TDAM Talks 2022 Year Ahead with Robert Vanderhooft

ANNOUNCER: TD Asset Management welcomes you to this week's podcast. As a reminder, this podcast cannot be distributed without the prior written consent of TD Asset Management.

INGRID MACINTOSH: As 2021 comes to a close and we look forward to the year ahead, the landscape continues to evolve. From inflation fears to omicron, there's numerous factors our investment teams are focused on. My name is Ingrid Macintosh here at TD Asset Management, and joining me on today's edition of TDAM Talks is Rob Vanderhooft, CIO here at TDAM.

We're going to speak about the recently held Year Ahead broadcast and answer some of the key questions that arose during that discussion. Rob, welcome.

ROB VANDERHOOFT: Thanks, Ingrid, glad to be here.

INGRID MACINTOSH: So Rob, the Year Ahead broadcast, it's an important annual event here at TDAM, and it's where you and your investment leadership team provide your views on where the economy is headed in the next year. And we deliver that specifically to our advisors, our planners, and our portfolio managers.

This year you kicked off the session by giving a global economic outlook, and you helped us identify some of the trends, and disruptors, and opportunities that were forecasted for 2022. To kick things off, what's your general feeling about what we should expect in the year ahead and how the Wealth Asset Allocation Committee is setting ourselves up to ensure our investors are really in the best position to benefit?

ROB VANDERHOOFT: Well, first off, certainly 2021 has been really an exceptional year with respect to returns. We've carried out an equity risk position on throughout the year. So we've been modestly positive on equities and that carries into 2022. But our expectations are certainly for much lower returns given the out sized returns in 2021.

Markets have really normalized following the pandemic shock and pullback in markets. If you look at how we're positioned, we're still underweight fixed income. We do expect rates to rise, which would be negative for bonds. We do have a modest risk position in equities. We do expect earnings to slow somewhat and economic growth to slow a bit from the really torrid pace that we saw through 2021.

But we're still quite optimistic given that you look at purchasing manager indices, for example, and they're all really quite positive. You look at expectations for GDP growth for the US, for example, for four key forwards in the 9% to 10% area, which is exceptional. And that'll carry us well into 2022 with a positive view on economic growth and therefore earnings for companies. So again, we're not quite as bullish as we were at the beginning of 2021, but we continue to carry a modest risk position into 2022.

INGRID MACINTOSH: That's a great overview. Thank you so much for that. And we really want to focus our podcast on some of the key questions that we heard during the broadcast, because we think they're probably representative of what our listeners are thinking about. So the first question we have is an interesting one. So in lieu of the news on new variants, we are still in the waning stages of the COVID-19 pandemic, which saw markets really respond quite tremendously after falling on news of entire economies being shut down.

So as we come to the end of 2021 on some positive news, strong corporate earnings, and the re-establishment of supply chains, what are the chances or risks that are existing in 2022 for a pullback, or a market correction, i.e. either related to new news on the pandemic, or other elements? Like, are we headed for another storm here?

ROB VANDERHOOFT: Yeah, at this point that doesn't seem the most probable scenario that we pull back significantly. Early indications on omicron are certainly transmission is much more severe, but mortality is significantly lower. And if that does continue to hold, the impact on economic activity is probably not that significant. There does tend to be little appetite certainly from governments and from individuals to move back into a lockdown situation. And so, we'll probably continue to see positive economic growth. Again, unless this turns much more negative or we see an additional variant come through.

INGRID MACINTOSH: Other drivers of pullback risk in 2022 that you think about?

ROB VANDERHOOFT: Yeah, you look at where earnings are, and I talked a little bit about earnings earlier and correlated to economic growth, but we do see positive earnings, revision positive earnings surprise. It would be unusual to see a significant market pullback in the face of those positive numbers. And so, yeah, you could see the market correct modestly, but we wouldn't expect a significant pullback.

INGRID MACINTOSH: It's good news. Let's turn to the other question that keeps burning, and this is the conversation around inflation. Is it transitional? Is it transitory? What are your concerns right now, or what's the view on inflation and the impact that it's going to have on sectors of the economy?

ROB VANDERHOOFT: I would say we've never been in the transitory camp. We were much more concerned about inflation certainly than what the Fed had indicated in most central banks as well. If you look at wage prices or wage inflation, for example, that's been very significant. We've got a massive recovery in the jobs market certainly in North America and really globally as well.

And if you look at where wage settlements are coming in at, it's 3% plus at this point. So that is underpinning and really becomes self-reinforcing, so as people see wage settlements above 3% that becomes the new floor. And we are seeing good price inflation as well. If you look at Canada, and we printed a CPI of 4.7% this morning, the highest since 2003. The US printed at 6.7%, a number which is the highest since I think 1982.

