Ingrid Macintosh, VP Wealth, Head of Global Sales Enablement
David Sykes, SVP TDBG, Chief Investment Officer
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INGRID MACINTOSH: Hello, happy New Year, and welcome to TDAM Talks Podcast. This is our year ahead special, always one of our most anticipated crystal ball episodes where we consider twists and turns of the financial landscape and take a look at the trends that may-- lots of disclosure-- shape the markets in the year ahead. I'm Ingrid MacIntosh. And today, I'm welcoming back David Sykes, Chief Investment Officer here at TD Asset Management, who will be the first to say that there is no crystal ball. But let's look at the trends and themes for the upcoming year. So David, welcome back. It's been a minute.
DAVID SYKES: Hi, Ingrid, nice to see you. Thanks for having me.
INGRID MACINTOSH: OK, we joke a lot about this, but philosophically, what's your view on year-ahead forecasts?
DAVID SYKES: Well, year-ahead forecasts are interesting.
INGRID MACINTOSH: Entertaining.
DAVID SYKES: Entertaining. They're a necessary exercise. But I would say, I can make lots of predictions. But my confidence in those predictions is rather low. I think what's more important as investors and as an investment team is that we focus on not just the next 12 months but the next 36 months, the next 60 months, the next 10 years. We really do take a long-term perspective. And trying to guesstimate the next 12 months is awfully fun. But again, I think what's really important for us is that our team is made up of people who really stick to a very, very disciplined investment process. And if I think about my confidence in that process, it's extremely high. I think about our various portfolio managers and our analyst teams and the rigor that they go through each and every day to make sure that they follow a process that will continue to find companies that can repay their debt, can increase cash flow, can increase dividends to shareholders. That's really what I have high confidence in. But I'm happy to talk about the year ahead. I'm happy to make all kinds of predictions. But we'll see whether or not they come true.
INGRID MACINTOSH: Well, what I love about a year-ahead forecast is we record them. And I can look at last year's and see how well we did. And guess what? I've done that. I've listened back to the 2023 year-ahead podcast. And I think we got a lot right. It's like the secret of comedy. Ask me, what's the secret of comedy?
DAVID SYKES: What's the secret of comedy?
INGRID MACINTOSH: It's timing. And so, really, I think we'll talk about a lot of the things we predicted, how they played out, and we'll look forward. So we looked back. We talked about inflation rates, geopolitics. We could have probably not predicted what we saw. But maybe just give us a little bit of where we are at the end of '23 compared to where we predicted.
DAVID SYKES: Yeah, so I think if we went back a year ago, we were talking about interest rates that were high and were headed higher. But we did feel, at some point, you'd see a reversal in that trend and rates move lower. I think they've moved materially lower as we've entered the end of '23. And we've seen pretty strong returns in fixed income. Now that's been very much at the end of '23. That story took a little bit longer to play out. I think you've seen a significant rebound in equity markets, very strong--
INGRID MACINTOSH: Surprising, really, when you think about it.
DAVID SYKES: Really strong.
INGRID MACINTOSH: Can you put that in context for people? Where are we at the end of the year compared to where we were even three months ago?
DAVID SYKES: Yeah, I mean, we've moved, just in the last two months, 12% to 15%, depending on the major indices. So it's been a huge, huge move. And you've seen bond yields go from something like 5% in the United States on a treasury to now 3.9%, so just a massive move in the last 3 and 1/2 weeks. The one interesting area for me has been on the alternative side. If I think about real estate, global real estate, it's actually done much better than we would have thought. In a rising rate environment, in a post-pandemic world, lots of questions about office and vacancy, we've had positive returns in that asset class. And so that's been a very nice, positive surprise. But I would say, as we enter the end of '23, it's no secret that rates have moved up materially over the course of the year. We've seen significant improvement in inflation. The United States and Canada had 8%, 9% inflation. We're now down to 3% or 4%, depending on the measure you use. There's no question in my mind, as we look ahead, you're going to see the impact of those rate increases. They'll manifest themselves in various ways. But I think, economically speaking, inflation is down a lot. And you've started to see growth slow. And I think in Canada more so than a slowdown in the United States.
INGRID MACINTOSH: So let's break it down a little bit. And this is what our listeners love is, like, let's look at it asset class by asset class and get your gut on how we're feeling about it. At a high level, optimistic, pessimistic, neutral going into '24?
DAVID SYKES: I'd say neutral to optimistic, but again, depending on the asset class.
INGRID MACINTOSH: OK, equities?
