[00:00:06.290] - Intro

Good afternoon, ladies and gentlemen, and welcome to this month's conference call with Derek Hebb from CIBC Wood Gundy. Please be advised that the call is being recorded. I would now like to turn the call over to Mr. Derek Hebb, Senior Wealth Advisor. Please go ahead.

 

[00:00:21.570] - Derek Hebb

Oh, thank you, Chris. Today, we're joined by Michael O'Callaghan, Director of CIBC Private Wealth Management's Investment Strategy Group. Michael, who I interviewed last April, joined CIBC in 2011 and is responsible for providing market commentary, portfolio strategies, and investment recommendations to CIBC Wood Gundy Investment Advisors and their clients. Michael is a graduate of the Richard Ivy School of Business's MBA program, and he is a CFA charter holder. He has more than 16 years of experience in the financial services industry. Michael, thank you for joining us this afternoon.

 

[00:01:03.150] - Michael O'Callaghan

Thank you very much for having me. It's a pleasure to be here.

 

[00:01:05.400] - Derek Hebb

It's great to have you on the call. Michael, to get us started, can you just spend a couple of minutes talking about the economy? How are we doing?

 

[00:01:17.440] - Michael O'Callaghan

Well, we're not doing too badly. I mean, the CIBC Economics group has been forecasting the real GDP growth in Canada and the US, and they're estimating will come in with modest growth of 1. 1% in Canada, but that will rise to roughly 2.5% by the end of 2026. The US economy obviously is doing better than that in Canada. Growth is estimated to be about 2.7% in the US by our Economics group, and that should stay roughly in that range to the end of 2026. So overall, it seems we're doing pretty decently. If you look at the unemployment rate, which is another gauge that people use, keep in mind that if unemployment gets down to 5%, economists widely look on that as an economy operating at full capacity. So, in the United States, we've been well below that level for quite some time. We're at roughly about 4.1% right now, so we're very, very red hot on the labour market, and that's expected to continue to be at that level, roughly at the end of 2026 in the US. It's a very, very tight labour market, very, very well-employed consumer with good job prospects willing to spend.

 

[00:02:21.820] - Michael O'Callaghan

In Canada, not so much. We're expecting to come to the end, and when the numbers come in, that 2024 will have an unemployment rate of about 6.3%, but that's expected to fall to about 5.8% courtesy of bank rate cuts by the end of 2026. So, although we're not doing tremendously well in Canada, unemployment-wise, labour-market-wise, we're okay for now. Nothing recessionary to point to on the rise there.

 

[00:02:48.830] - Derek Hebb

Thanks, Michael. We're dealing with a great deal of uncertainty, especially with respect to potential tariffs. Are there sectors of the market that are well positioned for growth despite these threats?

 

[00:03:02.480] - Michael O'Callaghan

That's a good question. With just a few days into the Trump administration, and already there's a ton of executive orders that have come out, and people are very scared of what's going to happen. Are the tariffs going to hit uniformly across all sectors? And then what will the response be from Canada? But if you look at tariffs and you say, are certain things going to be tariff-immune or tariff proof? It's tough to find that there will be anything except those sectors of the economy that really may not pertain to be anything that is imported, that is crossing the border from Canada to the US. Let me give you an example. Real estate might be one. So, if you have a real estate company that might have lots of multifamily or single family dwellings in the United States, I would argue that those assets are already in the United States. You're not importing homes into the US or whatever. So, the question is, is that going to be exempt from this type of thing? Then you look at the Canadian telecommunications sector. All of those companies, Bell Canada, Rogers, TELUS, pretty well all their revenue is generated in Canada by Canadian for Canadians; no tariff impact there.

 

[00:04:03.130] - Michael O'Callaghan

But when it comes to things like energy, automotive parts, and stuff like that on the industrial front, agricultural products, it's a lot different of an equation. And there's where the uncertainty lies in terms of the impact on Canadians. And then what will the countervailing tariffs be that Canada imposes on the US? The result of all that will probably be to stoke inflationary forces. But then that begs the question as to whether or not the expected bank rate cuts that people want to see over the course of 2025 will be implemented to the extent that we think they will.

 

 

[00:04:36.880] - Derek Hebb

Thanks, Michael. So, what is your market outlook for 2025?

