FidelityConnects: Why investors may want more Canada in their portfolios

[00:00:32] Pamela Ritchie: It is shaping up to be a standout year for the TSX. Canada's benchmark index topped 30,000 points for the first time yesterday. We see it powering ahead now, it's up 20% year-to-date. Despite the upswing our next guest is keeping his eye on the risks and says that patience and diversification is the key to staying ahead. Which sectors are speaking to him today, and how is he protecting downside while staying invested? Joining us here today to unpack all of this and more across the Canadian landscape is Fidelity True North Fund portfolio manager, Max Lemieux. Great to see you, Max. Bonjour, thank you for being here.

[00:01:16] Max Lemieux: Good morning.

[00:01:18] Pamela Ritchie: Good morning. Let's talk a little bit about Canada's reaping incredible windfalls on the stock market itself. There's a whole 'nother story, of course, that goes along with the economy but it's been a pretty fantastic time. How did we manage to avoid the worst?

[00:01:35] Max Lemieux: Yeah, it's a nice surprise, let's put it this way, since the first black Monday of February, if you remember. It's quite exceptional. Let's face it, a couple of factors that we really need to earmark here. It's the fact that most Canadian companies, especially industrials because industrials are the real victim of this tariff saga or crisis, the reality is that most Canadian goods are still sheltered under the free trade agreement. This is currently being renegotiated, there's a lot of back and forth. The new government led by Mr. Carney, I think, is making headways based on what we're hearing from Washington, Ottawa, large banks, large corporations. There's all this stuff happening in the background that we don't fully know today. The tariffs that are imposed on Canada are still one of the lowest in the world compared to the other countries, other geographies. We've really escaped the worst case scenario on that front. That touches many companies.

[00:02:45] Number two, the Canadian banks have also escaped another risk. It doesn't mean that this will be permanent but the reality is there's been no real significant increase on loan loss provision. Those potential loan losses, those ratios have not gone back to the normal that we've seen in previous cycles. It's important to say that maybe where we've been misled is that the quality of the lending on the books of the Canadian banks might be somewhat similar to what we've seen in the U.S., which is the following. In the U.S. the large diversified banks had about, pre-GFC, 2008, they usually had about 20,22% of their books lent to subprime. That was the most risky part of their portfolio. Now it represents 10 to 12% of the books. That's why we've not seen much in terms of credit accident in the U.S. I think Canada has probably followed as well. Exposure to subprime probably much lower than pre-2008, therefore, I think the most risky type of lending has moved, or gradually moved towards private credit, private equity type of investors so we don't see it as much. There are a few cracks that appeared more recently in the past few weeks in the U.S. but in Canada that's not something that we've seen so far. We'll see, the cycle is not over. The banks, basically, have been very resilient, has helped Canada.

[00:04:21] The last thing that is important to mention is gold, precious metals. Obviously, nothing to do with Canada, it's really about the global Joe politics and negative real rates, central banks in the world buying back gold in a big way over the past two years, three years. Really, I think it started to pivot when the Russians invaded Ukraine, a lot of countries decided to diversify away from the USD. We'll see how long that lasts but so far there seems to be a trend. I was reading something about the World Gold Council, they've been working on this for years but it seems that it's getting some progression on this front, sort of digital gold which could eventually be used as a collateral. When banks want to lend you money you might be able to use gold as part of your collateral. We'll see where it goes.

[00:05:18] Of course, there's a lot of sentiment. The participants in the marketplace, there are a lot of individual investors. It's up to 20% of the daily volume in the U.S. It's very reminiscent, again, of the tech bubble of 2000 except that now since COVID we've seen three small bubbles. The bubbles are not as big but they're more frequent. That's kind of the pattern so far that we've seen. All in all, Canada has been lucky in that big global mess, I would say, and it's a nice surprise.

[00:05:49] Pamela Ritchie: Yeah, it's a nice surprise and you've invested into it and we want to hear more about that. You're mentioning we've seen a few cracks and that goes along with the story of a bit of frothiness. Some people weigh in on that, some people say, actually, things are valued very well considering what they are about to produce on the AI front so they're not overvalued. I guess, just the risks of that world cracking, how your fund, True North, is always a place for stability in times where there is, perhaps, a wobble in the market. I want to just ask you about in a riskier moment, if you agree this is one, how does the fund ultimately perform?

