Investors could be facing more stock swings in the days ahead. Does your portfolio have the right risk management approach for heightened volatility? Kim Parlee talks with Bruce Cooper, CEO and Chief Investment Officer, TD Asset Management about investment strategy in periods of market turmoil.
Yeah, I think the first factor, I would say, would be decelerating global growth. And if I think of the three big blocks in the world-- you've got Europe, you've got Asia led by China, and then you've got North America-- Europe has for sure decelerated and probably started to do that 6, 9, 12 months ago, even. And the data there has been pretty patchy.
And of course, the politics continue to be pretty challenging. Think about Brexit, the French protests, think about Italy. So Europe, I think, has for sure slowed.
We would say in China, the economy is also probably a little weaker than the headline numbers would suggest. The Chinese government will always say we're growing at 6 and 1/2%. But when we look at some of the data underneath the hood, it appears to us that that's also growing a little slower.
The US, of course, has been the good news story, really, for all of 2018 from an economic perspective. And I think, still, the economy is OK, but we're seeing signs there that it's slowing a little bit also. To me, that's most evident in the housing market, where a lot of the data peaked kind of 9 to 12 months ago.
So I've often used the analogy of a car. We were in fourth gear, and now we're in third gear, or second gear, or something like that. We're still going forward. We're just going forward more slowly than we were, let's say, 9 or 12 months ago.
We're not in the R gear, which is reverse or recession, are we?
Correct. Exactly, exactly. We're not in recession today for sure. And our view is we're not headed for a recession. We don't have a perfect crystal ball on recessions. Nobody does.
But there's a variety of indicators we follow. And most of those would suggest to us that growth is decelerating, but that we're not entering recession.
So economic growth, I know, was one thing that you looked at for volatility or concerns about it. Second one was central banks.
Yeah, central banks-- right from the beginning of the year, we said a key theme this year was going to be that central banks were pivoting from emergency to neutral. And obviously, that's been happening all year. We've seen the Fed raise rates. We've seen the Bank of Canada raise rates, the European Central Bank.
Of course, still stuck on more or less zero, but have talked about ending their quantitative easing program. So on balance, the monetary backdrop is tightening. Of course, from a historic perspective, we're still at very low rates.
But what's striking to me is that even though rates are low-- let's say Fed funds at 2% or the 10-year bond in the US somewhere around 3-- even though we're at those low levels, rates are having an impact. I talked about housing earlier. Mortgage rates in the US are 5%. That's already having the impact of slowing the housing market a little bit. We're seeing companies with weaker balance sheets experience stress. GE would be an example of that.
Spreads on high yield and investment grade bonds are widening out a little bit. Higher rates are causing P/E multiples to come down, which is kind of a normal relationship. But we've seen the P/E multiple in the US and Canada contract by two or three points this year. So I think higher interest rates are certainly having an impact.
We are seeing, to your point, that interest rate increases are starting to take in the economy. But we're also seeing, at the same time, it looks as though that the US Fed and the Bank of Canada are maybe slowing down the rate of increases too, because of concerns about growth.
That's right. And I think those two things are actually connected. So we've gotten to a point now where monetary policy is no longer accommodative. Maybe it's around neutral. I think in the housing markets it's a mild headwind.
And to the extent the central banks were trying to slow growth from kind of above trend levels to maybe back to trend, it makes sense to me that they're, if not going to pause, maybe they're going to slow down over the course of 2019. So we'll get maybe fewer rate hikes than we expected. And we're probably closer to the end than the beginning. And to be honest, we've been pretty consistent in our views that we believe in a lower for longer interest rate environment.
And this year, interestingly, the 10-year yield hasn't moved a lot. Overnight rates have moved up. The central banks have raised rates. But 10-year yields are actually down 50 or 60 basis points now from where they were six, eight weeks ago, and haven't moved a heck of a lot all year.
