Chief Wealth Strategist on finding optimism in difficult markets

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- Hello and welcome to the "Money Talk COVID-19 Daily Bulletin" for Wednesday, May 20. I'm Anthony Okolie. In a few minutes, Kim Parlee will be speaking with Brad Simpson, chief wealth strategist at TD Wealth on why, even in these challenging times, he's finding optimism in these markets. But first, a quick wrap of today's headlines.

Inflation in Canada has fallen below zero for the first time in more than 10 years. The Consumer Price Index dropped 0.2% in April versus the same month last year, as the coronavirus lockdown takes a toll on consumer demand. The CMHC says home prices could fall up to 18% and may scale back mortgage underwriting to limit excessive borrowing. There are concerns the pandemic is causing significant declines in real estate prices and rising debt levels.

The financial support program announced last week for large companies is now accepting applications. LEEFF, as it's known, will provide bridge financing for the country's largest employers whose needs are not being met through conventional financing. Meanwhile, big box retailers that remained open during the peak of the coronavirus pandemic continue to report solid earnings. Lowe's and Target reported stronger than expected first quarter earnings, as digital sales surged 80% and 141% respectively. And that's a wrap of today's headlines. Next, Kim Parlee's conversation with Brad Simpson.

- Brad, you wrote in your recent portfolio quarterly strategy report that there's a good reason to be optimistic. Investment itself is an exercise in optimism. There's still a lot of bad news to come, though.

- There is a lot of bad news to come, but me, I guess I'm a little bit of a brave soul. And I'm very comfortable saying that there is, indeed, an awful lot to be optimistic about. And I think that, fundamentally, I think if we start thinking again like investors instead of speculators, that if you look at the long term history of ultimately what investment is about, is there is an innate belief that you're going to have a better tomorrow than where you are today. That is the full-- that is the idea of business itself. And I think, you know, there's a long history that would show that in both equity and in fixed income markets return, which would say you're rewarded for thinking that way.

- Let's take a look at a chart that you actually had in this report you just pointed out. It's the S&P 500 total returns from 1926 to December of 2019. And there's a tiny little red circle in the bottom right corner. And why are you showing this? I mean, is this another, again, triumph for the optimists?

- Yeah, I think this tells you two things. First and foremost, the returns over that 100-year period is 9.3%. And there's been some bumps along the way. There's been a couple of world wars. There's been epidemics. There's been crises. There's been terrorist attacks. There's been any number of things that you want to think about that are going to bring you down and think about, boy, those are horrible. And they are.

But at the end of the day, that markets prevail and ultimately, businesses are born on the idea that you're going to invest in the business, you're going to employ people, you're going to come up with better products and services. And the little red circle at the bottom there, to give it context, you look at the chart, it's a little blip along the way. Quite frankly, when I asked my creative person to update this chart, they said it doesn't need to be updated. And I said, oh, yes, it does-- let me show you. And I circled that. They went, oh, and I said that's the downturn we're in right now. So it really does put it in context.

- Yeah, it is great context. You got another chart here that I know you put out that I want to bring up. This is a chart on the bond market. And I think it's showing the growth of US corporate triple-b excess returns over treasuries. And again, we're looking 100-year time frames here. Why is this interesting? What are you showing here?

- Because the other side is that when you invest in bonds, remember what you're doing is you are lending somebody money, right? And let's face it-- there is no more optimistic thing to do than to lend somebody money. Because when you do so, you believe that they're going to pay you interest as long as they're holding that for you and that they're going to give you your capital back at one time. And so we thought it'd be really interesting, again, because we're always looking at these long term equity returns.

We said, look, let's go look at triple-b bonds over the long term. So triple-b are kind of like investment grade but not the highest investment grade. And it's kind of right before you start to move in to start making your way into high yield. And so if you look at this in these terms is that there are only three instances over the last 100 years where a triple-b bond underperformed a treasury bill bond by 5%, which is really quite remarkable.

And the second thing if you look at it is actually what the default has been like over that time-- so default meaning I'm not going to pay you your money back-- is only 2% to 3% over that whole period of time. And your worst losses during each of those was either in 1931-- so two years into the Depression-- which, I'll tell you, we always think of 1929, but really the Depression was really kind of '31, '32 to 1938, where you were down 15%, and in 2008, you were down about 5%.

And so again, it just shows that over the long term, that it is a triumph of optimists when you're investing either between equity or stock investments when it comes to, a, getting your money back, or getting a dividend, or getting an interest payment, or getting a capital gain.

- Let me ask you-- I think 100-year perspectives always do give great context, and that's important when you're showing time frames. I don't mean to be the eternal pessimist against your optimism, but we still do have a lot more uncertainty. We're talking about second waves, third waves, fourth waves. The World Health Organization came out today and said that the coronavirus could be with us forever.

- Right. And it may very well be. And ultimately, that's not my line of work. But what I do know is if we look at over a long period of time that over the now centuries, we human beings have become increasingly better at managing pandemics. So if you look at smallpox, for example, it took us 3,500 years to eradicate the planet of this. That's quite an awful long time. We look at HIV/AIDS, it was a 15-year period from where it was in a far more ugly stage, which we hear in the early 1980s, into 1995, where we improved the drugs greatly where people can still live a long and healthy and prosperous life.