[00:06:37] Max Lemieux: It's a very good question. Sometimes there's data to back our view of the world and sometimes it's not hard data. It's soft data, it's intuition, it's judgement, it's history. I think there's a bit of everything right now. To be honest, it feels to me a bit like ... I remember very well 2001 until 2003, there were two years in the U.S. where there was no clear leadership. We had no idea when we would get out of that recession or global crisis. As we know, after September 11 in New York City, invasion in Afghanistan and Iraq, oil was all over the place and the consumer was fragile. We might be in that period where we came out of COVID, rates have gone up. Now they're coming down a little bit but because of steadfast inflation, or at least inflation that doesn't come down as much as the Fed would like or the central banks want, we're stuck with long term rates that don't really go down and, therefore, the cost of money for public debt, corporation, remains higher or will go higher unless there's more easing from the Fed.

[00:07:54] We'll see what happens under new Fed chairman, we'll see, but the whole thing is lack of direction and lack of synchronization within markets. All this started also during COVID for different reasons but now it continues to be that way so the playbook is very different than what we've learned back in the '90s and 2000. As I said, those new market participants that are driven by also influencers, thanks to social media you can hear about stock markets guru every day for 24 hours a day. They've got no friction costs, no commission. I even heard now in some countries in Europe you have an account with, let's say, Robinhood, whatever the discount broker, you'll be able to mimic the trade of an influencer. It's going to be like copy trade. I don't know if that's going to be allowed in the U.S. or in Canada but it's always reaching a new level.

[00:08:53] Therefore, to your point, it feels like there might be more risk because these type of investors drive the market now and there is less active money out there so we need sometimes to reassess. I mean, all the time we need to reassess what is a true risk and is company XYZ, despite the fact that it might be a great quality name, which usually in True North, we like to see these companies that are leaders in their marketplace, continue to grow margin, grow earnings, and we know long term stocks tend to follow earnings. The reality is that in the past year, thanks to the volatility and the lack of clear direction, lots of investors have been hiding in quality stocks where their valuation was creeping higher and higher. At some point there are rotations. We've seen over the past two months a lot of quality stocks in different sectors, we've seen profit taking. Honestly, in relative that's been hurting a bit True North, not in absolute terms, but that's something that we have to be aware more so today than, let's say, 10 years ago.

[00:10:01] I think the way to win is to remain mindful in the long term. If you own a good company with a good business model — and, of course, now you have to test this all the time about is AI a tailwind or is AI likely to impact negatively this business model or destroy completely a business? We're seeing the Google business model changing also because of their AI overview. This is impacting so many companies. So far lots of companies, when you talk about AI in the quarterly reports, they don't even know exactly what they're talking about. It's always more being on the defence as opposed to understand, really, what they can gain out of it. We're still early innings but I think to be diversified, to have a bit of a longer term horizon because of these mini bubbles, thanks to the retail investors, making sure that we own companies with good balance sheets but also every day thinking about is their business model at risk?

[00:11:04] AI, again, I think there'll be great things about coming from AI and there'll be terrible things coming from it. The data centres that are being built, it's crazy because it's a lot of billions of dollars. That reminds me of the tech bubble when Lucent, Nortel, Cisco, they were selling to AT&T and Verizon but the problem is that the client, the telcos, were in so much debt and interest rates had gone up at some point they had to pull the plug and the network was built. This time, the company's building these data centres, they're flush with cash. They continue to grow earnings at 20%+. Either investors will tell these companies, listen, there's no return on capital, you cannot prove it, it's been five years that you're spending billions after billions. When will this end? We don't know but I can assure you that there's a good chunk of the capex in the U.S. today that is purely driven by data centres. Right now the whole tariff situation ends up also paralyzing many industries and companies in the U.S. This tariff impact, final impact, we'll see it in the next two, three quarters because a lot of companies had done a lot of pre-buying to avoid the tariffs in the first half of this year.

[00:12:28] Pamela Ritchie: That's another reason why, arguably, things have been much better than expected. Can we just pick up on that again? You mentioned that back in the 2000s there was the building of the network and the telcos at the end of it were quite indebted by the whole thing. It's different today. That said, you're starting to see creative types of financing. I won't say names but there's some very large chipmakers in the U.S. that are essentially giving loans to their clients to spend back on their chips. We are seeing some of these interesting...

[00:13:02] Max Lemieux: Vendor financing.

