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Kim Parlee talks with Rob Vanderhooft, Chief Investment Officer, TD Asset Management, about how periods of higher volatility can help clear excesses, and create investment opportunities. Rob also weighs in on why the death of oil has been greatly exaggerated.
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[MUSIC PLAYING]
- Hello, and welcome to the MoneyTalk COVID-19 daily bulletin for Wednesday, May 27th. I'm Anthony Okolie. In a few minutes, Kim Parlee will be speaking with Rob Vanderhooft, Chief Investment Officer at TD Asset Management, about how volatility can create opportunities in the market. But first, a quick wrap of today's headlines.
Two of Canada's biggest banks said their second quarter profit was essentially cut in half, as the shock of COVID-19 forced both the Royal Bank of Canada and the Bank of Montreal to set aside massive piles of cash for possible loan losses. And the end of an era for one of Canada's largest newspapers. Torstar, the company that owns the Toronto Star and over 70 other newspapers, agreed to be taken private by two prominent Canadian business families.
Social media firms are in the spotlight after President Donald Trump threatened to regulate or shut down these companies, a warning apparently aimed at Twitter after they began fact-checking his tweets. And finally, the European Union proposed a massive $824 billion coronavirus recovery plan to provide support to the bloc's hardest-hit countries, without increasing soaring debt levels of southern countries, including Italy, Spain, and Greece.
And that's a wrap of today's headlines. Next, Kim Parlee's conversation with Rob Vanderhooft.
- Rob, we've been on a bit of a roller coaster since the pandemic really took hold, I'd say, in North America, at least, in early March. What are your thoughts on where market levels are right now?
- Yeah, I mean, we've certainly seen market selloff, and probably to an overreaction level, certainly on the equity market side. Again, markets hate uncertainty. We've probably eliminated some of that uncertainty at this point. Markets have rebounded. I would say that they're the higher end of fair valuation now, given what we expect to happen with respect to earnings.
- If you look forward-- and I would say, even with the markets, that we're seeing a bit of an uneven recovery. We've seen, of course, some of the big techs really, really get amplified. Some are leaving some of the rest behind. Are you expecting more volatility as we go forward?
- No, I think we've seen the volatility calm down relative to the very, very high levels that we saw at the early stages of the pandemic. So we've seen it calm down. We've seen markets return to almost normal operation with respect to liquidity. So initially, we had liquidity challenges, I would say, certainly on the bond side, but a lot of that is eliminated. So we're returning a bit back to normal with respect to those factors. So we don't expect that type of volatility to return unless there's an abrupt change in the pathway that we seem to be on.
- What about-- we're seeing that path to recovery. What does that look like from your perspective? Or maybe I should ask you, what information are you looking at to understand what that path to recovery might look like?
- Yeah, and again, we've seen a massive impact on economic growth, but again, what we're looking towards is some bounceback in the economy. You look at what happened in China and South Korea, you've had pretty rapid rebounds with respect to industrial production, to services.
Where you've seen economies lag is on the consumer side. So there's been a reluctance for the consumer, for good and valid reasons. Certainly unemployment's been affected. There's a reluctance still to go out. So that psychological overhang will continue for a period of time. So the consumer rebound hasn't happened to that degree, and we would expect that to continue to be a lag.
And again, the pace of the recovery really depends on treatment and vaccine. And should there be a valid vaccine, and the timeliness of that, that allows the consumer confidence to really re-engage in the market.
- Given all those factors-- and again, I know everything and everyone I've talked to, including you, talks about vaccine dependence, obviously. It's the big one. What's your investment strategy throughout the crisis?
- Yeah, again, we've kind of stuck to really long-term expectations, and kind of looking through this and looking out 12 to 18 months. So strategically, in terms of our long-term asset mix, we'd scaled back a bit in equities, and then tactically, as markets got to very low levels for the equity markets, we were buyers.
So we returned to our long-term strategic targets with respect to allocation. And then more recently, as equity markets have rallied, we've tended to sell a bit into those rallies, again maintaining that long-term strategic target, but tactically adding to positions and selling positions as we moved along.
