FidelityConnects: Canada's moment part 4: From strategy to allocation

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Hello, and to round out today's discussion we're joined here at the

 

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table by portfolio manager on Fidelity's Global Asset Allocation team, David

 

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Tulk. Warm welcome to you.

 

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You've been listening to all that?

 

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Absolutely. This is a great way to bring all the themes home with some really

 

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great content we had earlier today.

 

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Oh, that's good. I'm really glad that we can ask you some of the questions,

 

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pick up on some of the things but ask for your expertise in other areas.

 

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If you don't mind let's just link what Heather was talking about on the idea of

 

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capital cycles. Once they're in motion they tend to keep going.

 

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Are we in the capital cycle?

 

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I think there's certainly an opportunity for us to make that conclusion and I

 

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think where it starts with is the government.

 

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The government policy with the recent budget, the recent intentions,

 

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I think that sets a good ecosystem for a lot of the private sector

 

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to sort of pick up the next level of it.

 

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When you think about capital cycles some stuff governments do have to

 

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fund or at least create a regulatory type environment where it's easier for

 

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the baton to be passed to industry.

 

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We're waiting for a couple of agreements, maybe a program or

 

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two, just to really open the proverbial floodgates, specifically

 

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within the energy sector, with respect to pipelines and other infrastructure.

 

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Our sense, at least from talking with companies across the country, is

 

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that there is definitely the desire and some of the economics are very

 

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favourable to meet this moment when you think about higher commodity prices.

 

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They just need a little bit of confidence that the government is with them for

 

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the first couple of steps and then that transition can take place.

 

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That's part of the optimism that I think really infuses this whole

 

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conversation.

 

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Part of the way that you from your seat and the team are expressing through

 

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investments this discussion. If we sat down with you a couple of years ago much

 

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more of the US conversation in terms of overweights that transitioned into

 

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international, a number of investors have heard you and your colleagues speak

 

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about this.

 

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Here we are, you are already overweight Canada so that

 

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is the expression of optimism of things to come.

 

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Let's just go into that a little bit.

 

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Absolutely. I mean, to your point, if you roll back the history we had been

 

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very concerned about Canada. Reetu, in the earlier segment, also gave a pretty

 

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good sense of the reason why in terms of a lack of productivity growth, a very

 

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elevated household debt cycle that needed to be worked through.

 

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Each of these issues, I think, on the margin have started to improve.

 

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Part of that is certainly things that have happened within the domestic economy

 

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but also, again, is the recognition of what David Bridges talked about in terms

 

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of the global order really changing where I think there is this

 

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restructuring into a multi-polar type world where a lot of

 

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countries or regions will look to try to secure energy, secure other

 

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commodities, really in the sense of some strategic security.

 

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The sense of that really benefiting Canada is a nice external catalyst.

 

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As we think about some of the things happening within Canada's economy

 

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it really dovetails with that progress.

 

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A really important point, I think, to make in this environment is that

 

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things might not feel great today, and technically Canada is in

 

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a recession right now if you just look purely at two consecutive quarters of

 

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declining GDP, but the inflection is something that I

 

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think is very positive to look towards.

 

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As we know, the market likes to get really ahead of what's happening in

 

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the wider economy. Even if we haven't seen shovels in the ground and

 

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commodities moving to tidewater today the sense is the market knows

 

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that this could potentially be coming and they want to be part of it and then

 

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we want to part of it too. This is the type of theme where we don't mind being

 

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early because I think a lot of things are moving in that direction so we're

 

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very patient with this type of thesis and it is now, again, coming together as

 

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an overweight we have for the first time in more than a decade towards

 

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Canadian equities and the Canadian dollar as well.

 

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Because it's Canada and it has a sophisticated financial system

 

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do you think other investors around the world are very careful always

 

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with the way they maneuver and move money but just have less concerns because

 

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it's Canada. You're not worried about investing in a country that has all kinds

 

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of great prospects but maybe isn't run very well.

 

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I'm just wondering sort of what the Canadian, again, maybe premium is the

 

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right way to look at that.

 

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Investors are happy to invest here because it's Canada.

 

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Is that fair?

 

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Absolutely. As Joe pointed out you have the rule of law, you have

 

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stable and pretty trustworthy governments.

 

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A lot of that in the background, I think, is a positive.

 

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When you think also just about Canada being very much of a developed,

 

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sophisticated capital market but it's also a small market as well.

 

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I can just point to some of the conversations that we have with our wider team,

 

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other portfolio managers who are managing very large sums of money, they've

 

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really also bought into the Canada thesis.

