Market Insights

[music] >> Hello, everyone. I'm Kim Parlee, I'm in for Greg Bonnell today and welcome to MoneyTalk Live, brought you by TD Direct Investing. Coming up on today show, we will be hearing from TD Asset Management Scott Colbourne on whether there are more rate hikes ahead for the Bank of Canada. That is the big question. Will they hike more, will they cut a little bit or will they hang out where rights are right now? Also, Bart Melek will give us his outlook for oil as the Russian price Comes into effect. What will that mean for energy markets, energy producers and the overall global economy? And Jimmy she will take us through a new trading trend that could cause more vulnerability in the market. Before we get to our guest today, let's get you an update on the market.

Starting off with the TSX, we are seeing some strengths in marketing stocks as investors.

Shopify trading to the upside today.

taking a look at the S&P 500 south of the border, the S&P 500 is slightly higher as investors digest the latest US PPI, producers price index, which came in a bit hotter than expected, raising fears about continued inflation, and again, the big question, of course, is what's going to be happening now with consumer inflation?

You will be getting that CPI report on Tuesday, so markets will be focusing on that after the weekend.

Let's take a look at the NASDAQ as well. He mentioned Shopify having some upside and the tech heavy NASDAQ is trading up, though only by a small amount right now.

That is your market update.

As widely expected, the Bank of Canada raised interest rates another 50 paces points this week, marking its seventh hike in a row. While our central bank did flag inflation is continuing issue, they signalled that this hiking cycle may be coming to a close soon. Scott Colbourne, manager for active fixed income joined Greg Bonnell to discuss the future path of rate hikes.

>>I think there is a little bit in the market today for the hogs and the doves.

We went into it, and the market was split between 25 and 50 basis points. We got 50, so a little bit more hawkish. But the language has changed, to your point.

Now it's a question of-- they were going to raise rates, will raise rates. Now we're going to consider whether we're going to raise rates going forward.

So there's an optionality. There's a data dependency that the Bank of Canada is focusing on now.

And the question is whether the next one is zero, the end of the rate cycle, or is it a 25?

And so this is the trajectory a lot of central banks have taken us. It was-- been a focus on pace, rapidly frontloading rate hikes.

And we're getting towards the end of that, whether it's the Fed or the Bank of Canada or the RBA or others.

Now it's like, where are we going to end up? What's the terminal rate?

And then how long are we going to stay there is sort of the trajectory that I'm looking at as an investor.

>> I mean, the whole point of raising rates like this to try to tame inflation is to be restrictive, right, to put the brakes on the economy to a certain degree. I imagine at 4 and 1/4 percent, we're fully restrictive.

I guess an argument can be made that have we made-- are we at the point where we think we can cool inflation with a rate like this?

>> And I think that's the debate that everybody's having, right? So monetary policy works with a lag.

And so we're starting to see-- in the last GDP data, we saw domestic demand softening, right?

Both on the housing side and the consumption.

So there's evidence that the rate increases, these rapid rate increases are starting to feed through in the economy.

. But as the Bank of Canada has pointed out, inflation is still high. It's peaking, and it's coming over, but it's still unacceptably high.

There's still lots of uncertainty.

So we've got to let things sort of feed through, trickle through, and see how monetary policy's impact is going to feed into the domestic and the global economy. So it's time to reflect, time to step back from these rapid increases, and focus more on maybe we just need a pause here. We'll assess the data over the next-- and the next meeting's in January. And we'll see where we go from here.

But the market now, going forward into January is sort of split between 0 and 25.

So it's sort of like today except on less of a note.

>> A best case scenario is, of course, they've just, as you said, front-loaded a lot of pretty big rate hikes this year.

You get inflation under control. You get it moving in the right direction. You don't do too much damage to the economy, although you slow it down.

Let's talk about the yield curve, the inversion that we're seeing on the Canadian curve, and what it tells us.

>> Look, the most dangerous words in the investing language, it's different this time, right?

So a lot of people are pushing back on the concept of a recession, both domestically and the Canadian Bond market as well as in the US market. It's very inverted.

It's been a reliable indicator, not a great timing indicator.

