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February 13, 2024

NCM Outlook 2024 Webinar Replay

Wan Kim (AKA The Growth Coach) chats with portfolio managers Alex Sasso, CFA and Michael Simpson, CFA about what's in store for 2024 and how they are managing their portfolios.


Alex Sasso’s outlook for 2024
Michael Simpson’s update on NCM Dividend Champions fund
Alex Sasso’s update on NCM Income Growth Class
Alex Sasso’s update on NCM Small Companies Class
Is it possible that there will be no rate cuts this year?
What do you think about companies that try too hard to pay dividend?
How will rate cuts affect dividend payers?
How will higher shipping costs affect the portfolios?
Do Canadian energy companies fit the NCM Income Growth or NCM Small Companies portfolios?


Wan Kim:

My name is Wan Kim. I'm Senior Vice President, National Sales and Marketing for NCM. Some of you know me as the Growth Coach and have participated in some practice management sessions that I've hosted in the past, and I really want to appreciate the people that have been able to participate in that and still want to come to hear this session. I'm going to be your moderator and I think everyone's really here to hear our two great fund managers speak. So with that, I'm going to lateral it to Alex Sasso to take everyone through the outlook. Thank you very much.

Alex Sasso:

Great, thanks Wan. It's nice virtually meeting all of you. So you guys know markets are never dull, and it was only this time last year that we were thinking that the balance of risks in the economy could tilt us towards a recession. So the yield curve was inverted. Earnings were decelerating. We had government subsidy checks that were running out. And let's not forget, we had a very aggressive Fed embarked on a program to raise rates to fight this stubborn thing called inflation. And obviously inflation in my view, is a wealth destroyer. It destroys the wealth of assets. Now admittedly, many of you on Main Street haven't really seen this, haven't really felt it and the mood hasn't changed. But I can tell you on Bay Street and on Wall Street, the mood has certainly improved over the last few months. I'll take you through the reasons for this shift.

Our goal today really is to help you have more meaningful conversations as you contemplate your client's portfolios, how they're positioned and what 2024 may have in store. And Mike and I, and I have to say, are really fortunate that we have a broad team of equity and fixed income portfolio managers and analysts that have helped us. There's 17 of them in total and I've tasked them to weigh in on this presentation. And so what you see from the chart master there is 2024 in a nutshell, and this is what we're thinking at this time. So number one, the risk of a recession we believe has declined further, inflation continues to trend towards central bank's targets, inflation being the key variable in our opinion to watch. Inflation is definitely the key variable to watch. And really the two-year treasury is a great leading indicator of what inflation will be.

Number three, we appear to be at a peak in the interest rate cycle. I don't think that's a surprise to a lot of people, but what may be a bit more of a surprise is corporate earnings are growing and that's key. The next one as is evidenced in the market stocks are now in bull market territory. And finally we see strong tailwinds as we move through 2024. And I can see a lot of you right now are screaming at me saying, "Sasso, did you not see today's inflation number? How can you say that inflation is progressing towards the 2% target after this morning's number?" And to me it looks like inflation still came down from December's number. It was a bit higher than consensus, but it came down from December's number. But the bottom line in my opinion is the trajectory is going in the right direction. It just may have lost some of its slope.

Operator, if you can go to the next slide please. And what we're going to start with here is just a quick review of calendar '23 and Q4 '23 and what the different asset classes did in terms of performance. You can see that the TSX in Q4 had a nice quarter at 8%, for the year, just under 12%. The S&P 500 in Canadian dollars, again a nice quarter at 9%, 8.9%, the year came in at 23%. Very impressive. The Canadian dollar, slightly better than the US dollar. And then the non North American developed markets, 7.6% for Q4 and a nice 15% for the year overperforming Canada, but underperforming the S&P 500 and our friends on the fixed income side, the FTSE Canada Universe Bond Index, very strong Q4 pulled that market into positive territory for the year and the year it did about 6.7%.

Operator, next slide please. So one of the key reasons we had strength across so many asset classes was because of what we call the Fed pivot. So what is the Fed pivot? And when the Fed governors met back in December, they lowered the median projection for the Fed funds rate for both 2024 and 2025. And that's what you see here on these charts. It's called the Dot plot. Now during this what I call a historic Fed meeting, there was an acknowledgement by the Fed that we are at the peak of the interest rate cycle and they expect to cut rates in 2024. And that's why we had such a big pivot and that's well before we see the 2% target inflation rate because the big fear is the damage that can be caused by an overly restrictive policy for too long. And then that pivot was obviously very positive for equity markets and we saw an immediate reaction from investors around the world, but it wasn't just a US story.

Operator, if you can go to the next chart. We are expecting rate cuts to be greater than rate hikes globally for the first time since 2020. And this is because inflation today is a tailwind where for the last little while it had been a headwind, and frankly central bankers need to be applauded for doing this without creating a recession in most economies. Now, there were some economies that did teeter into a official recession, but I would say most of them have been characterized as a relatively mild recession. Next chart please. And in the bond market, that Fed pivot meant that the fixed income investors enjoyed a really strong final quarter, as you can see here, rewarding those fixed income investors for their patience after what was a very difficult year. In fact, it wasn't just a difficult year, the bond market almost tilted into negative territory for a third consecutive year, something we had never seen before.

Now the FTSE Universe Canada bond index was up 8.27% for the fourth quarter, bringing the year to date return as we showed in the previous slide to about 6.7%. Now in my opinion, it should be noted that there was outperformance, excuse me, in the credit market, and to me this is critical. We spend a lot of time looking at credit spreads and the Canada high yield bond index returned, call it 8.4% for Q4 and about 10% for all of 2023. Now in the investment grade and the non-investment grade spreads, right now they're sitting at their long-term averages suggesting that financial stress is not rising. And I think that's really important. And as you know, spreads would be rising if the credit market was worried about a change in trajectory of profits, they would be worried about the prospects of a recession.

