Kim Parlee speaks with Michael Craig, Head of Asset Allocation, TD Asset Management about the major market-moving news of the week, and the potential longer term implications.
Print Transcript
- It has been a very busy week in markets. Elections, Chinese property problems, and of course, the Fed. And it's only Wednesday. Here to help us sort through it all is Michael Craig. He is Head of Asset Allocation and Derivatives at TD Asset Management. Mike, thanks for joining us.
A lot to get through. Glad you're going to be able to help us through it. I want to start with the Fed. We saw that they basically teed up a taper. You know, talked that it could be happening by November, and talked about rate increases happening next year. What does that mean from your perspective?
- Two key things that came out of the Fed today. One is that tapering is likely to start in November, and the speed of tapering is quite a bit faster than investors thought. They look to be finished by mid-'22. So originally we were kind of thinking maybe $110 billion a month for 12 months, maybe finished by the end of the year. But it looks like they'll be finished by mid-2022.
The other thing is on the interest rate side, about half of the participants are looking for the first hike in 2022. One thing I'd say is that the dot plots are notoriously inaccurate for what actually happens. And so, I would look through that a little bit. And then longer term, they're looking for kind of peak terminal rate around 1.8% in 2024.
So again, quite a bit lower than what we've been seeing in the past. It's not surprising. So a lot to unpack today, but the beginning of the withdrawal of stimulus is coming.
- I have to say, I was a bit surprised not to see a bit more of a market reaction. I know we're coming off the heels of a big sell-off and a rebound. But-- and there was a reaction, it just wasn't quite as big as I thought it might be.
- I found the reaction actually quite confusing. The bond market flattened, so longer term yields rallied, which is not a growth positive indicator. So I thought that was quite interesting. And then the stock market had a nice rally, has been rallying all day, and kind of held its ground after the Fed. I don't think today's message was bullish for the stock market. I mean, this was not a dovish message whatsoever.
I think it would probably be in the more hawkish side. I would be interested to see how things open up tomorrow once investors have 24 hours or 12 hours to digest the news. I would expect a little bit of choppiness in the next few sessions.
- Well in fairness, there has been quite a bit to digest, as I alluded to. And we are coming off the heels of the news with Evergrande in China. And you know, what that could mean, for those who may not be familiar. Of course the Chinese, excuse me, property company having problems maintaining its bonds, being able to pay out to bondholders. Can you just give us some context about how big a deal this is from your perspective?
- Yeah. I mean Evergrande, its debts are about 1% of Chinese GDP. They owe about $300 billion. A large company, but they build about 3% of Chinese development. So it's not, within the grand scheme of things, they're certainly not the only game in town. They have succumbed to the classic problem that sometimes haunts real estate developers, where they have a lot of long-term assets. Mismatched a balance sheet, meaning they don't have good line up between their borrowings and their assets, and they come into a crunch where they don't have enough cash to fund current operations.
And that's kind of what's happened. This has been unfolding for months now, the bonds have traded at very, very distressed levels. And so they will be broken up, they'll be pieced off. This will be a wind down, et cetera. We don't really see this as a systematic risk. The bonds have been trading as low as $0.24 on the dollar, yesterday they had a little rally to $0.30 a day. They're trading on recovery. Equity holders will probably get wiped out.
But there is value there, it'll just have to be reorganized at a lower price. But in terms of systematic risk, Chinese stocks have actually been trading sideways for months, not a huge downdraft. Other kind of property developers have been soft, in more sympathy, but the overall markets held up well. And financing rates, if you look at CHIBOR, not a lot to see here in terms of overall tightening of financial conditions. So I don't see this as a systematic risk of anything, but it is certainly an indicator that growth is slowing in China. And this particular company has come to that.
- One thing that didn't make the list of things that people were watching at the beginning of the interview was inflation. And we're seeing more on supply chain issues really hitting some are calling a crisis-level record backlogs of cargo ships stuck off the California coast. You know, this has huge implications for retailers and manufacturers, we've been hearing car companies talking about having chips. How intense do you expect inflationary pressures to be over the next little while?