 

[00:04:41.870] - Michael O'Callaghan

Well, with the data we have right now, and of course, this is early days, we've had a tremendous market performance last year, 18% on the TSX Composite Index, and we had a north of 20%, again, on the US index, the S&P 500. We had mega-cap technology names driving US equity outperformance. In Canada, we had financials, materials, energy were driving contribution in Canada. This year, I would suggest that investors should temper their expectations. We're probably not going to see as robust a positive response in Canada and the US as we saw previously. But overall, we think that the direction will continue to be up, bolstered by that consumer who remains gainfully employed, is willing to spend money, and that is roughly 70% of your economy. So, that provides a good boost coming out of the gate. Will we see the broad sector participation in the markets moving up as we did last year? There are 11 GICS sectors as they call them, that make up the TSX Composite Index and the S&P 500 Index. For calendar 2024, all but one of those, that is 10 of these sectors in Canada, finished in positive territory. A very broad-based participation there, a very good year, and it was also 10 in the United States.

 

[00:05:57.460] - Michael O'Callaghan

We may not see the participation this year through as many sectors as we saw last year. But overall, so far, even though you've been off to a bit of a rocky start, it does look like the Trump initiatives are starting to stoke those mega cap technology names and optimism for economic growth south of the border, and we hope that that can lift the Canadian markets in tandem as well.

 

[00:06:20.420] - Derek Hebb

Thanks. Michael, you and your team have a very well-defined, multidisciplinary investment process. Can you provide an overview of your process and just talk about the various strategies that you manage?

 

[00:06:36.020] - Michael O'Callaghan

Yes. We have an approach that we think is quite unique. We use fundamental analysis, technical analysis, and quantitative analysis. So, for those that are not familiar with those terms, fundamental analysis is what we call the private detective work. So, we go on to a company's website, find out all about them. We review their corporate presentations. We look at their quarterly financial statements, their annual financial report. We read equity research on those companies to get a very good idea of who they are, what they do, how they make their money, how they get paid, and what competitive advantages they have. Then we overlay on top of that a technical discipline. That's a study of the actual stock price chart to give us an idea as to whether or not now is the right time to buy that stock and add it to the portfolio, or should we wait? On top of that, we overlay a quantitative model that our Portfolio Strategist, Ian de Verteuil, provides, and that gives us a quantitative score. That number is based on about 15 different variables that the quantitative model looks at. So, if we get a green light on all of three of those disciplines, we look on that as a stock that we probably should add to the portfolio.

 

[00:07:43.300] - Michael O'Callaghan

But since technicals and quantitative sometimes point in opposite directions, we allow ourselves to put equities into the portfolio that have a green light on two of those disciplines, provided it has a green light on fundamental. So, to get into the portfolio, green light on fundamental, technical, and quantitative, or fundamental and technical or fundamental and quantitative. And the reason for that is fundamental is important because that's about 70 to 75 % of our process. The technical and quantitative combined comprise the remaining 25, 20%.

 

[00:08:16.550] - Derek Hebb

Thanks, Michael. It's great to hear your insights, especially in light of current events.  I should note that you and your team are accessible to me and my clients. On that note, if anyone has questions about the material that Michael discussed, please contact me.

 

[00:08:27.950] - Derek Hebb

In the interest of time, this will conclude today's call.  Thanks to everyone for listening in, and Michael, thank you again for joining us on this month's call.

 

[00:00:00.040] - Intro

Good morning, ladies and gentlemen, and welcome to this month's conference call with Derek Hebb from CIBC Wood Gundy. Please be advised that this call is being recorded. I would now like to turn the call over to Mr. Derek Hebb, Senior Wealth Advisor. Please go ahead, Mr. Hebb.

 

[00:00:15.750] - Derek Hebb

Thank you, Alena. Today, we're joined by Al Daxner, Senior Vice President of Barrantagh Investment Management in Toronto. Al, who I interviewed in August of last year, has over              25 years of investment experience and is responsible for leading Barrantagh's institutional client service and marketing efforts. Prior to joining Barrantagh, Al was Executive Vice President and Managing Director at McLean Budden for over 13 years. And prior to that, he worked at Ernst & Young Investment Counseling, and he was a financial analyst at SEI. Al is a CFA Charter holder with an MBA and undergraduate degree in Biochemistry from McMaster University. And he serves on the National Audit and Finance Committee of the Canadian Red Cross. Al, thank you for joining us this morning.

 

[00:01:05.930] - Al Daxner

Thanks, Derek. Good morning.

 

[00:01:07.390] - Derek Hebb

Great to have you on the call. Al, as you can attest, small cap markets in Canada this year have been defined by a commodity rally led by the junior gold miners. How does Barrantagh's quality-value philosophy approach the materials and energy sectors?

