuts in 2024. And I think the market got ahead of ourselves. And I think like, you know, obviously some of the Intel on our side, we're kind of calling for three rate cuts and so what you saw in the first quarter of 2024 is a repricing. And so those six rate cuts are now closer to three, can argue two, two to three rate cuts. And so what drives that change in sentiment for investors is really the inflation data that's coming out. Also the comments made by Federal Reserve Committee Chairs. And so what do we need? That was one of your questions, right Aaron? What do we need? We need inflation to get closer to 2% and so when they're looking at inflation dynamics, like we talked about, goods are coming down. That's great. But once again, that shelter component, the services component are still high. Labor is still very, very tight. When you think about unemployment, it's still historically low. So to get that portion of inflation to come down is still very challenging for central banks.

 

Aaron (11:36)

Central banks do not have an envious job. Their tools are very blunt. It is interest rates. They need to wait for them to filter through the economy. You generally do not want to see a lagged effect which has an outsized impact on something like employment. I am sure you keep track of all the data discussing the number of housing starts that are happening. It seems like they are coming on at quite a pace. Everyone moved in at once. They still need to see what that looks like central banks' objective is to keep stable inflation and full employment. Right now, you're seeing inflation come down. Employment is at record highs. In the next topic, we can discuss some of the labour issues that are arising both in Canada and the US. Maybe we'll hop into that here right now. Watching Canada's employment market and the employment data come out is like watching a ping pong match. It seems like it bounces from one side to the other massive underperformance, massive overperformance or one month it's entirely government employees or part time or full time. Trying to unpack some of the trends in Canada is a must be an aggravating task at best. What are you seeing in the inflation market or sorry, the employment market in Canada and where do you think it can go? Cause there's certainly not many more people to put to work.

 

 

Giuseppe (12:59)

Yeah, so that's a really good point and I'll try to unpack of that, unpackage that. So there's a lot of cyclicality or seasonality as well to some of this data that we get. And so we tried to smooth that data out and stats can do some of that as well. We've got some sources who kind of also provide this eliminating seasonality. And so when you think about employment, you're absolutely right. It's been very strong. Unemployment levels are really low, employment levels are high and you brought in, Canada in general has brought in 1 .6 million, and that's an arguable number, but immigrants. But you're looking at the workforce. So we use hard data, obviously, but also some data that we use surveys and what not. And it seems that the labor market is still tight in Canada. Business owners are still looking for employees. And so we've...for us to kind of relate that to markets or to inflation, if that's still happening at these days, well, people within the labor market have the power to negotiate salaries. So salaries can push up, which is gonna, once again, impact inflation. I think that's what we saw in the past few years when another factor of why inflation was stickier last year was the labor market. And so I think now we're getting to a closer part where, you know what, there might be, I'm not saying in the next three months, but maybe towards the end of the year, where we'll say, okay, now all jobs are full or most of the jobs that are full and just still peripheral jobs that are all be available. But maybe the market can not necessarily soften, but be less tight than what it is right now. And so that's definitely very difficult to impact on a quarter to quarter basis, but something that we're definitely tracking.

 

Aaron (14:50)

I find it interesting to watch the wage growth because I guess a couple of the old adages around inflation is cost push or demand pull. It seemed like early COVID we had demand really pulling inflation up. Then cost push started moving it upwards with wage growth. Wage growth was pointed to top out at 6 -7%. Now it's down to the 4 % range.

 

Giuseppe (15:10)

That's correct.

 

And so once again, that's still high. All right? So.

 

Aaron (15:20)

Historically what is wage growth generally trended like over a you know a rolling 24 month period

 

Giuseppe (15:27)

Probably around 2%, probably around that 2 % number. So...

 

Aaron (15:31)

Okay, so just in line with inflation, it's not wildly above or wildly below inflation as it generally makes sense to think about it like that. Now, Canada's job market seems very strong. The US, I just traveled down there last week. It is crazy. Help wanted signs everywhere. Couldn't go inside a McDonald's because the dining room was closed and it was only drive through. Are there any different expectations for the US versus Canada? Because it does seem like their inflation is a little bit more persistent and maybe that's driven by their economy not having the same level of cyclicality to it. Maybe add a little bit more light to that.

