Show Transcript
Equity markets enjoyed a strong rally in the first quarter. But can that momentum continue in the months ahead? David Sykes, Chief Investment Officer at TD Asset Management, speaks with Kim Parlee about the key market drivers and the implications for various asset classes.
Print Transcript
[AUDIO LOGO]
* The second quarter for the markets is officially underway. It follows the first three months of the year that saw the S&P 500 post its best first quarter performance in five years. Even the TSX managed to hit a new high as Q1 drew to a close. So what can we expect in the next three months? Who better to ask than David Sykes, Chief Investment Officer at TD Asset Management. It is lovely to have you here.
* Hi, Kim. Thanks for having me.
* Let's just start off with what happened, I guess, in the first quarter, and lots of things going on. But people watching interest rates, AI, the Mag Seven, whole bit. So what did you see in the first quarter?
* So from the equity market perspective, I think, as you mentioned in your introduction, a very, very strong start to the year. I'm not sure if I would count on that continuing. Year to date, first quarter, S&P 500 up something like 10.5%, 11%, the Canadian market up 6%, 6.5%-- really, really strong.
* If you think about annualizing those numbers, I wouldn't want to do that. I wouldn't want to get too carried away. But I think one of the big impacts for the market in the first quarter was really about interest rates. If you think about where we began this year, the Fed, from the market's perspective, was thinking about seven rate cuts during the course of 2024.
* Now, as we sit here today looking at some of the incoming data, whether it's been GDP data, it's been employment data, or inflation data, it's not going to be seven. We're looking at two or three cuts in 2024 that are priced in now to the market. And so I think the tug of war here has really been about stronger growth and how that's been impacting the rates markets.
* It's funny because if you think back six months, the world-- and I'm not talking you, but the people who are the retail, perhaps, audience-- obsessed with rates. What are happening with rates? And I know many on your team rightfully have pointed out to me, what are earnings doing in terms of another data point? So what are you seeing in earnings? Or what are you expecting for the next quarter?
* Yeah. And I do think capital markets are right to obsess on rates, because rates, ultimately, are the price of money. And that's the most important price in capital markets and in our world. But I do think one of the fundamental things that was misunderstood was that, with higher rates, companies could still survive. Companies could still thrive.
* And I think from an earnings perspective, that's really been the key for the equity market. Last quarter's earnings were stronger than expected. I think some of that was AI, but I think a lot of that was also if we look at just economic growth, the consumer in the United States is strong. Spending on the consumer level has been resilient.
* If I think about government spending, we had the CHIPS Act in the United States, we had the infrastructure bill, and we had the Inflation Protection Act. Now, that was all about a year and a bit ago. But that had some delayed spending impacts, and that's just starting to come through now.
* And in addition to that, you've had a lot of corporate capex on things like AI-- things like graphics processing units, AI, the whole infrastructure. And if you add all that up, it's been quite strong. And so the economy has outperformed expectations. So while not great for lowering rates, very, very good for economic activity and for corporate revenue. And so I think the earnings side has really come through and helped the equity market rise to its all-new highs.
* What about, just take a longer term look out-- it's interesting because we've had a huge rally in the markets. Again, you wouldn't want to straight line that and assume what's going to happen. Markets don't run up forever. But when you think about the things that are coming in the upcoming, let's say, 6 to 12 months-- you said the Fed will probably have some cuts coming, but less than we originally thought. What about the Bank of Canada? What are you seeing there?
* Yeah. So the data on the Canadian side has been interesting. So GDP here has been weaker. Fourth quarter GDP ran about 1%. We've just had the data for January and February. And it's actually looking stronger than expected. We've also had two weaker-than-expected inflation prints in Canada.
* So our best thinking would be that the Bank of Canada will also cut two or three times this year. Of course, the overnight rate in Canada is a little bit higher than in the United States. I think we'd expect more cuts in Canada than in the United States. And it's really due to the sensitivity of interest rates in Canada-- a lot of consumer debt, a lot of mortgage debt.
* And you have seen a little bit of slowing-- I would argue more slowing of the Canadian economy than the United States. And inflation is looking a little bit better in Canada than it is in the United States. But those differences are not large. And I think you'll see maybe one more cut in Canada than you would expect in the United States.
* A couple more questions-- one just on AI. I think there's been so much excitement-- I'm not going to say hype, I'm going to say excitement-- on AI in terms of the chip makers and those types of things too. And I know you've talked about maybe you want to see longer term the AI impact on the earnings-- how companies utilize AI, productivity, those types of things. Are we starting to see that? When do you start to expect to see that?