And so they wouldn't be at their historic long-term averages in terms of spreads. But as we all know with the bond market and particularly two year treasuries, and I've talked about this a lot in past webcasts, the two-year treasuries are the best predictor of future inflation.

Now, operator, if you can go to the next chart. And what we're showing you here on this chart is the fed's preferred measure of inflation. That's the PC or the personal consumption expenditure data. And that's the blue line you see on this chart and you can see it's on a trajectory to 2% or perhaps even lower, if in fact the Fed doesn't act quickly enough. And this is the reason the market thought we were going to get a March rate cut because obviously the Fed has to cut well in advance of the time that inflation actually gets to 2%. Now, question for you.

I know what you guys were all doing this past Sunday, you were watching the Super Bowl, but the previous Sunday 60 Minutes was on, and I'm wondering how many people here watched that? It was really intuitive and if you haven't seen it, I'd recommend you do see it. And Jerome Powell was being interviewed by Scott Pelley and like I said, it was a really good dialogue between the two. But effectively Powell in that interview told the markets that he was not going to cut rates in March, but he hinted that he would cut rates later in the spring and the summer. And I think that's really important for the market to know, it's really important for the Fed to telegraph these things. So that's the fed's take on things. Let's take a look at what the market thinks next chart operator.

Okay, so this is a little bit busy. I'll take a second to explain it. This is the market's view of rate cuts and what we can expect as we progress throughout the different central banks' meetings throughout the year. On the left side you have Canada, and on the right side you have the US. We've highlighted the year-end number in beige near the bottom of the two tiers. So you can see the difference between the overnight. For example, on the left you see 5.018 in Canada, decreasing by 130 basis points or the minus 1.324 you see in beige there, to finish the year at about 3.695. Now this chart was put together before today's data. It's going to have changed a little bit, but it'll give you a sense of how aggressive the markets are expecting these central banks to be. On the right, you see the overnight rate in the US at 5.329 decreasing at the last meeting on December 18th by 160 basis points or 1.629% to finish the year at 3.7%.

So you can see the markets are expecting both Canada and the US to finish the year at roughly the same rate. Now you might be thinking, "Well, Canada's economy is underperforming the US economy, why wouldn't Canada be more aggressive?" And frankly, it's a fair question and one of the reasons is because Bank of Canada's tasked only with managing inflation and getting it to the target rate, which is currently 2%. Where in the US it's slightly different. They're tasked with getting inflation to the target rate, plus also protecting the job market. Now the updated expectations from the Fed can clearly be observed in this next chart we're going to show you. So operator, if you can go to the next chart. So this is the performance of the S&P 500 in 2023. From July to October, the market was down 10% and it was a reflection of the prospects of a recession.

But two things changed. The outlook on rates changed vis-a-vis that the knowledge that the Fed might adjust. And we saw that pivot in December. But the other thing, and very importantly, we saw an acceleration in earnings, in looking forward earnings, and we can see a lot of the strength in that in the US economy it came from three major spending bills. We had the $800 billion dollar CHIPS Act, we had the $1 trillion dollar Inflation Reduction Act and $1 trillion in the infrastructure bill. That's a whole heck of a lot of money that was being pumped into the US economy. And one of the last times we saw a soft landing after we had an inverted yield curse between the threes and the tens was in the late 60s. And the reason for this was because of the amount of money that was being spent on the Korean War and how that stimulated the US industrial base.

And so we can make that same argument today with what's happening in Ukraine, what's happening in the Middle East, and of course the improvement of supply chains across the economy. Now remember, the economy today is different than the economy of old. And I want to bring this up because 50 years ago when rent rates went up, it significantly impacted families that had one income earner and typically there was one income earner back then. They often had a mortgage and when rates went up, they had to spend less. And so for example, Detroit saw sales go down, the factories shut down, factories across the country shut down. Now one income earner lost his job and there wasn't a lot of protective social security back then either. So it had a massive impact on the economy where today we have social security, we have two income earners and we just had a 550 basis point increase in rates, and yet the Fed managed to maintain full employment.

So kudos to the Fed and that second income earner significantly helped the consumer to continue spending as we moved throughout '22 and '23 when the prospects of a recession started to increase. Next chart please. And when you have full employment and you have a confident consumer, you have a strong economy. That's the bottom line. And of course all of these things help earnings. So next chart please. So this chart shows the progression of earnings from a deceleration to a trough and into 2024, what is expected to be a fairly significant amount of acceleration. Now you'll note that as we move out throughout the year, estimates typically come down. That's normal. That happens pretty much most years in a business cycle. But once again, I can read your minds and I know what you guys are thinking and you're thinking, "Well, it's all about tech and it's all about the Magnificent Seven."

To me that is only partially true. Next slide please, operator. So here is earnings expectations, earnings growth by industry. And you'll see that healthcare, and I'm starting on the far left side here, communication services right next to it, and other industries, have had really strong expected earnings growth. In fact, eight of the 11 of the industries that you see here, we're expecting to have either strong, high single digit growth or low double-digit growth. Now we all know, and it's really important to keep in mind, that expected earnings growth has been really strong and it's been overshadowed by the Magnificent Seven.

And if you can go to the next chart please. You can see how dominant the Magnificent Seven here is. This is the percentage of stocks that are underperforming in 2023 on the far right. 71% of stocks underperformed, the S&P 500 shows you the power and the heavyweight that we have in that Mag Seven. Next chart please. And you can really see in this chart how dominant they are. So here this is the different industries and what percentage of the companies in that industry have underperformed. And you can see, for example on the far right utilities, 93% of utility companies have underperformed the S&P 500 in real estate consumer staples.

