Bank of Canada delivered a 50 basis point rate hike as it tries to tackle surging inflation. But inflation is just one of the many headwinds facing global markets these days. Kim Parlee speaks with David Sykes, CIO, TD Asset Management about the market opportunities and risks this year.
Print Transcript
[MUSIC PLAYING]
- The Bank of Canada just delivered a 50 basis point rate hike today. And that's the first time we've seen something like that from the Bank of Canada in decades. They are, of course, trying to battle what's happening with inflation. But that is only one of many things that are going on in the markets right now. Here to tell us what he is watching and get his reaction to what he was seeing is David Sykes. He is Chief Investment Officer at TD Asset Management. Dave, nice to see you
- Hi, Kim, how are you doing?
- I'm well. I almost caught myself when I was giving this intro. I was about to say 50 basis point cut, because I've just been saying that for so many years. I'm not used to when they do a 50 basis point hike. So maybe we just start with that. I know that you do more than just watch the news day to day, but it was a pretty material move that the Bank of Canada came out with today, and probably the first of the G7 central banks that are going to start doing the same thing.
- Yeah. So you're right, Kim. The Bank of Canada did increase the overnight rate today from 50 basis point to 1%. I guess the story is that they moved it a full 50 basis points in one meeting. But I think they did a really good job of telegraphing this. I think if you are a capital markets participant, this really wasn't a big surprise.
I think it was telegraphed quite well. And I think the message that was given from the bank was very clear. If you listen to the monetary policy report that Tiff Macklem gave this morning, he really said three things. He said, one, the Canadian economy is strong. We've actually recovered all the way from the pandemic.
Two, he's very clear that inflation is a problem. It's higher than they expected. It's at 5.7%. And it's also expected that it will stay higher for longer than they expected. And the third point that he made very clearly was that interest rates, the major tool that the bank has, are going higher. We'll see if the next few meetings are 50 basis point increments. But there's no doubt that interest rates in Canada at the short end are going higher.
- All right, well, let's talk a bit about what you're watching. I mean, he made mention, of course, of inflation. I think he also implied that a lot of the inflation was coming from outside of Canada. We're bringing it in. So when you look at everything that is going on right now, maybe you could just kind of let us know, what are the risks that you see in what you're paying attention to. There's a lot going on.
- Yeah, so Kim, there are a lot of risks. You know, look, I've been doing this job a long time. My colleagues, we've been investing in markets for decades. But it's a very, very complicated time. If you think about coming out of the pandemic and where we are, there's some debate about people are done with COVID. Is COVID done with us? Well, we have to figure that out.
You know, inflation, as you mentioned, is a huge problem. That's being exacerbated by some issues in China and their zero COVID policy. Really shutting down major portions of major cities. Millions and millions of people, large chunks of their GDP. What's that going to do our supply chain? What does that do to inflationary pressures?
If you think about this horrible Russian invasion in Ukraine, what that's going to do to commodity prices, not just energy, but for food and materials. There's a lot of things to worry about. And I think right now, at this time, I think it's the sage advice we always give, and it's more important than ever, which is to be diversified, to be in quality, to understand your plan, to understand your objectives, and make sure you're sticking to that.
- So within that, I know that you, of course, and your team, with the Asset Allocation Committee, you take a look, obviously, at how you're positioning from a macro standpoint and what you see. I wouldn't mind running through some of that, if we could.
When it comes to equities right now, my understanding is that you're neutral on US equities. You're max overweight on Canadian. And then max underweight on international equities. So maybe this will go back to the top there. So tell me a bit about just your reasoning on the neutrality on US equities.
- Yeah, so Kim, I think, if you look at the United States, I mean, a very attractive equity market for the last number of years. Had an incredible move in 2021. If you look at 2022, the economy is strong, but it's pretty clear the Federal Reserve is indicating the same things that the Bank of Canada has indicated, and interest rates are going to go higher.
We know that growth is likely to slow in the US economy. We are going to reopen from COVID. We are going to see lots of demand for services. But a little bit of a slowing in the economy. Earnings growth won't be anything near as robust as it was last year. It'll slow down, probably in the mid-single digit range.
And overall, if you look at US stocks, I wouldn't say that they're a screaming bargain. They're certainly not anywhere near as high as they were a year ago. But I think from a valuation perspective, they're about fair. Lots of great companies in the US. But we're positioned in that neutral spot.
- On the Canadian, though, I think it's interesting, the very reason, perhaps, we're max overweight now is part of the reason that nobody liked Canadian equities a couple of years ago. Maybe I'm wrong. Tell me what you see here.
