U.S. and Canadian markets saw steep 1-day declines as volatility spikes. Kim Parlee speaks with Michael Craig, Senior Portfolio Manager, TD Asset Management about the triggers behind the selloff and what to expect next.
There's nothing. You can't really point any-- to any smoking gun. The markets have been pretty weak this month. And we're now at 10% correction. Not really, in the grand scheme of things, not a big deal.
Broadly speaking, if you're in the US here now, your returns are zero in the year. And Canada, slightly negative. So it's not this doom. The headlines would be very, very unsavory, but the bigger picture, it's just one of those mediocre years. 2017 was a great year. 2018 is a bit of a wash.
I think it's hard though, I think, for a lot of people that, for people who have been in the industry for a long time, or if you've been an investor for a long time, you could say, yup, this happens. This hasn't happened to a lot of people though yet.
This doesn't feel good. And this was-- I mean, this seems to be almost an acceleration of what we were seeing in the past few weeks.
Yeah. Believe me, managing money, it's like having someone put a drill in your temple today. It's not fun. But it's important to have these bouts of volatilities because it actually starts to build risk premium into the market, and people start thinking about investing a bit more seriously.
When it's going up constantly, risk starts to get carried away. People just believe that that's the way it always is. And sometimes you need these corrections, if nothing else, to build in a bit of risk premium. And quite frankly, since the great financial crisis, we really haven't had many periods like this.
Things are changing. Central banks are tightening policy. And this is going to be more of the state of affairs in the foreseeable future. And when I say that, I mean the next multiple years forward.
Let's talk a bit about-- I know when you and I chatted earlier there was here's the fundamentals of what I've-- and again, nothing new today. These are things we've been seeing emerge for the past little while. And then there's the things, I'd say, almost on the fringe. The geopolitics, which can kind of accelerate things or not.
Let's talk about the fundamentals. Central banks. I mean, what is happening there? We heard from one in Canada today, raising rates. Is this symptomatic of what's causing a bit of this right now?
I think this is the primary, the deeper reason that's driving the volatility. Central banks are finally stepping out of the markets. By next October, all G4 major central banks will be shrinking their balance sheets on a year-over-year basis.
The Fed started this, got this going a little while ago. And the ECB will soon, at Christmas, stop expanding their balance sheet. So they want out of the market.
But the problem is now there's the unintended consequences of quantitative easing. And we have to start to realize where our price is without this huge buyer of risk assets. And so the markets are just getting used to this lack of liquidity, lack of free money, if you will. And so we're going to have to find a clearing price that is where-- one where the central banks aren't involved.
Let me ask you about another key fundamental thing. And we heard this from Caterpillar, when the CEO was speaking on an earnings call this week about saying he believed we were hitting the high watermark when it came to the business cycle and where we are right now. Is that something else that's contributing to what's happening in the market?
- Yeah, I mean, we've had phenomenal earnings growth this year. It's not going to get any better. But that's actually empirically not a reason to sell the market.
I mean, so we've grown at 20% year-over-year earnings. Next year we're going to go to probably single digits. But that, if you actually look back at the data, that's not the peak of the investment cycle, if you will.
CAT's talked about increasing costs. Part of this is the trade wars and trade tariffs, and where this is basically is an own goal. There's no reason to have this except for the political aspects of it. So there are these risks, but ultimately this is not a-- this is not the turn in the cycle, if you think about just earnings growth.
What about debt? And when I talk about debt, I mean the world is-- and I know TD Asset Management has been talking about this for a long time. The world is awash in debt. You've got consumer debt, government, corporate debt. Rates start to creep up.
Where do we start to see that?
So this is the-- when people, when I speak to clients and they say, well, this idea of rates going back to 5% or 6% is just not possible in a world with as much a debt as we have, both on the corporate and household and government side. And so what happens is you get to a point where cost of borrowing gets prohibitive and aggregate demand stops.
So put another way, if you have a mortgage and all of a sudden your payments are going higher, one hike, you go for one last dinner. Two hikes, you stop-- no renovations, et cetera. And ultimately, this happens all at once, end growth, and that's when you go into recession.
And so that is probably how this will play out. We're not there yet, I don't think. We probably have a bit more time in this investment expansion. But this is kind of how things will play out. And it's really the reason why we don't believe interest rates are going to materially higher from here, certainly 50 basis points, whatever. But we're not going back to the mid-single digits that we saw in the previous, in the early 2000s.
Bank of Canada, I know, came out, and they talked about removing the word gradual, getting back to a neutral stance. And I know we talked about this earlier between 2.5% and 3.5%. You've got the President of the United States right now cursing every single time the Fed thinks about doing something.
I mean, do you expect the central banks to really-- I don't want to say hear the message. Should they be moving higher? Because at the same time, if they don't, there's a lot of irresponsible spending that's been happening at the same time.
Yeah. So number one rule of investing, don't invest how you think-- what they think or what you think they should do. Invest what they're going to do.
Central banks always typically over tighten and break the investment cycle. That's what they do. And so they're going to continue to tighten until we probably have a recession. Because we are so late cycle, that's likely the path we go through.
So I would expect them to hike again next year. I do think we're going to have a bit of turbulence in the first half of next year. And then Powell, Jay Powell, the US Federal Reserve President, will be tested.
It doesn't help when the president's complaining and starting to second guess whether he should have put him in place in the first place. This does not help the situation. But I think this is what I think is going to be really interesting going into 2019.
We're going to leave it there. But Michael, always a pleasure. Thanks so much for coming in.
Thanks for having me.
Michael Craig, he's Senior Portfolio Manager with TD Asset Management. And he joined me here in studio.