- It's hard to say. I mean, this is an ongoing theme of what we're dealing with. And that is demand has been juiced up by stimulus checks, and quite a bit of other large government transfers, et cetera. And lack of things to do, people aren't traveling nearly as much as they were, if it would have been two years ago. And COVID really wreaking havoc on supply chains. And it's a bit of whack-a-mole where one week it's chips, next week it's energy.
And so I just think we go through this period, I mean this is really one of the unintended consequences of COVID, and that's created chaos in our supply chains. Industry has incredibly adapted dealing with struggles. I would expect the supply chain issues to normalize into next year. A bigger challenge for us is what inflation looks like in the years ahead. I think inflation is one of those things, it's a very slow-moving train.
And you have to have a real longer term perspective on whether you think that aggregate demand will grow faster than aggregate supply, and what are the causes for that. And I think that is the bigger story for inflation. But it really is more of a decade thing, not so much how you trade markets in the short term. But there are-- it is going to be uncomfortable going into next year with higher inflation prints for sure.
- Let me ask, I've only got about 20 seconds here, Mike. But we're talking about the derivative impacts of COVID. We actually haven't even talked about COVID yet. So what is your take on what to watch for there?
- I think we're going to continue to see waves, although they are seeming to be less in severity. Markets I think, and people, have learned to start to live with this. I mean, I don't mean to make, the shock of COVID is waning as such. But I'd say there's two things that we're on the lookout for. One, terrible to think of a vaccine-resistant mutation of COVID. That would be a huge market shock, and it's certainly not a zero probability.
The second thing is to continue to watch hospitalization rates. Because that tends to lead to economic shutdowns. And so it's not so much the cases that matter as much, it's, getting COVID isn't fun. It's much more important to watch the severity of cases and whether you see hospitalizations ratchet up. And that will be the shock to earnings into '22. So that's typically where our focus is on COVID. That's an ongoing thing. And I'm looking forward to a day when it's not a pandemic, It's an endemic. But I don't think that's on the horizon quite yet.
- All right Michael, always great to have you with us. Thanks for the insight.
- My pleasure.
[MUSIC PLAYING]
A lot to get through. Glad you're going to be able to help us through it. I want to start with the Fed. We saw that they basically teed up a taper. You know, talked that it could be happening by November, and talked about rate increases happening next year. What does that mean from your perspective?
- Two key things that came out of the Fed today. One is that tapering is likely to start in November, and the speed of tapering is quite a bit faster than investors thought. They look to be finished by mid-'22. So originally we were kind of thinking maybe $110 billion a month for 12 months, maybe finished by the end of the year. But it looks like they'll be finished by mid-2022.
The other thing is on the interest rate side, about half of the participants are looking for the first hike in 2022. One thing I'd say is that the dot plots are notoriously inaccurate for what actually happens. And so, I would look through that a little bit. And then longer term, they're looking for kind of peak terminal rate around 1.8% in 2024.
So again, quite a bit lower than what we've been seeing in the past. It's not surprising. So a lot to unpack today, but the beginning of the withdrawal of stimulus is coming.
- I have to say, I was a bit surprised not to see a bit more of a market reaction. I know we're coming off the heels of a big sell-off and a rebound. But-- and there was a reaction, it just wasn't quite as big as I thought it might be.
- I found the reaction actually quite confusing. The bond market flattened, so longer term yields rallied, which is not a growth positive indicator. So I thought that was quite interesting. And then the stock market had a nice rally, has been rallying all day, and kind of held its ground after the Fed. I don't think today's message was bullish for the stock market. I mean, this was not a dovish message whatsoever.
I think it would probably be in the more hawkish side. I would be interested to see how things open up tomorrow once investors have 24 hours or 12 hours to digest the news. I would expect a little bit of choppiness in the next few sessions.
