Ingrid: Hi, I'm Ingrid MacIntosh, host of TDAM talks. And welcome to our mid-year summer series, where we're going to deliver four snack sized podcasts covering all aspects of the market equities, fixed income, asset allocation and real assets. So, to start us off, we are going to take a look at the equity markets over the last six months and look forward to what the rest of the year has in store.
Joining me today, Justin Flowerday, head of equities here at TD Asset Management. And Jeff Evans. Justin, Jeff good morning.
Justin: Morning.
Ingrid: Okay I'm going to make it tough on you. We got to do the whole podcast in about 12 minutes to make this as snack sized as I promised. So last six months. What about the markets?
Justin: Yeah, it's been, interesting times. I think if you were to ask me on January 1st and, you know, how would the markets have done with the backdrop of, a global economy which is headed into the biggest trade war in a century? an escalation in tensions across the Middle East, probably a challenge to US supremacy.
And I'll turn in artificial intelligence. what else can we throw in there? I don't know, by election. Canadian election. which probably provided more stability than anything else. But then, you know, look at the US and bond yields. Bond yields are now back through 5% based on fears around fiscal and spending fears around you know, overall deficit.
And so, you know I would have said look markets if we could have eked out flat, we would be in a good place, particularly after last year where we saw, you know, the MSCI up 28%. but I look across the world and I see Europe up double digits. I see Canada up high single digits. U.S. is, you know, it was it was down 20% at one point, and now it's back in the green.
So, interesting year. and I think, you know, it's turned out better than you could have hoped going into some of the, some of the events. I'm going to throw it over to Jeff Evans here. And really, just a quick introduction for Jeff. Jeff is, leads our empirical research team as part of the equity team.
And he's also a portfolio manager, and he's done, a whole bunch of interesting work on flows and, you know, provides lots of insights into the market for the PMS and the analysts on the team. So maybe I'll throw it over to Jeff for some, comments.
Jeff: Sounds great. thanks, Justin. And, thanks, Andrew. Great to be on the, the podcast. so maybe, you know, a couple of thoughts, as Justin has been a very interesting year and as you kind of come through all the noise over the last couple months. Here we are in June, with U.S. equity markets close to peak.
But I think more interesting is actually that the Canadian equity market, the UK, Germany, Spain, Australia, a lot of major developed markets at all-time record highs, which has been a very interesting pivot. What's been interesting is that it's led to this narrative of maybe selling the US at the end of American exceptionalism. People are starting to sell down their assets and rotating.
And when they start coming up a couple of months ago, we thought it would be really important to dig into the flow data. So, look at money going in and out of ETFs, mutual funds. What are investors actually doing? And what's really neat is that there's no evidence that people are actually selling their U.S holdings. Certainly, some people are.
There's going to be some flows coming out. But on balance you're still seeing net money going into the US equity market and the US Treasury market. Now again, despite all the fiscal noise and uncertainty, now clearly the pace has changed compared to what you saw in 2020 to 23, where everybody is scrambling to get into the US.
That has slowed down, but it's still net positive. and so, this isn't really about wholesale, you know, selling us equities, readjusting portfolios en masse. it's just small little adjustments at the margin. The incremental dollar is going somewhere else to try to spread things out. which I think makes sense, particularly given the concentration risk that you've seen in US equities.
People are, finally, you know, aware that there needs to be a little bit of a rebalancing or readjustment in portfolios. but it's not the wholesale selling that. I think a lot of people have tried to make the argument of.
Ingrid: Yeah, certainly in the post Liberation Day storm, I couldn't believe that at the midpoint of the year that we would be where we are today. That was the easy part, guys. The looking backwards, I'm going to ask you to take a look forward now for our listeners and there, in their mid-year outlook, what does the next six months look like?
Maybe. Justin, kick us off. Yeah.
Justin: Look, I think I'll pick it up where Jeff left off, which is, there was a lot of hesitation about momentum in the US markets, and there was a view that, you know, you want it to be anywhere but the US. The rest of the world was going to take over from where the US led it left off last year.
And I look at some of the challenges we've had in the US. in, in the, in the year so far. And I think we're through some of the worst. And so, looking forward, you start to move into an environment where you might get a little bit more good news, right? So, you start hearing a little bit more about the tax cuts and the package that's going to come out, hopefully get through Congress in the next few weeks.
And when you look at some of the components of that, there's some meaningful drivers of, that'll be very, very helpful to earnings growth. And I'll point to, the R&D tax credit, as a specific one. And when you think about what's happened over the last few years, you went from an environment where you had, as part of the Tax Cut and Jobs Act, you had the ability for companies to deduct R&D, and the year was spent.
So immediately you just deducted any R&D. And so was an incentive for companies to spend on R&D. And then they got a tax credit for it. As we move through to 2022 that lapsed. And so, you went to an environment where you had, to expense that over five years. Right? R&D was expense over five years. That was a hit to free cash flow immediately.
It was a hit to earnings immediately. We're going back to being able to expense R&D immediately. So, there's a lot of Capex, deductions that are coming into play. So, lots of really good things coming out of, taxes that will support, earnings. And really, that's what we care about, which is, what are the companies that we invest in going to be able to grow earnings that in the coming years.