 

Giuseppe (16:14)

Yeah, so I think in the US, there's one dynamic, one key dynamic that's different, it's immigration policy in the US. In Canada, the number of immigrants that we've been able to bring over is roughly the same that the US has, and we're, you know, there are 10 times the population we are. And so to fill these jobs, how are we going to fill these jobs? And so the way that we're thinking about this is a little bit more political. And we've got a big election this year in the US. and to say, okay, well, what are the dynamics or some of the dynamics with, you know, either a Biden continuity or, you know, a Trump back in power. And so that's, that's a big, a big determinant on labor and labor concerns, right? So if you do have a Trump presidency, the likelihood of having more immigration to kind of fill these jobs is less likely. We think about on -shoring, something that's very, very, very close to our minds right now, our friend -shoring. So, you know, the US wants to be less dependent on China. And so the Vietnam's the world, Thailand the world, India the world, Mexico's are the ones that have benefited or seek to continue to benefit it, and potentially the US too. And so, but with that adds higher inflation costs potentially, because, you know, China is the market leader in terms of cost, right? But it also has, you also have potential issues with the labor market, continue issues on the labor market. Like you said, you know, the US just like in Canada, we're still looking for employees or, you know, workers. And so if you're trying to onshore, friends shore, let's say onshore for the US, you still need these workers and you need capital and you need workers. And that's the US is a bit of a tough situation regarding those two, those two components.

 

Aaron (18:09)

Okay, thanks for that. And I guess we'll wrap it up with the usual question I ask. And that's the outlook. It's the million dollar question, the hardest one to answer. Most of these three topics, inflation, interest rate, and employment are intertwined. Do we have a bit of an outlook on them for the next, we'll call it medium term?

 

Giuseppe (18:35)

Yeah, you know, I know we talked a lot about like factors why inflation is stickier. Don't get me wrong, being sticky doesn't mean that inflation is, you know, continuing to come higher. We're expecting a slow ground, a slow grind, where inflation is going to come down slowly. It's going to eventually get to close to its 2%, maybe 2.3%. Maybe it won't get all the way down, but it's going to get to a level where central banks are going to be more comfortable to start cutting rates. Like I said, you see it in Latam, peripheral Europe. The euro the the European Union is talking about cutting rates to Canada might be a place that will begin you know shortly in can argue the next three months to cut at least point 25 percent or 25 basis points and so looking ahead we do expect a slow move down in yields and Positive growth and so you've you've had this you know that we think about Asia and China and then the US you know China US the biggest the biggest drivers of the economy or GDP, growth in the US is continuing to be strong. Retail sales are strong. Many metrics that we're looking at continues to be strong. China is having a tough time stimulating, absolutely. But doesn't mean that that'll continue. We still think that there's still strong growth from China, Asia, India, for instance, very strong growth in India. And so we might not see this double digit growth that we've seen historically in Asia that's kind of helped the rest of the world but we do expect, you know, slowly, slowly that growth, global growth is going to continue to improve. Rates are going to come down. So when we relate that to financial markets, what's that, that's benefit, that benefits obviously the bond market, but also benefits any risk assets. So any equity markets as well. And so that's, you know, obviously we have probabilistic scenarios and so that's one of our scenarios. So stickier inflation, but still trending downwards and some growth kind of a little bit of a resurgence for growth. Are there risks? Absolutely, there's risks. We can't not mention the risks, there are risks. But right now with the data that we're getting, let's say, you know, cautiously optimistic.

 

Aaron (20:42)

It's a breath of fresh air to look at the markets and think that good news is good for the markets. Over the past couple of years, markets were rallying on job losses because that meant interest rates were going to go down. I prefer markets to be correlated with strong employment, strong economic growth, and it seems like that's a bit of the picture you're painting.

Aaron (21:06)

Well, I think we'll wrap it up there today Giuseppe. Giuseppe is going to be a regular on the webcast. Next time maybe we'll dive into the emerging markets segment as well as fixed income and how to place that in your portfolios. If anyone watching this webcast has any questions, you can email me directly at aaron.sherlock@cibc.ca or Google the Sherlock Group to get in contact with me. Thank you very much. Have a good day.