* So, look, I think it's fair to say we are seeing that. But just take a step back here. When we talked about last year in equity markets being very strong, in my mind, 2023 was really about technology, the Mag Seven. But it was really about AI-driven companies that would enable AI to happen-- so I think specifically about chips, semiconductors, things that allow the AI magic to happen, if I can phrase it that way.
* I think 2024, or 2025, '26, and beyond is about adopters. What companies adopt that technology? And if I think at its most basic level, to me, AI is really just analyzing massive, massive data sets, picking out a pattern or trying to find a particular piece of information, and then making processes more efficient.
* And if I think about that from a corporate perspective, that's very, very powerful. Because if you can increase productivity, wow, that almost is the Holy Grail. And so to me, AI is real. But let's remember something. AI is absolutely, in my mind, in its infancy.
* Someone over the weekend sent me a funny little note, a video from 1994. And it was a talk show talking about the internet, and what was the internet, and what is this "at" symbol. That was 30 years ago. And you think about back then, retailers didn't have a digital website.
* But fast forward to today, and look at what that's done for productivity, corporate earnings, et cetera. I think we're in the same phases with AI. This is going to be clearly, right across the economy, whether we're talking about medicine, agriculture, if we're talking about finance-- this has implications that are so broad and so big. I don't really see the impact of this in 2024. I see it over the next five, 10, 15 years.
* And in my mind, this is real. And it's about cost savings and productivity. And I think that's going to be very, very helpful for earnings.
* Let me ask just quickly. As you think about some of the political, geopolitics-- you know, those are probably closer than 15 years out. So you've got this massive trend with AI kind of helping the productivity. But then you've got US elections, the Middle East. You name it. Everything's coming out. What are you watching for to understand what's material to markets?
* Yeah. I think the big thing in the United States, as it goes with the election, it's really going to be about not just the occupier of the Oval Office, but how does Congress shape out? If you have a full Republican slate or a full Democratic slate, that's going to really shape policy. And I think that will drive capital markets.
* Unfortunately, we're going to have to wait and see. On the geopolitics side, I'm very happy to see, today as an example, that President Xi and President Biden had a phone call. People are talking. And I think that's the first step to avoiding consequences that we don't want to see.
* But I think the biggest difficulty for me and for people who are trying to invest is that we don't know what the next thing will be. And so for that reason, you talk about asset allocation. You talk about portfolio construction and how to make sure you have proper diversification because those events will surely come, but we don't know, unfortunately, what they are.
* Now, we have the Wealth Asset Allocation Committee, where you look with your team about potential opportunities that are out there. You've just talked about a whole bunch of things that are happening in the markets. How does that play out? And let's start with fixed income. What do you see?
* Yeah. So I think from a fixed income perspective, the Wealth Asset Allocation Committee meets monthly. And we discuss and debate how our positioning should be from an overall portfolio perspective. I think for fixed income, I think we're feeling quite optimistic about fixed income, I think largely for two reasons.
* One, yields today are much, much different than they were two, three, four years ago. For so long, rates were so, so low. Today, if you look at government bonds, you can get yields in the 3% to 4% range. If you look at corporate bonds and high yield, you can get yields in the 5%, to 6%, to 7% range. You package all that together, I think that's going to give you a nice, consistent yield that you can count on 12 to 18 months into the future.
* But also, as I mentioned in the previous segment, you're going to see some rate cuts, we believe-- probably in the back half of this year. But that'll give you a little bit of a tailwind as well. So we think you could expect mid to high single-digit returns in fixed income.
* Equities?
* So equities, it really depends geographically. I think equities overall-- on one hand, as I've mentioned, equities have moved up a lot. Globally since probably the end of October of last year, equities are up about 25%. So let's be realistic. That's probably not going to carry on for the rest of this year.
* But I think you have seen all-time highs in Europe. You've seen all-time highs in North America. One area we're not particularly optimistic on would be China. I think there's some issues going on in their housing market, debt, et cetera.
* So I think we probably underweight China. But North American markets look good. The issue just fundamentally becomes that valuations are starting to get a little bit stretched at 21, 22 times. Doesn't mean we're going to have a colossal fall from here, but I wouldn't get too, too carried away about multiple expansion from here.
* We'll see earnings growth. We'll see upside. But let's also be realistic. We haven't had a 5% or 10% pullback in a while. You're going to have one. And I think that would be the moment when then you have to steel yourself for this moment to say, a good 7%, 8%, 9% pullback, that'd be a great entry point for equities for the rest of the year.