- Let's, if we could, not get too deep into the tactics, but a bit. We've got some charts here showing about wealth asset allocation perspective. Bring up fixed income here. What do you do with fixed income in a near zero interest rate environment?
- Yeah, and again, our position is underweight fixed income. And we'll continue to have that position. We would expect rates to continue to be low for a very long period of time. Central bank action would imply that. If you look at inflation numbers, for example, continue to be very, very low.
So rates should stay low for a long period of time, which means that what we're looking towards is some of the yield-oriented areas. So we've had an increase in our investment-grade corporate bonds as a component of portfolios, again to add yield to the fixed income area. But yeah, we do expect quite low rates for a very extended period of time.
- We'll bring up the chart on equities on your thoughts on that. And this is showing, as we can see, that you're favoring US equities right now over Canadian.
- Yeah, and again, looking at the relative economic performance, Canada versus US, Canada we would expect to lag the US on economic performance. One of the overriding factors to that is roughly 12% of our GDP in Canada is oil and gas related, and that's been under an enormous amount of pressure.
So we would expect to relatively underperform. And that's how we get asset allocation and position. We do expect the US to also outperform Europe economically, and therefore, earnings should continue to outpace what we expect internationally, and certainly in Canada, even from lower levels.
- What about-- tell me a bit about the alt market. Again, we'll bring up your thoughts on that, but we can see here, when you look within alts and real assets, it looks as though you're more overweight on commercial mortgages, which is interesting.
- Yeah, the commercial mortgages, again, in a theme of added yield, we continue to see very strong spreads for commercial mortgages. They've widened out to a degree, as all other spreads have widened out. They're pretty good absolute and relative yields. So we've continued with an overweight position there.
On the infrastructure side, we're still seeing very good opportunities for strong returns. So low double-digit returns possible in the infrastructure in some of the projects we're looking at right now. So pretty attractive levels. On the real estate side, we're more neutral at this point.
We are seeing some implications in terms of lower rental rates, lower rent collections for some sectors of the economy. If you look at the office market, generally OK, industrial, OK. We're seeing a little bit more impact on retail. Multi-unit residential has actually come through better than we would have expected.
- Last category here, bring up the gold currencies and cash.
- Yeah, and again, I mean, the gold position, they're really more from a hedge with respect to further risk. And so I think that's why gold is getting a bid here. The relative cost of holding gold with very low rates is extremely low. So again, gold is more there for the hedge position. And then the Canadian dollar. Again, we're reflective of what our expectations are for Canadian economic performance relative to what we see in the US.
- Rob, let's talk a bit about oil. It has been a crazy ride, particularly painful for, I'd say, Canadians, who have gone through quite a bit already. But we have seen, I'd say just recently, oil prices starting to move back up, a bit of a surge. Is it going to last?
- Yeah, you know, we've seen a pretty good bounce in oil prices, and that's encouraging, but our expectation is it'll be tougher going from here. So if you look at where we were pre crisis, back in February at $53 for WTI, that we wouldn't expect to get back to those prices for quite some time. And so it's great to see the bounce in oil, but again, we wouldn't see that pace continuing to accelerate towards a $53 price.
- Let's bring up a chart, one that you recently published. It takes a look at supply and demand of crude and the story of oil. It's going to get on both sides. But it's showing, just in terms of millions of barrels per day, from the first quarter of 2019 all the way to where we're going. Just maybe take us through what's happening both in supply and demand, and why you think what you think.
- Yeah. I mean, that's really the crux of our argument with respect to that we've bounced in oil, but it could be tough to get a higher price. If you look at the demand destruction that we've seen as a result of COVID-19, you can see that the line dropped precipitously there, probably 20 million barrels a day of demand destruction in the second quarter.
Again, relative to what is a normal 100 million barrel a day market. So a pretty significant demand destruction. We've seen supply responses. OPEC+ has come up with an agreement to reduce production. And that could get us closer to supply/demand balance towards the end of this year.