 

Outro (21:42)

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Introduction

Short video of a stock market chart arrow moving in an upward trajectory with upbeat music play in the background. Magnifying glass appears and becomes the “o” in Sherlock’s Clues. Full title comes into focus, Sherlock’s Clues – Insights on Investing & Economics with the investment philosophy below “Investing Success: Powered by Process, Fueled by Discipline, Rewarded by Patience.”

Aaron (00:11)

Thanks for joining me today, Andrew. I know we've had a little bit of an issue lining up our schedules. We're just a couple of time zones apart. For the listeners here, Andrew's based in Australia. While I'm in Australia's much colder cousin, Canada, we've just now cracked zero degrees. So woohoo, spring's coming on the way. A little background on Andrew. He is co-founder and managing director of Maple Brown Abbott.

 

global listed infrastructure. He's got over 20 years of experience financing and investing in the infrastructure space. I'm personally very excited to discuss Infrastructure today with Andrew as full disclosure, it's a core holding of almost all of my clients' portfolios and I don't think it's as understood as well as it should be. And hopefully Andrew can unpack some of the questions that I have and provide some expert insight to the space.

 

I guess with that, Andrew, I'll lead into the first question. I usually try to just define things out of the gate so people have a broader idea of what we're discussing. And that's what makes up infrastructure. Here in Canada, we've got pretty limited infrastructure. You think power lines, pipelines, and utilities. That's about it, but it is a much broader category to provide a little bit of context around that and the broader definition of infrastructure itself.

 

Andrew Maple-Brown (01:25)

Thank you.

 

Yeah, absolutely and thank you Aaron for having me here today. In terms of instructor, instructor assets generally have certain key characteristics. So specifically, they're assets which provide central services, so assets used by a large number of people on a regular basis. Secondly, they're assets with a very strong strategic position. So we like monopoly assets, we like

 

Thirdly, their assets are very predictable and stable cash flows. So our methodology, we're forecasting those cash flows over a number of years to come up with our valuation. So it's critical that they have that stability and predictability in cash flows. So in terms of the types of assets that we're investing in, globally, we view about 110 companies on the listed stock exchanges as well fitting those definitions. Typically, about half of those companies are regulated utilities, so regulated water gas and electric utilities. About a quarter of the companies are transportation concessions, so toll roads and airports predominantly, also some railway tracks. And the final quarter are assets subject to long-term contracts. So these include telecommunication towers, renewable assets and pipelines as you've just mentioned. So relative to the Canadian listed market, as you said, there's a number of pipeline companies and several regulated utilities.

 

On a global basis, there's a lot more regulated utilities and different types of regulated utilities, so water utilities, as well as gas and electric utilities. There's a number of transportation concessions that you can't access through the listed market, such as toll roads and airports. And there's also contracted assets like telecommunication towers and their renewable assets, in addition to the pipeline companies that you see in Canada.

 

Aaron (03:12)

Excellent. Thank you for that. With that being said, the world's becoming smaller. You're starting to see more investment abroad. I'll pick on a few of our large institutional money managers and pension funds, which are certainly moving more into the infrastructure space over the last 5, 10, and 15 years. What do you see the reasons for that being? And maybe I'll just cue up a couple areas diversification, hedge against inflation, and reducing volatility. Let's touch on a few of those areas.

 

Andrew Maple-Brown (03:40)

Yeah, absolutely. I think you've very well hit the key reasons for investing in infrastructure and you're spot on. There has been a significant move, particularly in the private markets, towards focused investing in infrastructure. We think that there are very attractive opportunities in the listed markets and we can talk about the differences between those markets. But ultimately they have the same investment characteristics. They're the same underlying companies which exhibit those same characteristics, subject to the same regulation and contracts and so forth. So the reasons for holding them within the portfolio are the same. And essentially, what we see is those key attractions include that defensive nature of the investments, so the lower cash flow volatility, the natural inflation linkage that a lot of these assets have, the higher income yield, certainly relative to global equities and also the diversification benefits that the assets can provide to a portfolio.

