Show Transcript
The rise in the U.S. 10-year Treasury has gotten the attention of equity markets, and the Nasdaq index has been moving sharply with every up or down beat in rates. Kim Parlee speaks with Michael Craig, head of Asset Allocation, and Scott Colbourne, Managing Director, both at TD Asset Management.
Print Transcript
[MUSIC PLAYING]
- A 10-year US Treasury has been moving up for weeks, spooking a big part of the markets, especially the NASDAQ, technology, and momentum stocks. So the question is, is this going to continue? Is there more to come? And what does it all mean?
Michael Craig is the head of asset allocation. And Scott Colbourne is managing director. Both at TD Asset Management. They join me now.
Michael, let's start with just what's been going on. We've talked a bit about this, but rising yields have shaken up the markets. The NASDAQ's almost down, I mean, close to 10%. What's your take on what's happening?
- So the rising yields is really reflecting the expectation of a more robust growth backdrop. The roll out of vaccines in the US has been far faster than people expected. There's a stimulus deal that's going to get probably signed off this month, this week, and more to come on the infrastructure front.
So the growth factor, obviously very strong. And therefore, the bond market is the steeping, whereby the overnight rate is anchored. But the longer-term government bonds have been selling off. And that's really just a reflection of a healing economy-- an economy that's emerging from recession. Unemployment rates are falling.
And so it's telling you that things are looking better. It's not a bad thing. It's a good thing. And the bond markets been quick to get on this.
- Let me ask you, yeah, you say not a bad thing-- good thing, because, again, it's about growth of where things are going. But I think for a lot of people who might have been holding some of those tech and momentum stocks, it doesn't feel as good right now.
So maybe you could explain, why are we seeing that sell-off? And why are equity markets going down when the economy looks like it's picking up?
- So some equity markets are doing OK. Others are struggling a bit. Within technology, there was some excess. Certainly early February, things are going a little bit parabolic. And people were bidding up tech assets quite aggressively. And so some of this is simply just a shakeout. And it's really just a healthy correction of-- and that's taking care of excess.
But from a more fundamental reason of why tech has underperformed and the NASDAQ's underperformed is that, as growth starts to rebound and we go into a period where growth this year could be between anywhere from mid to high single digits, growth is not as scarce. And when something's not as scarce, it's not worth as much.
Moreover, many of the companies within the NASDAQ, they're not really making any money. We're buying them on the hope that they make money someday in the future. So there's uncertainty there. And when you start discounting that by a higher rate, as the bond market is giving you, it's not worth as much.
On the flip side, there's a better place to be right now. And that is as things open up, and as you have strong economic growth this year-- and it won't last forever, but those companies that are more sensitive to the here and now of strong growth are doing very well. Financials, industrials, energy, materials-- all very, very strong returns year to date. Many of these were laggards last year, but they are reflecting a stronger growth backdrop and doing quite well.
- We'll come back into that rotation idea. Scott, I want to bring you in and really just talk about the yields. Again, people are focusing on this more than they've ever focused before. But is the rise in yields we're seeing, the quickness as the rate of change there, is it healthy? Is everything functioning as it should be?
- Yeah, when I look at the interest rates and where they are, you look at three things. One, historical levels, right? So we're still, absolute levels over the last 25 years were very low. So 1.6%, 10-year rates in the US, very low.
Why we're here? As Mike has laid out very nicely, it's good growth. It's global. This is a normalization. This is healthy. It's a great new story. So rates should be going up.
And you allude to the last issue, which is just the rate of change, right? So last year, 10-year yields bottomed in the US around 50 basis points. And they made their way up to about 90 basis points at the end of 2020, a nice gradual increase. This year, we've basically got out of two months. And we've seen about 110-- 120-basis point increase.
That's the issue that's captured people's attention. It's the rate of change. And so I think there are some concerns about the regulatory backdrop and the microstructure of the bond market.
But basically when you step back, it's a great news story. And the markets, broadly speaking, and the credit markets, and the equity markets are still responding reasonably well to this adjustment. So a little concerned about how quickly we got there, but generally speaking, a good news story.
