The Dow Jones Industrial Average saw its worst December performance since the Great Depression. But stocks have bounced back and the markets have recovered nearly all of their losses. Is there more room to run? Kim Parlee speaks with Michael Craig, senior portfolio Manager at TD Asset Management.
Hello, and welcome to the show. If you had embarked on a trip to sail around the world three months ago, and you were happily at sea not checking the news, and you came home today and checked the markets, you'd be like, oh. Oh, wow. Nothing to see. When in fact, the markets have been in steep drops and rallies.
Joining me tonight to make sense of just what has been going on is Michael Craig. He's senior portfolio manager at TD Asset Management.
And we're going to kick things off with the Fed. I mean, that is the amazing thing, which we'll talk about. I mean, we're really pretty much back where we started. But oh, my gosh. What a ride over the past few months. The minutes came out from the Fed. That's been part of the reason we've seen such a ride. What came out today that was of note to you in terms of what they said?
I think it was a confirmation of a few things. First off, I think we're going to see the end of quantitative tightening this year. So the Fed has been slowly running off their balance sheet, which expanded during the financial crisis and over in the past 10 years. They've been draining that and releasing bonds back into the market, which had led to tighter financial conditions. You've pretty much got most Fed governors on side now to end that this year, which is a year early. It was scheduled to end in 2020. So that's been a confirmation of a fairly market positive signal.
The second thing is as far as future hikes-- so we were talking back in October, I think. And the markets are still pricing in four this year. We're down to zero in the US and half in Canada. And within the Fed governors, I would say it's about a 50/50 split for one more hike. So you got about a 50% chance of another hike this year. I would take the under and expect no hikes this year. So we've really gone from a restrictive for a policy was moving towards restrictive to policy now that's going neutral.
What happened? How does that happen?
I think the Fed blinked. I think the markets started to riot because of tighter conditions. Powell had come in and was seen as somewhat of a new type of Fed chairman. People thought he'd be quite different than Bernanke, Yellen, Greenspan. And what we found is that after a bit of stress in the markets which started feeding through to economic data, the Fed capitulated. And they've done about a 180 and now have really talked back a lot of tightening.
So it's the world we live in. We're in a world of assets that are inflated one way, whether you look at real estate, stocks, et cetera. But that's the world we are in. And ultimately it's we're reliant on loose credit conditions, too, to see positive returns.
Let me ask you. One thing, I was actually speaking with one of your colleagues today, and we were talking about just how the market is reacting to the Fed. And it feels to me as though the volatility that comes from Fed moves or minutes or comments or things like that are much more amplified than they used to be. You know, it's always been important. It's one of the most important things for equity markets. But it feels as though as we are much more reactive now.
I would agree with that. I mean, the Fed-- ultimately, credit conditions and credit excesses are what we kind of thought of as far as inflation in the previous century as being the boogeyman. The boogeyman today is misallocation of capital through excess credit conditions, or easy credit conditions.
And so we look at credit very closely. We look at excess credit growth. We always are warning signs-- so 2015, you saw that with shale oil sands. In 2004, you saw it within the telecom sector, excess fiber optic. And in 2007, it was much more dramatic with housing.
Today, I think the Fed was probably pulling it back. But we don't really see a ton of excess credit growth elsewhere. So there's really no need for the Fed to be excess hawkish. Or they are going on a playbook, I think, that is somewhat out of date, if you will.
How are you feeling about growth? I mean, because I know one of the big things-- that if you take a look at credit cycles, when credit gets tightened too much, then growth tends to fall off a cliff. I mean, so does this sound-- the Fed is talking about being patient right now. Looks like they're watching the data more than they have to. But any concerns about growth recession?
So I think this year we'll see a growth slowdown. And I think that's, broadly speaking, been priced into the market. That's not an aggressive view. A recession is-- I wouldn't say it's not possible, but it would be very much a tail case, low probability, high impact event. Something we'll watch for. But I don't see a recession this year. I just don't think there's excesses built up. But the biggest risk to recession was excess Fed tightening. That's off the table now. And I think we should see a pretty decent year in equity markets.