 

Aaron (04:40)

The diversification benefits certainly were on full display in 2022 when you saw, we won't give out exact numbers, but you were significantly positive while the rest of the market was down drastically as it's not a correlated asset class to the public markets generally. I guess with that, I'd like to lead into what the Maple Brown Abbott process is, what makes you special? How are you different than the market?

 

Andrew Maple-Brown (05:06)

Yeah, absolutely. And thank you for mentioning 2022. I think that both 2022 and 2023, to be fair, will exhibit some of those differences between holding an infrastructure portfolio. 2022 was a very tough, tough year for global equities, as you've alluded to. And part of that was because inflation was really picking up and the outlook for the economy was weakening. So the infrastructure companies, both are less economically sensitive so less driven by those cyclical factors and also have that natural inflation protection. So it did hold up better in 2022 and I was very pleased to see that significant outperformance. To be fair, I should also say that 2023 was somewhat the reverse. The global markets were extremely strong, the economy turned out to be not as weak as people were fearing. So those other parts of the market, which are more economically sensitive, benefited far more from that stronger economic outlook than infrastructure companies did. So 2023 is very strong for global equities and the infrastructure sector, therefore for lag. So yeah, to your diversification point, absolutely, the asset class does behave quite differently and is far more defensive in most circumstances than broader equities. That's also a good segue into the question you then asked in terms of what we see as our differences. And one of the key differences that we really focus on is we think as to why do investors, why is it logical for investors to hold infrastructure within a portfolio? From our perspective, it's because of those differentiated investment characteristics that make it deserving of a strategic asset allocation. So it only deserves its own allocation if it does have differentiated investment characteristics. And what are those important characteristics?

 

To us, it's the low cash flow volatility, so the defensive nature of the asset class. And secondly, the inflation leakage. So our definition of infrastructure only includes the companies with the strongest combinations of those two characteristics. So we're really focusing only on core infrastructure assets. So we use a tight definition of infrastructure and we continue to focus on those characteristics throughout our investment process. And that's why there's only about 110 companies globally using our definition, which will exhibit those characteristics. I'm so that'd be the key difference I'd say to some other infrastructure managers who define infrastructure more broadly. I suppose a couple of secondary differences. Firstly, since our inception, we've set a capacity limit, which we calculate in a consistent manner since our inception 11 years ago, we continue to believe capacity is very important. So to ensure that managers don't become too large, particularly with an approach like ours, who are a high conviction manager, we're building portfolios of our best 25 to 35 ideas. So it's critical that we're able to select those companies, not just from the large cap companies, but also from the mid cap companies and to a certain extent the small cap companies. So if you get too large, you lose your ability to be nimble particularly around those smaller companies. And the other difference I'd highlight is the alignment of the investment team. So our investment team are owned over half of our business. So we're majority owned by the investment team. We've also each significantly invested our personal funds alongside our investors. And the whole team is dedicated to the single list of instructor strategy.

 

Aaron (08:45)

Okay, thank you very much. That's a lot to unpack there. And you know, you didn't give away all the secret sauce as to what makes you special. I did want to go back and comment on the 2023 lagging, the equity markets. The global infrastructure seems like it's more of a safe haven. It's a place when things get a little bit more volatile. Like you said, you have stable cashflow streams, and you know what you're getting versus something which is more economically sensitive. I'd like to lead that into the next question around what sectors or thematics you're seeing that could provide tailwinds for the infrastructure space. Over the next number of years, we won't go long term because that's an impossible task to try to predict. Do you see any sectors where you have higher conviction than others? What would be the reason behind that?

 

Andrew Maple-Brown (09:34)

Yeah, absolutely. Firstly, all the sectors we invest in, we think will exhibit the characteristics that we're seeking. So we're always, we'd be pleased to invest in any of those sectors. But the relative opportunity obviously changes through time, depending on the specific growth opportunities for each individual sector at a point in time, and also critically the valuations. A couple of sectors that I'd highlight at the moment.