DAVID SYKES: So on the equity front, I think it's fair to say that we've seen earnings that were much more resilient in '23 than expected. On a year-over-year basis, each quarter was slowly trending down. And in Q3, Q4, we're expecting you're going to have negative year-over-year earnings growth. But as we get into the second half of next year, even with a rather significant slowdown in economic activity, you should see year-over-year earnings growth pick up. So growth will be positive on the earnings front. There's questions around the multiple. But I suspect-- we think about 4%, 5%, 6% returns for next year. At least in Canada, the dividend yields are very strong. A little bit of an elevated valuation look in the United States. Europe has had a decent year in '23 for equities, probably less optimistic about Europe. And China, I think has a bit of work to be done. But overall, I would say, mid-single digit returns as we look out to '24.
INGRID MACINTOSH: For so many of our investors portfolios, bonds make up a meaningful portion. What's the outlook for bonds from here?
DAVID SYKES: So we've had a big move, as I've mentioned. But I still think more upside to come. Again, depending on the geography, the Fed, the Bank of Canada, more so the Fed, has indicated that they will cut rates. The Bank of Canada has said some time in '24. And with that backdrop, we still think there's room for yields to move lower. And remember, with fixed income, it's not only that duration side of the equation, whereas rates move lower, yields drop, and you get a capital gain. You also do get the income. And the yields coming into the end of the year are in that 4% to 5% range. So I think we'd look for high single-digit returns in the fixed income market.
INGRID MACINTOSH: That's a great outlook. And I think compared to the beginning of the year, you didn't have that protection of that running yield. And today, you do so net-net. fixed income investors are in a much better place. How about alts, real estate?
DAVID SYKES: Yeah, so on the alternative side, we talk about alts. But really, if we divide it up into its subclasses, at one end, a very low-duration area would be our commercial mortgages. If the yield there today is 7%, the duration is something like two years. So we're very, very keen and supportive and optimistic about the return profile for commercial mortgages. On the Canadian real estate side, I think it's a little bit more challenging. I think it's a year where we're going to finally see if we get an answer to the question about return to office and what does happen to occupancy. We'll have to see. But I think that would be on the weaker side. And then on the very, very strong side, I think if we looked at our global infrastructure product, there's just so many projects around the world with very attractive returns. Whether it's in ports, whether it's in wind turbines, whether it's in solar farms, we just have so many exciting projects in that product, that I think it's going to be another year of, hopefully, strong double-digit returns for our infrastructure product.
INGRID MACINTOSH: One last one. Newer tool in the TDAM tool kit is the area of commodities. What's your outlook for that?
DAVID SYKES: Yeah, so very keen on commodities, not necessarily from a sense of trying to call a bottom or call a top. But I think the key with commodities is it provides a number of features from an asset allocation portfolio construction perspective. If I think about the role commodities plays, generally speaking over time, you've seen positive returns, which is nice. You've generally see that it's a protection against inflation, which is nice. But what's really cool about commodities is, generally speaking, with major asset classes, commodities has a very low and sometimes negative correlation. And so if you have a portfolio and everything's working or nothing's working, that's really not what you want to see. You want to have a diversifier in there with those low to negative correlations. And that's really the spot for commodities. We've done a lot of work on this. And it's hard to say exactly, but, in general, an allocation to a typical portfolio of 3%, 4%, 5%, 6%, we feel is about the sweet spot. And so for commodities, really happy with our team there, and think it's a really important building block to a proper efficient portfolio.
INGRID MACINTOSH: Yeah, I think that's a great holistic portfolio look on it. Your mission in life isn't to find the highest returning asset classes all the time. It's to build portfolios that are resilient and will endure over the long time. And I think that's really a great way that you've framed it.
DAVID SYKES: Yeah, and Ingrid, just to add to that point, I think it's really key for people to remember. We have views on the price of oil. We have views on wheat and corn. And we have views on all kinds of commodities. But really, at the end of the day, what we are is stewards of capital. We come to work every single day for our clients. And we strive as best as we possibly can to seek the best risk-adjusted returns for those clients. And we think about ourselves as stewards of capital, as I mentioned previously, for very long periods of time, not necessarily the next six months or 12 months, trying to find that one asset class that outperforms all others.
INGRID MACINTOSH: I want to talk now about some of the things that we wouldn't have seen coming in 2023, some of the big themes, and what they maybe look like in 2024. So indulge me a little bit here. First, I want to talk about the magnificent magnificent seven theme. And for our listeners, this is really the dominating securities that really held most of the return in 2023, so Microsoft, Apple, NVIDIA, Amazon, Meta, Tesla, and Alphabet. What's the outlook in 2024? More breadth, same sort of theme?
