It’s been a challenging start for global equity markets rattled by geopolitical risks, inflation, and rate increases. Anthony Okolie speaks with Michael Craig, Head of Asset Allocation and Derivatives, TD Asset Management, about the outlook for markets going forward.
- Mike, this has been a very difficult market of late. What's giving the market so much trouble?
- Well, there's a lot of different narratives playing out in the market right now. And so on any given day, one of those narratives may be taking hold. List off, kind of top of mind, geopolitically, there's continued severe lockdowns in China due to COVID-19. Within Europe, obviously the headlines out of Ukraine continue to be quite dire and troubling, as well as there's a tremendous amount of saber rattling, and that's certainly got the market on edge.
And then from the more fundamental basis, we are in a situation where inflation is way, way, way above where it should be. You've got central banks that have done a complete 180 earlier this year in terms of policy, and I would argue that we probably are on the verge of a material slowdown in growth. So, I just listed off five major headwinds to financial markets right now, and as a result, you're getting quite a bit of volatility, intraday volatility and day-over-day volatility.
- So given that backdrop, do you think that we're seeing signs of a more sustained pullback, given all the risks and headwinds in the market right now?
- Well, let's go through maybe the asset classes. I think with fixed income, which has just gone through one of the worst starts in 50 years, I think that's probably behind us. I think the fixed income markets will start to look not so much at the current headline of inflation but that kind of headline out six months from now, which will be more of a slowdown. And that will be creative to bond yields. I think you'll see in some parts inflation all over. And so I would expect, actually, the bond market volatility to come off from the boil a little bit or, even better, to see a rally in yields.
Within the stock markets, the S&P has been quite resilient at these levels. We have seen buyers come in right around here. My sense is that's probably the market where there's going to be continued volatility over the next few quarters.
Trying to predict the world is a bit of a mug's game, so we will always think about probabilities of outcomes. And I would say there's really two. On the positive scenarios is we have a slowdown, inflation becomes much more hospitable, and central banks take their foot off the gas in terms of hikes. That's probably the best case scenario. In that case, you get a more sideways to slightly up equity return.
The negative scenario is that we start to see parts of the world into recession. And that's a bit more of a negative scenario for equities, and there would be probably some more downside ahead if that did materialize.
- And as you mentioned, central banks are aggressively hiking rates or indicating they will be hiking at a faster pace. How do you see the central bank meetings impacting markets?
- So to be very clear, there's a lot already priced in the market. If you look at the short end and straight curves, markets are pricing, give or take, 10 or 11 hikes between now and early next year. I would take the under on that. I don't think they're going to get that far.
You'd have to see a central bank come in and do 75 basis points to really upset the market. You've already seen the key decision makers within the Bank of Canada and the Fed really push that back. You've seen some regional vice presidents or presidents talk about 75 basis point hikes. And I just don't think there's any appetite for that.
So market's expecting 50s. That's a lot. There is a risk that you see 25, but I think the central scenario is 50. And I would argue that's pretty priced in, particularly in the bond market and the currency markets. And so now it's a question of what do things look like in terms of actually occurring over the next-- really, it's between now and the fall that I'm really focused on in terms of policy from central banks.
- OK, so given all this volatility and the cloudy economic outlook, what is TD Asset Management's approach in navigating these challenging conditions?
- Well, there's two types of markets. There's ones where you're earning lots of return and you're being aggressive, and there's markets where you have a bit more of a defensive tilt. And it's really about just preserving investor capital and being prepared for the next leg of more creative markets.
Within our group, we've actually upgraded fixed income. It's more of a neutral setting. So as a firm, we've been underweighing government rates for a long time. And with the recent sell off in yields and levels now that 10-year treasuries now yielding around 3%, a little less, these are pretty attractive levels for entry points. And so we've been adding to fixed income.
We've been high grading our equities. What I mean by that is really focusing on companies with superior business models. Tend to grow a little bit slower, but much more higher quality streams of earnings and balance sheets. These are the firms that will tend to perform in a more topsy-turvy market.
So reducing areas like small cap, really reducing exposures in Europe and Asia as they're really feeling the acute pain of higher commodity prices, and really focusing on North American equity, as we think probably the best place to perform over the next little while. So more of a defensive footing.
We'll be forever holding more cash than we typically do just to weather these bouts of volatility, and ultimately be liquid and ready when our work indicates that the outlook is far more creative than it is right now.
- Thanks for that backdrop, Michael. When markets are rough and volatile, as you know, it's not always easy to keep a cool head. What are the most important things for investors to keep in mind right now?
- Well, these are markets where you can lose a lot of money if you get swept up in the day-to-day. And you almost need to be a little bit numb to the intraday swings, if you will, because there's not a lot of liquidity in the markets right now. And it's not taking much flow to create larger-than-normal price swings. So you really have to ignore that noise.
I would say, again, what are you trying to achieve? What's your longer-term view? Are you buying things that if they go down 5%, you'll be happy to buy more? Really have an understanding of what you're investing in, and really have a strategic mindset, and one that is open to the various probabilities that I just laid out in terms of states of the world. So it's not easy. It's very challenging.
But I think those would be my words of advice. And to really be cautious about getting chopped up. Talking to a neighbor the other day who invested in a company because-- based on earnings report coming in. And I'm like, that's a really dangerous way to invest, if you really don't have a good understanding of the company, which he didn't.
So these are things I like to say. Really think through what your investment styles are and have a bit more of a longer-term perspective on what you're trying to do.
- What will you be watching for over the next few weeks?
- Well, I think the biggest key right now is inflation. And nobody, or very few people, were calling for 7%, 6% inflation a year ago, and now there's many who kind of jumped on the longer, higher inflation bandwagon.
I think there are arguments to be made about a higher degree of inflation in the years ahead because of lack of commodity supply and the problems we're facing with global warming and ESG, but let's just park that aside. Over the next 12 months, we would expect inflation to moderate. And it's really key to see that start to roll over.
And that really sets a path for a much different environment in about six months than the one we're in now. So really focused on inflation, I think that's really the key to a lot of things right now. And that's, I think, where the bulk of our focus is at this moment.
- Mike, thanks very much for joining us.
- My pleasure, Tony. Take care.