* Get your list out, the ones you like, and then watch when it happens.
* That's right.
* Alternatives.
* Yeah. So for us, alternatives really are an amazing building block for a portfolio because they're not nearly as correlated with fixed income and equities. And so we love that diversification. And remember, alternatives, it's not just real estate, although we do like our industrial real estate, our multi-unit residential. It's things like infrastructure.
* We have a global infrastructure fund, which we're hugely proud of. It's also commercial mortgages. It's also private debt. Those opportunities, I think, look very, very strong. There's some issues around office in Canada and office in North America because of back to work and COVID and those implications still working their way through. But we would say a 10%, to 15%, to 20% smattering of alternatives across the portfolio is a place that you'd want to be as an investor.
* And finally, cash and equivalents.
* Yeah, so cash sometimes gets a very bad knock. And I think it's very important to say that cash does have a place in a portfolio. Now, maybe that should be 1% or 2% or 3%. You like that cash for an optionality.
* As we discussed, we can't predict the future. No one can. I wish I could, but I can't. It's nice to have that cash with that optionality if you see an opportunity in the market. But what I'm afraid I'm seeing too much of are folks that have portfolios with 15% or 20% or 25% cash.
* And if you see a 43-year-old individual who's saving for retirement at age 60 or 65 sitting on that much cash, there's a lot of missed opportunity cost there. And so cash is important, but we'd have a small smattering of cash at the moment.
* It's a tough one, I think, for a lot of people right now, just because they've seen the volatility in the markets. And to your point, I think a lot of people just worried that they can't predict. I guess, how do you steel that mentality to make sure you're properly allocated?
* Yeah. And it is difficult because, obviously, this is real money. This is a very tangible item for people. But I think what people would miss is I can get that guaranteed return for a year or for two years, but think about what those rates of return will look like versus, say, a broader equity basket over the next 10, 15, 20 years, especially with all the positive things that we've talked about in terms of AI and productivity and corporate growth.
* And I think that's really the honest conversation someone has to have to say, look, this money is for a long-term usage. And I'd rather let that work for me and compound away as opposed to sitting in a relatively low-yielding vehicle just to play it safe.
* David, always a pleasure. Thank you.
* Thanks, Kim.
[AUDIO LOGO]
[MUSIC PLAYING]
* The second quarter for the markets is officially underway. It follows the first three months of the year that saw the S&P 500 post its best first quarter performance in five years. Even the TSX managed to hit a new high as Q1 drew to a close. So what can we expect in the next three months? Who better to ask than David Sykes, Chief Investment Officer at TD Asset Management. It is lovely to have you here.
* Hi, Kim. Thanks for having me.
* Let's just start off with what happened, I guess, in the first quarter, and lots of things going on. But people watching interest rates, AI, the Mag Seven, whole bit. So what did you see in the first quarter?
* So from the equity market perspective, I think, as you mentioned in your introduction, a very, very strong start to the year. I'm not sure if I would count on that continuing. Year to date, first quarter, S&P 500 up something like 10.5%, 11%, the Canadian market up 6%, 6.5%-- really, really strong.
* If you think about annualizing those numbers, I wouldn't want to do that. I wouldn't want to get too carried away. But I think one of the big impacts for the market in the first quarter was really about interest rates. If you think about where we began this year, the Fed, from the market's perspective, was thinking about seven rate cuts during the course of 2024.
* Now, as we sit here today looking at some of the incoming data, whether it's been GDP data, it's been employment data, or inflation data, it's not going to be seven. We're looking at two or three cuts in 2024 that are priced in now to the market. And so I think the tug of war here has really been about stronger growth and how that's been impacting the rates markets.
* It's funny because if you think back six months, the world-- and I'm not talking you, but the people who are the retail, perhaps, audience-- obsessed with rates. What are happening with rates? And I know many on your team rightfully have pointed out to me, what are earnings doing in terms of another data point? So what are you seeing in earnings? Or what are you expecting for the next quarter?
* Yeah. And I do think capital markets are right to obsess on rates, because rates, ultimately, are the price of money. And that's the most important price in capital markets and in our world. But I do think one of the fundamental things that was misunderstood was that, with higher rates, companies could still survive. Companies could still thrive.
* And I think from an earnings perspective, that's really been the key for the equity market. Last quarter's earnings were stronger than expected. I think some of that was AI, but I think a lot of that was also if we look at just economic growth, the consumer in the United States is strong. Spending on the consumer level has been resilient.