DAVID SYKES: So I think a couple of points I would make. One, you're absolutely right. The market in the United States in 2023 was really driven by those seven stocks. Don't hold me to the exact numbers, but something like 70% of the total return of the market was attributed to those seven stocks. There's good news, though. Those are real companies, the ones you just mentioned. I mean, these are real companies with real business models with a competitive advantage with significant cash flow generation. These are real businesses. I think for us though, the question would really be around valuation of some of them. They tend to be a little bit more on the pricey side. And they're building in quite a bit of expectation. I think as we move into '24, if you start to see rates come down, both at the short and the long end of the curve, that should allow a rotation away from those big magnificent seven and into some smaller caps, a mid cap, some value stocks that have not participated over the last two years. The average stock in the S&P 500 is kind of flat to down over the last two years. And while the valuations on the magnificent seven tend to skew on the high side, for the average stock, the other 493 stocks, the multiples on those stocks are basically in line with long-term averages. So I think as we look out, those magnificent seven companies are going to continue to dominate, take share, do what they do. But I think for us, if you see a normal rate environment, a normalization of those rates, I think you see a rotation away from the magnificent seven. And the market breadth can broaden out and take us to new highs.
INGRID MACINTOSH: So another huge theme in 2023, and really, the evolution of generative AI, or Artificial Intelligence, a lot of discussion in 2023 about this. How do we think about it going into 2024? Is this a game changer? How do we think about it when we look across asset classes?
DAVID SYKES: So I do think, you know, a lot of times, technologies get overhyped, and expectations get ahead of themselves. I do think AI is real. It's absolutely a game changer. I think about productivity and cost savings for corporations as companies continue to weave AI into their everyday business operations. It's real. There's a huge margin enhancing opportunity there. I think that's absolutely for sure. I do think a lot of companies are still trying to figure out or optimize ways to use AI to their benefit. But it's really going to be on the cost synergies, cost savings. I think less of it on the revenue side. But it certainly is real. And I think it's one of the reasons why we would argue that margins for the market as a whole would tend to be flat to up, in our humble opinion, as opposed to down, because we do think AI is going to increase that corporate productivity by a fair bit over the next 5 to 10 years.
INGRID MACINTOSH: Good. Double click on that. Is there any sectors when you think about it, like is it just dominating the semiconductor space, or do we think about it across all sectors?
DAVID SYKES: I think you have to think about it across all sectors. I mean, clearly, it will be most heavily focused in technology. But if you think about financial services, if you think about industrial companies, if you think about health care, even if you think about consumer staples companies, there are some giant behemoths who will use AI to be able to make their internal operations more efficient. Whether it's as mundane a topic as taking notes in a meeting and storing those notes or scouring databases and regulatory rules and being able to find information faster or quicker to do it with less people, I think, is going to be a fundamental feature that will play across almost every company in the public markets.
INGRID MACINTOSH: Largely unregulated so far. So I think 2024 will be interesting to see how that all comes through too.
DAVID SYKES: Yeah, like all things, the technology tends to get ahead of the lawmakers. And so we haven't seen a lot of new rules coming out around AI. But I'm sure they will be on a fast follow.
INGRID MACINTOSH: I'm going to tie the next couple of themes together, because I think, for our listeners, this is probably something that touches almost everybody in some way. And it's the intersection of interest rates, home prices. Maybe let's talk about interest rates. The question everybody will say is, Canada, US, how far or how fast on the way back down? We're at the top of the roller coaster. What are we looking at?
DAVID SYKES: Yeah, so I'll try and break it up into two geographies. So if you look at the United States first, the typical mortgage in United States is a 30-year fixed mortgage. And pre-pandemic, you could get a 30-year fixed for something in that 3% to 4% range. Not that many months ago, if you were looking to buy a new home in the US, you were financing at almost 8%. And so what that really did was it caused people to stop moving. If you had your starter home and you wanted to trade up and get a bigger house, you just didn't do it because the cost of financing that now was so expensive. But ironically, in the United States, if you have that 30-year mortgage, you're good. Your rate hasn't moved up from, say, 3% or 4% to 8%, so a lot less interest sensitivity for the consumer in the United States. So you didn't see, necessarily, a collapse in home prices. But what you did see a collapse of was sales of existing homes. It literally just dropped off a cliff, because at those high interest rates, people just stopped trading up.
