Transcript
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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: Hello and welcome to the first edition of TDAM Talks for 2023. As always, our first talk of the year is our year ahead forecast. My name is Ingrid Macintosh. I’m the host of TDAM Talks and I am joined today by David Sykes. David is the CIO here at TD Asset Management.
Welcome, David.
DAVID SYKES: Thanks Ingrid, nice to be here.
INGRID MACINTOSH: So as I said today, we’re going to be talking to David about his guidance for the year ahead in 2023: what we can expect from the markets and how we’ll be positioned for our investors. So, David, I’m going to send you the first question. And at the risk of sort of looking back to the start of ‘22 and asking people to make prognostications.
What should we be expecting from markets for the year ahead in 2023?
DAVID SYKES: Yes, so that’s always a difficult question to answer. And, you know, the difficulty, of course, as Yogi Berra said, is that predictions about the future. But we’ll take a shot at it. And I think it’s very important to set the scene a little bit. You know, last year in 2022, we really saw the story of inflation and interest rates.
And so just to put that in context, you know, roughly a year ago, both in Canada and the United States, short and interest rates, overnight rates were virtually zero. And then you fast forward 12 months and the Bank of Canada was at four and a quarter and the U.S. Central Bank, the Fed was at four and a half percent, just massive rises in short term interest rates.
And of course, if you look at the longer end of the curve, rates were roughly 150 basis points in each country at the beginning of the year and ended, you know, in the U.S. around 360, 370, and in Canada, somewhere close to 300. So again, a huge, huge upward move in interest rates. And I think what we have to think about long and hard as we look into ‘23 is these rates are going to take effect, but they take effect with a lag.
It’s going to take some time. You’re going to see this work through the economy, work through the system, whether it’s, you know, consumer financing on mortgages, which everyone talks about, whether it’s business investment, whether it’s confidence, whether it’s in movements in the U.S. dollar, especially on a trade weighted basis. Financial conditions are going to be tight. And so, you know, as we look into ‘23 and we look out over the next 12 or 18 months, I think we are confident in the investments, confident in our process.
But I would say that we’re slightly cautious on the year ahead.
INGRID MACINTOSH: Let’s go a little bit deeper here. So are we at the stage now -- I mean, we’ve seen a really difficult year for investors where as those rates are rising, the fixed income assets were seeing negative returns or equity markets have seen negative returns. As we look forward, what do we see in terms of the market, the recovery? Do you think we’re fully already pricing in a recessionary scenario?
DAVID SYKES: Yeah, so I don’t believe that we’re priced fully for a recessionary scenario at the moment. I think if you look at the fixed income market, the projections from the fixed income market is that rates will rise a little bit more in the first half of ‘23, but then we’ll see cuts from central banks. I think that might prove to be a little bit optimistic.
I think what we’re going to see is interest rates, you know, move a little bit higher from here and then probably stay higher for a little bit longer than people expect. And I don’t think we expect rate cuts in ‘23. And of course, that’s going to have obvious implications for the economy and for corporate earnings. So from my perspective, I would say we have not fully priced in a recessionary scenario given where markets are today.
INGRID MACINTOSH: So what does that do for your, sort of, forward earnings outlook?
DAVID SYKES: So if you look at consensus for 2023, and let’s just focus on the equity market for a moment, if you look at consensus earnings growth for 2023, year over year, is expected to be about 6% to the positive. One of the issues with that is that year over year growth in the first two quarters of the year is going to be flat to slightly negative, which means the market is expecting a pretty material rebound in corporate earnings in the second half of ‘23.
I think that’s going to be optimistic. You know, see earlier comments on interest rate rises, slowing economy. That does seem to us to be a bit of a difficult task. So I think we’re going to see earnings revisions throughout ‘23 to the downside and that’s really going to put pressure on the equity risk premium. And I think that’s going to prove, you know, a much more difficult environment than what we’ve been used to over the last decade or so.
INGRID MACINTOSH: I think one of the things that nobody could have anticipated at the start of 2022 was the geopolitical risk. And how is that impacting us globally, what you see there sort of looking out over the next 12 months?
DAVID SYKES: So there’s a number of implications. And I think, you know, one was sort of an obvious one, which was we just started to get momentum coming out of COVID globally. You know, we were starting to reopen, starting to see improvement in supply chains. And then you had, of course, you know, the horrible invasion, Russia into Ukraine.
And that really, really put an increase on various commodities, on energy prices, on food prices. And so that one, we’re still dealing with very, very difficult situation. But another geopolitical sort of event that’s happening is this renewed tension between the United States and China. And there are pretty significant implications there in terms of production of semiconductor chips, of import export rules.
And I think a broader one that we you know, we need to explore a bit more is sort of this notion of reshoring, bringing production back to North America, perhaps away from China. And there’s no inflation implications of that. There’s supply chain implications of that. But, you know, those are the sort of the two obvious ones. But, you know, more are going to creep up.