So we don't see this too often, but 2023 really has been a weird narrow breadth performance year. Next chart please. Now, if earnings growth is as strong as I've shown you in previous slides and analysts predict, we're likely to have broader participation in 2024, and this is a really nice chart from our friends at BMO. This chart shows that most industries have obviously significantly underperformed the Mag Seven, but you can see that what we're showing you here is even if we get a narrowing of a performance amongst those relatively few stocks, it doesn't mean that subsequent years will be underperforming years for the marketplace. Next chart, please.

This looks quite healthy to me. 11.7% growth in 2024 followed by 12.6% for 2025. Next chart please. This is a good chart. So this deserves a little bit of explanation. Here is some work done by our friends at Scotia. This is what happens when the Fed is done tightening. If the Fed finishes its interest rate hikes, which we think it is, and we avoid a recession, and that's the blue line that you see there, performance has been significant 12 months out as you can see. However, if the Fed tightening ends up resulting in a recession, that's the red line, it's going to be a choppy market for one year forward. And in the presentation thus far, we've basically spent a lot of time talking about how the Fed is done raising rates, which is often described by economists as the beginning of the next cycle or the next bull market.

It'd be really nice knowing how long and how strong is that next cycle going to be. And the next chart's going to help us with that. Operator, you can go to the next chart. So this is noisy, so please bear with me, but really want to focus your eyes on the navy blue bars. That's the post World War II data of the S&P 500. On the left tier you see the length of the bull market and that's the left side there. And that red bar, that gives you the median amount of length of time that the market will be in bull market territories, that's over a thousand days, 1,324 to be exact or over four years. And on the right side, we're showing you the strength of that bull market. And that adds up to on median, sorry, not average, of 86%, but it wouldn't be a bull market without talking about some of the risks.

So if you can go to the next slide, please. So unfortunately these days, all of these slides have geopolitics. When we talk about risks, have geopolitics on it. That's probably not a surprise to anybody, but in my opinion, the big one here is inflation and particularly sticky inflation. If central banks get aggressive and overcut or overstimulate, we definitely don't want to see a 1970 style reinflation. That would be a big issue for central bankers around the world. Now before getting to the conclusion, I wanted to give you guys an idea of what it's like for Mike and I, in fact, the whole analytical team here at NCM during earning season. So four times a year as you guys would expect in a condensed three to four week period, we have all of our companies and the companies we're interested in reporting. And so we burn the midnight oil in a big way during this time period.

So we're listening to conference calls, we're reviewing quarterly earnings estimates, we're updating our models, we're rolling up our sleeves, and I just wanted to show you guys what it's like for us. Operator can go to the next slide. So this is what it's like for us. So you had earnings, earnings, earnings, earnings, and then all of a sudden headline from China will come out and we're completely distracted. So kidding aside, let's go to the next slide please. In summary, a soft landing is what we're expecting. That's being fueled by expected interest rate cuts both here in Canada, the US. In fact, you'll see it in Europe as well, falling inflation. And then of course we think that the global economy in today's day and age is a lot more resilient than what the history books have taught us. So with that, thank you for your time. I will lateral it back to Wan Kim.

Wan Kim:

Thanks, Alex. That was really good. We actually, I see a few questions that have come in. I'm going to keep encouraging everyone to send the questions. We're going to try to get to them all at the very end, but now I'm going to hand the keys off to Michael Simpson who's going to take everyone through dividend champions and his thoughts on what's happened. So Mike, it's all yours.

Michael Simpson:

Okay, thank you Wan. If the chart master could go to the next slide. Okay, I'm Michael Simpson. For those who don't know or didn't get the press release, I joined NCM very happily in September, 2020, and I'm going to go through the fund that I managed called the NCM Dividend Champions.

Next slide. So basically I always believe that Canada is where we live, but the Canadian marketing economy is somewhat limited. So I have the ability to invest in Canadian and I'm choosing to invest in American stocks as my foreign content. So Canada, if you go back to the history, was created, we started with four provinces. We built a railroad to unite both east and west. And I look for companies that generate free cashflow, pay dividends, and more importantly, grow their dividends. A lot of talk about, "Well, why don't you just buy the dividend aristocrats?"

You have to have active management when you're managing a portfolio. It's not you buy and forget about it or buy and perspire. You have names like Algonquin Power that once were great dividend payers, but they stumbled onto hard times. First Quantum, a mining company, not necessarily their fault that there was a political change in the country they're doing mining, but nonetheless, it happened. We try to own between I would say 35 to 45 names and we try and look for the best dividend payers that can grow their dividends over time. It's also crucial to point out it's not about absolute dividend yield and saying, "Well Mike, why don't you invest in something with a 7% dividend yield?" There's lots of people scouring the market. So it is our view that we have to be very concerned about sustainability of the dividends. So our goal is to get those companies that can grow their dividend over time.

Next chart, chart master. So this is a schematic between risk and return. We learn that in finance, we learn this in business school, et cetera. So the dividend champions have a number of great characteristics. Usually, but not always they're an oligopoly industry. There's not too many players. They might have some key advantage in terms of technology or personnel or dominant market share. They sometimes can grow with the economy sometimes a bit faster. But what we always look for with the dividend champions is a strong balance sheet. With the strong balance sheet, companies can withstand shocks both internal and external.

And back in 2019, the end of 2019, we got an external shock that we hadn't seen for over a century, namely the first global pandemic in over a hundred years. Dividend cutters, we try to avoid those really can do damage to the portfolio. So this is what we try and do, but dividend investing is just not buy and forget about it. We constantly have to monitor it. And like Alex says, sometimes earning season is good, sometimes it's earnings hell because you have so many companies in such a short time period. But we're there, we're going through reports, we're listening to conference calls, we're asking questions, et cetera, et cetera.