But one of the concerns is the inventory positions. Inventory positions have been very, very high, continue to be high. And so working down that inventory position will be critical to get higher oil prices, again, approaching back the $53 to $55 area for oil prices.
- And what do the inventories and that level of oil prices mean for Canadian oil producers, or the entire energy sector in Canada?
- Yeah, I mean, it's been quite tough in the oil patch in Canada, looking at $33 WTI right now. If you look at WCS, which is essentially the price referenced by most producers in Western Canada, that's trading at a $48 differential right now. It's kind of bouncing around. But still, quite low prices, and profitability at those levels is hard to come by for most producers.
And so you've seen a big drop in capital expenditures or expectations by virtually all producers. And so we would expect production to come down somewhat. The challenge is for the oil sands producers, which is 2/3 of our production, cutting production is difficult. So you're seeing a majority of production cuts, you will see the majority of production cuts coming from more of the conventional oil and gas producers.
- Yeah, where there's a little more flexibility. Let me ask you, when you-- I think when we saw, if I rewind back a month, we saw those huge drops in oil prices, I mean, there were headlines and conversations going on about the death of oil all together, replacing oil with alternative energy at a much bigger scale. What do you say to those ideas? Is that something we should be thinking about?
- Yeah, and again, if you look at the last 10 years, there's been a 1% to 1.5% increase in oil demand per year. So that's kind of one to one a half million barrels a day per year. So that trend has continued to increase, and our expectation is that it will continue to increase.
Again, if you look at consumption in Canada, for example, we do tend to vilify the producers of oil with respect to CO2 emissions, et cetera, but we tend to disassociate what's going on the consumption side. In Canada, consumption continues to grow. And so we are probably third highest in the OECD with respect to per capita consumption of oil. And that hasn't slowed cyclically.
It's slowed as a result COVID-19, but again, as the economy returns to more normal levels, that will continue. And again, the very low prices mean that consumption activities probably won't change considerably for a period of time. And we're all for the renewable energies. On the infrastructure side, we've got a lot of projects in the renewable space. But the death of oil will take a long period of time.
- Rob, thanks very much.
- Thank you.
[MUSIC PLAYING]
- Hello, and welcome to the MoneyTalk COVID-19 daily bulletin for Wednesday, May 27th. I'm Anthony Okolie. In a few minutes, Kim Parlee will be speaking with Rob Vanderhooft, Chief Investment Officer at TD Asset Management, about how volatility can create opportunities in the market. But first, a quick wrap of today's headlines.
Two of Canada's biggest banks said their second quarter profit was essentially cut in half, as the shock of COVID-19 forced both the Royal Bank of Canada and the Bank of Montreal to set aside massive piles of cash for possible loan losses. And the end of an era for one of Canada's largest newspapers. Torstar, the company that owns the Toronto Star and over 70 other newspapers, agreed to be taken private by two prominent Canadian business families.
Social media firms are in the spotlight after President Donald Trump threatened to regulate or shut down these companies, a warning apparently aimed at Twitter after they began fact-checking his tweets. And finally, the European Union proposed a massive $824 billion coronavirus recovery plan to provide support to the bloc's hardest-hit countries, without increasing soaring debt levels of southern countries, including Italy, Spain, and Greece.
And that's a wrap of today's headlines. Next, Kim Parlee's conversation with Rob Vanderhooft.
- Rob, we've been on a bit of a roller coaster since the pandemic really took hold, I'd say, in North America, at least, in early March. What are your thoughts on where market levels are right now?
- Yeah, I mean, we've certainly seen market selloff, and probably to an overreaction level, certainly on the equity market side. Again, markets hate uncertainty. We've probably eliminated some of that uncertainty at this point. Markets have rebounded. I would say that they're the higher end of fair valuation now, given what we expect to happen with respect to earnings.
- If you look forward-- and I would say, even with the markets, that we're seeing a bit of an uneven recovery. We've seen, of course, some of the big techs really, really get amplified. Some are leaving some of the rest behind. Are you expecting more volatility as we go forward?