- Yeah, it's interesting, because I think with a lot of headlines saying markets selling off in the meantime. To Mike's point, you have to take a look at financials, industrials. Even global equity markets, they've held up fairly decently in the past little while. So it just depends, I think, what you're focused on.
I just want to go back at the rate of change, though, Scott, if I could for a minute. I mean, you mentioned that was a catalyst in terms of what we're seeing. I mean, do you have any sense of the rate of change going forward?
- So I think the rate of change is going to slow down. It's very difficult to sustain this pace. If you're thinking about anchoring, where do we go? Where could interest rates go? A reasonable anchor for the long end.
30-year interest rates over the long-term has historically been about where the Fed calls its terminal rate, where it forecasts short-term rates could ultimately go in the longer term. And that's between 2.25% and 2.5%. And guess what? 30-year rates are around 2.3% in the US.
So we're getting up to the levels where it makes sense in the context of where we ultimately-- we want to go on a long-term basis. I don't think the markets have the ability to sustain a 1% increase every-- 1 to 50 basis point increase every couple of weeks. So I think the natural response to the market will see us slow down a bit.
- Michael, I want to get into the Wealth Asset Allocation Committee. You've made some changes in terms of what you see for the markets. But before we get there, just maybe talk to me a bit about the rotation we're seeing, just generally speaking, what sectors are looking more interesting right now.
- So first off, I think this is very much a tactical move. I think you've got to be careful. This is not something for the next 10 years, but it's something that's more of the here and now. And I think it'll go into the end of the year. But by no means should people be comfortable with this position long term.
Technology still is an area that's going to offer very good returns, I think, over the next 10 years. But it's going to be challenged this year. We like areas that are highly sensitive to growth. So you think when things are really going, people borrow money.
That tends to be very beneficial for financials, particularly with the steepening of the curve. So the difference between what they lend at versus what they borrow at is attractive. And so you're going to see, I think, pretty good returns there.
Energy has been another place completely crushed last year that's making a nice rebound. The market is tight. You didn't see OPEC turn on the increase quotas last week. So that's bullish for oil.
And you're also-- what's interesting is, with the recent rally, you haven't seen rig counts come back in the Permian whatsoever. So this is very different than previous cycles. As soon as you got a bit of a strength in oil prices, you saw massive activity in the US. It's not coming back. There's much more discipline on the supply side in that market, and that should be bullish for energy.
And industrials-- and this is a little bit-- you're all are looking towards an infrastructure package in the US. But another way to think about that and invest that more on a tactical basis is industrials, where they will be net beneficiaries from what looks like a package that'll be like 10% of GDP-- very, very huge package. And we expect to see that later this year.
- Let's get into some of those tactical changes. Again, you just came out with some of these changes. And I want to run through them. And again, I hear you loud and clear. These are shorter-term tactical changes that will be revisited, I'm sure, as the market cycle matures.
But Canadian equities right now, you have a set to outperform. You've moved to a maximum overweight from a modest overweight. How come?
- Three things about Canada that's interesting. A, they've been cheap. Canada has had a-- the last decade has not been great for Canadian equities. They've underperformed US markets materially. So valuation not too bad. Dividend yields anywhere from 4% to 5% in financials part.
Two, I just mentioned the preference for materials, energy, financials. Well, that gets you to Canada off the get go. And the third, what's interesting the last few weeks is you had some turbulence in the market. But you really haven't seen the Canadian dollar sell off, whatsoever, which is a different dynamic than we saw last year.
Any time you had a market turbulence that Canadian dollar sold off, our sense is that you're going to see a continued increase in the Canadian dollar. And so you don't have that currency tailwind of being invested in the US as much this year. And so makes Canada a pretty nice place to be on a 12 to 18-month basis.
- OK, let's talk a bit about emerging markets. It's moved to a modest overweight from a neutral. Scott, maybe just get your thoughts on this. And also, I'll come back to Michael afterwards. But Scott, go ahead.
- Yeah, I mean, just like the equity market, you're getting a bit of a rotation underneath-- the good news stories and the more challenging emerging markets, right? So the commodity-based emerging market complex is and will continue to do better in this environment, as we see a restoration of global growth.