What about China? I mean, we've had-- the Chinese economy's slowing. We've got the trade wars, whether they're full fledged or not, partial. What impact are you seeing there? And what are you expecting to see the Chinese government and central bank doing to help their economy along?
So if you think about, if you're a US or Canadian equity holder, you had a tough 2018. If you were a Chinese investor, invested in Chinese equities, you would trade the experience of a North American investor in a heartbeat. It was far harder on Chinese or emerging market assets in 2018.
I think this is one of those cases where it's still fairly pessimistic. The growth indicators are weak in China. And that's fully priced. This is the part of time, I think, it does make sense to look at emerging markets as perhaps an allocation in your portfolio. You want to buy when things are at a trough, and I think we're at that right now. So I think about if I really wanted to get more aggressive, EM assets likely have a bit more upside than developed assets this year.
I want to bring up a chart that you brought in. And this is taking a look at financial conditions in the US compared to China. Why is this interesting?
So there is an old market adage, don't fight the Fed. The Fed's easing. You want to own risk. When they're tightening, you've got to be careful. This chart shows-- I think 2019, I think could change a little bit. On the blue line is the Fed, kind of some of the financial conditions in the US. And the white line is in China.
And so there's two things here that's important. One is that financial conditions have done a U-turn since December. They've gotten quite easier in the US. Credit has rallied. It's a lot easier to get money.
But what's different today is that in China, we measure credit growth by a term called total social financing. It's an aggregate of all kinds of different types of credit growth in China. And they are pushing on the gas. They're really, really juicing up their economy. There's a ton of credit flowing in China. You're not seeing in the economic data yet. But anytime you have a mass of capital going and credit growth increasing, that tends to be very bullish for equities.
Is that the opposite of what we had heard earlier? Was there a pullback in terms of central bank conditions or the shutting down of different kinds of financing before?
So for different reasons, in the US for the last few years, you've had tighter conditions. You know, balance sheet, QT, et cetera. In China, there's been a tremendous crackdown on-- call it shadow financing.
So forms of credit that the government didn't like, they're just ultimately destabilizing in. And also the anti-corruption campaign. So you've had kind of these policies that have, probably for the long term are good, but near term have really choked out Chinese growth. And so that's reversing now. Now you're getting the credit taps running quite hot, very, very strong tailwinds to risk assets.
So if someone's listening to this and saying, OK, this sounds great then for equities. I mean, if you've got money coming into the markets, that's what juiced the markets for the past decade. Are we going to run into that again?
I mean, look, I wouldn't say this for the next five years, but certainly for the next 12 months, I think you have a pretty sanguine backdrop. We like US equities. We like emerging market equities. Pretty supportive of Canadian equities, actually. If you think--
Well, one of the reasons is this is-- generally speaking, this is reflation. And when you get reflationary impulses, it's pretty good for commodities. And so with the TSX being somewhat commodity dependent, it should be pretty-- and also valuations pretty cheap in Canada. Like TSX valuations are very, very inexpensive.
A good backdrop for the TSX, as well. We are a little bit lukewarm, if you will, on Europe only because still kind of a political Gong Show. Certainly had the Brexit negotiations that are clouding things. Populism is making a very strong case in Europe, but not a great investing backdrop. And the ECB is kind of stuck between a rock and a hard place.
They're actually moving towards tighter policy. They've ended their quantitative easing. And they were talking about rate hikes this year. I don't know that's going to happen. But ultimately, it's just not a great backdrop for European assets at the moment, relatively speaking.
I want to talk a bit about just Canada, because you talk about the reflationary trade. And again, I know you're coming at it from a macro standpoint. So you have, obviously commodities more interesting in that kind of environment. But at the same time, there's lots of politics going on in Canada. I mean, you've got a government buying into a pipeline. You got the stranded oil sector with-- I mean, how, from a macro standpoint, do those kinds of issues affect the attractiveness of the Canadian market?