- Yeah, so I mean, it's this horrible circumstance around the invasion of Ukraine. It's really put a bid to commodity markets. And we all talk about energy and natural gas. But you also have to remember some of the other commodities. If we think about wheat and nickel, if you think about fertilizers, I mean, these are all things that Canada produces a lot of.
And so I think that not only the higher prices, but the demand from around the world. That's really, really going to help Canadian companies in those areas. Also, we're talking about higher rates around the world. And higher rates should, at the margin, help our Canadian financials, whether it's insurance companies or banks.
And so from that perspective, there's going to be winners and losers in this. And we do think Canada, relative, is going to be a pretty big winner. And we think it's a strong case for Canadian equities this year.
- And on the international equities, is this just a rising rates and risk off idea for the max underweight on international?
- Yeah, Kim, I think in part. But I think it's also a little more fundamentally driven. I mean, if you think about the major international markets. If you think about Europe, I mean, they're literally undergoing a war at the current time. That has to have an impact on GDP.
If you think about what that's going to do to their supply chain, slowing economic activity, pressure on corporate margins. So there's, I think, a real concern there. And then, if you go a little bit further into Asia and China, those concerns I talked about earlier, you know, big, big chunks of the population in GDP have been shut down effectively due to the zero-COVID policy. And I worry a little bit that the Chinese growth rate might be a bit ambitious this year at 5.5%, and it probably gets revised lower.
- I want to squeeze in the other assets really quickly, Dave. I've only got about 30 seconds. But alts and real estate, you've got at overweight. Fixed income, it's been a rough one. And you've got neutral, depending on the government side. Maybe just take us through quickly your thinking on those two.
- Yeah, so Kim, on fixed income, we have been underweight. And today, we've moved to a more neutral position. It's always hard to call the top, but you know, yields have moved a lot in domestic fixed income, whether it's US or Canada. Yields have gone from about 150 basis points to about 260, 270. That's an attractive yield. There might be a little bit more to go. So we've moved there to a more neutral position on domestic treasuries.
And on the alt side, I think this is a really important point. Our institutional investor base has really been on this theme for years and years and it continues. There's a lot of very attractive risk adjusted returns, whether it's in Canadian real estate, global real estate, or infrastructure. Many projects like wind farms, battery storage. If you think about solar, there's lots of really, really great stable long-life asset investments that are available there that our clients are really seeking.
- Good stuff, Dave. We'll talk to you soon. Thanks for taking the time to join us.
- Thanks very much, Kim.
[MUSIC PLAYING]
- The Bank of Canada just delivered a 50 basis point rate hike today. And that's the first time we've seen something like that from the Bank of Canada in decades. They are, of course, trying to battle what's happening with inflation. But that is only one of many things that are going on in the markets right now. Here to tell us what he is watching and get his reaction to what he was seeing is David Sykes. He is Chief Investment Officer at TD Asset Management. Dave, nice to see you
- Hi, Kim, how are you doing?
- I'm well. I almost caught myself when I was giving this intro. I was about to say 50 basis point cut, because I've just been saying that for so many years. I'm not used to when they do a 50 basis point hike. So maybe we just start with that. I know that you do more than just watch the news day to day, but it was a pretty material move that the Bank of Canada came out with today, and probably the first of the G7 central banks that are going to start doing the same thing.
- Yeah. So you're right, Kim. The Bank of Canada did increase the overnight rate today from 50 basis point to 1%. I guess the story is that they moved it a full 50 basis points in one meeting. But I think they did a really good job of telegraphing this. I think if you are a capital markets participant, this really wasn't a big surprise.
I think it was telegraphed quite well. And I think the message that was given from the bank was very clear. If you listen to the monetary policy report that Tiff Macklem gave this morning, he really said three things. He said, one, the Canadian economy is strong. We've actually recovered all the way from the pandemic.
Two, he's very clear that inflation is a problem. It's higher than they expected. It's at 5.7%. And it's also expected that it will stay higher for longer than they expected. And the third point that he made very clearly was that interest rates, the major tool that the bank has, are going higher. We'll see if the next few meetings are 50 basis point increments. But there's no doubt that interest rates in Canada at the short end are going higher.
- All right, well, let's talk a bit about what you're watching. I mean, he made mention, of course, of inflation. I think he also implied that a lot of the inflation was coming from outside of Canada. We're bringing it in. So when you look at everything that is going on right now, maybe you could just kind of let us know, what are the risks that you see in what you're paying attention to. There's a lot going on.
- Yeah, so Kim, there are a lot of risks. You know, look, I've been doing this job a long time. My colleagues, we've been investing in markets for decades. But it's a very, very complicated time. If you think about coming out of the pandemic and where we are, there's some debate about people are done with COVID. Is COVID done with us? Well, we have to figure that out.