Next slide, chart master. Some good news and bad news. The good news is as we age, we get smarter. The bad news is we're getting older. There was an interesting stat from Bill Morneau's old company, Morneau Shepell, which is now within the Telus orbit or empire. But every day 1000 Canadians turn 65. So as we get older, and there is a little myth that's saying, "Well, once you turn 65, you're going to stop doing things and you can just coast go to GICs," but that's incorrect because a lot of Canadians are active well into their 80s, so they need inflation protection that you get from a well diversified stable dividend portfolio. Next slide.

With the cost of living with the rapid growth of the cities in Canada from immigration, from temporary foreign workers, from students coming to our Canada to study at our great Canadian universities, Canadians now owe a lot of debt, $1.82 for every dollar they have to spend. A lot of that is tied up in housing. Some of it is personal credit lines. We also have high corporate debt. So we have to be very careful of the companies we look at, we always are, we just don't turn this on or off, this screen of ours. We look at companies that can have a flexible balance sheet, have what we call balance sheet flexibility. They need the flexibility to pay a dividend, grow their dividend, reinvest in their business, or sometimes when it makes sense and it's accretive, do an acquisition. And next slide please.

We're all fussed about rates. Rates are so high, but sometimes we take a step back and look at and look at bond yields over longer time periods. This is only about nine years, but you can see that the Government of Canada 10-year bond yield is coming down and it is well within where the market's been, the market has performed for many years. I used to say in slides that was around in 1981 when they had a 19.5% Canadian savings bond. But if you go back 40 years, the average yield on the government of Canada 10-year bond is between 4.5 to 4.6. So we're well within that range. Next slide please.

Same holds true in the US where we've got a plethora of data and statistics, the dividend growers, what we call at NCM the Dividend Champions, have performed the best going back to 1972, almost 50 years. The dividend payers are doing all right, but the non-payers not very well. The dividend cutters and the limiters, they get instant justice or vengeance in the market, so you don't want to be in a dividend cutter. It's important to do your work and that's where you can rely on NCM. We have the team of portfolio managers that are seasoned that have been through many cycles, and we can take a look at companies and make sure that they have the ability to pay a dividend. Next slide please.

All right, so we're all worried about a recession. The economy. We spend so much time, we have our favorite economist, our favorite strategist, but guess what? It's very hard to predict such a complex beast as the economy. But we know as Louis Rukeyser used to say, recessions eventually come. But one year after a recession starts, or sorry, more importantly one year after earnings peak, what type of companies do the best? Well, the type of companies that do the best are the dividend payers. The companies that don't do well are the non-dividend payers, and the overall market is only up about 1%. So these dividend payers and dividend growers, so it's important to point of dividend growers, even after earnings peak, usually caused by a business slowdown, sometimes the recession, they're still doing well because investors realize these are solid companies. Next slide please.

So why is it about dividends? You've heard it, but what is the real essence? Let's really strip the different layers and get to the heart the part of the matter. So there's no company that can resist recessions or no company is recession proof. But dividends help you resist recessions. For example, I know you're looking at your screen, there's a lot of red. I own two waste companies. There could be huge turmoil in the mid east, but guess what? They're still picking up the garbage in Ohio. So that's why we own waste connections in Republic Industries. Dividends help to reduce volatility. It's been documented and tested. Getting your cash early or getting your cash frequently helps to reduce the volatility of your investment and your overall portfolio.

Inflation fighters, you heard Alex talk about this, insidious inflation that erodes your savings. But if you've got a company, a Dividend Champion company like a Dollarama or a Emerson Electric in the US that's raised their dividend every year for 68 years, Ford is for 50 years, Enbridge for 40 years, this is really going to help you fight inflation that's going to make a difference. Because don't forget, everyone has their own personal inflation basket and the inflation is measured off the CPI basket. Next slide please. Dividends have made a major contribution to returns. Right now people are all fussed about interest rates, but really what drives the markets are earnings and dividends.

Over 95% of a stock market's return over 70 years have come from two sources, dividends and earnings. Since 1930, 40% of all US stock market returns have been in the form of dividends. In periods of high inflation, which we're coming out of, the number jumps all the way up to 54 %. And the Canada, the TSE 300 goes back to 1977. You could have accumulated almost four times your wealth as an investor if they had stayed in the market and reinvested their dividends. Next slide please. So this is the growth of the TSX composite, including reinvested dividends. So clearly when you're reinvesting your dividends plowing in them, you have more and your money compounds. It's like Albert Einstein said, the eighth wonder of the world is compound interest.

Next slide chart master. All right, so with the NCM Dividend Champions, we don't try and be heroes. I don't try and be a home run hitter. I try and be a singles hitter because I got a great team, I want to get on base. So three year number, upside capture almost 81%. Downside capture, 80%. So on days like today, yeah, I'll be down, but I can't predict the future. But usually historically I've been down not as much as the market. So this is what we do. We're giving up the upside to protect on the downside, it's all about preservation of capital, preservation of wealth, and that's what we're geared to, that's what's in our DNA. Sometimes you can teach it, but when you've been doing it for so many years, it just comes naturally. Next slide.

Wan Kim:

So I think Mike, that's going to be the cue for Alex's portion to talk about his products, but I want to say on behalf of a whole bunch of advisors that I've spoken with, I think we are thrilled to have you manage dividend champions. You've done a great job. I want to say that I was the first human being to buy Dividend Champions when we reopened the fund, and I'm just incredibly proud and thrilled with your contribution and everything you're doing for Canadians and advisors.