[00:13:03] Pamela Ritchie: Vendors financing, exactly. The circular financing, whatever you want to call it. 

[00:13:09] Max Lemieux: Yes, happening again. Human beings, we've not reinvented much. We're faster.

[00:13:13] Pamela Ritchie: Nothing is new under the sun. We've got lots of those.

[00:13:16] Max Lemieux: It's not new. But to your point, very important to notice this, and it doesn't seem to be endemic yet but it's starting, we're starting to see it again. The AI thing will be part of our daily life and the question is how much money companies will make out of it. I think it's going to help a lot on the cost line for margins but not every company is as big as Microsoft with 400 million corporate users that can afford maybe to pay 5, 10 bucks a month to have a Copilot. It's in the making, we'll see how that will evolve. Listen, thanks to our amazing research team based in Toronto, London, Tokyo, Hong Kong, we have footprints, boots on the ground, it's really helpful to have last minute information in real time and to have an objective view on so many situations, so many companies. Honestly, it's a true help and that's how I think we continue to strive to always prove on what we do and to keep a very flexible mind to adjust to different trends in this market while keeping an eye on the risk and absolute risk.

[00:14:33] It's part of my philosophy in True North, we've always seen that if a single sector represents more than 20, 25% of the fund it gets big. It reminds me of the tech bubble when Nortel and all these tech names were about almost 40, 50% of the index. You have to be careful about this. Even if you love a sector, I want to remind our clients, during the super cycle in 2000 we were bullish on oil but in 2007, 2008 it was more than 35% of index. We were, I think, at 24% even though we were bullish on oil, not that I believed  back then in peak oil but there was a construct, a backdrop that was positive. I think that's how we control risk also in terms of sector, in terms of companies, and that's how we're going to continue to do it, Pamela. I think Canada, we don't know what will be the new free trade agreement like but the odds are fairly high that there will be, I don't have a crystal ball but based on what I'm reading there's still going to be a free trade agreement. I think there are many sectors in the U.S. where they need Canada. Think of aerospace, for instance, that's super interesting to talk about.

[00:15:50] Pamela Ritchie: Yes, I wanted to ask some of the investments and how you are intertwining them in this really interesting...

[00:15:59] Max Lemieux: [crosstalk] Every week is different so far this year so it's not always easy to take a long term view. Look at aerospace, because the U.S. is such a large net surplus thanks to Boeing and all the military aerospace businesses. It's not like the car industry where Mr. Trump wants to rebuild the domestic car industry. It's not the same for aerospace. You look at the deal, the deal signed with all the European countries excluded aerospace. There's no tariffs. It's a more narrow, nichey, complex industry. Canada, we're gift-, not gifted like natural resources but we have a strong sector in that sort of space and at different level. Doesn't mean that I own every single name in aerospace but there are different plays in Canada, different companies where there's also companies that have been improving over the past few years, or companies are in a turnaround mode, new CEO coming in.

[00:17:01] There's a lot of special situations that even though you could be neutral or even bearish on another type of sector there will always be good companies or situations that could yield an attractive return for our investors. I think that this is interesting to see how that's going to pan out over the next 12 months but as long as you don't haven necessarily, a recession in the U.S., and we'll see, maybe there'll be one.

[00:17:32] Pamela Ritchie: Maybe we already had it.

[00:17:32] Max Lemieux: The consumer remains somewhat resilient. Yeah, maybe we've had it.

[00:17:35] Pamela Ritchie: Maybe it was already there.

[00:17:36] Max Lemieux: 2001 till 2003, no clear sense of direction, and even we were debating in 2001, 2003, are we in a recession or not for two years.

[00:17:48] Pamela Ritchie: I know patience is a big part of any good investor and you come armed with patience when you take a look at the portfolio itself, maybe just a word to that because if there is no clear direction, there's obviously a very powerful theme in the market which is AI, and we've spoken about that, but the patience to sort of see where some of the chips land, just speak to that right now. What do you do in the meantime?