 

Firstly would be the regulated electric utilities. We're very excited by the importance of the electric utilities. For a couple of things going forward, firstly there's a big need to decarbonize the electric grids globally. That will involve a lot of investment in renewables but equally will involve a lot of investment into the networks. So into the transmission network and into the distribution network.

 

Secondly, we're big believers in electrification. We think more and more of the energy globally will switch to electricity. And for the same reasons, that will also require huge investments again into generation and particularly renewables, but equally so into the networks, so into the transmission grid and into the distribution grid. And so just to focus on transmission for a moment, why is that so important? Generation typically has come from single sites, large coal or gas or nuclear facilities into the demand centers and that generation has been available for a hundred percent of the time. One of the key issues with renewables, well firstly that they aren't necessarily located at the same locations where those large historical generation sites have been, so you need new transmission in order to link in those new renewable sites. But secondly, renewables are intermittent. And so how do we solve that intermittency? There's multiple ways, obviously different types of generation helps. But one of the critical pieces is having a broader network. So more transmission enables us to ensure that if the wind's not blowing at one location, then hopefully the sun will be shining in a different state or whatever. So transmission will be critical, both in terms of linking in that as new sources of generation, also firming up the grid, providing a reliable network of electricity. So we think there's very large investment needs in the transmission network and also the distribution network, which is becoming a lot more complex as renewables, as the intermittent nature of the grid and also as we've got residential generation at sites and batteries going into houses. That also increases the complexity of the grid. It's a very large investment needed by the regulators. The regulators need to ensure that the returns are sufficiently attractive to incentivize that regulation. And importantly, two valuations in a number of markets for these utilities we think are looking quite attractive now for a couple of years of underperformance.

 

Aaron (12:46)

I was just going to say that we're getting just north of four or five hours of sunlight in my part of the world here now. So solar panels might not be the most efficient, but I certainly see wind farms going up on a regular basis.

 

Andrew Maple-Brown (12:58)

Yeah, it's a really good point actually. It's, you know, we can, you know, you can talk what you like about renewables, but in cold locations like where you sit, the challenge of electrification is much greater. How do you produce and store the volume of energy that you would need through winter to be fully electric? That is still a question to be solved for. But electrification is far easier in more moderate climates like where I sit in Sydney. The need to have gas to residential houses is much more questionable at this point in time. And maybe in the future will be few as well, but for some time, I expect that cold climates will need gas networks, at least as a battery for those very, very cold, cold periods in order to provide the volume of energy required. But yeah so still to be worked on in your neck of the woods.

 

Aaron (13:52)

Moving in the right direction and trying to take care of the environment while returning value to shareholders, I guess, is a it's a scale that's more easily said than done. I would like to point to one topic which more of the institutional money gets to chase and that's the private infrastructure side of things versus the publicly traded side. Can you speak to the public versus private infrastructure and maybe touch on the valuation difference between the two areas?

 

Andrew Maple-Brown (14:22)

Yeah, absolutely. You'll have to cut me short on this topic because I could talk for a long time. But in terms of, I suppose, firstly, to summarize, at the end of the day, as I said earlier, they're the same assets. If you own an airport in Vancouver and an airport in Toronto, that's a bad example because they're both government owned. But if you own one private asset versus one listed asset, they're the same assets. They're subject to the same regulation or laws or passenger flows and so forth. We've looked globally and there's no proof that operationally either listed markets or private markets are better. In some cases, the listed markets are better operators. In some cases, the private markets are better operators. There are actually currently more assets and a greater value of the infrastructure assets sitting in the listed markets than there are in the private markets. So the biggest and I'd argue the best infrastructure assets tend to still be in the listed markets.

