- 2020 took investors on a roller coaster ride from a historic market drop in March to a massive rebound in record speed happening midyear. The markets ended at all-time highs. So what can we expect in 2021? Here to tell us what he is thinking, Rob Vanderhooft. He is chief investment officer at TD Asset Management.
Rob, good to see you. I want to start off by just saying I remember a conversation that you and I had in person, different than now, just over a year ago, where I know that you talked about the fact that you were concerned or had some concerns around the pandemic or what was then to be the pandemic. It turned out to be quite prophetic.
But when you look back on 2020, what lessons would you say that we could learn from 2020 that we can bring into 2021?
- Yeah, good point. We talked a year ago about the possibility that this could evolve into a full-flown pandemic and that we were overdue for a global pandemic. And certainly that's what happened. We didn't think the probability right at that time was that high. But in terms of what the learnings were, you look at the market reaction. It's certainly down quickly. Very strong central bank and government action, monetary fiscal stimulus such that the outcome and looking through that pandemic really caused the markets to rebound really quite quickly.
It probably illustrates the difficulty of market timing in those types of events. To have gone to all cash, for example, at that time would have been difficult. And fixed income did quite well. Equities did poorly for that period of time and then rebounded quickly. And so you would have had to make all the right moves to be able to take advantage of that pullback. And again, it illustrates the need to look at long term and maintain consistent equity allocations.
- Yeah, market timing is tough in the best of times. During a pandemic, when things feel very anti-intuitive, to your point, it gets even trickier. You have just come out with a report, and the title of the report talking about key investment themes for 2021 and beyond. And the overall headline for it is that you are still bullish on equities to varying degrees and varying asset classes.
And you've got five reasons you talk about why you're optimistic. And I wouldn't mind running through each one, Rob. And the first one you talk about is strength in numbers. What numbers and what strength are you seeing?
- Yeah, we're certainly seeing manufacturing activity at good levels, very significant rebounds. Global purchasing managers indices are 52.4, which anything over 50 is expansionary. So it gives you a pretty good indication that that activity is strong. Inventory levels are also quite low, which reinforces continued strong manufacturing. Commodity prices have responded really quite well in the industrials area. So copper, nickel, aluminum, zinc have all responded quite strongly.
Lumber prices, for example, as well are basically three times what the 10-year average is. And a lot of that strength is related to US housing improving, Canadian housing improving as well. So a lot to reinforce better economic activity to support continued growth in earnings.
- So good-- it's interesting strength we're seeing there. We'll come back to commodities in a minute, too, in terms of what you're seeing. But number two on your big five themes is return to corporate profitability growth. So, again, we've seen valuations really move up, and it looks like we're starting to get some interesting earnings and forecasts from companies right now.
- Yeah, and I think you've seen earnings rebound quite quickly. But then, as you talked about, anecdotally, right now some of the numbers are coming through, certainly for financials better than expected numbers. I would say broadly, we're seeing earnings surprise, earnings revision, really quite strong. For us, that's an indication that there is continued better momentum in corporate earnings. And that underpins our view on the equity markets.
- You talk about number three on your reasons for strength. Aggressive and effective policy action coming from the government's clearly helped move things. And then even today, Janet Yellen used the words-- and I'm not paraphrasing-- "act big" when she's talking about what she plans on doing for the US economy.
- Yeah, you look at the Biden administration, the amount of fiscal stimulus that they're proposing at this time. That's in addition to the enormous amount of fiscal stimulus we've already seen globally. And global short rates are at a new record low at 63 basis points. So while economies have rebounded, we're still very accommodative from a monetary policy perspective. And as we know, monetary stimulus does lift asset prices. And certainly we've seen that.
- Number four, talking about politics, you mentioned Joe Biden coming in as the new president of the United States, and with control, albeit tenuous, I would say, with the Senate, of both houses. And that's going to have an impact.
- Yeah, we think it does in the shorter term, probably the quantum of stimulus. The expectations are that that will increase. And that's the proposal that they have in front of-- or will have in front of Congress.
So in the shorter term, more stimulus than otherwise would have been. But I would say longer term, a lot of that has to get paid back. So there's a longer term effect in terms of drag with respect to taxes, et cetera. So a shorter term pause. There's probably, longer term, a bit more of a drag on the economy.
- Something to watch, absolutely. Last of your fifth factors right now for strength is vaccines, which is the game changer right now.
- Yeah, vaccines, quite a number-- we've seen two approved. We've seen Johnson & Johnson pretty close to approval, which is more of a normal vaccine that we're used to seeing in terms of handling characteristics, et cetera. I would say right now, the pace of deployment is less than was initially expected. That's certainly the impact in Canada.
Hopefully we can catch up to what the pace was expected to be. But that allows more of a return to a normal economic growth pattern and broadens the number of industries that are in a position to recover. And if you look at tourism, you look at the airlines, et cetera, they're very negatively impacted, but it allows some of those industries to begin to recover as well.
- Yeah, very hard hit. Let's talk a bit about some of the asset classes, as you see them. We've got a few boards we'll bring up here. The first one, what this means for 2020 and beyond. Equities-- I've got a look here at US, Canadian, international, Chinese equities, and emerging market equities. Overall pretty bullish. Neutral on emerging markets.