The next portion, I still see a lot of questions, so please, please keep coming and keep asking the questions. We've got lots of time. So Alex is going to now take you through NCM Income gGrowth and Small Companies. And this is again really important because we promise CE credits and a lot of you need, it's brand new year, brand new cycle. We're going to make sure you get those CE credits as well. But we are going to answer questions as well. So Alex, it's all yours.

Alex Sasso:

Wonderful, thanks. Thanks Wan and thanks Mike, appreciate that. Operator, if you can go to the next slide please. Okay, so on the small mid-cap side, what are we offering? Well, we're offering basically what we call a proven and repeatable investment methodology. What we do over here is we marry fairly sophisticated quantitative analysis and we've got some people on our team that really specialize in that and we merged that with a roll-up-your sleeves fundamental analysis. We've got hundreds of companies in our database, we've got models on a whole host of companies. We've got a substitution board that we're always thinking about. And when you buy one of our products, whether it be Mike's product or my product, you're buying a group of companies we think are the best in their respective fields that are growing faster than their competitors, but trade at a discounted price.

So you'll notice in our portfolios, and we advertise this, that your trailing price to earnings is less, but you're getting better ROE, return on equity, better return on invested capital. You're getting faster sales growth and faster earnings growth. And what's really important to us as well is estimate revisions and the change in earnings on top of all of that. That gives companies the ability to afford a distribution increase or a dividend increase. Mike and I for fun, we talk dividends. I know that might seem weird, but we are both very, very big fans of dividend payers between the US and Canada. The products we're going to talk to you about today, Mike's Dividend Champions or Income Growth, which is the small mid-cap dividend focused fund I manage, we've got Canada and the US covered with those prospects. Next slide please.

Okay, so we talk about many blue chips being a proven way to outperform. We know small caps over very long periods of time outperformed. Yes, they've underperformed recently. They tend to do well in periods of declining interest rates and faster earnings growth. We think over the next few years that we will have that recipe and as a result we should see relatively good growth amongst what we call these mini blue chips. And a mini blue chip is the same thing as a blue chip, the traditional definition of a blue chip, except they tend to operate in smaller niches. And then we really have a group of businesses that have focused exposure, that have an ability to outperform that have fewer eyeballs on it. And the opportunity there is that we can find, especially given our experience, we can find under-loved, under-followed businesses that aren't as efficiently priced as some of the mega caps that we also see paying dividends out there.

And they tend to be takeover candidates as well. If you're BigCapCo and you're big cap CEO, you can buy a small cap blue chip and spend a lot less time and a lot less risk than trying to go and create that yourself. Next slide please. And the great example of this would be a company that we had in our portfolio for years. It was a company that I was a big fan of. It's a company called Intertape Polymer Group. And Intertape was acquired by a private equity for $2.6 billion US for a big, big premium. And the reason the big premium was there was because they realized that it would be very, very difficult to replicate what Intertape had been doing over many decades. Next slide please.

Okay, so this is to me a really important slide and for those advisors on the call, this I think can help you whether you're interested in an NCM product or not, this can help you increase the probability of picking an investment product that has a better mathematical chance of outperforming. And so the only way you can tell if a fund manager has skill is to take a look at his or her track record over longer periods of time. In any one year, any fund manager can underperform and in any one year, any fund manager can outperform. But can they do it with some sort of consistency? And the only way you can judge that is by taking a look at their long-term track record. So the other thing is that, as Mike mentioned, high yield equities tend to outperform low or no yield equities and certainly equities that cut.

We've got some good slides that we're going to show you in a minute on that as well. But over long periods of time, reinvesting those dividends leads to that magic of compounding that Mike was talking about. High active share. What's active share? Well active share is how different you are than an index. If you invest in an index, you're going to underperform that index by the amount of fees that that product has. I.e. Many ETFs are focused in and the majority of ETF dollars are in passive strategies that charge a certain management fee with an expense ratio. So you're going to underperform that index by that amount, it's just financial math. In order for you to pick a product that's going to outperform, you have to be different. And the only way you can be different is by bumping up your active share. So always ask your fund manager what their active share is.

And if they don't know what their active share is, then chances are their active share is fairly low.

And then the last one, portfolio management alignment. This one is key. Always make sure that your fund manager that you're aligning with has some of their personal net worth in the fund that they manage. And the data behind that is in the US fund managers have to report to the SEC how much they own of the product they manage. We don't here in Canada, I suspect it's coming at some point, but we don't currently. But always ask your manager how much of the fund or how much of their net worth they have in the fund that they manage.

And the reason is because Morningstar took that data in the US and found out that those managers that had a meaningful portion in the fund outperformed by over 200 basis points per year. That is a significant number. So the point being is if you pick a manager that has a strong track record, invests in high yield equities, has high active share and has some of their own money in the fund, you're just stacking mathematical probabilities in your favor. And as a result, you as an advisor can have a good meaningful conversation in January when you do your year-end review with your clients. Next slide please.

Okay, so this is what we're trying to do with the fund is we're trying to find tomorrow's blue chips. There are many blue chips today that we have in the fund, and those would be the four companies that you see below that line. These are companies that we have owned or currently own. And the point being is that the four companies that we're highlighting at the top there, those are companies that not too long ago we would've classified as many blue chips. So you take a look at the Mac's Milk symbol there, that was purchased by a company called Alimentation Couche-Tard. We all know that name, but it wasn't that long ago this was $150 million-dollar market cap. Our objective is to get a couple of those in the portfolio and it will make a meaningful difference to investors in our funds. So when we do that work, when we're looking at those earnings calls, we're trying to figure out whether or not there is the potential for these small companies to become mid-cap companies, to become large cap companies.