 

So the airport example, the largest 10 airports are all either in listed markets or government owned. So some of the largest airports in the world, like Beijing Airport, Frankfurt Airport, Charles de Gaulle Airport in Paris, Heathrow Airport are all in access through the listed markets. So in terms of quality of assets, we think they're very similar. Notwithstanding that, most of the money recently has been flowing more into private market assets and what that has in private market instructor assets. And so what that has resulted in is valuations in the private markets, we believe are significantly higher than the equivalent assets in the listed markets. Based on our calculations over the last 3 years, looking at comparable assets, when assets are traded in the private markets, they've traded about a 35% percent premium to where the equivalent asset trades in the listed market. And from our perspective, that doesn't make sense. Typically, you'd expect an illiquidity premium in the return for investing in private assets. To us, it doesn't make sense to be buying assets at such a significantly higher price and then still expecting an illiquidity premium. In terms of why this is happening, it's really just a flow of money lot of people are trying to acquire assets or invest privately. For some, it's a good reason for the sovereign wealth funds and so forth. They take control of assets and I understand that the control premium argument, but for most investors, there's no control being taken. The far more common reason that we see is investors like the fact that private assets don't get marked to market, they get marked to a model and they get marked less frequently.

 

So they perceive there's a lower volatility. At the end of the day, we'd argue it's only a perception because they're the same assets and the private markets are actually using higher leverage. So then the private markets have higher volatility, we would argue. But yeah, a real conundrum from our perspective, assets trading, same assets trading at significantly higher values in one markets than the other. And from a listed perspective, we see that as an opportunity though. It's an opportunity for two reasons.

 

Firstly, there's a huge investment need for the listed infrastructure companies. So that's widening their roads or upgrading their water networks and so forth. And this investment earns attractive returns, but it needs to be funded somehow. Typically, it'd be funded through issuing debt, issuing equity. We encourage that listed companies, instead of issuing equity, it is more accretive to sell non-core assets to the private markets or sell stakes in your core assets. That will make that investment more accretive because you're getting a higher valuation for those assets. And pleasingly, we're seeing a number of listed companies doing that. And it's good for the private markets too, to get further assets going to their markets. The listed infrastructure market will continue to expand because there is so much investment being needed by these listed companies, but they'll be able to fund that expansion through a more efficient lens.

 

And secondly, hopefully, you know, those high valuations also provides a bit of a floor under listed market valuations. If the listed market valuations ever widen too far, then we do see private players coming in and trying to do M&A, trying to take out bid for those publicly listed instructor companies. So, yeah, wide valuation gap, which we view as a positive for the listed markets.

 

Aaron (18:56)

Maybe we'll take this conversation offline afterwards, because I've got a bit of a bone to pick with the private equity valuations and the market to market side of things doesn't make sense to me, but we will save that for another conversation. Last topic to discuss and arguably the most difficult and the one which usually puts people's feet to the flames is the outlook. I know you touched on it briefly with the thought around electrification, decarbonization,

Aaron (19:23)

A couple other areas which I think are interesting as well is the age of our current infrastructure. I know at least in North America, it's terrible. We're starting to see brownouts and power outages in areas which you never saw them before. And then you can't talk infrastructure or long duration assets without looking at interest rates, inflation, and then a broad macro outlook.

 

I'm sure we could put this all into a small university course, but I'll give you a couple of minutes to touch on that.

 

Andrew Maple-Brown (19:51)

Yeah, excellent. You are spot on. I won't quote you the statistics in terms of age of assets and need of investment, but it is massive. What's most relevant for our opportunity set, and I touched on this previously, but the 110 companies that we look at currently have a market capitalization of about two and a half trillion dollars. So that's a big opportunity set.

 

Those companies each year are spending nearly $300 billion, so more than 10% of their market cap on just organic capital expenditure. So that's just the investment needed on the existing infrastructure assets. And that's the best investment that they can be doing because only those companies can do that investment. So the returns that they receive are either regulated, and again, the regulator needs to set them sufficiently attractive in order to incentivize them to do that work, or they're negotiated in a bilateral basis. So there's no competition around those returns. So $300 billion a year, just in terms of upgrading those existing assets. So it's a massive investment opportunity, which is going to drive the continued growth as well as the growth in the existing assets, the increasing users on your toll roads or passengers. It's also driven by that further investment which is a big opportunity for our listed market. And that's why we don't care that if assets get auctioned, it is more logical that the winning purchasers will be private structure players because they're willing to pay a higher price. There's a huge amount of investment which the listed companies will be doing regardless of any other incremental opportunities.