[00:18:17] Max Lemieux: The portfolio is well diversified. Sometimes you want to tilt it toward the offence, sometimes you wanna be a bit more defensive. We're not at 10 or 20% cash, right? It's not like in 2001 or 2008, back in those days I had a strong conviction that things would get worse, a lot worse. It's not the case now. It seems like maybe cycles are very different. I mean, I don't know how they teach at university what is a recession when the last one officially was 2008. It's been so long. I think you have to stay focused on companies turning the rocks. It's really stock picking. When I think about being patient and extending your time horizon, usually in the past, Pamela, I would tell you when I buy a new company in the fund usually I look at a 12-month horizon. I think now because of this new volatility, new geopolitics, I think about two years now because I can't predict if there'll be a recession. It's just harder.

[00:19:19] The cycles are just too different than in the past. You can find stories, good stories in every sector. Energy is important in Canada. The fund is still a bit underweight. Short term it's hard to see oil going, having a huge layup but the reality is that at the current prices for oil Canadian companies are better companies than they used to be. They have the [crosstalk].

[00:19:46] Pamela Ritchie: What does that mean? You've said that before. It's not as dependent or tied to the price sitting at sort of $60 and change globally. What does that mean? They're better companies, they don't need to be hanging on every oil price move.

[00:20:03] Max Lemieux: The oil patch in Canada, in natural gas, it's been consolidating. The fact that now there's a pipeline, TMX, to export the oil you depend less on the U.S. so therefore the discount that you were selling at to the U.S. market, it's being narrowing. These companies having consolidated their synergies and therefore the rate of return on a barrel is better than it used to be. Of course, if oil goes to 40 bucks we'll have a different conversation but you don't need $100 oil, like in the super cycle, to have a proper return. That's what I'm trying to explain here. Natural gas is a bit different because it's harder to export but this year, as we speak, we now have the first terminal, LNG Canada, starting to export liquid gas. There'll be another terminal in '28 that's been sanctioned, a smaller one. If LNG canada does well they're likely to have another phase in 2030. If all this takes place we're talking about 10% of the overall production of natural gas in Canada that will be exported as energy.

[00:21:13] Pamela Ritchie: Then you'll see gas get up off the floor, the gas price.

[00:21:17] Max Lemieux: The discount versus the U.S. should improve. We're talking here three, five years. That's why we're still on the wait but at some point you have to choose your horses, the best companies in those different groups, and you want to start building a position. You've known my style over time, I tend to be an incrementalist. I buy gradually my position, I build them over time, quarter after quarter, when there's a stronger conviction based on execution or news flow. It's a very dynamic world. Then you've got the compounders. Again, I'm not saying that one should buy Dollarama today but the point is Dollarama has been an expensive stock most of the time since it's been public, 2010, that's when we started True North, when I was named on True North. The execution has been amazing.

[00:22:18] Sometimes there are short period of times, a year or two where there's a bit more competition coming from Walmart, because as we know they compete against Walmart and then it's location, but these guys have expanded the business model to South America, now they're entering Mexico. They just made an acquisition in Australia this year which did not come out of the blue because five years ago they looked at Australia so they knew exactly what they were buying. You try to stick to companies where you feel that management also will have a long term vision. We're trying to have a long term timeline when we buy but you have to be aligned. There are companies like this in many sectors in Canada. In the industrials, I know it's very diversified in itself, we've got transportation, we've got aerospace, we talked about this. We have automotive, we've got the ENC engineering firms. As you know, the Canadian engineering firms are good quality stocks, they've been great stock over the past couple of years. You name it like...

[00:23:21] Pamela Ritchie: They've really run the engineering firms. Is there more there? I mean, there's lots, it sounds like lots more projects to build but in terms of valuation of the companies they've had a great run.

[00:23:32] Max Lemieux: I think in the short term I think investors should be not necessarily careful but just pruning a little bit the risk. It's true that in the U.S. we don't know. The budget deficits are still running high. We don't know that spending over the next year, if it's going to be really there or not or is that going to slow down. Some of these companies are exposed to other projects around the globe but the reality is these companies will also benefit from AI. They're experiencing productivity gains also from their employees. Now, maybe that will be passed on to the consumer. Then, of course, some of these companies also are involved in nuclear. It's not the bulk of their operations but they benefit also from that renaissance, if you want. I think it's case by case. For sure it's just harder to make a case for are you going to have the same type of return over the next year? Probably harder but again, it's very dependent on what's the dynamic in the U.S. and the rest of the world.

[00:24:41] Pamela Ritchie: Can we zero in on the nuclear story there, Max, a little bit? As you said, and I don't know if it goes along with sort of the engineering companies story, there's been great enthusiasm for lots of good reasons. It looks like this is a new power source that's going to be powering parts of the AI story for sure but it takes a while to get it rolling. Again, is there a breather in there in terms of the investment thesis for it?