- Well in fairness, there has been quite a bit to digest, as I alluded to. And we are coming off the heels of the news with Evergrande in China. And you know, what that could mean, for those who may not be familiar. Of course the Chinese, excuse me, property company having problems maintaining its bonds, being able to pay out to bondholders. Can you just give us some context about how big a deal this is from your perspective?
- Yeah. I mean Evergrande, its debts are about 1% of Chinese GDP. They owe about $300 billion. A large company, but they build about 3% of Chinese development. So it's not, within the grand scheme of things, they're certainly not the only game in town. They have succumbed to the classic problem that sometimes haunts real estate developers, where they have a lot of long-term assets. Mismatched a balance sheet, meaning they don't have good line up between their borrowings and their assets, and they come into a crunch where they don't have enough cash to fund current operations.
And that's kind of what's happened. This has been unfolding for months now, the bonds have traded at very, very distressed levels. And so they will be broken up, they'll be pieced off. This will be a wind down, et cetera. We don't really see this as a systematic risk. The bonds have been trading as low as $0.24 on the dollar, yesterday they had a little rally to $0.30 a day. They're trading on recovery. Equity holders will probably get wiped out.
But there is value there, it'll just have to be reorganized at a lower price. But in terms of systematic risk, Chinese stocks have actually been trading sideways for months, not a huge downdraft. Other kind of property developers have been soft, in more sympathy, but the overall markets held up well. And financing rates, if you look at CHIBOR, not a lot to see here in terms of overall tightening of financial conditions. So I don't see this as a systematic risk of anything, but it is certainly an indicator that growth is slowing in China. And this particular company has come to that.
- One thing that didn't make the list of things that people were watching at the beginning of the interview was inflation. And we're seeing more on supply chain issues really hitting some are calling a crisis-level record backlogs of cargo ships stuck off the California coast. You know, this has huge implications for retailers and manufacturers, we've been hearing car companies talking about having chips. How intense do you expect inflationary pressures to be over the next little while?
- It's hard to say. I mean, this is an ongoing theme of what we're dealing with. And that is demand has been juiced up by stimulus checks, and quite a bit of other large government transfers, et cetera. And lack of things to do, people aren't traveling nearly as much as they were, if it would have been two years ago. And COVID really wreaking havoc on supply chains. And it's a bit of whack-a-mole where one week it's chips, next week it's energy.
And so I just think we go through this period, I mean this is really one of the unintended consequences of COVID, and that's created chaos in our supply chains. Industry has incredibly adapted dealing with struggles. I would expect the supply chain issues to normalize into next year. A bigger challenge for us is what inflation looks like in the years ahead. I think inflation is one of those things, it's a very slow-moving train.
And you have to have a real longer term perspective on whether you think that aggregate demand will grow faster than aggregate supply, and what are the causes for that. And I think that is the bigger story for inflation. But it really is more of a decade thing, not so much how you trade markets in the short term. But there are-- it is going to be uncomfortable going into next year with higher inflation prints for sure.
- Let me ask, I've only got about 20 seconds here, Mike. But we're talking about the derivative impacts of COVID. We actually haven't even talked about COVID yet. So what is your take on what to watch for there?
- I think we're going to continue to see waves, although they are seeming to be less in severity. Markets I think, and people, have learned to start to live with this. I mean, I don't mean to make, the shock of COVID is waning as such. But I'd say there's two things that we're on the lookout for. One, terrible to think of a vaccine-resistant mutation of COVID. That would be a huge market shock, and it's certainly not a zero probability.
The second thing is to continue to watch hospitalization rates. Because that tends to lead to economic shutdowns. And so it's not so much the cases that matter as much, it's, getting COVID isn't fun. It's much more important to watch the severity of cases and whether you see hospitalizations ratchet up. And that will be the shock to earnings into '22. So that's typically where our focus is on COVID. That's an ongoing thing. And I'm looking forward to a day when it's not a pandemic, It's an endemic. But I don't think that's on the horizon quite yet.
- All right Michael, always great to have you with us. Thanks for the insight.
- My pleasure.
[MUSIC PLAYING]