Inflation noise has been growing louder. U.S. Fed Chair Powell said inflation has increased notably in recent months. So why aren’t bond yields rising? And will equity markets continue to make record highs? Kim Parlee speaks with Brad Simpson, Chief Wealth Strategist, TD Wealth.
Print Transcript
- The noise about inflation has been getting louder and louder. And just last week, the Fed chair Jerome Powell acknowledged that inflation has increased notably in recent months. Some people saying that's a bit of an understatement. And that rate hikes could come a little bit earlier than anticipated.
So what does that mean and why did it not impact the market the same way about fears of inflation did a few months ago? Here to shed some light on that and also what investors should be thinking about, Brad Simpson. He is Chief Wealth Strategist with TD Wealth. He joins us from BC.
Brad, always a pleasure to have you. And if we could just start with some sort of explaining of what's happening. We have been seeing strong inflation numbers, but we're not seeing the same reaction in the bond market as we had before, which really just kind of stop momentum stocks in their tracks. So what's happening here?
- Yeah indeed, and thanks for having me. And every time you think you kind of got this figured it out, a wrench gets thrown in and it's back to the drawing board. One would think that you would come out with a 5.6% jump and that all the inflation concerns would kick in. And of course, the Federal Reserve Board talking about higher than expected inflation.
And, of course, bond yields would start to back up. The bond market would back up, but no, the the exact opposite has happened. And in fact, one would argue, I think it would kind of take it in stride. And I think really, I think that what we kind of have to kind of come to terms with is that we have these incredible stops and starts that are going on.
In that we've never brought an economy, and we've never brought a fixed income market or an equity market out of a pandemic before. And we are going through this process of really on almost a weekly basis it seems like, kind of, taking the measure of where we are and then implementing those changes.
And I think probably the most important kind of takeaway that I think, if anything, what the bond market is telling us is that we may see higher inflation, we may see growth, but we think that rate of change is kind of come to an end. And if you think about that is that we've really had this accelerating pace of change that was going on.
But if anything, we kind of look back and go you know that maybe hit its peak for the rate of the change that we were seeing in March and April of this year, and that kind of reaction that we saw to the bond market where it was fairly muted. And if we kind of look at volatility afterwards and even credit spreads following that, they kind of didn't react.
And I think that's, if anything, it's just coming to the realization that we're now kind of at a mid stage for an economy, and maybe in the mid-stage of the recovery from the pandemic as well.
- You got some charts here that back up a lot of what you're saying, and I think that rate of change piece is really important. Let's bring up one here where it takes a look at bond yields that went down in Canada and in US and Europe despite what the Fed said. And again, if you look at this chart, maybe you can tell us what's notable for you. It seems like that rate of acceleration, that rate of change you're talking about is starting to feel less scary, I'd say, for the Fed.
- Yeah. I think what this chart tells me is one is on the far right hand side is looking at 30 year treasury yields. And if you were thinking that we were going to be moving into an environment down the road where we had runaway inflation, you wouldn't see this sort drop in yields that you saw out 30 years, but indeed that's what you saw.
And then the flip side is that if you look at the middle of the band there which is showing what happened in the five year. And what's happened there is that's where an awful lot of money has been rotating to, and that was really kind of from the acknowledgment of starting to move and move off of that, kind of, I would say, the inflationary trade and moving to one that's more normalizing a little bit.
And I think that's kind of the interesting part that you see of how fixed income markets has been reacting to this. But it's very distinctly different. Like 10 days ago, it was trading in the exact opposite way. And it's like, you know, we go from one narrative to another very, very quickly.
And I think that's one thing, I think, especially for a fixed income investor. If anything, it may be the other takeaway is to say, you know, you can't get caught up in this short term noise, in particular in interest rate markets right now because it really is trying to find direction still.
- Yeah. The short term stuff is, its stomach churning right now I think for a lot of people. Let's take a look-- I want to get to your asset allocations at the end here, but I do want to touch on a couple more charts. We've got one here we can look at which looks in the cyclicals.
And the performance, I mean, obviously did very well from the sell-off in March of 2020. But the semis, retail, home building, improvement, autos, retail, those groups of stocks did very well but they're starting to taper off again.
- And that's a very similar story to what we're seeing in fixed income markets, right. Is that I think one of the things that we're always talking about is that the reality is that when we're looking at how the market's reacting and how it's trading, it's not to the current state but it's the future state.
And this reflationary trade, what this is really showing is that really since March and April is that much of it has already been done. Now that might be an over-- that's the market probably overstating that.
But nonetheless when you actually have an equity market telling you something that is trying to answer what I think is really the big question for most people, is where does inflation go from here. Well, if you looked at the movement of these, I'd say that much of the story is already there.
- What's this next chart telling us? You've got to look here about cyclicals, but in comparison to defensive equities. So what is notable here?