DAVID SYKES: I think in Canada it's a slightly different story. Most mortgages in Canada are five-year fixed, and so, initially, Canadians were getting a five-year mortgage with a 25-year amortization at 2 or 3% five years ago. And you're going to see a wall of maturities coming due in '24, '25, '26. Something like 60% of mortgages that are renewing are going to have to reset, not at 2 or 3%, but something like 5 and 1/2, 6, 6 and 1/2. And that's going to be a significant increase in monthly payments, I mean, just a huge increase for the typical Canadian family. And so I think on the Canadian side, you've definitely seen concerns about the consumer. You've seen some slowdown in the Canadian economy. We had a negative GDP last quarter, and you have seen weakness in house prices. But the weakness has been 5% or 10% price declines and a bit of a lull in activity. But as we look through to '24, I think the Bank of Canada has been a little bit firmer, and have said, look, we see the end. It's in sight, but we really aren't there just yet. We're going to have to be patient. And so I think if you look at the Bank of Canada, they're talking about cutting rates in '24, but it's certainly at this point seems back-half loaded, and that will give some relief to those Canadians who do have to reset their mortgages, coming up in '24 or '25.
INGRID MACINTOSH: A little faster in the US, you think, that relief will come?
DAVID SYKES: Yeah, I think right now the market-- well, let's, take the Fed. The Fed in Powell's most recent press conference said they would cut three times next year. I think the market says that they will cut five times. I think we're probably-- our best prediction will be we're somewhere in between. We'd probably say four cuts next year for the Fed. And right now, the market thinks that the Fed would cut starting in March of '24. We find that a bit aggressive. I think we'd be more in the May, June, July camp for the first cut for the Fed and then something around that time frame for the Bank of Canada. Right now, again, in Canada, the market thinks the Bank of Canada will cut five times. I think we find that a bit aggressive, particularly with an inflation number that came out today, a little bit hotter than expected, still trending the right way. But I think what we have to realize is that interest rates do work, but you have to be patient. There's these long and variable lags. And we probably all want to see lower rates, but it's going to take a little bit longer, in our opinion, than what the market is pricing...
INGRID MACINTOSH: That sort of pivots me a little bit more to the questions that probably the central banks are looking at in terms of making those decisions, so what about the unemployment outlook for 2024?
DAVID SYKES: It's very interesting. Both central banks, and indeed central banks around the world, have indicated-- and the phrase really came from Powell and from Tiff Macklem. They talked about the battle against inflation was so important to win. We knew the horrible impacts from inflation, that they were willing to quote, unquote "take some pain." And I think that really meant that they were willing to let the unemployment rate rise. You've seen a pretty significant move in Canada. We've moved from something like 5% unemployment rate to 5.7 or 5.9 in the most recent release. TD Economics-- and I think we would support their view-- has Canadian unemployment heading something like mid-6's, 6.5, 6.6, 6.7, and that will feel some pain, for sure. I think that will do the job and slow down inflation by the end of '24 to something closer to that 2% midpoint for the Bank of Canada. I think in the United States, though, you've seen a stronger labor market. There's been a big, big upside surprise every month in nonfarm payrolls, and the employment picture just seems much stronger. Unemployment has moved. It was 3.5. We got to 3.9, last month 3.7. It probably goes just north of 4, I think, with current projections, but that will be the real sign of when we've defeated inflation. You will start to see those unemployment numbers tick up, and I think that's the sign that both central banks will say, OK, we've-- mission accomplished, and now let's start to take rates back.
INGRID MACINTOSH: And the final one I'd sort of put there on the same camp as the old big R. Like, How real are the recessionary fears for 2024? Like, we feel like we're landing the plane really well, a soft landing, but is there a risk of a recession in 2024? What would have to be true?
DAVID SYKES: Yeah, so I think there is a very real risk. And whether it's the technical definition of two negative quarters of GDP, or whether it's just very low growth, I think that's highly likely. I think it's probably more likely for the Canadian economy. As I mentioned, consumers here are much more interest rate sensitive. There's much larger consumer debt. I would guess, at this point, that we're going to see what I would call a recession in Canada, and you'll probably see that play out in Q1, Q2 of next year. But a recession doesn't mean the end of the world, as long as this isn't a negative GDP of 3, 4, 5%, as long as it's a modest recession, I think that's OK. It does look like, again, the United States is a little bit more resilient, a little bit stronger, less interest rate sensitive. And so I wouldn't be surprised if you didn't get a recession in the United States, but, again, really low growth, maybe half of 1 percentage point before the Fed feels comfortable to start taking the rate picture down again.
INGRID MACINTOSH: And from where they're sitting, they actually have the gearing to do it now. Both north and south of the border with rates where they are, at least they now have some levers to manage that.