- Yeah, we're bullish on equities versus fixed income. And we're not looking for dramatic returns over the next five years in equities, for example. It's mid to higher single digits, including pretty good dividend returns. So we're overweight those equity areas. And we're potentially getting a little bit more positive on Canada, although Canada does tend to be a higher data market and higher standard deviation. So a little bit more risk in Canada.
We're pretty optimistic on China, where we've seen strong economic growth. So we probably expect better returns out of China going forward. But it's at significantly high risk levels.
- If we take a look at alts and bring up the chart here, again, neutral on commercial real estate, a little more optimistic on mortgages and infrastructure.
- Yeah, we look at mortgages, the yield advantage relative to what we see in governments. Still a very significant yield advantage. And so in all of the yield areas, we're looking to add yield relative to the government of Canada. So we're overweight corporate bonds. We're overweight mortgages. Infrastructure as well-- there's a significant yield component to that. And there's very likely a lot of money going into infrastructure investment projects, et cetera.
And we still see quite attractive returns, both from a capital appreciation but also a yield perspective. And we're, at the moment, neutral on real estate relative to our long-term benchmark. If you look at office, pretty neutral. Rents are being paid. If you look at industrial, very positive activity. Multi-residential, still quite positive.
We've seen impacts in retail, which we expect a lot of that to be transitory as we see vaccines deployed to a greater degree. But it leaves us in a more neutral position on real estate at the moment.
- Yeah. We do hear from people saying when the vaccines come out, there is a lot of pent-up consumer demand of people getting out there. One can hope that plays out in the retail space.
Let's take a look at fixed income. Because, again, if we take a look at investment grade and inflation-linked notes, a little more overweight. Go to the other side here, we'll see with domestic government bonds, not so much. And maybe while you talk about this, just tell me that, given the low returns we've seen with fixed income for the last five years, why has there been so much money flowing into fixed income in the last few months?
- That's a great question. You look at our expectation in the shorter term is for quite low returns out of fixed income, certainly governments. Our expectation is we will see rising rates through the balance of the year, which is obviously negative for returns.
But to a degree, what we see is still a bit of that flight to safety, a bit of that flight to, yeah, returns were really good in fixed income in 2020, and a bit of chasing of those returns. So we still see money flow into fixed income-- a little bit surprising.
- What about some of the other-- I'll call them sub-classes? Gold, Canadian dollar, US dollar, what do you see there?
- Yeah, gold, we're slightly positive to potentially neutral on gold. Gold has had a big run. Some of that flight to safety trade may exit gold. You've also-- as rates rise, cost to carry for gold continues to rise. So we're probably a little bit less positive on gold than we were.
US dollar, our expectation is that the US dollar probably trades down a bit, and therefore we're a little bit more positive on the Canadian dollar. We're looking at that pretty carefully. We have seen a run in the Canadian dollar to this point. But longer term, could it be supported by higher commodity prices? Could we see a cyclical move in Canada, or a much bigger cyclical move?
- Well, just if I could, then, you talked a bit about what you're seeing in commodities earlier on when we were talking about equities. But do you see a commodity super cycle beginning here?
- Yeah. I'm not sure it would be a super cycle at this point, but we're certainly watching that carefully. We've had a tremendous underinvestment in a lot of the metals areas for the last decade. So on the supply side, there's not a lot of supply coming on board. Industrial activity has picked up, and so certainly copper has been a big beneficiary of that-- the other metals too, to lesser degrees, but they've all been quite positive.
I mentioned lumber prices-- quite strong. That could continue for a period of time, and agricultural commodities as well. If you look at soybeans, you look at, for Canada, canola. Canola prices are very strong. The corn prices are in pretty good shape, wheat prices, et cetera. So a lot of those would tend to favor Canada. So it's something that we're keeping an eye on.
And then if you look at oil prices, we still think oil is oversupplied. And Saudi Arabia has kept production down, but we're not in supply-demand balance at this point. So we don't expect a big lift in oil prices, which would be very positive for Canada if we saw that and positive for the Canadian dollar.
- Yeah. Let me ask you, overall, this sounds pretty, I'd say, bullish, optimistic in terms of the things that can happen with the rebound. But I need to ask you the same question that I asked you a year ago. Do you see anything that-- potential red flags or could derail your outlook?
- Yeah, we talked about the pace of vaccine deployment. Also, if you look at-- the COVID numbers are really quite high at the moment. And so it's that struggle between deployment of vaccines and pretty negative impacts from COVID. And you're seeing that in Europe in some of the shutdowns. You're seeing that in Canada to a degree as well.
The very short-term employment numbers that have come out have been a little bit disappointing as a result. And so, again, it's not-- there are still some concerns out there with respect to risks. So, again, it's not clear sailing from here, by any stretch.
And then equity valuations are on a PE basis at the higher end of a normal valuation. But with rates being very, very low, the earnings yield, the dividend yield, really quite attractive in equities vis a vis fixed income. But no question that's a challenge. And again, we are looking for modest returns in equities going forward, but better than fixed income.
- Rob, always a pleasure. Thanks so much for joining us.
- Thank you.