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INGRID MACINTOSH:As we record this week's podcast, the Bank of Canada has just made its sixth rate move of the year for a total of 350 basis points.
Fixed income markets have delivered a negative year-to-date return of close to 12%, and equity markets are off 15 to 20%. So, it might surprise you that today we're going to take a more optimistic view.
Joining me today to look at the future state of markets, discuss some of the bigger trends we're seeing in investing, is Michael Craig, Managing Director and Head of Asset Allocation here at TD Asset Management.
Hey, Mike.
MICHAEL CRAIG:Hi, Ingrid. Thanks for having me.
INGRID MACINTOSH:As always. So, I wanted to start off with the big question about, you know, how we're looking year-to-date. But first of all, how are you feeling about the bank's move today? Were you surprised by 50 versus 75? What are your thoughts?
MICHAEL CRAIG:I think there's been a handful of signals over the last ten days that are indicating that central banks around the world are starting to slow and ultimately end this hiking cycle.
There was a leak in the Wall Street Journal last week just before the blackout within the Federal Reserve, indicating that they may slow the pace of hikes.
There's been lots of press happening. There was an intervention, the Bank of Japan. So, today's move of 50 surprised the market. You know, I can't say we were going in with a huge, strong view one way or another. But the fact that we are starting to slow down and ultimately, we see the end of this hiking cycle, I would say within a few months, is not surprising.
I think you're starting to see material slowdowns across the global economy, which is telling you that this tightening of monetary conditions is starting to bite into the actual growth prospects across most of the world.
INGRID MACINTOSH:Let’s pull the lens back a little bit. And, you know, as we're coming in towards the end of the year and then looking forward, where do you think we stand right now? Like how are markets thinking about inflation and recessions, etc.?
MICHAEL CRAIG:Yeah, we kind of used this phrase the Fujiwara effect earlier this year. And a Fujiwara effect is when you have two cyclones approaching one another and those two cyclones in the market were inflation and the inevitable slowdown or recession.
And I think ultimately that inflationary story, while still a problem, is losing altitude. But now we will shift into some type of recessionary outcome in much of the global economy next year. Not necessarily a bad thing.
I think the markets typically be in the fore discount that they have already priced some of this in, some more than others. But that will be the story of ‘23, it will be recessionary conditions across much of the global economy.
INGRID MACINTOSH:Let's talk beyond asset class. Let's talk about the power of active management in a market like this and the tools that you have available to you.
MICHAEL CRAIG:So, when volatility is high, that tends to be when we thrive. I was at an investment lunch yesterday and the speaker made a very important comment and that is... it is a decade for active investors because of that increased volatility.
And we could spend the next couple of hours discussing about how the world is materially different than it was pre-COVID, both in terms of geopolitics, on trading relationships, on the kind of increasing tensions between China and the U.S.
A more challenging world does provide a much more richer opportunity set.
It also provides a lot more risk.
And so, from our perspective, you know, had a tremendous amount of tools that we can use at our disposal to earn higher returns for clients, but also manage the risk. You know, we're quite active in the options markets, right? We'll use those markets all the time to set up a better outcome for clients using insurance type strategies. And so, these are types of things that from as an active manager kind of critical to thrive in 2022.
INGRID MACINTOSH:So, it's like heading into a storm but knowing you've got all the tools and all the attire and look forward to it.
MICHAEL CRAIG:Yeah. And also, what we do, what we did five years ago or ten years ago or 15 years ago. It's all evolved today. And I would say that if we were having this conversation five years from now, you look back and say, all we're doing, these are the things that we've kind of added to our arsenal of tools that we'll see come over.
And I always have more to say about that in the next 12 months or so. More and more types of strategies or techniques that will come online. As you know, the nice thing about capital markets are always evolving, and that's also an area where we're looking at adding new things to our tool set to help with the risk and return for our clients.
INGRID MACINTOSH:You've been talking a lot as we've been talking. I want to drill a little bit into just how attractive fixed income is going forward and why, like, you know, from where we're starting today, I feel like that penalty that savers or conservative investors have had for the last 14 years is being alleviated. But what makes you so optimistic about fixed income going forward?
MICHAEL CRAIG:So, it's for income centric investors. It's really been a 12-year bear market. Your returns look okay. But the yield from those investments, particularly in the fixed income space, has been suppressed.
And it's been suppressed because of very abnormal monetary policy to stem, you know, the fallout from the global financial crisis. We essentially have, you know, there was a decision where one part of the economy healed at the cost of income investors. And that period has now passed. And while inflation is high today, it's hard to see...
I struggle to see inflation, and I don't think we're going back to the 1% era of the previous decade. But I also don't think that it's going to be anywhere near where it is today for a long period of time, because the backdrop is, well, probably a bit more inflationary. Not nothing in the backdrop is indicating that you're going to have hit of hyperinflation.
And if there's one thing you can learn from what happened in the UK recently, the bond market is back and enforcing fiscal deficit discipline on governments, as Liz Truss unfortunately just found out. So, to me, that backdrop is pretty supportive of fixed income. It's going to ensure that governments don't kind of go crazy on fiscal spending because they can't afford to.