 

[00:01:28.520] - Al Daxner

Yes, Derek, that very much is the case, and this does happen from time to time, as I think we all recognize commodities, in particular, the materials sector, are highly cyclical and quite unpredictable. Year to date, 2024, we've got nine of the eleven industrial GICS (Global Industry Classification Standard) sectors in small caps all underperforming the broader market in Canada. It really has only been materials. And then communication services as a small sector in the small cap markets are really the only two that have beaten the broader market. So, it's really been the heavyweight industry in terms of materials that has done well. And that's been led by gold, the junior gold miners. A couple of things to think about here. Yes, gold has risen, certainly central banks buying is part of that as a hedge to inflation. We have had elevated inflation for extended period of time, and of course, gold is used as a hedge against that. US dollar volatility, another contributor bringing investors to gold. Of course, geo-politics, no shortage of those issues in the world today, as well as interest rate cuts. So, to various extents, all of these has contributed to the rise in gold. And I know as we've talked in the past, our strategy does not invest in junior gold miners and has no exposure to mining stocks.

 

[00:02:49.360] - Al Daxner

And how we get to that, a couple of things to think about here. We qualify ourselves as quality value investors, value determined by traditional DCF (Discounted Cash Flow) valuation work. We combine that with management interviews, but I really want to focus on the quality part of the investment philosophy. When we think about what is a quality company, we think about companies that have pricing power. Of course, miners have no pricing power whatsoever as commodity prices are set globally. They tend to be low return on capital or low profitability over market cycles. They are high capital intensity, meaning it costs a lot of money to operate mining operations, balance sheets tend to be an issue with a lot of the smaller players here as well. And ESG profiles are generally not that strong as well. So we're looking for quality. We really don't find it in this highly cyclical, highly unpredictable part of the market. So, a little bit more perspective on that. What we've seen this year, gold was up 26% in March of 2024. That's the fifth highest monthly gain in 15 years. So, it was kind of rare to see the move we've seen in gold to the extent we have, in particular in March.

 

[00:04:04.860] - Al Daxner

We would note, historically, when we see gold prices move up more than 20% in a given month, the average of the next 12-month return is negative 2%. So yes, gold tends to move quickly and have big, big positive moves in short periods of time. It doesn't tend to stick around, what we've seen historically. Another way of looking at this is the weight of the energy and material sectors in the small cap market at the end of May was 56%. Well over half of the small cap market is represented by those two commodity-related sectors. Again, at 56%, that's the highest it's been in the last 10 years. So, another way of looking at the sharp move here and the overvaluation in those sectors. And when we've seen that historically, those peaks tend not to last very long, and we tend to see a moderation back or below their long-term average weight in the index, which is about 47%.  And lastly, there's a chart we use quite a bit here. We look at the long-term performance of the junior gold miners in the Canadian market over the last 15 years.

 

[00:05:09.970] - Al Daxner

And we know that the junior gold miners have returned, including this rally, just over 4% per annum. This has underperformed the price of the actual commodity or gold prices itself, which have risen 7 1/2%, and both of which are well below the overall return of our small cap strategy over the same period of just over 13%.

 

[00:05:31.860] - Derek Hebb

That's great, Al.  Interest rates appear to have plateaued and, in fact, have begun to moderate. What impact does this have on the strategy?

 

[00:05:44.530] - Al Daxner

Yeah, that's certainly no question. When we think about economics, we certainly see a moderation in inflation. We saw another CPI reading out of the US today, lower than expectation. So, of course, moderating inflation is going to be combined with moderation in interest rates, and we've certainly seen that already in Canada, and we think we'll start to see that happening in the US as well. So, a couple of things here. If we went back, really looking at the last two years or so, small cap has been out of favour, not just in Canada, but globally in US as well, until more recently here in 2024. And what really did that was the mantra of higher for longer as inflation proved to be quite sticky, and we clearly saw that interest rates were going to stay a bit higher for longer. This did take money out of perceived riskier asset classes like small caps, and that certainly had a negative impact. But when we get back to the fundamentals and looking at valuation of the various 11 industries in the market, and we see significant discounts to their five-year averages. In fact, in the small caps, we see on average about a 20% discount, where these stocks typically trade in some of the key sectors, certainly in our strategy, which would include the consumer sectors, both staples and discretionary.