It's always darkest before dawn, if you will. The backdrop is not great right now. Don't get me wrong. And that's why I kind of prefaced my remarks by saying--
--looks great. For this to be something sustainable for a five-year period, you need to start seeing capital deployed in our country and portfolio capital starting to move back into Canada making investments. That isn't really happening, quite frankly. But that's an issue for a long-term capital allocation, call it five years. But you are starting from a point where very cheap valuations, a very good mix of companies, whether it be energy, base metals, or precious metals. And those areas should do OK this year in a reflationary environment.
Let me ask about gold. Because that's something, obviously, was a lot more important in the Canadian market years ago than it has been lately. What are your thoughts on it right now?
So gold's an interesting asset. It doesn't always-- there's no kind of hard and fast rule for gold. People who've looked at gold for many years always think of it as an inflation hedge. There's other been reasons as far as excess monetary policy. I would say that there is some interesting things developing in the US. There is some debate about as far as their inflation targeting regime. We always thought about the 2% is the magic target.
And now there is debate in the US about average inflation. What the idea is, if you're below your target for a long period of time, then it's OK to be above your target for a long period of time and taking an average of the two. That is very stimulative. And this is much very much inflationary. I'm not saying we're going to go to 5%. But that is very much a tailwind for gold.
And so I think that in this environment, gold makes an interesting portfolio decision, interesting asset class. It's rallied a little bit lately, so be a little cautious because we are off the lows. But gold equities still trade quite cheap. And it's one of those things where this is a bit more for those who have a higher risk tolerance, but something to think about going forward.
What about volatility as well? I mean, we had December. Not a great month. And then, as I said, we're kind back up to where we were. So still doesn't feel good, by the way, even though that happened December. Are you expecting to see more of these kind of deep sell-offs and waves over the next little while?
So it's important to think, markets are a social exercise. We're all people. We're conditioned to markets. The challenge is volatility these days versus 20 years ago. Back in the '90s, volatility was high, but it was very consistently high. Today, vol goes through periods where it's very boring and then it's chaos. It's like flying an airplane. You take off--
I don't want to fly in the plane--
There's a lot of work. But during the flight, it's usually generally pretty smooth. Right now, vol was very high last year. It's collapsed since then. It will rise again. Don't get me wrong. But for the time being, when you have this policy response, easier financial conditions, I don't expect vol to be terribly exciting this year. In fact, if anything, you'd probably see vol falling, going back to periods we saw back in 2017.
It could change. If the Donald tomorrow trumps that all bets are off, and I'm imposing 25% tariffs on Chinese goods, you can just forget about everything I've said. But I don't expect that to happen. And so therefore, you're kind of setting up for a pretty sanguine environment.
And I think probably the market's getting a little more conditioned to these hard dates that the president puts in place tend to be moving targets, as a gentle way of putting it. So the loonie. Where do you see the loonie going?
So when you look at the Canadian dollar, you need to take into account the two sides of what's driving it. There's the US dollar and our domestic situation. Our domestic situation is OK. You know, we've had this huge imbalance in our household sector. It's well-known, so it's just kind of there. And if we do go back to the tightening environment, it will be a problem again. But right now, it seems like the froth is the bubble that's kind of dialed off of it. So the bigger driver of the currency this year I think is going to be more on the US side.
Everything I've told you right now sets up for a weaker US dollar. And therefore, if the US dollar is weaker over time, the Canadian dollar will appreciate or kind of just be carried on with the rest of current global currency is you'll see it stronger. And so you've already seen the dollar rally about $0.04 this I would expect another $0.03 to $0.04 of appreciation.
Once we get into Q3 of this year and the markets start focusing on our election cycle, I would say that'd be a time to start looking at dollars again. I think that will provide an opportunity to start looking at US dollars again as it is a higher yielding currency. But until then, I could see some tailwinds for the loonie.
Interesting stuff, Michael. Always a pleasure.
Thank you for having me.