So we are seeing lots of inflation through the system. Some of that is transitory or temporary, but my concern is that a significant component of that persist and wages certainly are one component that do tend to persist. We're also seeing all kinds of supply chain disruptions, which some of that, again, will be temporary in nature. And then we're seeing all kinds of commodity price inflation really across the board.

You look at where metals are copper nickel, zinc, aluminum-- you look at a five year chart of those and they're incredible. You look at some of the ag commodities as well. You look at oats, coffee, canola, wheat, et cetera, and some of that will be temporary. Certainly the ag part of that is probably more temporary nature to that, but some of the commodity metals will continue to persist with higher prices.

INGRID MACINTOSH: So I think about that systemically low interest rates have been a real penalty on savers for quite some time. And as you said at the outset when you look forward, you see rates starting to rise. And where might we be a year or two from now in terms of yields and rates for our investors?

ROB VANDERHOOFT: Yeah, and that's really the tricky part. That's the challenge where the economy probably can't take significantly higher interest rates without rolling over. We've added a massive amount of debt certainly on the government side with the amount of fiscal stimulus that's gone into economies. So our view is somewhat higher interest rates, but a 3% US 10-year and same in Canada would be a little difficult at this for economies to withstand. So we don't expect that rates will get to those levels, even in the face of certainly a significant surge in inflation at the moment.

INGRID MACINTOSH: So the direction is up, but the slope is not so steep. I'm going to pivot our conversation a little bit. We're getting lots of questions from the field about investing opportunities in Asia. What can you tell us about investing, specifically in China and Japan, and more broadly internationally?

ROB VANDERHOOFT: Yeah, at this point for China, we've got a little bit more neutral as you saw in the wealth allocation chart. And really, we've seen more slowdown in China relative to what would be normal for them, and so that'll impact earnings growth, et cetera. Our long term view on China is still positive, that you do need exposure to China and most investment accounts and investors are underweight China. So longer term, it's still positive, but the shorter term you're taking a bit of a pause as the relative economic growth is a little less than what would be considered normal.

INGRID MACINTOSH: I'm going to pivot us again. Thank you for that. And one of the themes we're hearing a lot from advisors and from their clients is a conversation around ESG investing, and we've always been focused on that here at TD Asset Management. But when we look at it, what can you tell us about how the focus on ESG both influences our investment decision making and in our investment processes, but more broadly as ESG becomes more prevalent in the minds of our investors, how is this likely going to affect capital markets more broadly?

ROB VANDERHOOFT: Yeah, I think you've made an important distinction there with respect to how it will impact how we invest. I mean, we already have ESG included as part of all of what we do, so it's very much integrated into the investment process that we look for long term sustainable earnings growth in companies and again, that correlates well with sustainability factors. So, I'd say there's an increased focus on it with respect to the risk components on ESG, but doesn't change the underlying fundamental process to any degree.

I would say, though, we're seeing a bigger impact on capital markets, and we probably will continue to see a bigger impact on capital markets. I guess one of the manifestations of that has been a reduction in capital into fossil fuels, for example. So we've seen some pension plans that have eliminated fossil fuels entirely, others have reduced, et cetera. We've seen less capital going into to the oil or the energy space, and that has and could lead to higher prices as production doesn't keep up with demand. Saudi Arabia, for example, came out the other day and indicated, based on what they see, all the reduced capital expenditures in oil and gas could lead to a 30% reduction in production by 2030 from 100 million barrels a day to 70 million barrels a day.

INGRID MACINTOSH: Huge.

ROB VANDERHOOFT: That would be massive in terms of impact on the capital markets. The balancing factor would be price, obviously, and prices would be substantially higher than they are now. And so while we don't necessarily agree with that, we do see that the reality that the capital budgets are down. They're probably down 30% in North America for exploration and production, and an element of that probably continues to persist.

And the challenge is, yeah, while North America is energy self-sufficient, the US is energy self-sufficient, it's relied on massive amount of drilling to be able to maintain that production. First year decline rates typically shale wells are 60% to 70%, so you've got to drill a lot to be able to maintain production. And that's generally the case globally. You still have to put a lot of capital in to maintain production and if capital falls off, production will fall off and prices will be the balancing factor.

We're seeing that in other areas as well. The energy transition isn't going that smoothly at this point. In longer term, we do expect positive demand in copper, nickel, zinc, aluminum, lithium. All of those are part of the electrification and infrastructure that will be required to support increased electrification of vehicles, et cetera. But there's not a lot of new copper mines, nickel mines, aluminum mines, et cetera, the bauxite mines, so that does imply that we could be in a period of continuing rising prices in the commodity sector.