[00:25:10] Max Lemieux: Uranium is very opaque, a lot of transactions that are private. The price has gone up. Everybody talks about data centres powered by many sources of energy. For sure nuclear will be part of it. The narrative is very strong but as you said, it takes a long time to build a new power plant, nuclear power plant, and then the SMR, the smaller size nuclear reactors. We're starting to see it so it's becoming real. The question is what will be the ultimate size of it? Maybe it's not going to be as big but I think we're a bit too early to be fearful of will that number be only half of what experts are talking about for 2030, 2035. A lot of things, I think, can happen. Look at what's happened only this year so far. I think the trend is there.

[00:26:14] The green trend, even though what we hear from the U.S. administration it's only about fossil fuel and coal, the reality is that most of the population, let's say New England, they want to continue to get greener. That trend, it's a bit of a stumbling block that we're facing today but I think long term one should continue to think that it will continue to migrate towards different sources of energy, and copper will be part of it. There's a lot of rare earth. Canada has rare earth sources, it's just we've been very lenient. That's why I think this crisis is a massive wake-up call. There are stocks that we own in true North, that we've owned for many years, that are involved in that rare earth or semi-rare earth kind of space. It took years before we started to see these stocks going up finally. That's, yes, patience but make sure that your downside is also protected. I think that's where the fund has excelled over time, beating the benchmark when you've got a normal market between zero and 10%, when the market is negative doing, I think, more than a reasonable job trying to protect the unitholders' savings. When it gets really harder to beat the benchmark it's when the markets is up 15, 20% like this year.

[00:27:48] Pamela Ritchie: It's fascinating, though, because you have the experience to go through and sort of look at things where you've seen almost mini bubbles and compare it to what's going on right now. I mean, that experience is just so completely in the face of those that would also perhaps try and do things themselves. We're seeing a lot of those different investors in the market, as you mentioned at the top, you can't really replace experience.

[00:28:16] Max Lemieux: Listen, I don't have enough free time to go back to school to learn how a business cycle works, and I don't think they would do a proper job to teach me anymore. You have to understand all of us and our research teams, we're all intellectually curious, we're all somewhat competitive to a degree, we're all here trying to win together. I can tell you, when we're facing adversity I feel that everybody makes extra efforts trying to help each other. It's great to see. In absolute terms these results this year are phenomenal but we cannot sit on our laurels. There could be risk from AI, from private credit, public debt reaching new levels. If the long term rates don't go down there'll be a lot of Western countries that will have to cut on spending at some point. It's not because next year taxes are going to be lower in the U.S. or you've got faster depreciation on your capital expenditure thanks to these new fiscal measures from Washington, for sure it's going to be a nice boost to the overall economy but there are also other aspects that won't be [crosstalk].

[00:29:30] Pamela Ritchie: As good.

[00:29:35] Max Lemieux: And the inflation's still there.

[00:29:35] Pamela Ritchie: And the inflation's still there. So you're investing through this. Max, we'll have to leave it there. It's always ... I find it calming and also fun to listen to you and your big brain so thank you for taking us through what you're doing in the fund right now, for joining us here on Fidelity Connects.

[00:29:51] Max Lemieux: Always a pleasure. Thank you so much.

[00:29:53] Pamela Ritchie: That's Max Lemieux joining us here from Montreal today. Coming up tomorrow, join Director of Research and portfolio manager, Steve MacMillan, along with equity research associates, Connor McGrath and Christian Ghezzi, as they share research notes on small and mid-cap companies in the U.S. What role can small and mid-caps play? These are U.S. companies across diversifying investors' portfolios and where are the investment opportunities? You can catch this in English with live French audio interpretation.

[00:30:22] Friday I'll be sitting down with analyst and portfolio manager, Ben Holton, for a chat on the latest in AI, where innovation is opening new doors in the outlook for U.S. software. We'll dig in deep there.

[00:30:32] On Monday live from London Investment Director, Tom Stevenson, joins us for a discussion on global markets. He'll discuss the latest headlines moving markets in the UK, Europe and even dive into the opportunities that seem to be bubbling in China. Thanks for joining us here today. We'll speak soon. I'm Pamela Ritchie.