Why Investors May Need Patience When Viewing The Road Ahead

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  • What a strong U.S. dollar will mean for earnings.
  • What the bond market is telling us about the likelihood of a hard landing.
  • Don't expect markets to hit bottom until rates have peaked.

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From surging inflation to rising rates, recession worries, and geopolitical conflict, markets are facing almost unprecedented headwinds this year. Michael Craig, Head of Asset Allocation at TD Asset Management, speaks with Greg Bonnell about his outlook and the road ahead for markets.


Greg Bonnell: September does have a reputation of being not very kind to the equity markets. And we've definitely been living that as investors. Of course, the key question is, what lies ahead? And does all this volatility present any opportunities for us on a certain timeline?

Michael Craig, Head of Asset Allocation at TD Asset Management joins us now. Great to have you back on the program. Let's start there.

I mean, it's been a tough year. It's been a tough September. Volatility, we're often sometimes told, can present opportunity. How do we see it?

Michael Craig: It's a very challenging backdrop right now. Equities have really repriced as a function of the cost of money. So when you think about them relative to what governments are borrowing at, they've come down. But probably not as much as they probably need to.

On the fixed income side, for 12 years, investors have really been challenged, finding sources of income. And I think I read earlier, we've gone from there is no alternative, to now, there is plenty of alternatives. And so for investors thinking about what they're trying to achieve now, I mean, we are at more attractive levels, particularly in the income space to think about that.

So that's kind of where the thought process is now, is that I think, the bond sell off is well entrenched levels of real interest rate. Bonds minus implied inflation are at very high levels, levels that typically can break an economy, or put them into recession. And so that area, I think, is a bit more interesting than perhaps the equity markets.

Greg Bonnell: Now, as we get interested in some of these areas of the market, of course, people will always want some sort of crystal ball to tell them exactly when to make their move. We know we can't time the market with any great efficiency whatsoever. Is it one of those scenarios where while things look interesting, things could still be tough for a little while?

Michael Craig: So for 12 years, we've almost had this Pavlovian response in markets, where you had easier -- every time we had these bouts of volatility, we've had easier policy pushing the cost of money, quantitative easing, et cetera. And so the reaction of a lot of investors is to buy the dip. I would be very cautious with that, in a sense that that combination is not likely to come anytime soon. And so you are buying into what likely will be a recession. And so I would urge patience.

I don't think people are always worried about missing it. I think a bit of patience probably makes some sense, as this bear market that we're in, and we are now technically in a bear market, will likely be one that's defined more by time than by the speed of the selloff, right? So we're probably for a longer period of a bear market than what we've really experienced in for a long, long period of time.

Greg Bonnell: Of course, in the summer, when we had that rally, it seemed to be a bit of doubt among investors that the Fed was serious. And then, Jackson Hole seemed to change that, and say, well, you know Jerome Powell actually is serious about all this. At some point, is there an argument to be made that the Fed gets the job done? And then, eventually, there'll be rate cuts. I mean, investors -- that seemed to be the hope that was being clung to in the summer that just got sort of thrown there with Jackson Hole.

Michael Craig: It will happen. It will happen. And I would say there's a high degree of certainty about that.

But again, it's too early. They have moved from being kind of a forward looking central bank, to really be targeting measures that tend to be lagging, which is a bit tricky. Because forward-looking measures of inflation have rolled prices paid, producer price indices are coming off. You're seeing a lot of the transportation measures start to roll as consumption-- people are consuming less, right? Rate hikes have an effect on people's behavior. But it will take some time to show up in CPI numbers.

So I would say just be patient, like the summer rally was on Fed misspeaking, talking about Fed funds being at neutral levels, which they weren't. I don't think that's what Powell meant, but that's what investors took. And then, you had a lot of technical analysis saying, oh, we were at these critical levels. Historically says, every time we got there, the bear market's over. And that was really only half the story. And so people started buying the narrative in the market. And I think people are-- it's the narratives that can kind of push you different ways, and it's usually what's the cause of bear market rallies. But I would wait for a bit more of a wash out, kind of, real economy, before you get kind of excited about really pushing back into equity.