 

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Part of that is us table pounding around those conversations but that's

 

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starting to resonate. It just creates this interesting dynamic.

 

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This is, again, nothing to do necessarily with the fundamentals but you can

 

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have a compelling story that investors overseas with large pools

 

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of capital will come to a comparatively small market like Canada.

 

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Those flows alone can really just be responsible for driving the TSX higher.

 

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We've seen that certainly in recent years.

 

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That's something where ultimately, again, you need to see the proof point, you

 

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need to the actual follow through but as a theme that's a little bit adjacent

 

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to the fundamentals, the flows and the momentum that can enter a market like

 

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Canada definitely need to be respected.

 

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We want to try to catalyze a lot of that in terms of how we have positioned

 

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our funds.

 

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You, from the position of where you're looking at things, will allocate

 

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to other managers to get more specific into particular companies but

 

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certainly the themes are something that you're looking at, AI defence,

 

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different areas of nation building to an extent, certainly energy,

 

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is that where you are investing into, AI, defence and energy?

 

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Is that basically...

 

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What we want is really the best of Canada.

 

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The people that are best positioned to give us the best of Canada are the

 

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underlying managers. We heard from Reetu, she is responsible for all

 

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of the analysts, there's a fund that reflects all of their best decisions.

 

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Then we want to also have diversified portfolio managers like Dan Dupont

 

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and Hugo and Darren that can also look across, really, the best that

 

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the research is giving them in terms of the ideas.

 

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Again, it's well out of my depth to pick those individual stocks but we

 

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have that great fortune of using a well diversified group of managers that

 

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really bring those best ideas into the portfolio.

 

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Our job as the asset allocator sitting on top of that is

 

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to just give those managers more money and let them follow the data,

 

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follow the ideas to bring security selection into the portfolio.

 

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One of the things that Heather was mentioning was integration.

 

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We're in the midst of CUSMA talks, we know this.

 

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Hard to really ask anyone exactly what's going on because no one really knows

 

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st this stage. The word integration, though, was something that she used a

 

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number of times.

 

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Where is the line for you, this is sort of standing back geopolitical story,

 

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between trade and integration? I mean, they're often together but they often

 

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sometimes have one or the other.

 

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Absolutely. I mean, geography makes interesting bedfellows.

 

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We are inextricably tied to the United States, certainly economically.

 

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We have tried to diversify certainly some of our trade into other countries

 

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to create closer partnerships and relationships with Europe, with a lot

 

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of emerging market economies.

 

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You can actually see it in some of the trade data that the percentage of our

 

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export share that goes to these other countries has been increasing.

 

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That has come at the expense of our trade with the United States.

 

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That's part of Canada's strategy certainly, having one customer responsible

 

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for, say, 80% of your exports, that's a lot of localized

 

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risks.

 

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To the point that Heather was making and the question that you asked, there

 

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will inevitably be a role for greater integration between

 

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these two countries. Whether that's purely economic in the form of

 

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trade, I mean the US is still an exceptionally important and large economy but

 

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there are geopolitical overlays, there are defence overlays.

 

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Again, referencing David Bridges sort of multi-polar type world, you can think

 

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of much more of a scope for there to be a fortress North America where

 

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Canada inevitably is embedded within the US and then we have competing

 

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geopolitical interests elsewhere in the world that, again, create their own

 

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dynamics among their regional countries.

 

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There is that role, I think, to play as part of what Canada is trying to

 

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achieve but it's a delicate line as well.

 

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You also want to be able to play up your role as a middle power, finding

 

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other countries and regions that share those similarities.

 

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You may not have a huge voice on your own but if you're banded together

 

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with six or seven other like-minded countries you can also exert a certain

 

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amount of influence on the global stage.

 

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All of this is just, again, exceptionally interesting to watch in real time and

 

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to invest through. It does speak to a very different world

 

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than what we had prior to the last cycle where it was

 

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very much of a US uni-polar world and everybody could hitch their wagon

 

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to the US with great success, now it's a little bit more nuanced in terms

 

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of where you find opportunity, how you build these relationships across

 

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countries.

 

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That may answer the question of how the super cycles, if that's what this is,

 

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are different. The last one was about building up China, essentially selling to

 

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China. This is more about selling to the world, or how would you [crosstalk]?

 

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That's the tricky thing. Your hesitation kind of belies the challenge that

 

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we're trying to face because we're not really sure who the next massive

 

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superpower is going to be.