- Yeah. I think the notable part of this is that if we got away from the short term noise on this is that we went through this extended period of time where growth was hard to come by. And so people disproportionately had their portfolios allocated towards the companies that were going to deliver that growth.
And really I think what this is showing us here is that we're moving into a different cycle than the one we were before the pandemic, and we're also moving into something different than what we saw during the last year. And that is-- and so if you're kind of in this next phase is no we're not going-- it's not a market that you want to be building large positions or moving your portfolio towards more defensive type of positions.
Really showing us that these kind of value when some of these cyclical names could be your financials and could be your energy still have some room to go in the out-performance that they've had while there's pullbacks along the way, that this is probably an area in people's portfolios that are going to continue to perform pretty well as we move forward in the next couple of quarters here.
- So this brings us to, kind of, what is your outlook in terms of when you look at fixed income equities, alternative and real assets, and gold and the loony. And I've only got about a minute and a half here Brad, so I'm just going to say maybe you could cycle us through. Let's start with fixed income and then run through the list in terms of what you're seeing.
- I think from our asset allocation committee's perspective, we're really looking, continue to see that any kind of duration assets, kind of both domestic and global, kind of your government guarantee will continue to be a maximum underweight there. And we think that's a really prudent stance and one that you should continue with.
That as long as if we believe that we're in a slowing rate of change environment, that credit spreads can continue to be very comfortable here and there's still value in the investment grade space. And so we continue to be overweight there. High yield is a similar story, though we would be a little bit more a little bit more cautious.
And equity markets, we continue to be overweight in the Canadian market and in the US market, and frankly in international market as well. And we think that-- but really and when you're looking at those overweight's that we are in, the kind of a critical part we think is that we've now moved into what we think of as a show me market. And that is the easy returns are done and we're really-- it's a lot more to do about a stock-picking, if you will.
Ensuring that you're actually finding the company and investing in the type of companies that can grow and profit in an environment where the demand on you from the market to be able to execute is going to become increasingly important, and those are the areas that you really want to build the focus on.
- What about, I want to squeeze this in-- alts and currencies. Alts, what do you seeing?
- Alts, I think, the first and foremost is in the real estate is that this continues to be an area of overweight for us, and we see that even though we've seen a lot of movement in the last nine months that will continue to gain strength, and in a kind of a in a market where there's still some kind of concerns of inflation and in the mid stage of an economic recovery.
That real estate continues to be a very comfortable spot for us particularly in the private side. And as for gold, we are neutral to underweight there, and we think that again that's a similar story to what we were seeing earlier. Is that if you're in an environment where that rate of change and growth is slowing, that's going to make it a little bit more difficult for gold from here.
- Interesting times. We're glad that you're here to help us guide through it, Brad. Thanks so much for joining us.
- Thank you, Kim.
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So what does that mean and why did it not impact the market the same way about fears of inflation did a few months ago? Here to shed some light on that and also what investors should be thinking about, Brad Simpson. He is Chief Wealth Strategist with TD Wealth. He joins us from BC.
Brad, always a pleasure to have you. And if we could just start with some sort of explaining of what's happening. We have been seeing strong inflation numbers, but we're not seeing the same reaction in the bond market as we had before, which really just kind of stop momentum stocks in their tracks. So what's happening here?
- Yeah indeed, and thanks for having me. And every time you think you kind of got this figured it out, a wrench gets thrown in and it's back to the drawing board. One would think that you would come out with a 5.6% jump and that all the inflation concerns would kick in. And of course, the Federal Reserve Board talking about higher than expected inflation.
And, of course, bond yields would start to back up. The bond market would back up, but no, the the exact opposite has happened. And in fact, one would argue, I think it would kind of take it in stride. And I think really, I think that what we kind of have to kind of come to terms with is that we have these incredible stops and starts that are going on.
In that we've never brought an economy, and we've never brought a fixed income market or an equity market out of a pandemic before. And we are going through this process of really on almost a weekly basis it seems like, kind of, taking the measure of where we are and then implementing those changes.
And I think probably the most important kind of takeaway that I think, if anything, what the bond market is telling us is that we may see higher inflation, we may see growth, but we think that rate of change is kind of come to an end. And if you think about that is that we've really had this accelerating pace of change that was going on.
But if anything, we kind of look back and go you know that maybe hit its peak for the rate of the change that we were seeing in March and April of this year, and that kind of reaction that we saw to the bond market where it was fairly muted. And if we kind of look at volatility afterwards and even credit spreads following that, they kind of didn't react.
And I think that's, if anything, it's just coming to the realization that we're now kind of at a mid stage for an economy, and maybe in the mid-stage of the recovery from the pandemic as well.
- You got some charts here that back up a lot of what you're saying, and I think that rate of change piece is really important. Let's bring up one here where it takes a look at bond yields that went down in Canada and in US and Europe despite what the Fed said. And again, if you look at this chart, maybe you can tell us what's notable for you. It seems like that rate of acceleration, that rate of change you're talking about is starting to feel less scary, I'd say, for the Fed.