The problem, you know, is that we can’t see around the corner all the time. And, you know, others will rear their ugly head. But those are the two that we sort of thought about in their implications.
INGRID MACINTOSH: Want to dig a little bit deeper, if we can, on inflation. So at the start of the year we were coming through COVID, we were talking about it as structural inflation. And then as you said, we had the war in Ukraine and that changed some of the supply chains and we created sort of a broader level of inflation.
You started to touch on it. But could you talk a little bit more about the impact that inflation may have on certain sectors of the economy?
DAVID SYKES: Yeah, this is a very important point. So, you know, inflation in my mind and I think in most people’s minds is really made up of two parts. There’s inflation in goods and there’s inflation in services. And if we think about the pandemic, the lockdown, you know, people sort of online ordering lots of goods, you really saw dramatic increases in goods prices around the world.
Now we’re faced with the reverse situation. It’s interesting. You know, when -- before COVID started, if you wanted to ship goods from Shanghai to L.A., you would use a container to do that. And it was priced at about $2,000 a container. Well, at the height of COVID, those shipping costs and those transportation costs went up so much, the container cost was about $10,000.
Sure enough, today, now that supply chains have started to normalize again, that container cost is back down to $2,000. So the point of all that is to say, you know, goods pricing is coming down. We’re seeing disinflation in that area. You’re starting to see it in consumer apparel. You’re really starting to see it in consumer electronics. You’ve seen it in used cars, used car parts.
And the point of all that to say is, you know, if you’re a retailer with, you know, prices that are declining and large inventory, that’s probably not a great place for you to be. On the flip side of that, though, on the services side, we are seeing pretty significant inflation in services. And when I talk about services, what I really mean are wages and salaries.
You’re seeing pretty consistent increases on that front. So things like hotels, airfares, you know, there’s going to be some pretty significant earnings, we think, in those sectors. And also with rising rates, that really is going to help the financial services sector. Not every bank, not every financial services company to the same extent. But there’ll be many, many winners in the financial services field because of those rising rates.
You’re seeing pretty consistent increases on that front. So things like hotels, airfares, you know, there’s going to be some pretty significant earnings, we think, in those sectors. And also with rising rates, that really is going to help the financial services sector. Not every bank, not every financial services company to the same extent. But there’ll be many, many winners in the financial services field because of those rising rates.
And we think that’s a place to be positioned for as well.
INGRID MACINTOSH: Well, when we talk about inflation, we talk about recessions. One of the hallmarks of a recession is the sort of job losses. But can we also talk a little bit about the job landscape and, in fact, wage inflation?
DAVID SYKES: Yeah. So, Ingrid, I think that’s actually the most important question. And the thing that we have to understand to really dig into this and we’re in a very unusual time and I’ll try and give you some numbers to see if we can make sense of this. One of the things that’s been incredibly sticky has been the labour market. Right now, the United States unemployment is 3.7%, and in Canada, we’re at 5.1%.
You know, in historical context, that’s an incredibly low unemployment rate. And so when companies are looking for workers, one of the issues at the moment is if you look at job openings in the United States and these are rough numbers, but there’s a report called JOLTS and it looks at job openings. Right now in the United States, there’s about 10 million jobs where there are postings for companies looking for workers.
But if you look at the labor force, the number of unemployed people in the labor force is roughly 6 million. And so you’ve got this tremendous mismatch between 10 million jobs, which we’re trying to fill with 6 million people who are unemployed in the labor force. And that gives you a ratio of roughly 1.7. So it means that workers, labour, have a choice.
They have some power in what they decide to do in terms of the job that they take. Historically, just to put this in context, that 1.7 would be well below one. You would quite often have more unemployed people in the labour force looking for work than there were jobs. And this has really shifted the balance of power toward labour.
And that really means that wage and salary increases are running at five and six percent, and that’s the large majority of inflation. Central banks, Bank of Canada, the Fed, global central banks have been very clear on this. And it’s a bit of sad news for the workforce, which is we’ve got to slow that rate of wage and salary increase.
And if we don’t slow that, we’re going to see rates meaningfully higher. But as I mentioned earlier, I think we’re you know, we’re well on our way to see that trend declining, but it’s going to take a bit of time.
INGRID MACINTOSH: So, you know, something that’s sort of where we’ve gotten so far with as we look back over 2022, certainly a challenging year with negative fixed income and negative equity returns. And as I ask you to look out on the horizon, I’m hearing maybe slightly higher rates, but maybe you get your coupon return on bonds are a little bit better.
And I can’t hold you to a highly optimistic view on equities from this moment. What are some of the other asset classes or some of the other tools that you look at? I know at TD Asset Management, we include Alternative assets in our toolkit. Could you talk a little bit about that landscape and how we look at those types of asset classes?
DAVID SYKES: Yeah. So this is a new capability for us in the last three or four years. And adding Alternatives to our lineup has just been tremendous in terms of, you know, the efficient frontier. If you think about the characteristics of risk and return that Alternatives offer, it’s tremendous. And because we have these capabilities internally inside the investment team, inside TD Asset Management, it means that we can craft solutions with meaningful weightings towards Alternatives and by Alternatives...