The third thing you talk about with regards to volatility-- and again, this goes back to the headlines-- is just trade. Are people getting along or aren't they? And what's your sense-- beyond the day-to-day, where do you see the US/China--
Yeah, I think this is a challenging situation. So in my mind, this is different than, say, NAFTA, where we had a lot of noise from President Trump, for example, NAFTA worst deal ever. And then magically, the deal is resolved and you get NAFTA 2.0.
And when you look under the covers, you see there actually wasn't that much changed from NAFTA 1.0 to NAFTA 2.0. The name is changed. So some people think, well, that demonstrates that he can turn a dime, which is possible.
But I think there are differences between, say, the NAFTA situation and the US/China situation. I think the differences between the US perspective and the Chinese perspective are more stark here. In other words, there are real concerns on the US side about some of the practices that we're seeing in China.
And obviously, technology transfer, respect for patents, that sort of thing, is very central. I think technology is hugely important here. The US, as we all know, is the global leader in technology today. They would be very keen to preserve that position.
China believes that in order to grow its economy longer term, it needs to move up the value chain and develop its technology industry. And so you have got a bit of a challenge, a tension between the two sides. I think fundamentally, these issues are challenging to resolve. And I think it's going to be pretty tough to get there by March 1.
So look, I don't have a crystal ball. And by their nature, these are human negotiations. Anything can happen. But I think within the realm of possibility is that we don't get it all resolved by March 1. Our kind of core theme has been that we expect trade frictions between the US and China to be persistent for many years to come. And I think that's the most likely scenario.
So what does this all mean for markets? And I don't want to just focus on equities. But tell me what your outlook is, because it paints-- it's not a comfortable picture. There's more volatility ahead.
Yeah. So let me make a couple of points. First, starting on the fixed income side, we have been lower for longer. We don't see a big backup in interest rates. And we think the most likely scenario is you get kind of coupon-like returns for the fixed income part of your portfolio.
If you went back three or six months, a lot of people were worried they were going to lose a lot of money in their bond side. So actually, I think that's an area of comfort. Bonds should continue to provide some level of diversification, modest level of income, modest level of returns. We would figure that in kind of the low single digits.
On the equity side, a lot of the headwinds we've been discussing means that in the near term, let's say the next 6, 9, 12 months, it's going to be hard for equities to make enormous headway. On the other hand, I don't see enormous downside risk either.
Look, the economy is slowing, but it's not in recession. I think the US economy is quite resilient. I don't see the kind of massive imbalances that preceded the two previous crises.
In the last crisis, obviously, housing got extremely expensive. There was overinvestment in housing. That infected the banking system-- terrible situation. Previous crisis was massive overinvestment in technology and telecom.
I don't see an analogy to that today. And so I see us downshifting to more trend kind of growth levels. Companies are generating substantial free cash flow. Valuations which were a bit higher in the year are now kind of more normal.
So I think we're kind of protected on the downside. But it's hard to make much upside in the next 12 months. So we're just kind of in this trading range.
The way I think of this is on the equity side, companies can pay good dividends and grow their dividends over time, which is very, very central to the way we've always run equities at TD Asset Management-- continues to be a phenomenal strategy. You're collecting your dividends along the way. As the dividends grow, it protects you against inflation, and the stock should follow it higher over time. So I think that core approach is very helpful.
From an asset allocation perspective, we've been broadly neutral, meaning we want people to have their normal mix between stocks and bonds, whatever that might be. Of course, that's going to vary depending on your age, and risk tolerance, and that sort of thing. I think if you're a kind of normal mix, if we do get a downdraft in equities, you've got that dry powder. You can buy more. And so we want people to have a bit of flexibility built into their asset allocations so they can take advantage of the volatility.
And then I guess a third piece on the equity side-- we've got strategies that are specifically targeted to helping manage this kind of volatile environment. I'm thinking about low volatility equities. For example, risk-managed equities, the retirement portfolios. These are strategies that are meant to create a smoother ride for our clients. I think this is exactly the kind of environment that we thought about when we brought those out. And so I think that all these different pieces are how I would think about constructing a portfolio in the current environment.
Bruce, thanks very much.
Great to be here.