- Yeah. I think what this chart tells me is one is on the far right hand side is looking at 30 year treasury yields. And if you were thinking that we were going to be moving into an environment down the road where we had runaway inflation, you wouldn't see this sort drop in yields that you saw out 30 years, but indeed that's what you saw.
And then the flip side is that if you look at the middle of the band there which is showing what happened in the five year. And what's happened there is that's where an awful lot of money has been rotating to, and that was really kind of from the acknowledgment of starting to move and move off of that, kind of, I would say, the inflationary trade and moving to one that's more normalizing a little bit.
And I think that's kind of the interesting part that you see of how fixed income markets has been reacting to this. But it's very distinctly different. Like 10 days ago, it was trading in the exact opposite way. And it's like, you know, we go from one narrative to another very, very quickly.
And I think that's one thing, I think, especially for a fixed income investor. If anything, it may be the other takeaway is to say, you know, you can't get caught up in this short term noise, in particular in interest rate markets right now because it really is trying to find direction still.
- Yeah. The short term stuff is, its stomach churning right now I think for a lot of people. Let's take a look-- I want to get to your asset allocations at the end here, but I do want to touch on a couple more charts. We've got one here we can look at which looks in the cyclicals.
And the performance, I mean, obviously did very well from the sell-off in March of 2020. But the semis, retail, home building, improvement, autos, retail, those groups of stocks did very well but they're starting to taper off again.
- And that's a very similar story to what we're seeing in fixed income markets, right. Is that I think one of the things that we're always talking about is that the reality is that when we're looking at how the market's reacting and how it's trading, it's not to the current state but it's the future state.
And this reflationary trade, what this is really showing is that really since March and April is that much of it has already been done. Now that might be an over-- that's the market probably overstating that.
But nonetheless when you actually have an equity market telling you something that is trying to answer what I think is really the big question for most people, is where does inflation go from here. Well, if you looked at the movement of these, I'd say that much of the story is already there.
- What's this next chart telling us? You've got to look here about cyclicals, but in comparison to defensive equities. So what is notable here?
- Yeah. I think the notable part of this is that if we got away from the short term noise on this is that we went through this extended period of time where growth was hard to come by. And so people disproportionately had their portfolios allocated towards the companies that were going to deliver that growth.
And really I think what this is showing us here is that we're moving into a different cycle than the one we were before the pandemic, and we're also moving into something different than what we saw during the last year. And that is-- and so if you're kind of in this next phase is no we're not going-- it's not a market that you want to be building large positions or moving your portfolio towards more defensive type of positions.
Really showing us that these kind of value when some of these cyclical names could be your financials and could be your energy still have some room to go in the out-performance that they've had while there's pullbacks along the way, that this is probably an area in people's portfolios that are going to continue to perform pretty well as we move forward in the next couple of quarters here.
- So this brings us to, kind of, what is your outlook in terms of when you look at fixed income equities, alternative and real assets, and gold and the loony. And I've only got about a minute and a half here Brad, so I'm just going to say maybe you could cycle us through. Let's start with fixed income and then run through the list in terms of what you're seeing.
- I think from our asset allocation committee's perspective, we're really looking, continue to see that any kind of duration assets, kind of both domestic and global, kind of your government guarantee will continue to be a maximum underweight there. And we think that's a really prudent stance and one that you should continue with.
That as long as if we believe that we're in a slowing rate of change environment, that credit spreads can continue to be very comfortable here and there's still value in the investment grade space. And so we continue to be overweight there. High yield is a similar story, though we would be a little bit more a little bit more cautious.
And equity markets, we continue to be overweight in the Canadian market and in the US market, and frankly in international market as well. And we think that-- but really and when you're looking at those overweight's that we are in, the kind of a critical part we think is that we've now moved into what we think of as a show me market. And that is the easy returns are done and we're really-- it's a lot more to do about a stock-picking, if you will.
Ensuring that you're actually finding the company and investing in the type of companies that can grow and profit in an environment where the demand on you from the market to be able to execute is going to become increasingly important, and those are the areas that you really want to build the focus on.
- What about, I want to squeeze this in-- alts and currencies. Alts, what do you seeing?
- Alts, I think, the first and foremost is in the real estate is that this continues to be an area of overweight for us, and we see that even though we've seen a lot of movement in the last nine months that will continue to gain strength, and in a kind of a in a market where there's still some kind of concerns of inflation and in the mid stage of an economic recovery.
That real estate continues to be a very comfortable spot for us particularly in the private side. And as for gold, we are neutral to underweight there, and we think that again that's a similar story to what we were seeing earlier. Is that if you're in an environment where that rate of change and growth is slowing, that's going to make it a little bit more difficult for gold from here.
- Interesting times. We're glad that you're here to help us guide through it, Brad. Thanks so much for joining us.
- Thank you, Kim.
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