After an extended period of placid trading, investors were reminded this week that a sudden bout of volatility is always possible. Kim Parlee speaks with Anna Castro, Senior Portfolio Manager, TD Asset Management, about how to navigate these uncertain markets.
ANNA CASTRO [00:00:31] Yes. Hi, Kim. Yes, there's a lot of volatility under the surface and you could see it from the beginning of the year. So on one hand, we have the value stocks. These are more cyclical companies, your banks, your industrials, your mining and energy companies, as compared to the growth stocks, which are usually the technology companies. And you have a big difference in the returns. And there's been a shift in their leadership and rotation in the market. So on the chart that I brought, you can see here that there were, on a monthly basis, you have big difference in returns between value versus growth. So, for example, during February, March, even through May, value performed very well and growth was out of favor, languishing as investors were very focused on increasing their growth expectations as the reopening was happening. The US 10 year bond yield actually peaked at 1.7%. And it's quite a difference. Go ahead.
KIM PARLEE [00:01:38] No, you go ahead.
ANNA CASTRO [00:01:40] It's quite a difference from what we've seen since June to July. We're in currently bond yields around 1.2%. And you have investors changing, they're revising down their growth expectations and you've seen cyclicals fall significantly from their highs. And in the past two months, it's actually the growth names, the technology names are outperforming. And in the past week, you've actually seen a shift again where it was the defensives that started to do better.
KIM PARLEE [00:02:11] Are you expecting these these tug of wars between sectors to continue? I mean, the one thing I think that's interesting is that, you know, in the past few months, there has been a tug of war, as you showed us. But the overall indexes seem to be ticking higher. And now we're seeing these tug of wars and things seem to be ticking lower. So do you expect that to continue?
ANNA CASTRO [00:02:31] Yes. And we expect this tug of war, this volatility to continue, both on the interest rate side as well as in the equity factor or sector rotation side. Investors are now trying to determine what is a mid cycle market type of growth to expect. And at the same time, you have some concerns on how the Fed will actually land out their tapering. So at the same time, both the Fed and the investor base is very focused on data, economic data, which is also coming out in a very fluid manner as we reopen and still deal with the tail of the pandemic. Overall though, I do want to stress, despite all these rotations happening under the surface, we still prefer equities over bonds. We see equities performing well, although the future returns might be lower from what they were in the past. In the short term, though, we expect, as I mentioned, this volatility could continue and the equity market could actually be range bound for the next few months.
KIM PARLEE [00:03:37] I mean, you are obviously someone who is in the business of managing money through these markets. So how do you, when things are range bound, as you just said, what are some some examples of some strategies to take advantage of these range bound moves? But still, you've got the sector rotation going on.
ANNA CASTRO [00:03:56] Yes, in our tactical asset allocation team, we're very focused on finding how to generate returns while managing risk. So we have different tools in our toolbox so we can use equities, fixed income, cash and options. And actually in this market, when volatility is high and there are certain conditions, I really like using options to manage the path. We can actually structure options to, even in a range bound market, to generate returns and reduce volatility. Let me give you an example of something with it in the past month. I mentioned earlier that we are positive on equities and I mentioned earlier as well that in May, leading up to June, technology was out of favor, but we were actually positive about it and we would be happy to hold it in the longer term. An example of how we used options was we went through a combination of options. We were able to structure a strategy that participates on a 3% upside return, which generated a seven times payoff, so a $7 return for every $1 invested, and at the same time managing the downside risk. Let me walk you through how we were able to do that. So during periods of great concern, market volatility, the prices of put options, the price that someone would pay for insurance for their holdings increases. So in this case, when technology stocks were out of favor, we were happy to buy them at 5% lower. We were even happy to buy them outright. But we saw an opportunity to sell a put to get paid for this willingness to buy technology stocks lower at 5% and earn an attractive income. And we use that income to buy a call spread. And this call spread actually appreciates value as a market rally, and it participates up to a 3% upside. So in that one combination, we were able to achieve three things. We were able to stay invested and participate in the upside of technology as it rallied, which was consistent with our view. And second, we were able to find a way to reduce the cost and reduce the capital outlay. And number three, compared to holding it outright, we were actually through the structure, less exposed to downside. So this structure will not participate in a sale of up to 5%. So this is an example of the power of using options in a creative manner, combining it with our research and due diligence to enhance returns for our clients.
KIM PARLEE [00:06:51] That's fascinating Anna. We're out of time, but those are three good things to have happen in a portfolio. Thanks so much for joining us. We'll talk to you again soon.
ANNA CASTRO [00:06:58] Thank you.