You know, inflation, as you mentioned, is a huge problem. That's being exacerbated by some issues in China and their zero COVID policy. Really shutting down major portions of major cities. Millions and millions of people, large chunks of their GDP. What's that going to do our supply chain? What does that do to inflationary pressures?
If you think about this horrible Russian invasion in Ukraine, what that's going to do to commodity prices, not just energy, but for food and materials. There's a lot of things to worry about. And I think right now, at this time, I think it's the sage advice we always give, and it's more important than ever, which is to be diversified, to be in quality, to understand your plan, to understand your objectives, and make sure you're sticking to that.
- So within that, I know that you, of course, and your team, with the Asset Allocation Committee, you take a look, obviously, at how you're positioning from a macro standpoint and what you see. I wouldn't mind running through some of that, if we could.
When it comes to equities right now, my understanding is that you're neutral on US equities. You're max overweight on Canadian. And then max underweight on international equities. So maybe this will go back to the top there. So tell me a bit about just your reasoning on the neutrality on US equities.
- Yeah, so Kim, I think, if you look at the United States, I mean, a very attractive equity market for the last number of years. Had an incredible move in 2021. If you look at 2022, the economy is strong, but it's pretty clear the Federal Reserve is indicating the same things that the Bank of Canada has indicated, and interest rates are going to go higher.
We know that growth is likely to slow in the US economy. We are going to reopen from COVID. We are going to see lots of demand for services. But a little bit of a slowing in the economy. Earnings growth won't be anything near as robust as it was last year. It'll slow down, probably in the mid-single digit range.
And overall, if you look at US stocks, I wouldn't say that they're a screaming bargain. They're certainly not anywhere near as high as they were a year ago. But I think from a valuation perspective, they're about fair. Lots of great companies in the US. But we're positioned in that neutral spot.
- On the Canadian, though, I think it's interesting, the very reason, perhaps, we're max overweight now is part of the reason that nobody liked Canadian equities a couple of years ago. Maybe I'm wrong. Tell me what you see here.
- Yeah, so I mean, it's this horrible circumstance around the invasion of Ukraine. It's really put a bid to commodity markets. And we all talk about energy and natural gas. But you also have to remember some of the other commodities. If we think about wheat and nickel, if you think about fertilizers, I mean, these are all things that Canada produces a lot of.
And so I think that not only the higher prices, but the demand from around the world. That's really, really going to help Canadian companies in those areas. Also, we're talking about higher rates around the world. And higher rates should, at the margin, help our Canadian financials, whether it's insurance companies or banks.
And so from that perspective, there's going to be winners and losers in this. And we do think Canada, relative, is going to be a pretty big winner. And we think it's a strong case for Canadian equities this year.
- And on the international equities, is this just a rising rates and risk off idea for the max underweight on international?
- Yeah, Kim, I think in part. But I think it's also a little more fundamentally driven. I mean, if you think about the major international markets. If you think about Europe, I mean, they're literally undergoing a war at the current time. That has to have an impact on GDP.
If you think about what that's going to do to their supply chain, slowing economic activity, pressure on corporate margins. So there's, I think, a real concern there. And then, if you go a little bit further into Asia and China, those concerns I talked about earlier, you know, big, big chunks of the population in GDP have been shut down effectively due to the zero-COVID policy. And I worry a little bit that the Chinese growth rate might be a bit ambitious this year at 5.5%, and it probably gets revised lower.
- I want to squeeze in the other assets really quickly, Dave. I've only got about 30 seconds. But alts and real estate, you've got at overweight. Fixed income, it's been a rough one. And you've got neutral, depending on the government side. Maybe just take us through quickly your thinking on those two.
- Yeah, so Kim, on fixed income, we have been underweight. And today, we've moved to a more neutral position. It's always hard to call the top, but you know, yields have moved a lot in domestic fixed income, whether it's US or Canada. Yields have gone from about 150 basis points to about 260, 270. That's an attractive yield. There might be a little bit more to go. So we've moved there to a more neutral position on domestic treasuries.
And on the alt side, I think this is a really important point. Our institutional investor base has really been on this theme for years and years and it continues. There's a lot of very attractive risk adjusted returns, whether it's in Canadian real estate, global real estate, or infrastructure. Many projects like wind farms, battery storage. If you think about solar, there's lots of really, really great stable long-life asset investments that are available there that our clients are really seeking.
- Good stuff, Dave. We'll talk to you soon. Thanks for taking the time to join us.
- Thanks very much, Kim.
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