- No, I think we've seen the volatility calm down relative to the very, very high levels that we saw at the early stages of the pandemic. So we've seen it calm down. We've seen markets return to almost normal operation with respect to liquidity. So initially, we had liquidity challenges, I would say, certainly on the bond side, but a lot of that is eliminated. So we're returning a bit back to normal with respect to those factors. So we don't expect that type of volatility to return unless there's an abrupt change in the pathway that we seem to be on.
- What about-- we're seeing that path to recovery. What does that look like from your perspective? Or maybe I should ask you, what information are you looking at to understand what that path to recovery might look like?
- Yeah, and again, we've seen a massive impact on economic growth, but again, what we're looking towards is some bounceback in the economy. You look at what happened in China and South Korea, you've had pretty rapid rebounds with respect to industrial production, to services.
Where you've seen economies lag is on the consumer side. So there's been a reluctance for the consumer, for good and valid reasons. Certainly unemployment's been affected. There's a reluctance still to go out. So that psychological overhang will continue for a period of time. So the consumer rebound hasn't happened to that degree, and we would expect that to continue to be a lag.
And again, the pace of the recovery really depends on treatment and vaccine. And should there be a valid vaccine, and the timeliness of that, that allows the consumer confidence to really re-engage in the market.
- Given all those factors-- and again, I know everything and everyone I've talked to, including you, talks about vaccine dependence, obviously. It's the big one. What's your investment strategy throughout the crisis?
- Yeah, again, we've kind of stuck to really long-term expectations, and kind of looking through this and looking out 12 to 18 months. So strategically, in terms of our long-term asset mix, we'd scaled back a bit in equities, and then tactically, as markets got to very low levels for the equity markets, we were buyers.
So we returned to our long-term strategic targets with respect to allocation. And then more recently, as equity markets have rallied, we've tended to sell a bit into those rallies, again maintaining that long-term strategic target, but tactically adding to positions and selling positions as we moved along.
- Let's, if we could, not get too deep into the tactics, but a bit. We've got some charts here showing about wealth asset allocation perspective. Bring up fixed income here. What do you do with fixed income in a near zero interest rate environment?
- Yeah, and again, our position is underweight fixed income. And we'll continue to have that position. We would expect rates to continue to be low for a very long period of time. Central bank action would imply that. If you look at inflation numbers, for example, continue to be very, very low.
So rates should stay low for a long period of time, which means that what we're looking towards is some of the yield-oriented areas. So we've had an increase in our investment-grade corporate bonds as a component of portfolios, again to add yield to the fixed income area. But yeah, we do expect quite low rates for a very extended period of time.
- We'll bring up the chart on equities on your thoughts on that. And this is showing, as we can see, that you're favoring US equities right now over Canadian.
- Yeah, and again, looking at the relative economic performance, Canada versus US, Canada we would expect to lag the US on economic performance. One of the overriding factors to that is roughly 12% of our GDP in Canada is oil and gas related, and that's been under an enormous amount of pressure.
So we would expect to relatively underperform. And that's how we get asset allocation and position. We do expect the US to also outperform Europe economically, and therefore, earnings should continue to outpace what we expect internationally, and certainly in Canada, even from lower levels.
- What about-- tell me a bit about the alt market. Again, we'll bring up your thoughts on that, but we can see here, when you look within alts and real assets, it looks as though you're more overweight on commercial mortgages, which is interesting.
- Yeah, the commercial mortgages, again, in a theme of added yield, we continue to see very strong spreads for commercial mortgages. They've widened out to a degree, as all other spreads have widened out. They're pretty good absolute and relative yields. So we've continued with an overweight position there.
On the infrastructure side, we're still seeing very good opportunities for strong returns. So low double-digit returns possible in the infrastructure in some of the projects we're looking at right now. So pretty attractive levels. On the real estate side, we're more neutral at this point.
We are seeing some implications in terms of lower rental rates, lower rent collections for some sectors of the economy. If you look at the office market, generally OK, industrial, OK. We're seeing a little bit more impact on retail. Multi-unit residential has actually come through better than we would have expected.