And I'll give you an example of that coming up. Next slide please. So here is a company called Boyd Group. And if you don't know Boyd Group, it's currently in the fund. They are an amalgamator of collision repair shops. Doesn't sound like an exciting business, but we locked into this company about a decade ago and at that time there was no analyst covering it, nobody following. There was very few eyeballs on it. It was generating about $15 million of EBITDA. It had a $35 million-dollar market cap. As unbelievable as that sounds, that is something that we can find in the small cap world and why I love managing small midcaps. But one of the things that we do when we put these companies in our portfolios, we spend a lot of time with management.

We become their partners. And so what we did with Boyd is we went across the street and we told the analyst community, "Here's a great company, you need to follow it, you need to pick it up. And then if you're as convinced as we are that this is going to be a good grower, then you should pick up coverage of this company." And you can see in 2013, we now have five analysts covering this company. It continued to grow. Revenues were now $844 million. EBITDA was about $69 million, but its market cap and its enterprise value to EBITDA significantly increased.

And part of the reason for that is you just had so many more eyeballs on this company. Fast-forward to 2020, now you had 12 analysts covering this company. Its multiple increase to 18 times, which is a little rich for our blood. But we knew that this was a company that had perfected the model of going out, acquiring, using the free cashflow of the business, pay down debt. Once that cash started building in the business, again, go out and acquire more rinse and repeat. So they would have organic growth and then on top of that they would have acquisition growth and the combination of the two made for a very strong stock price. Next slide please.

So specifically as we talk about NCM Income Growth, next slide please. What is Income Growth? For those of you that don't know, this is a really neat product. This is a small midcap dividend focused fund with multiple kicks at the can, so to speak. And what I mean by that is we're investing when companies that have a low payout ratio so that it could reinvest back into the business and they can use that free cashflow to finance the dividend and dividend increases. So right now we have, and we have had, this has been a part of our philosophy since we started the fund back in 2006, is we have roughly a 50% payout ratio and we insisted on having low payout ratio businesses. One, because if they come into hard times, they've got a lot of free cashflow in the business that they can use to skate through those difficult times.

But more importantly, they have a half of every dollar that they bring in to reinvest back in the business. Now you won't see a lot of REITs, utilities and pipelines in the fund. Not to say that those are bad businesses, but those tend to be businesses that have high debt levels, low return on assets, plus their payout ratio tends to be very high.

So our philosophy is different. So we're investing in companies where revenue growth, earnings growth, and as a result, dividend growth is higher than the average out there. And before we ever knew that rapid dividend growth was a recipe for outperformance, we knew that that was a better investment methodology than many of our competitors were utilizing in this asset class. The vast majority of dollars focused in on dividend stocks tend to be focused in on the mega caps where we like to pick the best companies regardless of their cap size.

What's really cool about this company is it's in a corporate class sold from an after tax perspective. And I'll quote Wan Kim, it's not what you make, it's what you keep because our unit holders will keep more for one, it's in a corporate class, so we use the expenses of the corporation to offset some of the interest income that the fund generates. And secondly, on the equity side, we're solely invested in Canadian eligible corporations which carry a lower tax rate. So if you see this fund, let's just say it had a 10% tax return over one period and you see another fund with the same rate of return, it's not the same on an after tax basis. Next slide please.

Okay, regurgitating some of the great charts that Mike had, and I've shown this in the past, but it is so powerful I felt compelled to show it again. On the left side you have your dividend growers and your dividend payers, their returns over long periods of time versus in the middle you see the S&P TSX, but on the far right, the non-payers. So a lot of advisors will say to me, "Hey Alex, have you seen this company? And what do you think of it?" And one of my first questions if I don't know it is it a dividend payer? What's their dividend track record been like? Have they been able to increase dividends? What's the payout ratio? And if they tell me it's a non-payer, then I say, "Well, I'm not saying non-payers are all bad, but you have to know you may have a headwind that you're dealing with because as a group they will underperform over long periods of time. The great thing about the dividend payers and the dividend growers is they also carry less risk. Next slide please.

And this is the same bucket of stocks over the same time period, but what we're tracking here is their standard deviation or how the industry measures risk. And on the far left you can still see those same dividend growers and dividend payers. And you may be surprised, even though they're outperforming, they carry less risk or a lower standard deviation. And that's because on the down days they tend to go down less and then they tend to recoup their losses quicker. And then over periods of time those dividends compound and help with the performance. But as you guys know, standard deviation takes into account downside deviation and upside deviation. So even though you have higher upside deviation with these, they still carry a lower overall amount of risk. Next slide please.

Okay, this is to show you Canada and what's happened over the last little while. A lot of these Canadian companies, it's not just the oil patch, carry some really strong free cashflow yields. And free cashflow yields, it's one of my favorite measures of trying to predict future stock price performance. And part of that free cash flow for dividend payers often go back to the shareholders like Mike and I, by increasing their dividend. So you can see here in Canada, even though the dividend yield has remained fairly flat over time, the base amount of dividends that these companies are paying are significantly higher and have been accelerating over the last few years. Next slide please.

Why I like small caps and why with Income Growth we've really focused on all different cap ranges, but small and mid-cap certainly, is because the pond that we fish in is just so much greater. And so I like having more options than less options. And as you know, the average portfolio manager in the US and Canada have a hundred names in their fund, but here in Canada they only have 125 companies that pay a dividend that have a market cap of greater than $3 billion. I've got those 125, plus I've got an extra 210. So for me, market cap size is less important than quality of company and the track record of paying dividends. Next slide please.

Okay, so this is a really cool slide. I really like it, but let me just spend a second explaining it. So on the orange-ish part at the top, that's your dividend amount. So for example, Income Growth right now pays just over a 4% dividend. Let's just say you had a product that paid a four or 6% dividend. So then on the left side in gray you see the rate of dividend growth, and the rate of dividend growth over there is two, four, six, eight, 10. But let's assume it's 10%. Right now income growth is slightly greater than that, but you can see how many years it would take you to double your money. So if the equity markets go sideways and you relied only on dividends and dividend growth, you can still be successful in the marketplace. Next slide please.