Some of the more challenged emerging markets are going to be challenged by the higher yield complex, particularly coming out of the US. And some of the currencies have been a little bit more challenged. So you have to pick your market-- pick your country, just like you're changing what you're picking in the equity market.
- Michael, thoughts on that?
- Yeah, it's, again, a sense of the expectations of a weaker dollar over time. And that tends to support the emerging world. The emerging world has really fixed their balance of payments issues. So they're much better. Their fiscal situations and their fundamental situations are far better than they were, perhaps, 10 years ago.
Canada's a good commodities-- place to be for commodities. Emerging markets-- another place where you can get that commodity exposure. So in an area that has underperformed for 10 years now, so, again, it's relatively inexpensive.
So again, we like being overweight equities right now. We think the big difference, though, this year versus last year-- last year was all about growth stocks. NASDAQ, that's what really performed. We think now it makes more sense to spread around, somewhat diversify that risk so that you can take a higher equity position, but not with the drastic drawdowns like you're seeing in the NASDAQ this month.
- All right, I'm going to squeeze in the last few here-- just snoop in here these changes in tactics. Scott, CAD, Canadian dollar-- you've gone from a modest overweight from neutral.
- Yeah, it's the same story that Mike's laid out-- very nice, a backdrop that's positive with the Canadian dollar. So yeah, as we recover, it's a good news story for Canada.
- And cash, also, again, you've gone from underweight to maximum underweight.
- Yeah, I think you're not being paid much in cash, right? And so it makes sense to invest in equities or an underweight in government bonds.
- We're also really early cycle right now, Kim. So this is where, generally speaking, when you're in early cycle dynamics is sometimes the best place to invest longer-term. So we think investors should be with a very supportive backdrop, both in the monetary fiscal side, as well as unemployment rates, which are high, but are gradually improving. It means you have a very good backdrop for risk.
So it's a time to be fully invested in our opinion. There will be a time to increase cash again as we get later in the cycle, but this is not the time to be defensive.
- Well, we're glad you're telling us about those times right now. Michael and Scott, thanks so much.
- My pleasure, Kim.
- Thank you.
[MUSIC PLAYING]
- A 10-year US Treasury has been moving up for weeks, spooking a big part of the markets, especially the NASDAQ, technology, and momentum stocks. So the question is, is this going to continue? Is there more to come? And what does it all mean?
Michael Craig is the head of asset allocation. And Scott Colbourne is managing director. Both at TD Asset Management. They join me now.
Michael, let's start with just what's been going on. We've talked a bit about this, but rising yields have shaken up the markets. The NASDAQ's almost down, I mean, close to 10%. What's your take on what's happening?
- So the rising yields is really reflecting the expectation of a more robust growth backdrop. The roll out of vaccines in the US has been far faster than people expected. There's a stimulus deal that's going to get probably signed off this month, this week, and more to come on the infrastructure front.
So the growth factor, obviously very strong. And therefore, the bond market is the steeping, whereby the overnight rate is anchored. But the longer-term government bonds have been selling off. And that's really just a reflection of a healing economy-- an economy that's emerging from recession. Unemployment rates are falling.
And so it's telling you that things are looking better. It's not a bad thing. It's a good thing. And the bond markets been quick to get on this.
- Let me ask you, yeah, you say not a bad thing-- good thing, because, again, it's about growth of where things are going. But I think for a lot of people who might have been holding some of those tech and momentum stocks, it doesn't feel as good right now.
So maybe you could explain, why are we seeing that sell-off? And why are equity markets going down when the economy looks like it's picking up?
- So some equity markets are doing OK. Others are struggling a bit. Within technology, there was some excess. Certainly early February, things are going a little bit parabolic. And people were bidding up tech assets quite aggressively. And so some of this is simply just a shakeout. And it's really just a healthy correction of-- and that's taking care of excess.
But from a more fundamental reason of why tech has underperformed and the NASDAQ's underperformed is that, as growth starts to rebound and we go into a period where growth this year could be between anywhere from mid to high single digits, growth is not as scarce. And when something's not as scarce, it's not worth as much.