DAVID SYKES: Yeah, and I think it is important too. I mean, I'm making projections and prognostications about '24, but any type of forecasting requires a huge amount of humility. Somewhere in here, I'll be dead wrong, one way or the other. But as we sit here today with all the information we have available, that's sort of our outlook.
INGRID MACINTOSH: So we've tried to cover everything. We tried to cover what's on people's minds. One of the questions I always have-- and I think it's really important when this area of imagination always comes to my mind-- but what are the risks or opportunities no one's talking about? What are you thinking about? What keeps you awake at night? And, also, what is that opportunity maybe that is elusive or that people aren't talking about yet today?
DAVID SYKES: Yeah, so I think the risk is always unknown, and we just don't know. No one would have predicted the global pandemic. No one would have predicted the ascendancy of certain political leaders. No one would have predicted some of the hostilities and the horrible things we've seen on the geopolitical front. So those keep you up at night, and you worry about them, but there really isn't a way to wrap your head around them. But I think on the opportunity side, there's a couple of interesting things. We talked about AI earlier, but if you think about technology and the impact that's going to have on the world, we're just getting started. And so if I think about things like semiconductors, and I think about giant industrial factories that need to re-gear for the internet of things, and new production lines, if I think about the electrification of the world thanks to EVs, and if I think about increasing phone penetration across the global consumer profile, I think about semiconductors and new technologies, we're just getting started. I know it seems like that we've talked about that for a long time, but that's really going to be an interesting space for a lot of opportunity. And the other place that we're pretty excited is in life science tools. And so the analogy I would use here is, this is not a way to play the gold rush. Sorry, it is a way to play the gold rush, but we're buying the picks and the shovels. And so what I mean by that is, there's a lot of discovery coming with AI, with the mapping of the human genome in health care, whether through pharmaceutical companies or biotechnology companies. But they all require these life sciences tools to do the tests to do the research. And we find that life science is a way you can win, capitalize on that trend, but you don't have to take the innovation or the R&D development risk, because whether a company is successful or not, they still need those tools. And so we really find that some of these life sciences companies are really, really attractive. And so, again, it's this theme of innovation. And we talk a lot about technology, but at the end of the day, technology, how it's used and implemented by various companies, is what drives earnings. It's what drives growth. It's what drives sustainable competitive advantage, and I think there's lots to be excited about.
INGRID MACINTOSH: Well, for someone who started the call, saying that, you know, not into prognostications, you actually have some amazing insights there.
DAVID SYKES: I'll make lots of predictions. I'll happily tell you who'll win the Stanley Cup, and I'll happily tell you who will win the Super Bowl, but my confidence is very low in those. But, again, look, hopefully these things pan out the way that I think and that the way the team thinks. But, inevitably, we'll be wrong somewhere. But, again, what I have really, really high confidence in, if I think about our fixed income team, and our alternatives team, and our private debt team, I'm incredibly confident in their ability to analyze credits, to understand companies, to make sure that clients get their money back. I'm incredibly confident in our equity PMs and the processes they go through to analyze the company, to analyze a sector, to make sure that companies have a competitive advantage, generate free cash flow, return it. I'm incredibly confident in our real estate team and their ability to find Grade A, class one office space next to public transit. I'm incredibly confident in our infrastructure team finding great investments across the world. I'm so confident in the team and the processes they follow. But will all of that pan out in the next 12 months? Probably not. But know if you have a long-term 5, 10, 15, 20-year view, again, our job as stewards of client capital is to really make sure that we're doing our best to really focus on risks and rewards and generate those consistent risk-adjusted returns over time.
INGRID MACINTOSH: And to get us where we want to be. That was an amazing conversation. I thought I would wrap it here, but you did say that I could ask you who's going to win the Super Bowl and who's going to win the Stanley Cup, so you put it out there.
DAVID SYKES: OK, so I have absolutely no idea, none at all. But so far from what I've seen, I'm going to go with the San Francisco 49ers. And for the Stanley Cup, boy, oh, boy I'll be in trouble. Rapidly wracking my brain, I'll predict boldly, it's not going to be the Maple Leafs, and I would predict it's going to be the Boston Bruins.
INGRID MACINTOSH: Well, like investing, it's just as much about what you don't own, so not the Maple Leafs, I can get behind that. Thank you so much. And to our listeners, I hope you have a great 2024. As you now know, this podcast is available on all major streaming platforms. If you'd like to learn more about our outlook, if you want to learn more about Artificial Intelligence, about health sciences, simply listen to TDAM Talks, and take a listen to some of the great contact we have there. Thanks. David, have a great year.
DAVID SYKES: Thanks Ingrid, much appreciate it.
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