- Last category here, bring up the gold currencies and cash.
- Yeah, and again, I mean, the gold position, they're really more from a hedge with respect to further risk. And so I think that's why gold is getting a bid here. The relative cost of holding gold with very low rates is extremely low. So again, gold is more there for the hedge position. And then the Canadian dollar. Again, we're reflective of what our expectations are for Canadian economic performance relative to what we see in the US.
- Rob, let's talk a bit about oil. It has been a crazy ride, particularly painful for, I'd say, Canadians, who have gone through quite a bit already. But we have seen, I'd say just recently, oil prices starting to move back up, a bit of a surge. Is it going to last?
- Yeah, you know, we've seen a pretty good bounce in oil prices, and that's encouraging, but our expectation is it'll be tougher going from here. So if you look at where we were pre crisis, back in February at $53 for WTI, that we wouldn't expect to get back to those prices for quite some time. And so it's great to see the bounce in oil, but again, we wouldn't see that pace continuing to accelerate towards a $53 price.
- Let's bring up a chart, one that you recently published. It takes a look at supply and demand of crude and the story of oil. It's going to get on both sides. But it's showing, just in terms of millions of barrels per day, from the first quarter of 2019 all the way to where we're going. Just maybe take us through what's happening both in supply and demand, and why you think what you think.
- Yeah. I mean, that's really the crux of our argument with respect to that we've bounced in oil, but it could be tough to get a higher price. If you look at the demand destruction that we've seen as a result of COVID-19, you can see that the line dropped precipitously there, probably 20 million barrels a day of demand destruction in the second quarter.
Again, relative to what is a normal 100 million barrel a day market. So a pretty significant demand destruction. We've seen supply responses. OPEC+ has come up with an agreement to reduce production. And that could get us closer to supply/demand balance towards the end of this year.
But one of the concerns is the inventory positions. Inventory positions have been very, very high, continue to be high. And so working down that inventory position will be critical to get higher oil prices, again, approaching back the $53 to $55 area for oil prices.
- And what do the inventories and that level of oil prices mean for Canadian oil producers, or the entire energy sector in Canada?
- Yeah, I mean, it's been quite tough in the oil patch in Canada, looking at $33 WTI right now. If you look at WCS, which is essentially the price referenced by most producers in Western Canada, that's trading at a $48 differential right now. It's kind of bouncing around. But still, quite low prices, and profitability at those levels is hard to come by for most producers.
And so you've seen a big drop in capital expenditures or expectations by virtually all producers. And so we would expect production to come down somewhat. The challenge is for the oil sands producers, which is 2/3 of our production, cutting production is difficult. So you're seeing a majority of production cuts, you will see the majority of production cuts coming from more of the conventional oil and gas producers.
- Yeah, where there's a little more flexibility. Let me ask you, when you-- I think when we saw, if I rewind back a month, we saw those huge drops in oil prices, I mean, there were headlines and conversations going on about the death of oil all together, replacing oil with alternative energy at a much bigger scale. What do you say to those ideas? Is that something we should be thinking about?
- Yeah, and again, if you look at the last 10 years, there's been a 1% to 1.5% increase in oil demand per year. So that's kind of one to one a half million barrels a day per year. So that trend has continued to increase, and our expectation is that it will continue to increase.
Again, if you look at consumption in Canada, for example, we do tend to vilify the producers of oil with respect to CO2 emissions, et cetera, but we tend to disassociate what's going on the consumption side. In Canada, consumption continues to grow. And so we are probably third highest in the OECD with respect to per capita consumption of oil. And that hasn't slowed cyclically.
It's slowed as a result COVID-19, but again, as the economy returns to more normal levels, that will continue. And again, the very low prices mean that consumption activities probably won't change considerably for a period of time. And we're all for the renewable energies. On the infrastructure side, we've got a lot of projects in the renewable space. But the death of oil will take a long period of time.
- Rob, thanks very much.
- Thank you.
[MUSIC PLAYING]