 

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We know for sure that the US is retreating but who is stepping into the breach?

 

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China certainly has a lot of potential, we saw the first commodity supercycle

 

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when China was in its early phase of industrialization but they've come

 

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a long way in terms of industrializing, building out much more of a

 

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middle class, a more dynamic, diversified economy.

 

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They may want different things that Canada can potentially produce than what we

 

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saw in the year 2000.

 

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In the same vein there are a lot of other emerging economies, or even further

 

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down the development curve in terms of frontier economies, that

 

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might also start to move up the value chain.

 

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As they become richer their demand for different types of products might

 

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also change. It's a very dynamic trading relationship and,

 

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again, it just allows us a little bit more in the way of opportunity to think

 

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about how these themes present themselves.

 

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There's more nuance certainly to take into account.

 

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The government is spending, there are large budget sort of

 

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frameworks, well, actual budgets but also the frameworks of where they're

 

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going, is there room to spend a whole lot more as the

 

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discussion of capital cycles gets going?

 

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There is, and this is where you have to be a little bit more nuanced and

 

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thinking about what are you spending the money on that you're borrowing.

 

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In this current government I think there's a very clear distinction between

 

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money that's just for the regular running of the government and

 

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all of the services that we take for granted, or at least pay for through

 

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taxes, and then there's all the other stuff that's more of a capital

 

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investment. This is creating the type of infrastructure that allows industry

 

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to feel comfortable investing.

 

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That, again, can be something that has much more of an economic payoff.

 

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It could potentially really lead to not only stronger GDP growth

 

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but it's also raising the potential level of GDP which is a really

 

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interesting dynamic because that's ultimately what's been missing in Canada's

 

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productivity challenges. If this money is now being spent on programs that,

 

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again, have actionable follow through in terms of the wider economy that's

 

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exactly what you'd want to see. I think this government federally certainly

 

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gets that. I think a lot of the provincial governments are also coming around

 

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to recognizing some of the potential that exists here.

 

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Now, this is not to say it's going to be implemented perfectly and this is,

 

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again, a very long horizon to see all of this come into work but

 

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ultimately in terms of the catalyst, and the catalyst that gets the market

 

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excited, that type of dynamic I think is already in play

 

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Fantastic. Just to round out discussion that is long

 

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term, exciting to invest into for a longer period of time, to the right now,

 

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the discussion of rates. Just remind us to think about how a hold

 

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from the Bank of Canada is a decision.

 

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Just remind us, it's the here and now, everyone's quite concerned about how

 

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inflation is filtering through to their lives, and the government is on hold.

 

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Tell us a bit about your thoughts on that.

 

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It reminds me a little bit of the medical philosophy of do no harm.

 

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I mean, the first step is if you don't have enough information you probably

 

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shouldn't be trying to make policy decisions.

 

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Yes, it's a very deliberate decision to just try to get as much information as

 

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possible. As we've seen with Canada's economy, I mentioned that GDP data,

 

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pretty atrocious, although we saw a bit of a hook higher in terms

 

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of future GDP. Some of the trade data that we've received showed a really

 

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strong jump in exports.

 

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It may be a very shallow and short-lived type of technical recession but

 

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we're also, again, dealing with the housing market story.

 

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which is a very slow moving dynamic but it is improving very slowly

 

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on the margin. At the same time we have the inevitable tweet storm that will

 

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accompany the CUSMA renegotiation.

 

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There's a lot of embedded risk there as well.

 

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We don't know how long the geopolitical type of shock will impact

 

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not only energy prices but potentially Canadian

 

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economic growth because that's one thing that does sort of set apart The Bank

 

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of Canada from other central banks, a sustainable increase in

 

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energy prices or commodity prices is a positive terms of trade shock for

 

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Canada which all things equal would bias the Bank Of Canada to potentially

 

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consider hiking rates but they need to be very careful in terms of how they do

 

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that because that terms of trades shock is not shared equally across the

 

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country. With all of these crosscurrents I think the bank is taking a very

 

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prudent approach to say, you know what, we need to sit on our hands, we need to

 

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absorb enough information as possible, and until there's sort of that critical

 

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mass of evidence on one side of the decision or the other, that's really

 

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what will tip them over. I think at this stage an extended summer

 

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break on the sidelines probably makes everybody feel better about things.

 

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Stay the course to an extent.

 

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David Tulk, it is fantastic to have your expertise wrapping this all up for us.

 

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Thank you for joining us here today.

 

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It's very much my pleasure. Thank you.

 

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