Greg Bonnell: Could there be more bear traps awaiting us as we work our way through this?

Michael Craig: So sometimes, it's this profession, mentally. You feel like you're a bit of a kite in the storm, if you will. And so I was actually just looking at the -- not to say this is the same. But to look at a previous bear market, I went to the '07 '09 experience. And within that bear market, there were a number of rallies, double digit, 15%, 25% rallies before.

You ultimately hit the bottom. And I think you have to be very disciplined to when you are looking for a degree of bottoming in various other metrics, to get comfortable that we are actually at the bottom. And that you've seen policy shift. And you start to see where inflation is on a to handle. And you're getting a feel that the central banks are really looking to ease policy again.

You'll see it in the bond market. It will start to steepen as the front end starts to rally. None of those things are happening yet, right? So again, I would say that rallies at this point forward, with nothing else changing, are bear traps.

Greg Bonnell: All right. So that's a good piece of information to take away from the conversation. What's happening in Britain right now? You get a new prime minister. You get a new-- there are a crew of finance ministers with the exchequer, right? And then, a pretty violent reaction in the markets to some of the plans that they have. Is this one of those? I mean, this is a G-7 nation. Do we need to be concerned when we-- in North America, about what effect they could have on our markets? Is this sort of a British problem? The problem, at the moment?

Michael Craig: This is a-- I actually think that historically, we'll look back at this period as one of those moments when the markets went on a completely different kind of direction, and economies going on a completely different direction than what had previously been understood. And what I mean by that is, the UK moved forward with a package of tax cuts funded by borrowing.

Now, look, we all have our ideologies. And there is an ideology that smaller government, lower taxes, OK. But to pay for tax cuts, usually you shrink services.

And there's an ideology where we increase taxes, and increase services, maybe only the sides. But to go and cut taxes, and then say, we're going to finance it with debt at 4%, and think that you're going to be able to spur growth, is a very risky strategy. And what you saw was that you can't do that anymore, because the marginal buyer of your bonds is not the central bank, it's investors. And investors are saying, nuh-uh, right?

So, and if you think about it-- So for a household making $200,000, these tax cuts are about a 4 and 1/2 thousand dollar savings. Well, Sterling's off 7% since it's announced. So you've already-- that household, in terms of goods they buy, US goods, they've already just lost $14,000.

And borrowing rates are up about 70 basis points, to 80 basis points. So epic fail. And I think it's a warning to other finance ministers that you've got to keep in mind the reaction in the bond market to your policy.

It's something you haven't really been able-- haven't really had to worry about for years now. And I think this is going to really usher in a sea change in how governments think about-- like we have to start prioritizing, and think about needs and wants, and focus on those needs. Because there is-- the cost of money is materially higher than it was a year ago.

Greg Bonnell: And I mean, what we're living through right now. And so much has happened just in 2022 alone. But of course, the greater context is the pandemic, the massive dislocations that we had across all sectors of the economy, had in the markets. It seems that we're going to be living with this hangover for a very long time.

Michael Craig: Yeah, I mean, now, we're going through the longer term implications of COVID, long COVID for certain. And even now, we've had just recently a bit of a surge here in Ontario. And you have absenteeism shortage, a shortage of labor, and an epic, an amazing amount of those 55 and over leaving the workforce.

So we do have true labor shortages. And so we're still living with that. My sense is though, that the behavior during the pandemic of excessive consumption, is now about to reverse. And that all, what we're talking about today, with supply chain challenges, and goods consumption, is about to reverse across the board.

And so in many ways, it's going to be weird, where you've got these very high borrowing costs. But I think prices of some goods is about to come down as retailers start discounting excessive inventories. But this is really a story that was going to kind of unfold over the next couple of quarters, we believe.

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