Next slide please. I know we're running tight on time. So the great thing about Income Growth is you can use a wealth creation strategy or you can use a income supplement strategy. If you just reinvested the dividends, it's been a four bagger over that time period. If you on the other hand had clients that needed to supplement their income, you can take those dividends in cash and it still would've left you more than the capital you invested since 2006. Next slide please. In terms of performance, we've added about 260 basis points over and above the TSX, over the life of the fund. Next slide please.

So we'll transition now to Small Companies and I'll go quickly through Small Companies. Next slide, please go to the next slide. Sorry, operator. So this, Small Companies is our pure small cap focused fund. Really what you're getting here is you're getting alpha and often what is a beta market. Very, very attractive valuations. It's got some of the best metrics that you'll see in a mutual fund because you tend to get much better growth and value for a market cap dollar. And then of course we've also got the largest amount of fish in that pond, so to speak. Next slide please.

Okay. So it really is a value methodology with a growth overlay. I've had people take a look at the metrics of the fund and say we're a value fund, and I've had people take a look at the fund and say we're a growth fund. That's the beauty of investing in small cap and mid-cap Canada, is you get growth revenue numbers and growth earnings numbers, but from a valuation perspective you get value style valuation metrics. Next slide please. And in terms of performance, significantly over performing to small cap index, so by 300 basis points on average per year. Next slide.

And just in terms of risk, what we've done is we've taken a look at the number of months that the fund has been around, so 227 months, and taken a look at seeing how much of those are down months. 106 of the 227 were down months in the market and we've outperformed 71% of the time in those down months. And then 28% of the time we've actually generated a positive rate of return during those time periods. Next slide. And then just very quickly, I'll finish on this slide. We will look at upside downside capture. On the left tier you'll see small companies, you can see the three year, and since inception, we have a difficult time keeping up with the market and that's because the small cap index is resource heavy. We tend not to be resource heavy, so it's difficult for us to keep up.

But where we add the alpha and where we add the value add is we tend to not go down as much. And if you look right on the right tier, likewise with Income Growth, our upside capture is 93.5% for three years and 107 since inception. But take a look at the downside capture. Because of the focus on dividends and the strength of the companies we're investing in, we tend to add a lot more alpha on down days than we add alpha on up days. So with that, thank you very much everybody for sticking with us through this time period. I'll lateral back to Wan.

Wan Kim:

Thank you everybody. So I've seen the questions in the chat room. The number one question is actually about CE credits and I'm happy to report that the CE credits will be sent to you by your NCM salesperson. So they're accredited by CIRO both on the IROC and MFDA side, so it's going to be a total of 1.5 CE credits. There are additional questions that I know are coming in and so I'm going to end the formal portion. So if you leave now you still get CE credits, but I have a few minutes with Alex and Mike and so there are a few questions that I think some people did want to ask. I think there's one, and this is for either of you, is it possible that there will be no rate cuts this year?

Michael Simpson:

I can start with that, Wan. Certainly the market was ahead of itself in November, December, predicting the number of rate cuts. So what's going to drive the market going forward, as we talked about in our investment meetings is earnings. So I think given that there's lags, it is within the realm of possibilities, but I think we'll still get a lower amount. It could be anywhere from one to three, but we still have 10 more months left in the year. So it is possible, but that's not our base case. So I would assume two to three cuts.

Alex Sasso:

So I would just reiterate, Mike said our base case is two to three cuts. It's probably going to start later than we originally thought, the market originally thought, March. We were thinking May, June. If anything, I think it might get pushed out a little bit. It's data dependent. So what we saw today, as I mentioned at the outset, is we saw stronger than expected inflation, but the trajectory still came down.

And if you remember that PC deflator, that's the Fed's favorite measure of inflation, we'll be really interested in paying attention to see what that number comes in at. And that will, I think, really guide the Fed. But I would agree with Mike, I think that's an outside chance that we don't get any rate cuts, but it is within the realm of possibilities. Our base case still remains two to three rate cuts throughout the year for both Canada and the US.

Wan Kim:

So this one, this is actually a really interesting question. I'm cleaning up the question, but the essence of it, and it's a fair question, is coming from this. Basically the advisor's asking about companies that force a dividend that obviously pay a dividend, but they're really tight on cashflow. What are your philosophy and thoughts with respect to dividend payers that really are more like trusts or something like that? How would you respond to that?

Alex Sasso:

So there's a high probability it exits the portfolio. So if we own that name for whatever reason, the low payout ratio became a high payout ratio. Again, I hate to keep saying this, but we roll up our sleeves, we get to know the company, we call management, we listen obviously to the quarterly calls, but we listen to management. We do a call in between the quarters, and that's because you want to know how the quarter's progressing and getting a feel of what management's worried about. If management's worried about the dividend and the survivability of the dividend, that is one of the fastest ways to evaporate a market cap. So you saw on that chart dividend cutters and how much it underperforms dividend growers or dividend payers. That's always in the back of my mind. So we'll know well in advance for it to get into that danger territory. But if we see the trajectory of the payout ratio going up over the quarters, that's a red flag for us. And chances are we will not get ourselves in that kind of a position.

Michael Simpson:

Let me just add a different perspective. The dividend is determined by the company's board of directors. I'd like to think that I can influence companies in paying a dividend, but the is, I don't. So the company has a board of directors. They have intimate details of the company's financials before investors like myself do. So it is a company decision to pay a dividend. The stat I've got roughly of the TSX, now there's about 225 companies, about 70% pay a dividends. So no one is forcing a company to pay a dividend. But unless you're in a unique situation, the one-percenters like Warren Buffett's Berkshire Hathaway, if you're in a slow or mature business and you have excess cashflow, it's best that you pay a dividend and install some discipline.