 

[00:07:04.760] - Al Daxner

Industrials has historically been our largest weight in the portfolio, as well as technology. So, small caps are showing 20% discounts here versus large caps are basically fully valued to their five year average valuation. And of course, what's more timely here with the prospect of lower interest rates is that the higher dividend yielding sectors - more of the interest-sensitive sectors - these are going to do really well as interest rates start to fall and the yield on these sectors starts to look more attractive relative to, say, things like government bonds. And this would include sectors like financials, communications, real estate, and utilities. As a reminder, as a value investor, we do focus on dividend yield and certainly yield well above the index and well above the median manager. So again, this has been a bit of a headwind to us as well. We've had the two headwinds of small cap out of favour. And then, of course, a higher rate environment has weighed on some of our yield sectors, including the ones that I just noted. So no question, falling interest rates is going to be a tailwind, both to small cap as a strategy, pulling investor assets back into it.

 

[00:08:16.510] - Al Daxner

As well, we're going to start to see a relief in some of these higher yielding stocks and sectors in the portfolio. And an ancillary benefit here is increase in merger and activity in the market as well in the portfolio, we would note, since 2018, nine different stocks we've held in the portfolio have been subject to takeouts at pretty significant premiums. We would note here that smaller companies get higher premiums on takeouts. The study we did from 2018 showed deals done less than three billion (dollars) showed premiums on takeout of 37% versus just 18% for deals greater than 3 billion. Lastly here, I would note, most recently here, back in the second quarter, we added a position in consumer discretionary in Sleep Country Canada, of course, pretty well known to Canadians selling mattresses, and they were subject... Sometimes you get lucky, I suppose, but subject to a takeover offer at a 30% premium from Fairfax Financial here recently. So again, another example of a takeout. We expect to see more activity here as lower interest rates will certainly allow financing deals to be done with more frequency.

 

[00:09:30.270] - Derek Hebb

Thanks, Al. Barrantagh's performance this year has lagged the TSX Small Cap Index. And Al, you touched on this. Can you just comment on key detractors and offsetting areas of strength in the portfolio?

 

[00:09:46.510] - Al Daxner

Certainly. So, often when you're talking about performance being ahead or behind a benchmark, typically there's several factors you want to explain, as you've probably just alluded to, here we're at the relatively short list. So, the strategy is up just over 8% for the first eight months of the year, so at August 31st. And this compares to the TSX Small Cap Index at about 13.6%, which is actually the same as the TSX Composite, the Large Cap Index is up 13.6% as well. So, we're running about 5% behind the benchmark. And again, there's really just one thing that accounts for all of that shortfall, and that was underweight in materials and no exposure to the mining, in particular, the junior golds.  That detracted 6.4% in terms of performance. So, it really was materials. Again, this can happen quickly. A lot of this underperformance was sort of back in that March through May period. We would note here that if we look at the quarter ending August, the strategy is up 6% versus the index at 2.5%. So, we're already starting to close the gap on that and the strategy has outperformed by about a percent here so far in September.

 

 

 

[00:11:00.190] - Al Daxner

So, as we've seen, some moderation in the material sector, but in particular, some of the copper stocks that have done quite well this year. We've seen copper prices moderate quite substantially as inventories are rising, and we're even seeing China as an exporter of copper, given the slowness in their industrial complex, which is really historically quite rare that you would see China exporting copper, just dealing with rising inventories. Offsetting this on the positive side, we've had some very good strength in terms of our financial stocks in the portfolio. Financials have added about 4.7% in terms of contribution versus the index. Within that, Propel is a fintech player, benefited from some of the spin off of tightening lending by the big banks. They've been a beneficiary of that. Propel's up 136% so far this year, as well as Definity, an insurance company, is up 34% here as well. And then within technology, one of our key holdings there is Softchoice, is up 66% this year. Mainstreet, as well, in real estate in terms of a REIT has been up 43% and been a good offset here as well. So going forward, we'd like and we would expect to see some broadening of the markets and see instead of just one sector really performing and producing all of the performance, we expect to see more of a broadening here.  And we think, again, that lower interest rates are going to benefit certainly those higher yield sectors and stocks which are prevalent in our portfolio as well. We expect to see more M&A activity, of which with greater frequency, you do see smaller companies as takeover targets.

 

[00:12:47.360] - Derek Hebb

Thanks, Al. Barrantagh gives us exposure to a segment of the market - high quality Canadian dividend-paying small cap stocks - that most investors do not have exposure to. Based on our discussion this morning, I think your portfolio provides an attractive growth opportunity and a timely entry point for investors. In the interest of time, this will conclude today's call. If anyone has questions about the material that Al covered, please contact me. Thanks to everyone for listening in. And Al, thank you again for joining us on this month's call.

 

[00:13:25.960] - Al Daxner

Thanks, Derek.

 

[00:13:27.140] - Derek Hebb

Take care.

 

 

 

 

 

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