Equity markets unraveled in the last quarter of 2018, sending investors into panic mode. But almost just as quickly, markets have recovered most of those losses. So what gives? Kim Parlee speaks with Brad Simpson, Chief Wealth Strategist, TD Wealth, who says we need a new narrative to understand the reality of today and what that means for investors.
Hello, and welcome to the show. It's great to have you with us tonight. I'm Kim Parlee.
We all tend to have short memories these days, so let's take a quick look at what happened to the equity markets in the last year. The markets took a steep dive, but we're almost back to where things were before the big decline.
But here's the question. Has anything really changed fundamentally to warrant that recovery? Here with me tonight is Brad Simpson. He is Chief Wealth Strategist at TD Wealth, to talk about that. Great to have you with us.
Thank you. Good to be here.
So there's the question. I mean, we saw the chart. And we saw what happened. And it's like we still have issues with China. We still have Trump as the president and all that goes with that. If we take a look at some of the fundamentals in the economy, not much has changed. So what has changed?
I think maybe just the actual market itself has changed, and the dynamic how it works. I mean if we quickly looked at where we were, we ended out the year and basically 90% of all asset classes lost money, really right across the board. And then you-- we just penned an article that we're going to publish in a couple days. And I call it "Fast and Furious."
So oh, no, we're-- are we in the middle of a big correction? Do we have a secular bear market? Then here we are, four weeks later, and well, all that's off and we're back again.
And so I think when you try to come to terms with this, we always try to put some sort of traditional kind of argument around, well, the market was this. And it's turned around. And it turned around because of valuations. But I think that's ignoring an awful lot of changes that have happened in the world over the last 30 years. And particularly, the last 10 that has brought us to where we are today.
So what are some of those changes? So, I mean, I will say that I think it's human nature to kind of look at the rules that governed us in the past to understand what's going on in the future. But you're saying, OK, things have changed past 10 years. What are they?
Look, when I started working in 1991, I was at a trading desk. We would sit there and we'd be kind of playing cards. And then the phone would ring. And somebody would go, we want $1 million of a block of, say, bank stock. And we'd, ah! We'd get on the phone, push button phone, and we'd phone and make an order for that.
So here we are 30 years later. You want to do that? You just push a button and it's done. And so that change of the rate that you do things is that sort of the story that we had coming to the end of '18 was, well, big correction. Kind of Christmas Eve, markets globally got to really the valuation levels where really kind of stern, thoughtful people would look at valuations and go, now I'm going to start purchasing.
And I think it would be closer to the truth-- if you kind of look at what happened during that time-- is the reality is the marketplace has changed in, I think, pretty four significant ways.
Right? So first and foremost is we have this thing called an ETF now. And it's not a negative thing. It's just a game changer. You have $5 trillion in assets in it. You have it spliced almost any way you want to look at, from traditional markets to lifestyles to whatever it is you want to do.
Stocks that went IPO on a Tuesday.
Exactly. So, you know, back in the day if you were going to change it, if you were going to buy a fund, the market closes. Its end of the day, they price it, then you go purchase it. Or you're going to buy a block of shares, you work it for a while till you find it. Now, I can swing billions of dollars either way, through any myriad of ETFs in any way possible that I want to be able to do so. So there's your kind of first check mark, right?
Then, your second one is all of a sudden, there's this thing called algos. So think about it, the same process, if you're working on Facebook or do a Google search, it's something based on somebody from the Silicon Valley who makes their way to Wall Street or Bay Street and then write code. If this is true, then buy or sell this at this rate or price.
And so that element is that there were times where in the past, when you'd see a market correction, the market starts to fall. Market closes. Everybody soberly kind of looks at it. Today, we kind of defy gravity. So you can have the market making one big run one way. And then, all of a sudden, the keystrokes kick in and say, now that this is true, and all of a sudden, it defies gravity and it runs the other way. Right?
And your third input is, you know, back in the day when the market did close after a really ugly day, well, kind of investment banks would come in and they would look at it in terms and say, well, we're going to start investing now at these sort of valuations. Well, they don't do that anymore.
Change in regulation.
Expensive for them.
Yeah. So then you go, well, then who are the liquidity providers, then? Well, it's really the algos are the liquidity providers. So the question really comes back to where we've been for, in many ways, the last 10 years of going, well, what decision is the Fed going to make with how much money will go through this pipeline? And so this trying to put, I think in the short term, sort of a fundamental narrative that we're so used to making? I think it applies very little today. In the short term, anyway.
Let me ask you. So I know we're going to get into-- when you take a look at your themes for your investment strategy. We're going to get into that in just a couple of minutes. I'll let people know. But what does this mean, those forces in the market? What does that mean for an investor today then? How do you navigate that?
Well, I think the first and foremost is that what I think what investors need to be able to do is that markets are so much today driven on a narrative. So I think you have to get your short-term narrative right. So if you're looking at your investment portfolio and it's moving really erratically, in many ways you have to just think and know this is just a massive amount of noise, and in the short term the market works more and more every year more like a casino, because of the design of the way it works today.