* If I think about government spending, we had the CHIPS Act in the United States, we had the infrastructure bill, and we had the Inflation Protection Act. Now, that was all about a year and a bit ago. But that had some delayed spending impacts, and that's just starting to come through now.
* And in addition to that, you've had a lot of corporate capex on things like AI-- things like graphics processing units, AI, the whole infrastructure. And if you add all that up, it's been quite strong. And so the economy has outperformed expectations. So while not great for lowering rates, very, very good for economic activity and for corporate revenue. And so I think the earnings side has really come through and helped the equity market rise to its all-new highs.
* What about, just take a longer term look out-- it's interesting because we've had a huge rally in the markets. Again, you wouldn't want to straight line that and assume what's going to happen. Markets don't run up forever. But when you think about the things that are coming in the upcoming, let's say, 6 to 12 months-- you said the Fed will probably have some cuts coming, but less than we originally thought. What about the Bank of Canada? What are you seeing there?
* Yeah. So the data on the Canadian side has been interesting. So GDP here has been weaker. Fourth quarter GDP ran about 1%. We've just had the data for January and February. And it's actually looking stronger than expected. We've also had two weaker-than-expected inflation prints in Canada.
* So our best thinking would be that the Bank of Canada will also cut two or three times this year. Of course, the overnight rate in Canada is a little bit higher than in the United States. I think we'd expect more cuts in Canada than in the United States. And it's really due to the sensitivity of interest rates in Canada-- a lot of consumer debt, a lot of mortgage debt.
* And you have seen a little bit of slowing-- I would argue more slowing of the Canadian economy than the United States. And inflation is looking a little bit better in Canada than it is in the United States. But those differences are not large. And I think you'll see maybe one more cut in Canada than you would expect in the United States.
* A couple more questions-- one just on AI. I think there's been so much excitement-- I'm not going to say hype, I'm going to say excitement-- on AI in terms of the chip makers and those types of things too. And I know you've talked about maybe you want to see longer term the AI impact on the earnings-- how companies utilize AI, productivity, those types of things. Are we starting to see that? When do you start to expect to see that?
* So, look, I think it's fair to say we are seeing that. But just take a step back here. When we talked about last year in equity markets being very strong, in my mind, 2023 was really about technology, the Mag Seven. But it was really about AI-driven companies that would enable AI to happen-- so I think specifically about chips, semiconductors, things that allow the AI magic to happen, if I can phrase it that way.
* I think 2024, or 2025, '26, and beyond is about adopters. What companies adopt that technology? And if I think at its most basic level, to me, AI is really just analyzing massive, massive data sets, picking out a pattern or trying to find a particular piece of information, and then making processes more efficient.
* And if I think about that from a corporate perspective, that's very, very powerful. Because if you can increase productivity, wow, that almost is the Holy Grail. And so to me, AI is real. But let's remember something. AI is absolutely, in my mind, in its infancy.
* Someone over the weekend sent me a funny little note, a video from 1994. And it was a talk show talking about the internet, and what was the internet, and what is this "at" symbol. That was 30 years ago. And you think about back then, retailers didn't have a digital website.
* But fast forward to today, and look at what that's done for productivity, corporate earnings, et cetera. I think we're in the same phases with AI. This is going to be clearly, right across the economy, whether we're talking about medicine, agriculture, if we're talking about finance-- this has implications that are so broad and so big. I don't really see the impact of this in 2024. I see it over the next five, 10, 15 years.
* And in my mind, this is real. And it's about cost savings and productivity. And I think that's going to be very, very helpful for earnings.
* Let me ask just quickly. As you think about some of the political, geopolitics-- you know, those are probably closer than 15 years out. So you've got this massive trend with AI kind of helping the productivity. But then you've got US elections, the Middle East. You name it. Everything's coming out. What are you watching for to understand what's material to markets?
* Yeah. I think the big thing in the United States, as it goes with the election, it's really going to be about not just the occupier of the Oval Office, but how does Congress shape out? If you have a full Republican slate or a full Democratic slate, that's going to really shape policy. And I think that will drive capital markets.
* Unfortunately, we're going to have to wait and see. On the geopolitics side, I'm very happy to see, today as an example, that President Xi and President Biden had a phone call. People are talking. And I think that's the first step to avoiding consequences that we don't want to see.