Then we look at Ebola into most recently-- it was really five years from really breakout to our ability to think of vaccines. And then now, you look at where we are with COVID-19, we're doing trial phases for drugs right now. That doesn't mean we have a vaccine tomorrow, but there's a big difference between having something in your horizon starting in 2019 and starting trials for vaccines a year later and 3,500 years for smallpox.

And my whole point is that one thing that's incredible about us human beings, and even one of the first three examples here, is our ability to adapt. And we learn and we grow. And we're really actually very good at these things. And I think that tells us an awful lot about investment, ultimately, fires off of that optimism-- but it's not a false optimism. It's warranted by the fact and the science behind it.

- The resiliency is comforting, I do agree. Let me ask you, though, on that theme of adapting is that we have to adapt to a near future-- some not great economic numbers that will be coming out are going to be here. You brought a graph that firmly shows that we are in a downturn right now. So tell me a bit about what we're looking at here.

- Sure. I think what we're looking at here is-- and this actually ties in quite nicely to our theme here-- is that we use something called the Regime Score. And a Regime Score is just really our way of trying to frame up where are we right now right. And so we're thinking about the things like ISMs and PMIs and purchasing orders and manufacturing numbers and service numbers that come in.

We think about sentiment and what investors are thinking about things and how are they looking at it. And so we have this baseline number of zero. And basically, even going into this crisis, we were starting to work our way below that zero. And so we were moving into a little bit more negative realm. Today, we're at a 0.3. We went as low as a 0.6 on this chart. And so that's the first thing to say is it goes how much headwinds we're against.

Another interesting thing that it shows us is we've broken out where we would be, which is the ugliest, most bottom line that's heading to the very lows. And that is, where would this Regime Score be-- so how much of a crisis would we be in-- without monetary and fiscal policy, without government involvement and central bank policy? Well, we would be in a pretty desperate, ugly place right now without that.

And so what it tells us is that-- well, it tells us three things. One, that we're in a pretty tough spot right now. It also tells us that it could be a heck of a lot worse. And the last piece of it is that because we've also put the S&P 500 in it, the way I would measure that is I would look at the line of where we are in our Regime Score-- about 0.3-- and then look at where the S&P is. The S&P got a little bit ahead of itself, and that's what we saw through that rally. So I think we're going to see more volatility here, and we'll see some draw-downs. But we're within the zone where we should be, but I think we got a little bit ahead of ourselves.

- I want to get to in terms of your outlook for equities and just asset allocation in just a second. But quickly, at 0.3 right now, given everything that's been going, do you think we're going to see a lot more in terms of more monetary, more fiscal coming our way? We've already seen almost an unimaginable amount.

- Yeah, and it's hard to get one's head around that, but I think the answer is, yes. A loan right now in the House is getting a debated, I think it's called the HERO Bill, if I remember correctly-- there's just been so many of them. But right now, the one that's being sent to the Senate is a $3 trillion package. We think that's probably going to look closer to around $2 to $2.25 after the horse trading and things go on with it. When you think about that, that's just another remarkable number with that.

And part of that is that around the world, we've put an economy, if you will, in a coma. We're now trying to bring that economy out of that coma. Sometimes actually trying to bring something back to life again takes a little bit longer than what you think. And I think it's probably going to take, in particular, a lot of some of those subsidies for businesses-- small businesses and some of what we've been doing in terms of sending people a replacement for their paycheck-- there's going to be more of it [INAUDIBLE] to fill up against that than what was originally thought.

- Yeah, 100% agree. It's going to be uneven, it's going to be bumpy, and we're still figuring that out. I've only got about a minute here, but let me ask you-- how does that all boil down to your outlook for-- not going ask about cash-- but your fixed income equities and real assets?

- I think a good way of looking at that is that I think where we want to be today is we want to be underweight in asset allocation, underweight fixed income. With the incredible move that we've seen in government treasuries, we think you want to be kind of neutral to overweight in equity and overweight in real assets. And that kind of on a factor basis is you really want to watch your fixed income risk-- so your credit and interest rate risk. And your equity risk is volatility's still a real concern.

- Let me just follow up with one quick thing. Can you just give me a little more on the fixed income and interest rate risk, because I think that's a biggie going forward.

- Yeah, it's a two-fold. So what I'm saying there is that, first and foremost, is that credit risk is ultimately in the, let's call it the third week of March of this year, where we really were in a zone of having something that looked a lot like the credit crisis back in '08 and '09. A lot of that has worked its way through the system and it's much better than what it was. But as an investor, I think you want to really do your due diligence when you're allocating to corporate bonds and making sure that you're doing that and you're allocating-- not chasing yield-- but allocating to really the highest quality that you can.

And I think the other part is that there's sometimes a temptation to go out longer on the yield curve to try to get a return from your government securities. I think you probably want to be pretty cautious with doing that right now.

- Brad, always a pleasure. You take care. We'll talk to you again soon.

- Thank you. Appreciate it. You too.

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