And from the management teams were speaking to, I would just say they are showing an incredible ability to navigate and to continue to grow revenues and protect margins. And so, we look at a year, a year and a half, and we're still seeing double digit earnings growth across the US, maybe high single digits in Canada. Europe is looking like it's going to be able to deliver 10% earnings growth.
Justin: So, a positive earnings growth trajectory and the negative revisions that we saw during the peak tariff narrative have slowed. And so, you've started to see a bit of a turn in revisions as well. So, from that standpoint, things are starting to look, quiet, you know, a little bit better than they did.
Ingrid: But put it a sector level.
Justin: Yeah. So, if I were to dig down into some sectors, you know, the one we've been talking about, a lot in the last few years, I think continues to be a very positive sector in terms of the fundamentals that are driving it, which is kind of the whole power generation value chain. Right. And so, if you look at what's happening in, data centers and the build out of data centers right now, I think at the end of last year, there was, power demand of about 200 terawatt hours from data centers alone that's growing to 600 terawatt hours by 2030.
So, three times increase in, power generation just from data centers. You add to that the reshoring activity that's taking place, all the build out manufacturing that's taking place, huge demand for power, and it really plays out across the entire value chain. So, you look at the companies that are selling the turbines, the power generation turbines, you look at the companies that are, providing the infrastructure to get the power to the end users.
Right. You look at the utilities, the companies who are out there building out infrastructure are getting paid high ROE and the earnings growth that they're going to be able to generate. And so that's a sector where we're continuing to find, a whole bunch of very interesting ideas.
Jeff: And maybe just building on that. I think the other thing has been interesting in the last couple of months, if you were to look at how equity markets performed from 2020, right now, just in the bottom of the market from April 2020, after Covid up to the end of 2024, we saw basically five years of risk on high beta cyclical outperformance.
With inflation, energy was performing incredibly well, materials really well, and people forget this, but even the semiconductors and tech stocks are higher beta and cyclicals. And you know, over, over the long term, we had a ton of very favorable dynamics that helped those sectors over 4 or 5 years. What the little blip in in April did was it reminded people that maybe you need.
Ingrid: A 17 percent blip…
Jeff: Just a little blip. And but, you know, in the long-term context, 20% down is pretty small. but what it did was it reminded a lot of portfolio managers that they did not have enough defense or offsets in the portfolio. And what we saw from basically Inauguration Day to Liberation Day was one of the largest and fastest defensive rotations on record in at least in the last 25 to 30 years.
And so, we've had a sector level. You were not seeing energy back to an all-time high. You haven't seen materials, even semiconductors. And Nvidia not back to all-time highs. but what you are seeing, as Justin mentioned, a lot of these utility stocks, anything that's exposed to the data center theme, showing very strong recovery and, just at the margin, having that little element of defense in the portfolio, I think you're seeing some of these, if you can tie it in with the secular, trend as well.
Those have been picking up and performing strongly.
Ingrid: Okay. Well, we promised our listeners a look back and look forward. So, looking back, a lot of noise. But we came out the other side with almost no damage done. In fact, we're a little bit ahead and I feel like we're getting a pretty optimistic outlook for the next six months. Two more questions. What is the risk that nobody's talking about?
Like what's the downside and what else? Like what else might there be that we should be thinking about?
Justin: Yeah, just on the risks. I mean, the one that we're really paying attention to, and this is more of a kind of company specific risk is, you know, we went through a phase where companies were able to refinance their debt at an extremely low rate, and this was through Covid 2020, 2021. We got kind of 0% interest rates and a lot of that debt is coming due.
And so, for these highly levered companies who, effectively grew earnings on, some high leverage, and very low, low interest payments are going are going to get reset. And that causes challenges. Right. And management teams sometimes are forced to make bad decisions. So going through the portfolios and ensuring that we avoid those types of companies, I think is something that doesn't get a ton of attention.
But we're going to see more and more, I'll just call it mishaps and blow ups in the, in the year to come.
Ingrid: Just any other thoughts?
Jeff: You know, maybe in terms of the opportunity, going down 17%, recovering back to an all-time high in three months. it's a nice opportunity for investors to come back and diversify. If they didn't. And I think that gets forgotten about, you know, when you're down 20%, you're panicking, freaking out under the uncertainty. That's the wrong time to make a change in your asset allocation.
it's times like right now or maybe it's worst rethinking the amount of U.S. equity exposure. Not in the extreme, but, you know, maybe dial back a little bit. Maybe you add some sectors like real estate infrastructure and utilities that have that diversification. downside risk potential. this is a great time to take advantage of a market recovery and diversify when you can. And, yeah, make sure that you're not exposed to just a single theme or single portfolio driver.
Ingrid: Gentlemen, thank you so much. And, Jeff, you set us up for two more of our podcasts on asset allocation and real assets. So, thanks very much. to our listeners. thank you. So much for joining us on the first of our summer series. thanks, and have a great day.
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