The second part is that I'm not saying that fundamentals don't matter-- they matter a lot-- but they matter a lot over the longer term. Still allocating capital based on a thoughtful way of thinking about discount to cash flow and what do the earnings look like, all those are really important. But if you're trying to put that into the context of when you see the sort of volatility we see sometimes, I think it's more, in many ways, you need to ignore it.
Now I think to also look at it is that, for the most part, wealth and retail type of investors, they're not the ones who are erratic anymore. I think they're actually more disciplined than many of really these algos and rhythms that they're out there doing, right? So I think that's a really interesting change in the marketplace, too.
You said that you've got ETFs, algos, banks, and liquidity all affecting really what is the craziness we see in the short term.
But you've got some themes that you have put together when taking a look at your, I'll say, longer-term investment strategy.
Sure. So my themes-- I'm on the wealth asset allocation committee, where every month we define themes for what we think is going out, say, 18 to 24 months. And so we had a couple new themes starting on February 1.
So first theme, which was second wind. It's really this idea that we were pretty cautious through much of '18. And '19 was really, the second wind was the idea that much is starting to transpire that would suggest that equity markets are going to have a second wind. And valuations, if you could look right across the board, from Canadian markets, global markets, emerging markets, we would all kind of put them at a undervalued level. We would put a US market at a fair value. And so in terms of evaluation part of, anyways, it bodes pretty well from here.
And do you think-- I was going to say, is that including the bounce back we've had since the sell-off before?
Yeah, absolutely. This was at the end of February, but it was still in-- I mean, today, valuations are still really good. S&P today, I know for the chartists out there, closed above the 200-moving-day average. So those folks are pretty excited about that, too. But the valuations are still very good.
Second one here is yearning for yield.
I think if we learned a lesson in 2018 was that the world has an awful-- the financial market has an awful hard time with a 10-year US Treasury at 3.5%. So this idea of people looking for investments for a better yield are running away from low interest rates. I mean, this is a theme that's still very much in place, and lower for longer is still in place.
You've got a new theme here as well, due credit. What is this?
If you wanted to look at late, in '18, a real positive was credit spreads for investment grade and high yield versus government. And for us, that's one of the key things we watch. Spreads between those broke out a little bit, but they didn't break out too much. And so by doing that, one, it said the credit market actually is still pretty strong. Secondly, it kind of changed valuations. So we were both neutral investment grade and high yield, and now we're overweight. And that's what, the due credit is that there actually is some pretty significant credit opportunities today.
Number four here is estranged. This isn't a relationship thing.
Well, it is a relationship thing, but really it's about trade relations. And let's face it, it comes down to trade relations between the US and China. So I think we would be kind of in the camp that this is a long-term story, much of it, the Made in China 2025--
It's not going to all come together by March 1?
--the technology. No. I think we would be in the camp that the $200 million and next tariff is kind of-- or a billion in tariffs are in play right now, and there will probably be some resolution on both sides as almost like a trade armistice, if you will. But this certainly has a long way to go, and estranged is very much a theme that's still in play.
Your final one here is bad moon rising.
Right. And bad moon rising really is that we went through of an exceptional period of no volatility through much of '16, '17. And '18 kind of, almost by plan, I would say, from the Federal Reserve Board's point of view was that we want to normalize the marketplace, and volatility is a normal part of the market. So bad moon rising is that every once in a while we're going to have these bouts of volatility, and A, to be able to manage and prepare for that, and also actually be pretty happy about it, because that is a far more normalized market and a real healthy thing.
I know you said you've got a note coming out soon titled "Fast and Furious". And just to kind build a little bit on the bad moon rising and the volatility of the market, as an investor, how do you think you prepare for that kind of stuff? Because you can tell me, there's going to be volatility. I'm like academically, intellectually I get this new volatility, and then I see it and my stomach drops.
Well, I think the starting point for that is the more you know about yourself along those lines is probably the right start, right? Your notions and understanding of what risk is and how you handle that is probably the greatest start, and then you can build an investment portfolio--
What do you mean by that?
--based on that. Well, meaning that it's fine to say, well, just have a long-term time horizon, but if you're in bouts of volatility and you just are uncomfortable with it, you can build investment portfolios that can reduce that sort of volatility. Investments don't just have to be made in things which way a stock market go or which way interest rates go. So there are hedging strategies that you can add into your investment portfolio. You can look at investments that are private investments and real estate and mortgage market and debt markets that aren't trading in the open market every day.
So I know for us, a big component of our way of looking at things is we actually think that true diversification, the starting point is your asset allocation and this element of risk diversification that we're always talking about, but also is you and your behavior. So we've built all kinds of quantitative tools where we try to uncover working with you, your blind spots as an investor and what are the things that are going to potentially trip you up, and try to answer some of those questions.
Why do some of us consistently go out and buy high and sell low? Well, some of us are more inclined to look that way. Why are some of us glued to all the bad news in a newspaper and it changes the way we think, where others kind of read it and look at it in context and move on? A lot of those things are hard wired in who we are as people, which impacts who we are as an investor.
So something to look at. I know that's something you work with a lot of your high net worth group on. Brad, It's always a pleasure. Will you come back?
Absolutely. Thank you.