* But I think the biggest difficulty for me and for people who are trying to invest is that we don't know what the next thing will be. And so for that reason, you talk about asset allocation. You talk about portfolio construction and how to make sure you have proper diversification because those events will surely come, but we don't know, unfortunately, what they are.
* Now, we have the Wealth Asset Allocation Committee, where you look with your team about potential opportunities that are out there. You've just talked about a whole bunch of things that are happening in the markets. How does that play out? And let's start with fixed income. What do you see?
* Yeah. So I think from a fixed income perspective, the Wealth Asset Allocation Committee meets monthly. And we discuss and debate how our positioning should be from an overall portfolio perspective. I think for fixed income, I think we're feeling quite optimistic about fixed income, I think largely for two reasons.
* One, yields today are much, much different than they were two, three, four years ago. For so long, rates were so, so low. Today, if you look at government bonds, you can get yields in the 3% to 4% range. If you look at corporate bonds and high yield, you can get yields in the 5%, to 6%, to 7% range. You package all that together, I think that's going to give you a nice, consistent yield that you can count on 12 to 18 months into the future.
* But also, as I mentioned in the previous segment, you're going to see some rate cuts, we believe-- probably in the back half of this year. But that'll give you a little bit of a tailwind as well. So we think you could expect mid to high single-digit returns in fixed income.
* Equities?
* So equities, it really depends geographically. I think equities overall-- on one hand, as I've mentioned, equities have moved up a lot. Globally since probably the end of October of last year, equities are up about 25%. So let's be realistic. That's probably not going to carry on for the rest of this year.
* But I think you have seen all-time highs in Europe. You've seen all-time highs in North America. One area we're not particularly optimistic on would be China. I think there's some issues going on in their housing market, debt, et cetera.
* So I think we probably underweight China. But North American markets look good. The issue just fundamentally becomes that valuations are starting to get a little bit stretched at 21, 22 times. Doesn't mean we're going to have a colossal fall from here, but I wouldn't get too, too carried away about multiple expansion from here.
* We'll see earnings growth. We'll see upside. But let's also be realistic. We haven't had a 5% or 10% pullback in a while. You're going to have one. And I think that would be the moment when then you have to steel yourself for this moment to say, a good 7%, 8%, 9% pullback, that'd be a great entry point for equities for the rest of the year.
* Get your list out, the ones you like, and then watch when it happens.
* That's right.
* Alternatives.
* Yeah. So for us, alternatives really are an amazing building block for a portfolio because they're not nearly as correlated with fixed income and equities. And so we love that diversification. And remember, alternatives, it's not just real estate, although we do like our industrial real estate, our multi-unit residential. It's things like infrastructure.
* We have a global infrastructure fund, which we're hugely proud of. It's also commercial mortgages. It's also private debt. Those opportunities, I think, look very, very strong. There's some issues around office in Canada and office in North America because of back to work and COVID and those implications still working their way through. But we would say a 10%, to 15%, to 20% smattering of alternatives across the portfolio is a place that you'd want to be as an investor.
* And finally, cash and equivalents.
* Yeah, so cash sometimes gets a very bad knock. And I think it's very important to say that cash does have a place in a portfolio. Now, maybe that should be 1% or 2% or 3%. You like that cash for an optionality.
* As we discussed, we can't predict the future. No one can. I wish I could, but I can't. It's nice to have that cash with that optionality if you see an opportunity in the market. But what I'm afraid I'm seeing too much of are folks that have portfolios with 15% or 20% or 25% cash.
* And if you see a 43-year-old individual who's saving for retirement at age 60 or 65 sitting on that much cash, there's a lot of missed opportunity cost there. And so cash is important, but we'd have a small smattering of cash at the moment.
* It's a tough one, I think, for a lot of people right now, just because they've seen the volatility in the markets. And to your point, I think a lot of people just worried that they can't predict. I guess, how do you steel that mentality to make sure you're properly allocated?
* Yeah. And it is difficult because, obviously, this is real money. This is a very tangible item for people. But I think what people would miss is I can get that guaranteed return for a year or for two years, but think about what those rates of return will look like versus, say, a broader equity basket over the next 10, 15, 20 years, especially with all the positive things that we've talked about in terms of AI and productivity and corporate growth.
* And I think that's really the honest conversation someone has to have to say, look, this money is for a long-term usage. And I'd rather let that work for me and compound away as opposed to sitting in a relatively low-yielding vehicle just to play it safe.
* David, always a pleasure. Thank you.
* Thanks, Kim.
[AUDIO LOGO]
[MUSIC PLAYING]