So we don't know when. But I would bank on the fact that there is going to be a recession in both Canada and the United States.

We can discuss how severe and how deep, and whether it's a shallow or a modest recession.

But I think we are definitely taking the signal from the bond market that we are going to have a recession.

And that's the lagged impact of these rapid rate increases.

And it makes sense, therefore, for the Bank of Canada to step back and assess here.

>> Is the bond market telling us something about the nature of the recession? We said we can discuss this, so let's discuss it, right?

I mean, as I said, best case scenario scenarios is, oh, you get a modest recession that you get out of fairly quickly, and we get the job done.

But of course, the worst case scenario is that you see mass unemployment, you see the things that happen during a deep recession. Can we avoid that scenario?

>> Well, I think one of the keys to that is the employment market.

And it's still, I would say in both Canada and the United States, still a solid job market. And to the extent that that is a harbinger of the extent of the recession, we definitely have seen employment growth slow down. But wages are still solid.

We've had a solid number out of the US. I think that, so far, the indications are that the employment market tells us that the slowdown is going to be more modest.

>> Is there an element, maybe, of surprise of how resilient-- I think even the Bank of Canada had to admit today that the economy's been a little more resilient in the face of what they've been doing because as we said, these have been big rate hikes we weren't anticipating heading into this year.

But the labor market remains resilient. GDP also some consumption softness, but there seems to be more strength there than most people bet on.

>> Yeah, I think that is a theme, a consistent theme globally, right? Both Canada and the United States, the North American economies, have demonstrated a resiliency that, initially, the models, the forecasting, the policy expectations would be for more of an impact. And whether it was the policies, fiscal policies, the policies that were directed to us during the pandemic-- Savings have been good. There's been a solid labor market adjustments.

Commodity markets were a tailwind for Canada.

So the unwind of this is taking a lot longer than perhaps the policymakers would have thought.

So, to me, that underscores a bit of a resiliency in the global economy and the domestic economy.

The more likely scenario is that we start to see a rate pause rather than a rapid turn towards cuts.

The market always flirts with, OK, central banks are done, now they're going to cut. Well, maybe in this circumstance, given the resiliency in the employment market, given the resiliency in the economy, that the right response would be to pause and really assess on the inflation front.

>> You mentioned the global economy. What about the global situation with central banks? I mean, we are where we're at right now in Canada, with the Bank of Canada signaling maybe we're done or maybe we're going to get a modest one the next time around. But we have different factors at play in our economy.

I think of the housing market. I think out of our debt.

What about some of the other central banks?

>> Well, we got an indication this week from the Reserve Bank of Australia-- so there's some similarities with Canada, a commodity-based economy.

They raised rates 25 basis points, but their messaging was a little bit more hawkish. There's likely more rate hikes to come.

So going back to that sort of tiered approach to policy that I sort of laid out, the pace-- well, the pace of rate hikes in Australia also sort of lessened. Now it's where do we get the rates?

So both the Fed, the Bank of Canada, and the RBA and other central banks are still saying there's a little bit of a ways to go. We may be in the seventh, eighth inning of rate hikes, but we're closer towards the end.

And then it's like, how long do we stay there? How does inflation play out?

How does the wage market, the employment market play out? How sticky is inflation?

We know inflation's going to fall next year, especially given the commodity price declines and supply chain adjustments. Is it going to come down back towards the 2% level, or is it going to be stickier at around 3% or more?

>>That was Scott Colbourne, managing director for active fixed income at TD Asset Management. Smart guy.

One of the smart guys I know talking about the markets and ratesand certainly one worth listening to. It's also been a very volatile week for the price of oil as traders way what a cap on Russian oil prices mean for the market. But with tight global supply, is the price set to remain lower for longer or does it have room to run higher? Those are the kinds of questions that Anthony Okolie was talking to you what with Bart Melek, head of commodity strategy at TD Securities.

>> To answer your question, I think oil does better, and probably the big factor behind oil's weakness is the uncertainty, the acknowledgement by OPEC that they will not reduce supply of oil going forward and part of the reason is, as you mentioned, is the price On Russian oil. It still quite uncertain how impacted the supply side will be.