Moreover, many of the companies within the NASDAQ, they're not really making any money. We're buying them on the hope that they make money someday in the future. So there's uncertainty there. And when you start discounting that by a higher rate, as the bond market is giving you, it's not worth as much.
On the flip side, there's a better place to be right now. And that is as things open up, and as you have strong economic growth this year-- and it won't last forever, but those companies that are more sensitive to the here and now of strong growth are doing very well. Financials, industrials, energy, materials-- all very, very strong returns year to date. Many of these were laggards last year, but they are reflecting a stronger growth backdrop and doing quite well.
- We'll come back into that rotation idea. Scott, I want to bring you in and really just talk about the yields. Again, people are focusing on this more than they've ever focused before. But is the rise in yields we're seeing, the quickness as the rate of change there, is it healthy? Is everything functioning as it should be?
- Yeah, when I look at the interest rates and where they are, you look at three things. One, historical levels, right? So we're still, absolute levels over the last 25 years were very low. So 1.6%, 10-year rates in the US, very low.
Why we're here? As Mike has laid out very nicely, it's good growth. It's global. This is a normalization. This is healthy. It's a great new story. So rates should be going up.
And you allude to the last issue, which is just the rate of change, right? So last year, 10-year yields bottomed in the US around 50 basis points. And they made their way up to about 90 basis points at the end of 2020, a nice gradual increase. This year, we've basically got out of two months. And we've seen about 110-- 120-basis point increase.
That's the issue that's captured people's attention. It's the rate of change. And so I think there are some concerns about the regulatory backdrop and the microstructure of the bond market.
But basically when you step back, it's a great news story. And the markets, broadly speaking, and the credit markets, and the equity markets are still responding reasonably well to this adjustment. So a little concerned about how quickly we got there, but generally speaking, a good news story.
- Yeah, it's interesting, because I think with a lot of headlines saying markets selling off in the meantime. To Mike's point, you have to take a look at financials, industrials. Even global equity markets, they've held up fairly decently in the past little while. So it just depends, I think, what you're focused on.
I just want to go back at the rate of change, though, Scott, if I could for a minute. I mean, you mentioned that was a catalyst in terms of what we're seeing. I mean, do you have any sense of the rate of change going forward?
- So I think the rate of change is going to slow down. It's very difficult to sustain this pace. If you're thinking about anchoring, where do we go? Where could interest rates go? A reasonable anchor for the long end.
30-year interest rates over the long-term has historically been about where the Fed calls its terminal rate, where it forecasts short-term rates could ultimately go in the longer term. And that's between 2.25% and 2.5%. And guess what? 30-year rates are around 2.3% in the US.
So we're getting up to the levels where it makes sense in the context of where we ultimately-- we want to go on a long-term basis. I don't think the markets have the ability to sustain a 1% increase every-- 1 to 50 basis point increase every couple of weeks. So I think the natural response to the market will see us slow down a bit.
- Michael, I want to get into the Wealth Asset Allocation Committee. You've made some changes in terms of what you see for the markets. But before we get there, just maybe talk to me a bit about the rotation we're seeing, just generally speaking, what sectors are looking more interesting right now.
- So first off, I think this is very much a tactical move. I think you've got to be careful. This is not something for the next 10 years, but it's something that's more of the here and now. And I think it'll go into the end of the year. But by no means should people be comfortable with this position long term.
Technology still is an area that's going to offer very good returns, I think, over the next 10 years. But it's going to be challenged this year. We like areas that are highly sensitive to growth. So you think when things are really going, people borrow money.
That tends to be very beneficial for financials, particularly with the steepening of the curve. So the difference between what they lend at versus what they borrow at is attractive. And so you're going to see, I think, pretty good returns there.
Energy has been another place completely crushed last year that's making a nice rebound. The market is tight. You didn't see OPEC turn on the increase quotas last week. So that's bullish for oil.
