Markets sell off: Healthy pullback or more pain to come?

Hello, and welcome to the MoneyTalk COVID-19 Daily Bulletin for Friday, June 12. I'm Anthony Okolie. In a few minutes, I'll be speaking with Michael Craig, Head of Asset Allocation at TD Asset Management, about the recent volatility in equity markets. But first, a quick wrap of today's headlines.

Lululemon missed earnings and revenue expectations for the first time in three years, despite a 68% jump in online sales, as store closures during the COVID-19 pandemic took a bite out of profits. The European Union antitrust regulators have set a July 16 deadline for a decision on whether to clear French high-speed train maker Alstom's bid for Canada's Bombardier rail business. The UK economy contracted a record 20.4% in April as a result of the COVID-19 lockout measures, wiping out nearly two decades' worth of growth. Finally, bankrupt auto rental company Hertz wants to sell as much as $1 billion of new stock to take advantage of the recent surge in its share price.

And that's a wrap of today's headlines. Next, my conversation with Michael Craig.

Michael, markets are up right now, but yesterday was an ugly day for Wall Street and Bay Street. Stock markets posted the worst day since March. The Dow closed down nearly 7%. What caused the selloff?

- Yeah there's, I guess, a couple of things. First off, we've had a pretty amazing rally off the lows. The S&P touched just under 2,200 back in March. It was 1,000 points higher. I'll call it 45%. I've got to be honest, the last 200 points seemed a bit excessive. It's always hard to pin the point of when you're actually going to see these selloffs.

But I think this was, in my opinion, a healthy correction. We were starting to get a bit frothy, a bit of excess. And it's actually-- while it's a painful experience to go through, probably a healthy correction in the backdrop of a very strong rally over the past three months.

- I guess the big question now is, was that a one-time drop, or could we see potentially more declines going forward?

- I mean, there's certainly-- the markets are highly sensitive to the news flow right now. It has gotten a bit more bleak over the last few weeks. Certainly a slight pullback from here wouldn't be hugely out of expectations, though the market is rallying pretty strongly today.

I would say, though, what makes today much different than, say, March is the information about COVID-19 is out there. We have a much better understanding about what we're dealing with. And two, that the fiscal and monetary support is still in full force. Powell recommitted to that this week at the Fed meeting.

And therefore we have a tremendous amount of both fiscal support through government policy and monetary support through quantitative easing. The Fed is still buying about $50 billion a week of assets. This is a tremendously accommodative policy. And so that will likely lead to higher markets over the medium term.

- Yesterday, of course, we saw the volatility index trade above 40 for the first time since early May. Should investors brace for more volatility ahead?

- Well, I think, given the backdrop of what's happening right now-- and I'd say three key things. There's COVID-19, there's ongoing geopolitical tensions, and there's, I think, tremendous uncertainty about the fall election in the United States. There are events that should keep volatility higher.

From our perspective, tactically, we've actually been using this volatility to monetize it and use this as an opportunity to actually add value to the high vol, because we don't think markets are going to realize the level of volatility over the longer period of time. So I think a higher vol environment is likely here to stay for some time. But at the end of the day, again, if you just bought stock a year ago and then just ignore the market over the last year, you wouldn't have really felt much volatility. It's really been a shorter-term phenomenon that we've been witnessing.

- And are you looking to add to positions during these dips? Or is there something that you're watching for before you get more bullish?

- We would certainly be buyers on pullbacks. We have been overweight equities now for some time, although managing our P&L quite closely, so when markets do kind of leap forward we haven't taken profit. I'm not getting too over our skis, if you will. But we would certainly be buyers of dips if we do fall another 5%, 10% or so. I don't see a whole lot of downside here with the accommodation in place. And so this is definitely, I think, a market to be bought on weakness, not a market to be sold on strength right now.

- The Fed this week give a whole new meaning to lower for longer. They indicated that rates will be near zero through 2022 and actually could be longer than that. They actually said that they'll keep rates down until the US is back on track to max employment. How big a reality check was it that the economy is in deep trouble and the recovery won't be swift?

- Well, we've been telling our investors for some time now that we would expect the Fed to be on hold for some time. And I think Powell just reaffirmed that. He kind of went out of his way to say that they're going to be near zero without actually giving explicit forward guidance like Bernanke did back in the early 2010s.

And so there's a few things in the markets we're looking for. One would be yield curve control where they pin the market lower, and the second would be forward guidance, neither of which he actually committed to. And so that's why there was a lot of dovish talk.

I think the key message from the Fed this week is that, from the economy standpoint, things are certainly still quite bleak and that the Fed would remain accommodative for years to come. And for us, that was the key takeaway from his statement, that we are not going to be dealing with quantitative tightening or monetary tightening for a long time going forward.

- And finally, as head of TD Asset Allocation team for TD Asset Management, what strategies are you using to ride out the economic recovery?

- So we look at things from a variety of time frames. Our shorter-term tactical team has been using-- it's monetized in volatility, rotating throughout sectors. For a while we were looking at kind of the early recovery sectors and more recently have rotated back into tech.

For our more medium-term strategies, we are very much in the camp of either wanting quality companies-- companies with strong balance sheets and with limited, if not zero, default risk-- and/or companies that are geared to structural trends. We think that if you continue to ride that structural growth trend, whether it be typically in technology and, in some cases, health care, those are the sectors that are going to perform quite well in the-- not so much over the next quarter, but over the next three to five years. And I think that's where you're going to get the most bang for your buck.

- Michael, thank you very much for your time.

- Pleasure to be with you.

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