The last quarter in equity markets was one for the ages, and one that feels like the dawn of a new frontier, says Brad Simpson, Chief Wealth Strategist, TD Wealth. Kim Parlee talks with Brad about his expectations for the markets in the next 12 to 18 months.
Can we just start with what's happened? I mean, we saw a huge risk rally in the last quarter, which you wrote in your last report says, it feels as though we're in the middle of an enormous transition. What is this transition?
- I sometimes think that I should just come out and say, change, as many times as I can, because that's how fast things are changing. Welcome to the era of Modern Monetary Theory-- or if not that, something very close or what we've been calling monetary policy three. I know that sometimes it almost gets a little bit tiresome to hear it, but the causation for much of what we've seen in the last three, four months is that we are moving into an era where not only are central banks setting monetary and interest rates, they're starting to act as really, essentially, a banker to the government to help them move the economy.
We've never done or seen anything quite like this before. And even if you look at the Jackson Hole meetings last week where the Federal Reserve Board basically came out and said between yield control and inflation targeting and quantitative easing and quantitative easing, that there's actually no short of that they won't do to get things going.
But I think the critical part is we need to start thinking as investors is that, much like the use of technology, like, what we're doing today, this crisis has just sped up the evolution of the use of this monetary policy three. And so we're living in a time when your economic environment changes because your inputs are changed. What happens is the dynamics of the economy changes, what happens with companies is how they compete changes and how they work with one another changes. And that's a real positive.
But how we look at these things have to start to change to be able to capitalize on that and to be able to make money and also to protect capital. And because there's positives that come from it, like we're seeing, right, but there's also some negatives. Like we know one thing-- somewhere, somebody's going to start paying for this. So one negative aspect that comes from this is that we're going to probably see some more tax.
If you kind of look at ECB tax rates going back to 2006, they've declined from 27% down to 23%. I think you might see them start working their way back up again. And this creates headwinds. And these headwinds will start to have an impact on how companies work, how they make money, what sort of income they make, and what kind of dividends that they pay. And I think all these things, you have to start thinking about the goods and the bads and how you're going to interact with it.
- Well, let's talk about those-- those goods and bads, Brad. Because really, I think it's interesting that decision making is shifting in so many places based on this new landscape we're in right now. I've got a chart here we pulled from your last report. It's something called the Market Risk Regime Score Chart. Refresh me on what that is, and also what it's showing, please.
- So it's kind of like almost in chart form, but showing in almost real time, what we're kind of talking about on what happens when you get central banks and governments around the world to start working together in a time of crisis. It starts to have a positive impact. So first of all, we're looking at a line that shows where the S&P 500 is, which is back above the two, but above where they were in February and higher.
And then you can look at the next line shows-- at the very bottom of it, it shows where we are at what we call a risk regime score, and where that risk regime would be if none of this policy was being implemented right now. And you can put numbers on it, but why don't we just give it-- you'd be in a time that looks a lot like a depression right now, which wouldn't be a lot of fun. I think we could agree on that.
The line in the middle, which is tracing the S&P 500, is the risk regime score with all this policy that we've been implementing. And it's not coincidental-- there's a really tight correlation between these two. And I think what's neat about it is what it shows is that you can talk about the changes that this is making, and ultimately, what it does to the economy. But what we're showing here is the direct correlation between the interactivity between governments and central banks and what it's doing to the S&P 500.
And some would say, oh, it's just money chasing up the price of stocks, but it's so much more beyond that. It's an economy that's starting to function in a different way and that the market is reflecting that and thinking, what impact is that going to continue to have down the road? And so that's where this whole concept and idea of our quarterly strategy was called Mirror of Our Times.
And that was you need to build a strategy that mirrors the environment you're in. And I worry that a lot of investors and, frankly, a lot of portfolio managers are still living in a world and thinking in a world that doesn't actually exist anymore. That's how big this transition would be. And so if that were the case, you'd have to start thinking about how you're going to invest in a much different way.
- Well, let's get right to it then, because along in that last report, you talked about holding a mirror up. You've got a look at all the different asset classes-- and we've only got about a minute here, Brad. We're going to bring the chart up, but I should just note, you're underweight on Canadian equities, overweight on US equities, neutral international emerging markets ex-China. It shows your equity factors, currency risk factors, alpha factors. Maybe just tell me the equities-- what really stands out to pay attention to?
- Well, I think the other thing that really stands out is kind of a couple-fold. One is that one of the things we saw going into this is that people were prepared to overpay for growth. In a world where central banks are saying, growth is going to be really tough and they're going to do anything to get it, growth is still going to be very much a place that you're going to be allocated to. If governments and central banks are going to be working together, they're going to be doing infrastructure projects.
There was a big announcement in Vancouver today about a new project that is being done there. We're going to see continued rollouts-- so real assets and infrastructure, as the economy starts to pick up, some of those kind of value names and making sure you're allocated to that, which have been so out of favor. As this economy starts to roll out, taking a look at Europe. Europe has underperformed the S&P 500 by almost 50% for the last 10 years.
They're doing the same sort of things that the US and Canada are doing. That's going to be a really interesting place to belt out. Be allocated in the equity market.
- It's a great to unpack, Brad. Always a pleasure. We look forward to talk a bit more about this ever-changing landscape. Brad Simpson, he is Chief Wealth Strategist at TD Wealth, joining us from Victoria.