And you're also-- what's interesting is, with the recent rally, you haven't seen rig counts come back in the Permian whatsoever. So this is very different than previous cycles. As soon as you got a bit of a strength in oil prices, you saw massive activity in the US. It's not coming back. There's much more discipline on the supply side in that market, and that should be bullish for energy.
And industrials-- and this is a little bit-- you're all are looking towards an infrastructure package in the US. But another way to think about that and invest that more on a tactical basis is industrials, where they will be net beneficiaries from what looks like a package that'll be like 10% of GDP-- very, very huge package. And we expect to see that later this year.
- Let's get into some of those tactical changes. Again, you just came out with some of these changes. And I want to run through them. And again, I hear you loud and clear. These are shorter-term tactical changes that will be revisited, I'm sure, as the market cycle matures.
But Canadian equities right now, you have a set to outperform. You've moved to a maximum overweight from a modest overweight. How come?
- Three things about Canada that's interesting. A, they've been cheap. Canada has had a-- the last decade has not been great for Canadian equities. They've underperformed US markets materially. So valuation not too bad. Dividend yields anywhere from 4% to 5% in financials part.
Two, I just mentioned the preference for materials, energy, financials. Well, that gets you to Canada off the get go. And the third, what's interesting the last few weeks is you had some turbulence in the market. But you really haven't seen the Canadian dollar sell off, whatsoever, which is a different dynamic than we saw last year.
Any time you had a market turbulence that Canadian dollar sold off, our sense is that you're going to see a continued increase in the Canadian dollar. And so you don't have that currency tailwind of being invested in the US as much this year. And so makes Canada a pretty nice place to be on a 12 to 18-month basis.
- OK, let's talk a bit about emerging markets. It's moved to a modest overweight from a neutral. Scott, maybe just get your thoughts on this. And also, I'll come back to Michael afterwards. But Scott, go ahead.
- Yeah, I mean, just like the equity market, you're getting a bit of a rotation underneath-- the good news stories and the more challenging emerging markets, right? So the commodity-based emerging market complex is and will continue to do better in this environment, as we see a restoration of global growth.
Some of the more challenged emerging markets are going to be challenged by the higher yield complex, particularly coming out of the US. And some of the currencies have been a little bit more challenged. So you have to pick your market-- pick your country, just like you're changing what you're picking in the equity market.
- Michael, thoughts on that?
- Yeah, it's, again, a sense of the expectations of a weaker dollar over time. And that tends to support the emerging world. The emerging world has really fixed their balance of payments issues. So they're much better. Their fiscal situations and their fundamental situations are far better than they were, perhaps, 10 years ago.
Canada's a good commodities-- place to be for commodities. Emerging markets-- another place where you can get that commodity exposure. So in an area that has underperformed for 10 years now, so, again, it's relatively inexpensive.
So again, we like being overweight equities right now. We think the big difference, though, this year versus last year-- last year was all about growth stocks. NASDAQ, that's what really performed. We think now it makes more sense to spread around, somewhat diversify that risk so that you can take a higher equity position, but not with the drastic drawdowns like you're seeing in the NASDAQ this month.
- All right, I'm going to squeeze in the last few here-- just snoop in here these changes in tactics. Scott, CAD, Canadian dollar-- you've gone from a modest overweight from neutral.
- Yeah, it's the same story that Mike's laid out-- very nice, a backdrop that's positive with the Canadian dollar. So yeah, as we recover, it's a good news story for Canada.
- And cash, also, again, you've gone from underweight to maximum underweight.
- Yeah, I think you're not being paid much in cash, right? And so it makes sense to invest in equities or an underweight in government bonds.
- We're also really early cycle right now, Kim. So this is where, generally speaking, when you're in early cycle dynamics is sometimes the best place to invest longer-term. So we think investors should be with a very supportive backdrop, both in the monetary fiscal side, as well as unemployment rates, which are high, but are gradually improving. It means you have a very good backdrop for risk.
So it's a time to be fully invested in our opinion. There will be a time to increase cash again as we get later in the cycle, but this is not the time to be defensive.
- Well, we're glad you're telling us about those times right now. Michael and Scott, thanks so much.
- My pleasure, Kim.
- Thank you.
[MUSIC PLAYING]
