Markets are tumbling as investors focus on worsening tensions between Russia and Ukraine and the upcoming U.S. Federal Reserve meeting. Anthony Okolie speaks with Michael Craig, Head of Asset Allocation and Derivatives, about what to expect going forward.
- Good morning, Tony. Yeah, lots of things going on. This started with really the Fed policy turning materially more hawkish. First time in a long time that the Fed has actually gotten well behind the curve. Previous Fed hiking episodes were preemptive for inflation. This time around, inflation is here.
So that started this to spike the market along were really high-- high revenue, low-growth tech sold off first. But now, since then, it's started to feed to the rest of the market. So broad-based correction, nothing too early to hide right now. It will pass, but these types of episodes early on in hiking cycles are not uncommon. And so it's not something that's terribly shocking to us.
- And could this be a more sustained pullback, given all the risks in the market right now? What are your thoughts there?
- Well, if it were just predicated on what I just mentioned, I would say that I wouldn't be too concerned. Certainly, the geopolitical side of things is where I think there's a bit more risk in terms of what's happening in Ukraine. It doesn't feel like either side is backing down. And Russia, in very many ways, is kind of overcommitted. It's hard for Putin now to back off without getting some type of victory. And right now, it looks like the West is not really willing to give him anything.
And so, to me, it's kind of an unknown. Markets hate uncertainty. I've said this before. And for us to see a material leg lower, you'd have to see some type of conflict, military conflict in Eastern Europe. And that would be something that I'm probably most concerned about right at this moment.
- OK, and I want to pivot back to the Federal Reserve and Bank of Canada. Of course, all this market activity, this volatility is happening as we have the big central bank meetings this week. How do you see the central bank meetings impacting markets going forward?
- I think the market is now kind of caught up to where central bankers are, and I do not believe that you're going to get any walk back from prior statements. I think the central banks will come out quite hawkish this week. Bank of Canada is looking like they will likely hike. Chances, they might not, just because of the impacts of Omicron in many of the Canadian provinces. But my sense is that probably is going to go and markets giving in the past now.
The Fed will be hiking in March. There is a bit of chatter in the market that it'll 50 point increase, but I think with the recent volatility, that's more likely at 25. And we're going to see a hiking cycle through the remainder of this year until either you see a material sell-off in risk, which is not our base case, or inflation moderating, which I think is likely, you start to see inflation really come off the boil. I don't think we're going back to 1% inflation. But the pace of current inflation I think is unsustainable, and I think we'll moderate into the summer.
- OK. So given all this volatility in the markets, how is TM positioning itself in terms of its asset allocation?
- We started reducing higher beta parts of our portfolios starting back in October, whether it be small cap, US small cap, Canadian small cap, US growth. When these things come, it comes in such a way that it always kind of surprises you, particularly with the conflicts in Eastern Europe. But we've moved materially into that direction.
We still somewhat have a bit of a risk position on. This isn't really too upsetting, I think. You get these corrections. And in many cases, it's a good thing. It's a cleansing of the market. So it's a cleansing of speculative energy that had built up.
You really see it in cryptocurrency. That's fallen materially. And so even the S&P is down 10% on the year, which is not fun but not the end of the world. Whereas in the crypto space, you've seen high double-digit losses across the board. And I think that's just pulling back a lot of the speculative energy.
This will stabilize. But the next leg higher in the market, our sense will be in stocks that are a bit more higher on the quality spectrum, companies that will work through this hiking cycle and be fine, earnings will not be materially affected. And so I don't think you're going to see a return of this real kind of high-momentum market anytime soon. I think it's going to more of a quality, whether that be growth or value.
You don't want to buy dying companies on the value side. And you don't want to buy companies with zero earnings either on the growth side. You want companies with real businesses, with positive cash flows, and resilient balance sheets. And those are the companies that I think will do just fine this year when this episode of volatility passes.
- What will you be watching closely over the next few weeks?
- Well, one of the first elements I think that is supportive is that the bond market, which started off the year quite poorly, has stabilized. And so you're starting to see-- part of that is a little bit of risk aversion. So, in all fairness, bonds are rallying I think off fears in Eastern Europe, although gold is not following.
So you're not really getting a full continuation of risk of safe haven currency assets supporting this. And so that reduction in volatility in the bond market I think is the first step to seeing more sanguine financial markets.
The second thing ultimately to start seeing is this kind of epic sell-off start to abate a bit. So look for intraday reversals where the market sells off and starts to bounce and then can't-- start to establish new lows. For us, that would be from more of a technical perspective, a sign that the market is nearing the end of the sell-off. It's gone farther than I personally would have thought, but then I wasn't expecting to see this Ukraine episode kind of spiral as it is. So that is a bit of a negative wild card.
But absent of that, a 10%, 15% now in the NASDAQ, I would expect us to see a little bit of that vol come off. Our expectation, though, is this is going to be a choppy, high-vol environment, probably 'till March, till when you get that first hike. Then everyone kind of relaxes, and we start going through the hiking cycle.
You tend to see the peak vol during hiking cycles in the lead up to the first hike. And then you start to see things moderate a little bit. So that's kind of how we're thinking about the next couple of months.
- Michael, thank you very much for your time.
- My pleasure.