You know, there are various schools of thought.

Something that there could be quite a robust decrease because OPEC has a particular And some things that much of the impact will be circumvented by Russia's, you know, clandestine fleet of 100 takers or so and other, perhaps, methods of circumventing these particular sanctions, these oil sanctions.

>> Do you think there are risks that Russia could cut off oil exports because of the environment?

>> I think the risk is small.

Of course, you know Russians are threatening that that could very well be the case.

But my suspicion is that they are in a conflict with Ukraine.

They are positioned against, of course, the United States, the NATO nations who are supporting Ukraine.

They are going to need that revenue stream, and I suspect that this is a lot of hyperbole on their part, perhaps, you know, threatening language that they are hoping may convince the allies to not take this action, but in the end, I think it's probably in the self-interest of the Russians to continue to do what they are doing, even if they get less revenue. Less revenue is better than no revenue.

>> Will talk about the other big announcement, course, OPEC plus and its allies agreed to keep production at current levels. Any surprise that decision for you?

>> This is what we thought was going to happen.

OPEC tends to be very guarded and how they change policy. Typically, and I think, you know, this has been true for a while, they try to balance supply with demand and, at the same time, make sure that their national budgets are adequate.

So I'm not particularly surprised, given that certainty of this price And the impact it will have on supply.

We thought that they were going to continue with their 2 million barrels per day cut from the last meeting, which resulted in, which ideally targets about 1.1 million barrels of resupply. And I think they are going to wait and see, see how demand evolves, how China's reopening impacts these markets and how the macro economies in the Western day.

>> So they could be more strategic going forward in terms of how they manage their production?

>> Absolutely. I think they have continued to be strategic for quite a while, and the reason they are able to do that, there aren't really significant competitors in the wings. In that sense, if OPEC cuts another half a million barrels after cutting the 2 million barrels worth of quotas last time around, it's not like there is excess shale production that can fit that void and reintroduce new supply.

OPEC is pretty free to do as they will, at least for now.

>> Now, what are some of the geopolitical risks for oil going forward? We have heard that the US is seeking to hold tapping its oil reserves to refill their stockpiles. You've mentioned lack of demand from China.

What are some of the risks you see going forward for oil?

>> Well, the big risk, of course, is surrounding natural gas.

It might be a little strange for me to talk about natural gas when we are, you know, trying to answer question about oil, but we are still at the start of the winter, and the winter can still get very cold, perhaps a lot colder than we expect. We certainly don't know.

Weather forecasting is hard, particularly future weather as opposed to back casting.

so far, inventories have been ample but there remains a risk that natural gas stockpiles will be reduced quite significantly and that will mean that we will be tappingdistillate supply then we have been. As we all know, the supplies are quite low by historic levels and so is oil, and so there is some excess capacity of refining and China, and if we do find that distillate demand is much higher than we thought because of winter conditions, we might see these oil markets go into, you know, a tighter cycle than now.

>> Given these risks in the markets, what is your outlook on the price of oil heading into 2023?

>> We are quite positive on oil. I think, at this point, everyone knows our logic.

I will stay to hear again.

We do think that open will continue to behave quite strategically and although we do expect demand growth to deteriorate next year or because certainly with the recession, we expect the recession in many parts of the world, in Europe, probably, the US, most likely sliding into a contraction at some point, but we are still expecting demand to be positive, well over a million barrels per day. And at the same time, we are seeing a crisis in the natural gas market where, as I said, we could get much higher demand for product and I think OPEC continues to behave quite strategically, and they will write size their production to make sure that there isn't an oversupply of net likely will drive prices higher. And I think the other big risk here is that once we see a pit in Federal Reserve policy, so we don't expect that until, you know, well into the middle of the year, that's when the markets, we think, are going to start pricing it, we can see speculative money drive it up. So fundamental should remain tight for the moment.

We start thinking that this contraction in demand growth has been reversed or goes the other way, I think oil does a lot better. Perhaps not as quickly as we've helped. We have written this out a few weeks ago and, you know, as I said… > Things change.

