Markets have been facing increased volatility amid concerns about economic growth and high rates. Anna Castro, Senior Portfolio Manager and Head of Retail Asset Allocation at TD Asset Management, discusses her market outlook and the benefits of being selective with your long-term strategy.
* The latest decision by the Fed to keep rates on hold comes at a time of increased volatility in the bond market, especially in the past few weeks. My next guest says the big question hanging over markets in the near term is, where do we go from here? Are we at a crossroads?
* Anna Castro is Senior Portfolio Manager and Head of Retail Asset Allocation at TD Asset Management. It's great to have you here.
* Thank you. Nice to be here.
* Let's talk about the crossroads. What do you mean by a crossroads?
* So the positive surprises in economic growth, specifically in the US, has increased the pricing of risk of what additional restrictive environment would mean, what would it mean in terms of the uncertainty of monetary policy moving forward to ensure that we get inflation under control, considering such strong economic growth.
* Yeah. Yeah. And I think everyone always is surprised at just how much that economy keeps on churning and keeps on moving. You've brought in three charts. I'm going to ask you to just tell us about why you're bringing these out and what you're watching within them.
* The first one, I think we're looking at bond yields. What do you see here?
* So I wanted to just showcase that the US 10-year government bond yield, especially around October, hit the 5% mark. So this is the highest level it has been in 15 years. And so the US long-term bond yields are impacted less about what the central banks are doing right now, but market expectation on the path of monetary policy, the level of growth, and supply and demand dynamics.
* And so here, the impact here is with the long end of the US government bond yields rising, it has also impacted the cost of debt of corporations and consumers. So this led to additional tightening through market prices of about three more hikes more than what the Fed has done.
* So this is the Fed saying the work's being done for them when they're doing this. Yeah, and you can see just the slope on that chart is so high.
* Yes, in the past two months.
* Yeah. The next one you have here is you're looking at, I think, valuation in terms of the markets. Tell me what's showing up for you here on equities.
* So after being very resilient all the way up into July, US equities, here I'm just using the S&P 500 to illustrate it. It's like you're seeing the valuation fall by 2 multiple points, from a high of 20 times in the end of July to 18 times end of October. And what you're seeing there is that equity investors are saying that for bond yields are 5% and that's considered risk free, you are asking for more compensation to hold equity risk. And that's why valuations have fallen, to provide you a buffer for that equity risk premium.
* Yeah. And so we've seen the markets come down. We've seen the valuation. How does that jive with earnings growth itself and maybe the forecasted earnings growth? That's your next chart.
* Yes. So in this chart, we have two lines. So the white line shows you the trailing earnings growth so far, which indicates also how we've been doing in this current earnings.
* Which is better than expected, right?
* Which is interesting.
* Yes, so so far, Q3 earnings have been good. Earnings have been better than expected from what it was trending or what is expected. You're also seeing stabilization there. But in general, it's actually what we need to think about is earnings growth for next year, or forward-looking earnings growth is what matters to equity investors. And what's being expected is 10% from where we are right now.
* And what is interesting is that we had a pause on the rate of increases of earnings revisions up. So we're not having earnings revisions downward, but the momentum of earnings revisions up has slowed down. And this has also concerned earnings equity investors, because you don't want to hear this is as good as it gets.
* And so with considering that increased tightening and geopolitical risk, either you need to have some certainty on your earnings growth moving forward or you want to see higher earnings growth to be compensated.
* It's interesting, because I would just say, I would have thought, actually, we would have seen more revisions down. So we're not seeing the down. You're just not seeing the up, at this point.
* Not yet. And so now that you have more tightening, the question is, that new tightening and all the other risks that we are faced with right now, how much more can we go from here?
* Yeah. There's just, there's so much risk in the world. I think we got through COVID, we were thinking, what more could happen? And you know, careful what you ask for, right, sometimes.
* OK. So given that scenario that you've painted, looking at those three kind of data points, how do you believe people should be thinking about the markets right now?
* So first of all, I talked about broad themes at the top. And each, what I wanted to highlight is that having a multi-asset portfolio, you are exposed too or you have access to different asset class, different countries, different sectors. And right now what's interesting in this particular of environment, you're having mini cycles or mini themes undergoing in each asset class.
* So the short term, we talked about the expectation of higher bond volatility, which, because of the magnitude, can impact equity volatility. But that can actually provide opportunities in the long term for long term investors. And case in point, we talked about sell-off the past two months. Today markets are up 1% to 2%. So things can change really, really quickly.
* So in the long term, if you're focused on your long-term goal, the key thing is having a good mix of a diversified portfolio of different asset class that could give you different types of returns. And so right now, with the sell-off in fixed income and the higher income or yield component, we're seeing opportunities on high quality government and corporate debt. And the attractiveness there is that you could actually have capital gain, additional capital gain from this income component if yields go down, or market participants price in yields going down.
* Within equities, after the sell-off we've had from the summer, you have an opportunity to leg in into high quality equities in different sectors. So you've had those in industrials, technology, for example, and even in energy. So in Canada, we have quality energy companies, good balance sheets with free cash flow and growing dividends. And not only that, they actually-- energy, oil prices benefit from stronger than expected growth in inflation. So these have actually done well.
* And then the other component is having commodity as an asset class, a diversifier to incorporate in the portfolio. And this stands to benefit from an inflationary environment, as well as it has secular themes. It has its own supply and demand dynamics.
* The other aspect would be real assets, such as infrastructure, which can benefit from long-term energy transition themes that are less linked to the economic cycle, per se, as well as real estate. You have different asset classes. It's not just offices, which has a lot of bad press in that case. But you have some very interesting themes in multifamily, like residential, and industrial properties.
* And as a Canadian investor, it's also good to have a global portfolio. And for example, since the summer, you've had positive returns from holding US dollar assets relative to Canadian dollar because US dollar has appreciated while Canadian dollar has weakened.
* So having all of this put together, having a team to select them and to do research and understand different parts of the market is very, very helpful.
* It's-- I was going to say, it's nice, even though-- I mean, it's a very tough world, right, to invest in it. When you say it like that, about opportunities in commodity, commodity stocks, US dollar, infrastructure, there are places that provide these in their own business cycle, inflationary hedges for people to think about these things.
* Yes. And I like giving the analogy-- might be very simplistic-- about it's about when you think about your long-term plan to be healthy, you think about meal planning. And so you can, when you're making a meal, the various ingredients when you go to get groceries, impacted the prices, supply-demand, climate change, or where you are. But in general, the key thing is like overall, despite all of this, a key thing is to come up with a very nutritious meal plan, thinking about your long-term goal to be healthy.
* You watched me eat Halloween candy. That's why you're saying that to me. Anna, thanks so much for coming in.
* Thank you.