And also right now, when we look at kind of forward projections of inflation, you know, those are in around the range of 2%. But you can buy a 10-year corporate bond right now and earn 4.5, 5%. So, there's a huge spread over an expected inflation and actual yields today. And so, to get a real return above inflation in fixed income is kind of a first in a long time. And that's why I think for investors it provides a tremendous amount of value today versus the last, you know, since I was in my early thirties, which is a long time ago. So that's kind of where the mindset is on the fixed income story.
INGRID MACINTOSH:That's feeling like some good news like I'm telling you, better fixed income, more optimistic, longer term about equities.
MICHAEL CRAIG:I think for income investors. So really, really optimistic. Now I do think there's going to be some volatility in equity. But, you know, for dividend stocks now, you know, 4 or 5%, not too bad. I think you're going to see high yields weaken over the next little while. But high yield, in about 6- or 7-months' time, high yields going to be really, really attractive.
And so, I'm you know, I'm kind of looking at this and saying the opportunity set is getting really, really rich. And it's one of those again, one of those periods of, you know, in the cycle where it's like we can make a lot of return for our clients, we've got to make sure we get it right. But ultimately, this is where it gets really exciting because you do see those opportunities are starting to unfold and that's kind of where our group is thinking right now.
INGRID MACINTOSH:I don't let anybody off on this, so I'm going to hit you now with a couple of my rapid fires. You've touched on them a little bit, but I’m going to throw them at you again to get your sense on these things. So first of all, the inflation.
MICHAEL CRAIG:Going lower.
INGRID MACINTOSH:Excellent. Pension gilt crisis we've seen in the UK.
MICHAEL CRAIG:Train wreck. Yeah.
INGRID MACINTOSH:With a warning shot.
MICHAEL CRAIG:Well, I mean, look, a lot of this was baked in with Brexit, right? I mean, if you materially rip up trade agreements with your largest trading partner and restrict the flow of capital and people between those two blocks, you by definition lower the potential that your country can grow.
And that's already baked in. And that was a political decision. It is what it is. And now you're seeing the fallout. I mean, the UK has had four finance ministers in the last four months.
So, these are capable people and all of them failed. And I think that the crazy things about recessions are... they always expose the weakest links, and this is the first one and there will be more exposed. I have no doubt there will be some degree of financial accident in the global market over the next six months.
It always happens. Always, always, always. And so, I think to me, in many ways, it's like, you know, you have a friend that does something really, really dumb and you're like, I better not do that right. And I think other countries are looking at the UK as an example where, you know, inflation is not something central banks can create or really can control, they can moderate it, but it's essentially a function of policy and the UK's policy has been horrible and now they're paying for it.
And so it'll pass and you know, cooler heads will prevail and they'll set a course... you know, they'll set a course for probably better days ahead. Still, their institutions are still very strong. But it is an example where, you know, poor policy has huge implications on a multi-year basis. We forget that sometimes, usually you need to study history to see it, but it's a real-life example of a real screw up.
I would say... this is not a political statement, just like if you want to... if you had a vote that would really hurt your wealth, vote yes. And your wealth goes down. You vote no, it doesn't. An aggregate. They chose yes, to have their wealth go down because of further political reasons. And I think the way it was framed, you should never, you should never have had a decision like that go to a vote.
INGRID MACINTOSH:As a lover of history and as given your focus on regimes. Last one I'll throw at you is the concept of déja vu. [laughs] Have we been here before?
MICHAEL CRAIG:I would say that is becoming increasingly clear that the period of the 1991, to call it 2020 was a vacation from history. And we are going back to a world where geopolitics matters a lot more, that the era of kind of everyone getting along is probably over and we should expect more conflict globally.
And that's where... and history is riddled with that. I mean this is not something new. We’re in, again, this is, it's a bit unnerving, I'll be totally... not to end on the negative. But these are things I think that are really important to take account of. And this is why this profession is fascinating. You know, as much as you have to be solid in math and economics and finance, history, sociology, political science, game theory are critical skills.
And it is, it will force investors to continue to build their various ways of thinking because I think we're going into a world where I think it's more than just the numbers. You have to understand the game and the implications of a kind of great power struggle across among countries. And, you know, whether you think about German and European energy policy or trade and high-tech goods or innovation, how it's going to be shared, it's not 2015 anymore. It's changing rapidly and you've got to be on top of it.
INGRID MACINTOSH:I think that's a great place for us to wrap up, not only our listeners getting a sense of, you know, the things we expect you to be thinking about as an asset manager and an asset allocator. But literally the breadth of considerations that you and your team are looking at every single day as we try to protect and grow the assets of our clients.
So, Michael, thank you so much for joining me today.
MICHAEL CRAIG:My pleasure. Thank you for having me here.
INGRID MACINTOSH:We'll circle back in a few months and see how right you were.
MICHAEL CRAIG:Can't wait.
INGRID MACINTOSH:For our listeners, you can find our recently published Wealth Asset Allocation Committee perspectives on the TD Asset Management site, along with more of our thought leadership and commentary.
You can also receive the latest expertise and updates from TD Asset Management by following us on Twitter @TDAM_Canada and on LinkedIn at TD Asset Management.
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