INGRID MACINTOSH: That leads me to a couple of follow on questions here. So first off, what about alternative energy such as nuclear in the face of this fundamental repricing of carbon?

ROB VANDERHOOFT: Yeah, and I certainly think that could be, should be a bigger factor. If you look at China, for example, they consume about 50% of the coal in the world in a year, which generates massive CO2 emissions. Their nuclear production is now at 4.9%, and they're building nuclear quite rapidly. And that'll have a major impact on their CO2 emissions or should have a major impact on this vehicle emissions.

You get a massive impact moving from coal to natural gas and you get even bigger, in fact, moving from coal to nuclear. But the challenge with nuclear is we need to change the narrative, we need to speed up regulatory process. Nuclear is an eight-year regulatory cycle and a few years, two to three years to build in some cases. The challenge is to reduce that regulatory time frame such that nuclear can be a bigger part of the equation going forward.

And that nuclear carries a significant more base load than coal going forward. But that's going to be a big challenge, but I think those are the conversations that we need to have and to change the status of nuclear to a green fuel.

INGRID MACINTOSH: I feel like we could do a whole separate conversation, Rob, on driving change and the power of engagement as part of an ESG strategy, but I'm going to pause on that one for a moment. What I am hearing, though, in your remarks here is so many considerations that aren't just focused on maybe the carbon sector, but companies more broadly, and I'm sensing that if we look back we've sort of seen all boats rise over the last couple of years as we've recovered from the first COVID pullback. But let's talk about the importance in this landscape going forward of security selection, and how do you think about that going forward.

ROB VANDERHOOFT: I think in an environment of lower returns as we expect into 2022, security selection becomes that much more important. And we certainly think in terms of how we select securities, there is a big opportunity to differentiate. And we think that'll be a bigger part in 2022 and certainly ESG element of that and risk factors related to that will continue to be important to differentiate between companies.

INGRID MACINTOSH: And for our listeners, if you didn't tune in to our recent podcast with Justin Flowerday, head of equity research here, we talked about how our very large team of equity research analysts takes those elements apart, so I'd encourage you to listen to that.

But back to you, Rob, we have covered a lot of ground today from inflation, to omicron, to Asia, to nuclear, to oil. Let's just talk, as we wind things down, about tail risks and opportunity. Do you think there's a risk out there that nobody's talking about? And then I'm going to ask you, what's the great opportunity out there that maybe no one's talking about? But first let's have a little focus on what are the risks out there.

ROB VANDERHOOFT: Yeah, yes, we talked a little bit about one of the risks and one of those is a commodity super cycle. Not just a short cycle here, but an extended cycle which, again, could underpin inflation for a long, long period of time. So that's certainly one concern. The COVID variants continue to be an ongoing concern. The path of omicron is probably the most likely in terms of greater transmissibility, but lower mortality.

But if we do see a variant with a greater mortality, that would be a massive concern. So those are a couple of things that we would highlight as risks at this point. Certainly, the level of debt in the economy is an ongoing concern. We've gone through, as I indicated, a massive amount of fiscal stimulus, which at some point needs to get repaid. And the implication of that is likely higher taxes going forward, really across the board. So that fiscal stimulus at some point becomes a fiscal drag as you need to repay that over time.

And the level of debt does highlight or magnify some of the risks in the economy as well. And so those are a few.

INGRID MACINTOSH: Those are the big ones. I want to turn you to-- I can't have you ending on a conversation around risks. How about we pivot the conversation. What are some of the opportunities that nobody is talking about?

ROB VANDERHOOFT: Yeah, I mean, certainly we look at 2022 is still reasonably strong with strong returns. Where we could be surprised is some of the resolution on the backlogs that we're seeing, some of the transportation issues. If that's relieved, we see better economic activity, but probably some mitigation of the pressure on inflation. So that would obviously be quite positive.

Earnings have continued to surprise. Earnings revisions have been positive as well. So there is some prospect that our expected returns for 2022 might be a little bit higher as a result of that. So we continue to maintain that positive risk exposure for 2022. I'd say we're reasonably optimistic at this point and have a reasonable risk position on.

INGRID MACINTOSH: That is a lot of ground that we have covered today. Thank you so much for being with us today and giving us the-- almost the trip around the year ahead broadcast for our listeners.

ROB VANDERHOOFT: Thank you.

INGRID MACINTOSH: And to all of our listeners, please keep an eye out for our Market Perspectives Year Ahead publication, which will be available shortly on the TD Asset Management Insights page. In addition to this piece, please revisit the site regularly as we have a lot of thought leadership papers, market commentaries, and insights planned in 2022.

To keep current on all things we produce, follow TD Asset Management on Twitter and LinkedIn . Thanks again for taking the time to listen, and please have a happy and safe new year.