Because I've seen so many companies over the year waste money either on acquisitions, destroy capital, buy back stock when their stock is too high, reinvest in the wrong area. So if your best use of cash, you can't find it, you should pay a dividend. So just to clarify, it's not a matter of forcing, but sometimes companies get ahead of their skis, and I mentioned earlier a company like Algonquin Power that had to cut their dividend, that was due to debt levels that were too high, a payout ratio that was too high, and a regulatory change in a new jurisdiction they entered to in the US. So again, I want to reiterate all this requires active management and that's what we do at NCM.

Wan Kim:

Perfect. So there's a few more questions I'm going to take. I'm going to answer one that came in with respect to fund structure. So yes, class means a corporate class. And so if you don't see class, it's not a corporate class of funds. So Dividend Champions is a mutual fund trust, NCM Income Growth and Small Companies are mutual fund corps.

But this question is actually, I think it's a two part question. It's from a really good client of ours here in the GTA. With interest rates potentially coming down later this year, do you see a lot of upside in dividend producing positions? And second question, how will the increase in shipping costs affect positions in the funds? And I know this advisor owns both of your funds.

Michael Simpson:

Yeah, I can start. Just basically all assets are interest rate sensitive, more so on the dividend side. So interest rates coming down will be a gigantic boost for the dividend payers. It will even highlight the dividend growers, what a fantastic job they're doing in a declining interest rate environment. So just so as people know, we've been in a bear market for dividend payers as the Magnificent Seven performed or produced over 107% in 2023. See now, momentum changes. Now the Magnificent Seven is down to the Super Six as Tesla has fallen out of favor slightly.

So the other question about the Suez and Red Sea, not right away. I think that'll take time for that type of inflation to come into the economy. There's I guess general merchandise that gets shipped, but we have companies that deal with different points in the world, so I don't expect that to have a dramatic on inflation. But to the caller's question, we have seen a rapid rise in container rates, which we saw come down dramatically. So we're going to keep an eye on that to monitor and see how high it gets.

Wan Kim:

Alex, any thoughts on your positions in Canada with respect to increase in cost of shipping that may impact the funds?

Alex Sasso:

Yeah, so I've probably listened to, I'm going to say 60, 70 quarterly earnings calls and it's probably come up in the calls by management or vis-a-vis question in the Q&A portion maybe 1% of the time. So my perception is that it's not a big issue, particularly for small cap Canada. I don't expect it to change gross margins all that much. And then just reiterating what Mike said with regards to dividends, dividend payers actually underperformed in 2023, and it wasn't just the Mag Seven, it was the competition for vis-a-vis money market funds, GICs and things like that.

So when you can get 5%, 6% in those instruments, it puts pressure on the dividend payers. And we saw a bit of that in 2023. That pressure has subsided somewhat. And now looking forward, I think 2024 is going to be more of a stock picker's market. It's going to be more about earnings growth, and over a long period of time that's what the market is, is the correlation between earnings growth and dividends and the performance of the markets are so tightly correlated. '23 was a bit of a different animal, but we expect those trends to continue to go forward.

Wan Kim:

Beautiful. So if we missed any questions, looks like we still have a lot of people asking questions. So I'm going to take in one more question that just came in from Alberta and then we're going to still collect - we're going to answer the questions that we may have missed, but this question probably more for Alex, do Canadian energy companies or not fit within the small cap fund?

Alex Sasso:

So the answer is yes. So energy companies, metals companies, I suspect the question is because those companies are, their stock prices are determined by the underlying commodity prices. So yes, we invest in those companies. We tend to be underweight. So over a cycle, you will see us underweight energy, you'll see us underweight metals, and you'll see us underweight companies for which they don't control the selling prices of the products that they sell. So you can invest in the world's greatest energy company, but I promise you if oil goes from a hundred dollars to $50, you will lose money on that EnergyCo, likewise, CopperCo, NickelCo, UraniumCo. You need to spend more time understanding the underlying commodity than the company itself.

I often joke that these companies come in and they pull out all these wonderful maps and show me where all of their deposits are and why they think their deposits are going to be bigger than what they've delineated so far. I say, "That's great, let's spend half the meaning talking about your view of the oil price and why you think it's going higher or lower." And that's because 85% of the direction of the stock price, the correlation of the stock price is the underlying commodity price.

So I prefer to invest in companies that control the price of the product that they sell. So there are still some great companies out there. I spend a lot of time trying to understand what's happening in the copper world. For example, if you've seen some of my recent presentations, you'll know I'm pretty excited about copper. I think the supply demand fundamentals look really good there. So I will overweight copper, but this is a short time period in which we're overweight copper over the majority of the business cycle. We will be underweight commodities in the small cap world.

Wan Kim:

Beautiful. Thanks Alex. I think this other question, why is the NCM sales team so good-looking submitted by Corey Longo here at NCM?

We're going to skip that question, but all kidding aside, I really appreciate everyone's contribution. There's still a lot of questions. I want to respect everyone's time. Well over time, we're going to make sure you get the CE credits. Any questions we miss, we're going to definitely follow up with. But with that, thank you very much to our advisors for participating and a bigger thanks to Alex and Mike for all the work they did preparing for this outlook and update. So thank you everybody. It's going to be a great year.

If you need the fund codes, they're on our website. Send us a note, We will be in touch. Thanks everybody.

Alex Sasso:

Thank you.

Michael Simpson:

Thank you. Bye.



NCM Team

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