 

So that's one of the most exciting aspects from our perspective is that need for further infrastructure investment and the critical role of these listed structure companies will be playing in providing that investment. In terms of your macro question, I'll try to keep it brief because it is a broad topic. But in terms of the outlook, as I've touched on, infrastructure assets do not have the same economic sensitivity as the broader market investing in assets which are less sensitive to economic cycles. Secondly, infrastructure assets, and particularly our strategy, are intentionally investing in assets which have inflation linkage. So our sector will perform better relative to global equities when economic growth is weaker and or when inflation is stronger. So where do we sit today there has been expectations for some time that the economy will slow and the economy has remained surprisingly robust. It has defied those expectations, but we still think looking forward that the risk is that the economy will slow, that there will be a slowdown. And in that environment, certainly we believe infrastructure assets are better protected because they don't have that economic sensitivity.

 

Similarly, inflation has come from extremely high levels a couple of years ago. It has come back towards targets. But again, we think that the risk of anything is that the inflation remains sticky. So from both those perspectives, we think infrastructure is well positioned and critically on from a valuation perspective, it's surprisingly cheap relative to global equities. Relative to global equities, it's some of the lowest relative valuations we've seen certainly for a number of years. So overall we're positive on the outlook for the sector.

 

Aaron (23:26)

One thing I do like to add is infrastructure generally returns capital in the form of dividends as well as share price appreciation. So when I look at dividends, I generally like to think you're getting compensated for being patient if the share price is not moving up and to the right and reinvesting those dividends as well in a portfolio like yourself helps generate long-term returns.

 

Andrew Maple-Brown (23:50)

Yeah, absolutely. Typically, at the moment, the dividends of the underlying companies with our portfolio is around 4%. And so, yeah, a strong dividend yield relative to broader equity markets. The growth in earnings of our companies is typically around 5% or 6%. So you've got that combination of income yield plus growth, we think is an attractive proposition in what is generally a lower risk sector and particularly with our definition of infrastructure.

 

Aaron (24:23)

All right, perfect. I think we've covered just what every topic I needed to. I'm sure we could keep this going for another hour at least, but it's what, 8.30 in the morning now. You probably need to get some work done for the day. To all the listeners, I'd like to thank Andrew for joining me If you have any questions, please send me an email at aaron.sherlock @ cibc.ca or you can Google the Sherlock Group at CIBC Private Wealth and I can give you more information on how to position infrastructure within your portfolio.

 

Outro (24:55)

Upbeat music begins to play in the background while CIBC disclaimers are displayed.

This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2024.

CIBC Private Wealth consists of services provided by CIBC and certain of its subsidiaries, including CIBC Wood Gundy, a division of CIBC World Markets Inc.

If you are currently a CIBC Wood Gundy client, please contact your Investment Advisor.

Aaron Sherlock is an Investment Advisor with CIBC Wood Gundy in Saint John. The views of Aaron Sherlock do not necessarily reflect those of CIBC World Markets Inc.

The CIBC logo and “CIBC Private Wealth” are trademarks of CIBC, used under license. “Wood Gundy” is a registered trademark of CIBC World Markets Inc.

Clients are advised to seek advice regarding their particular circumstances from their personal tax and legal advisors.

This report is not an official record. The information contained in this report is to assist you in managing your investment portfolio recordkeeping and cannot be guaranteed as accurate for income tax purposes. In the event of a discrepancy between this report and your client statement or tax slips, the client statement or tax slip should be considered the official record of your account(s). Please consult your tax advisor for further information. Information contained herein is obtained from sources believed to be reliable, but is not guaranteed. Some positions may be held at other institutions not covered by the Canadian Investor Protection Fund (CIPF). Refer to your official statements to determine which positions are eligible for CIPF protection or held in segregation. Calculations/projections are based on a number of assumptions; actual results may differ. Yields/rates are as of the date of this report unless otherwise noted. Benchmark totals on performance reports do not include dividend values unless the benchmark is a Total Return Index, denoted with a reference to 'TR' or 'Total Return'. CIBC Wood Gundy is a division of CIBC World Markets Inc., a subsidiary of CIBC.