Bulls vs. bears: Why divergent market views may suggest more volatility ahead

The widely divergent views on where the markets are headed may spell more volatility ahead for investors this year. That according to our featured guest today, Michael Craig, head of asset allocation at TD Asset Management. Michael, great to have you back on the program.

Great to be here.

Great to get your thoughts on the year. We're happy to-- I'm not even saying the name of last year anymore. It's like, it's behind us.

Yeah.

As we look forward to this year, though, we could be forgiven for maybe saying, oh, I hope everything's good, the all clear. But we still got some proper chop ahead?

Well, yeah. I mean, the markets have already kind of discounted a degree of economic calamity this year. Stocks are well off their highs. Bonds had a really miserable year in 2022.

And that's already-- that's kind of preceding what will likely be the real economy this year, and data is showing that we're seeing continued slowdown across various indicators in terms of activity. So that's fine. In terms of this year, I'd say there is a pretty-- I mean, the question right now that is, I think, on top of most people's minds is that it's the bond market versus the central banks. And the bond market is pricing in cuts in the second half this year, and the central banks are still in very much hike mode and are looking to hike more. And I think this is where the battle will be. This is where you're going to-- this will drive a lot of volatility because if for either side to kind of win on this or be correct will have major implications for other asset classes.

Does that spell volatility in the sense that then every data point that we get in where an investor may say, well, this will mean this, so therefore this, or this will mean that, so therefore that, you get these swings?

Hypersensitivity to each data point, which is actually kind of crazy because half the time, they get revised anyway. It's really about the trend of economic data. Economies tend to trend.

There's a lot of momentum. And so a data point might miss modestly, but the overall direction is lower. But the market, you get a big reaction.

Last week, you had a deluge of fairly negative data. Jobs numbers were OK, and both the bond and stock markets were euphoric. And that's the kind of-- at the end of the day, poor economic data shouldn't necessarily be positive for risk assets.

And I don't think the central banks are actually looking at that growth that in terms of their decisions on cutting. So-- but you get these overshoots in the market. And I think in any given day, people will try to explain things away about why it's happening. And I just think you have to step back and look at that kind of the broader, longer term, minimum couple of quarter picture and a short term horizon and a longer term to get a sense of what to do.

So you talk about the bond market not fully believing the central banks and the Fed in terms of what they've been saying about what they want to do with rates and how long they want to keep them there. What about when you take a look at the bulls and the bears, say, for the S&P 500? I think this is a pretty wide divergence, you were telling me before, between where the bulls and the bears think we're going to end up too.

You know, and it's one of those things-- not to sound like a two-handed strategist, but they both could be right. And what I mean by that is when you look at the actual S&P and you take out the kind of mega-cap top six names, the market's now only 7% below its highs. You know, it's been a pretty material recovery in the smaller companies. And where you continue to see a lot of pressure-- not so much today but a lot of pressure-- is in things that had kind of gone stratospheric and are still kind of deflating.

And so you've got your mega-cap tech on one side, but then you've got other parts of the stock market that have done quite well. Energy did very well last year. Health care did fine last year. And so it's more of a stock picker's market. It's a world where you've got a lot of confluences, and there will be certain asset classes that are going to be in a prolonged bear market and some where actually, things don't look so bad and you probably do OK over the next couple of years because valuations are-- in certain areas are actually quite attractive.

After the year that we had-- I'm still not naming the year, but the year behind us that we had all the volatility we saw, some portfolios obviously didn't perform the way investors wanted them to. Is the sentiment-- you don't have to look far. If you want someone to reinforce your negative viewpoint and your negative sentiment, you don't have to look far. Is that a little bit overdone at this stage?

Yeah, but I think with sentiment-- you know, in a bull market or in a market that's fine, it's really important because it's a very good short term measure. When you're in a bear market recession, like, it tends to be bad, and it's not really a contra-indicator because-- actually a lagging indicator. So on a given day, if you're trading around, sentiment's important. I'd be a little bit more wary about getting too contrarian right now because people are bitter or not happy.

I mean, you look at CIO surveys-- sorry-- CEO surveys. Quite bearish right now. Hiring intentions are quite low.

But a lot of the soft data is telling you that the people are quite negative. The hard data is not really reflecting that. Unemployment's still quite strong, for example.

So again, there's a lot of cross-currents right now. You got to step back and look at we have these major economic forces at play, high levels of debt-- very, very much more higher cost of borrowing. Ultimately, that's going to drive economic progress in the medium term. And I think those are two things that you have to watch for and be mindful of that that's going to be driving things for some time. And that's where the risk is, in our opinion.

So obviously, you sharpen your pencil. You take a look at opportunities in the equity space. What about fixed income?

Because that was a tough year as well because the central banks are so aggressive with the super sized rate hikes. That was not good for the bond portfolio. Could we be in a situation this year where there's some opportunity there?

We think so, yeah. I mean, last year was one of total misery in fixed income land. I think ultimately, in terms of inflation, there is some aspects that are transitory, but it's just-- no one ever defined what transitory was, whether it was a month, a quarter, or two years. And what's interesting right now is when you look at the market, the expectations for inflation, there are actually-- the traders in the market that trade based off inflation data are actually looking for inflation sub 2% by June, which is actually-- people don't realize it.

That's pretty aggressive.

That's very aggressive. If that is remotely accurate, then the bond market provides relatively interesting value. We have been in an era of financial repression where bond yields had been well below inflation or just touching it now. We're in an era where they're still below headline inflation. But expectations of inflation, it's actually yields are much, much above.

And so right now, anyone who tells you this is what's going to happen this year, you know, forget it. Like, you've got to be open to a pretty wide range of outcomes and think about, almost in your head, war game what you'd want to do in each of those outcomes. Our approach right now is we can step back a bit, hold duration-- or in fixed income, earn yields that are higher than they've been for a long time, and see how things play out a bit before we get committed to risk again, if you will. And like I said, I think there are places where equities do OK. But I would have a higher conviction in the fixed income markets right now, not so much the belly but certainly the long end where we think inflation will moderate this year.

Given the fact that we're not out of the woods yet and we could have some volatility, you talked about duration. Is it really about your timeline for what you want to do here? If you're-- you're probably not expecting great things in short order, that there's going to be some chop.

Yeah, by definition, equities provide far better value today than they did a year ago. And you should always be looking at equities as a source of long term wealth creation, not as something to trade around over-- you know people do trade in and out. That's fine.

It's a really hard way to make a living. I've done it before in a previous role. But if you're thinking about in a five year horizon, there are certainly areas of the equity market that I think you look back in five years, three to five years, and say, yeah, that worked out quite well. And so that area, over the next 12 months, we might be flat, right?

Might not go anywhere with a lot of volatility. But that's ultimately how I would think about it right now. They are not nearly as vulnerable as they were 12 months ago.

I think in some of the growthier parts of the market, if you don't see earnings-- for growth of your stocks that have no earnings, there's still, I think, a bit of risk there. But other parts of the market where you get companies making good money, yeah, it's not a bad time to start looking at that. But you've got to have a view of over, you know, three years.