> Things change. And forecasting of the future in particular is quite hard. But I think the general theme remains.

>> I know that you had around table on allocative commodities. Were there any themes you think investors should be aware of?

>> I think one of the key themes here is that the supply side is quite constrained.

and although we do expect a cyclical type of downturn, we don't expected to be anywhere near as deep as it has been historically. Because historically, we've seen 40, even up to 70% some cycles, some commodities like oil or copper. We don't see these type of corrections coming up. That's mainly because for base metals, for example, we are seeing constraints on the mind side, we are seeing constraints with smelters, we have energy problems around the world.

And we are seeing a less significant drop in demand than we normally would expect during a contractionary period.

And for metal like copper, we are seeing first signs that electric vehicles, and that's Chinese data, it showing that copper is being supported on the demand side by EVs. Taking that logic forward,using a lot more metal per vehicle as this whole decarbonisation initiative around the world matures. We are going to see a lot more of that copper demand for ESG purposes.

>> That was Bart Melek, head of commodity strategy at TD Securities, talking to MoneyTalk's Anthony Okolie.there is a new option strategy that's being gaining wide popularity among retail investors.

Something called short dated options have become an increasing part of trading volumes and according to Jimmy Xu, portfolio manager at TD Asset Management, it may also be creating more vulnerabilitiesin the market.

It is a fascinating discussion and he joined Greg Bonnell to explain.

>> A really interesting year considering what's happened when interest rates, tightening.

that is a theme that has come across.

>> Using this kind of option strategy, I want to explain this because I've had a few guests mentioned it to me on the side after shows.

people told me that Jimmy is the guy to talk about it.

Zero day short-term options, how do they work?

>> You know what, the strategies, they are actually quite clever.

Historically, if you go back to prior to the financial crisis, the strategies are being implement by institutional investors.

But the same type of strategies are now being seen being invested by everyone. These 02 date maturity options, the expired options, are basically options that expire the same day, as the name would suggest.

So what investors are doing is they are selling options at the start of the day in hopes that when the options expire worthless, as they decay down to zero, they can capture the premium from what they sold.

And it's really interesting why they are doing this now is since April and May this year, the CBOE, the US option exchange, has put out effectively daily options with daily expiry. So investors can do this every day, day in and day out.

What they are trying to capture on is the decay of the options. So when they saw the option in the morning, they collect that premium. By the end of the day, they hope that it becomes worthless, if they are right, they will buy it back at a lower price.

What's interesting about the strategies, why they are so popular is there very capital efficient.

Totally takes, requires margin in the account, which makes them popular.

And second, there are also popular because they don't have to take overnight risk. They can sleep at night knowing that they closed at the positions at the end of the day.

>> That's interesting. We should make clear, though, this is something that's happening in the market that we want to discuss. We are not making any recommendations about how you should structure your trades.

Let's talk with some of the risks, that though, that could be associated with you.

Oh, and option that expires in one day, what's the risk?

>> Does a lot of risk involved anytime your short selling options.

And the strategies has, for the lack of a better word, blown up historical prior to the great financial crisis.

So it's interesting now we are seeing a resurgence of this in a period where financial conditions are tightening and volatility is rising.

So what investors aren't lamenting the strategies, they are usually selling options, because they are short maturity by definition, they only collect a small amount of premium.

However, if the market moves the wrong way are most too much or more than would be expected, loss could be four, five, six, even 10 times the amount of the premiums they collect.

So there's a lot of risk involved. But here's a good thing.

When we look at some statistics that talk about these pretty strategies, it seems like the hit rates for the positive P and L rates are sometimes more than 50%.

And I think there is a psychological aspect this, right? So you did this day in, day out, and it turns a small profit every day and you all of a sudden you're really confident in the strategy and maybe you start to increase their size and maybe you start selling off options when it's not really attractive.

That can get you into a lot of trouble.

I think Nicolas Taleb who wrote his book when fooled by randomness, as is great turkey example. It is like a turkey out of the turkey farm every day. Getting fat.

It's a great life. You call your other turkey buddy to come.

And then when things getting roles along, the markets move more than you expected.

Lights out.

>> Alright, good words of caution right there.

You don't want to be the turkey on things giving.

So that's a strategy. Those of the risks are of the strategy. How popular is the strategy?

>> I think what surprised us the most is the popularity of the strategies since these weekly options that were listed earlier this year.

So just looking at market stats over the last month, almost 40% of all traded options volumes are these zero day maturity or expiry options.

And that's quite remarkable.

Just put that in context, that's $2.4 trillion in notional.

Granted that not all of the is volumes are related to these trays because people still use same day maturity options for other activities.

But it's still a large chunk of the market. And I think it's popular because now, training is just getting easier and easier. Retail investors can trade on their mobile app.

It takes seconds to do it on their phone. And in the US, commission trade, a commission is free for trading options.

So when there is no explicit transaction costs, it just makes the strategies a lot more attractive to the average investor.

When you look at the trading volumes, each trade is typically 5 to 10 contracts, which is, for the most part, too small for institutional investors.

So our theory is that these things, the strategies are dominated by retail investors.

And I think that's a trend that we are seeing post-pandemic or retail volumes are becoming a greater, greater portion of the overall market activities and we are seeing it in the options face as well.

>> I would never seem to fully understand why a market is moving in either direction, even after the years that I've been doing this. There have been times this year I'm like, why is it doing what it's doing?

It's like, I don't know, is just doing it. Is this having an impact on some of the wild move ceasing this year?

>> It's possible.

It's hard to determine was actually causing the wild moves in the market. But we know that based on trading activities with these types of investors, there selling these options in the morning, and you're saying option volumes really pick up in the morning.

And that could create a bit of volatility. The most the phone comes at the end of the day when investors are trying to close off the position, especially think start to move in an average direction.

And what that could cause is more volatility at the end of the day, where investors are trying to close these positions.

Just to give you an example, if your short a put option or Markets goes against you, you have to sell more stock, which puts more downward pressure.

And that could cause wild swings in the market when you had pockets of liquidity especially when you're like this.

>> So that can cause, be in isolation for the wild swings we've seen this year.

We talked about the risks for an individual investor.

As you said, we are not recommending the strategy.

We are just trying to try and unravelit because it's playing a role in the market.

We talk about the risk about this turning against an individual investor. What about longer-term or overall vulnerability for the market? I mean, there's some activity here which is definitely influencing the trade.

>> I think when you separate the different between the short-term off activities is what the strategy is and of longer term, that's my call, normal often activities.

>> Longer-term, oh, two days?

> For institutional investors.

And most investors in the option space. Other than these type of strategies, they typically buy and sell options that are one month or longer maturity. So if you look at what's happening in the VIX index-- that's the CBOE Volatility Index-- and the S&P 500 this year, it's actually been pretty muted despite the volatility that we have seen. What's interesting is that these volumes, because they are one day to expire, they actually don't show up in any of these metrics for the VIX index so that the impact for traditional options investors are actually quite limited.

but on the short end, I think what's interesting is that given all of this open interest, all of these volumes be absorbed by the market really easily, I think the marketmakers are really happy to take that flow even though there is no commission.

We know the bid offers on options are typically wider.

So having that to a volume, selling in the morning, buying in the afternoon, is really profitable for the market makers.

So these flows, despite the fact that they are 40% more, they consist of 40% of the market, they've been absorbed by the market makers quite easily. So if you're not watching, you might just miss out on these types of trading that's happening.

>> That was Jimmy Xu, manager at TD Asset Management.

What a great interview and a great way to understand these 02 expiry date optionswe will have to see if these trends persist in the longer term.

On Monday, we are going to be talking to Chris Graja senior retail analyst at Argus to research, taking your questions about retail stocks and what a time to be talking about retail stocks!

A lot of interesting things happening around the holidays. What's going to happen in January?

What's going to happen in 2023 with these retailers has a lot of people are worried about something like a recession coming up? And a reminder, if you want to get a head start, you can email moneytalklive@td.com, get your questions in now, we are going to queue them up and get them already for Chris and for Greg on Monday.

That is it for our show today. You take good care.

Thanks much for washing today.

Have yourselves a fantastic weekend.

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