...of course, we’re talking about real estate, whether that’s Canadian real estate, whether it’s global, whether we’re talking about global infrastructure or private mortgages. I mean, these are incredibly important tools for us that offer lots of yield, lots of diversification, relatively low volatility. And because we have those in-house now, it’s a capability that allows us to really add great solutions from an overall asset perspective.
INGRID MACINTOSH: And in that time, when equity returns aren’t predictable and fixed income returns, albeit higher yields. So we’ve reduced that penalty on savers from a fixed income perspective. But Alternatives are giving you that incremental day in, day out, non-correlated return.
DAVID SYKES: Yeah, that’s exactly right. And so again, from that efficient frontier standpoint, very important, you know, in my in my opinion, to have a nice weighting towards Alternatives, I think it’s a really important point. And, you know, I wouldn’t get too, too negative on equities either. We haven’t talked a lot about sentiment towards stocks. Halfway through 2022, people were very, very negative on equities.
And I’d say by the end of ‘22, if we look back, people were not quite as negative, but still a lot of bearishness. If we can get through the first half of ’23, we’re going to see some downward earnings revisions, we’ll see higher rates. But if we get that, you know, that that elusive pivot from the Fed or the Bank of Canada - and I think the Bank of Canada has hinted at this a little bit more than the Fed.
You know, Tiff Macklin’s been pretty clear in some press articles that he’s closer to the end. He’s you know, he didn’t see the transitory nature. He was worried about inflation a little bit too late. If we start to see the foot come off the pedal with the rate rises, you could end up with a very dramatic move in equities in the second half of ‘23, but we’ll have to see how it all plays out.
INGRID MACINTOSH: I think that’s an important conversation. We’ll touch on that a moment. You know, we’re talking about it from the standpoint of you as a Chief Investment Officer looking at the market landscape, I’m going to talk a little bit in a moment about, you know, how people are managing their own money. Before we get there... one of the themes that has really grown in significance over 2022, in the last two years is ESG and how we apply that into our investment thinking.
INGRID MACINTOSH: Can you talk a little bit about that from a TD Asset Management perspective?
DAVID SYKES: Yeah. So ESG is something that we’ve done here for a long, long, long, long time. So we were signatories to the United Nations Principles of Responsible Investing beginning in 2004. And I think from our perspective, ESG has always been part of what we do here, but we really have sort of a three-pronged approach. The first approach that we take to ESG is we want to be an inclusionary approach.
And what I mean by that is we are well aware of all ESG issues that impact companies and sectors, but we want to engage with our companies on those issues. You know, we’re not going to be exclusionary because we have equity ownership in many companies. We can engage in meaningful dialogue with senior management teams, with boards to address issues not just around environmental or social, but also governance.
And so we cover all those three pillars. But in addition, you know, sort of the second way we approach ESG is really around our vote. And of course, you know, if you have equity ownership, you get a vote on the proxy. And so we’re very diligent about how we vote our proxies, how we think about those issues. Again, engaging with companies and really making our statement in terms of what we see as risks and opportunities for companies.
And then finally, you know, our third pillar of ESG really revolves around our thought leadership. We want to make sure that we are educating our clients, educating ourselves about what are the big issues, what are the potential opportunities and risks. And so we put out numerous thought pieces throughout the year. And so with those three sort of pillars, which would be engagement, proxy voting and thought leadership, we incorporate ESG into everything we do.
INGRID MACINTOSH: That’s a great way to summarize it, because I think it means so many different things to different asset managers. So that’s really, really helpful. Again, coming off of a year like 2022, as people are coming into the new year, they’re looking maybe at their investing statements and they’re seeing a lot of red. One of the things we often talk about is our concern for people’s... for individual investors pain threshold and moving to the sidelines and an environment now where GIC rates have gone from negligible to something we haven’t seen in almost 15 years.
Can we talk about that as a risk? Right? What’s the risk of somebody sitting in GICs now or sitting in cash waiting for the opportune time to re-enter the markets?
DAVID SYKES: Yeah, from my perspective, look, it would be wrong of me to suggest that GICs don’t have a place if you know you have a purchase to make a major life event coming up in the next two, three, four, six months, GICs may be totally appropriate. But if you’re in a GIC because of fear, concern about, you know, a potential outcome... geopolitical events, a company’s earnings results, you really have to think about the long-term nature of what you’re trying to do.
We want money to compound over time and we don’t invest for two months or three months or six months or a year. You know, our time horizon is 3 to 5 to 7 to 10 to 20 years. And if you’re not willing to participate in the upside, you’re not going to receive that upside. And so, you know, to say that GIC is a blanket statement or a bad thing is not something I’m willing to do.
But if you’re investing for the long term - a college education, retirement, you know, a significant time frame - I think you can do yourself a lot of disservice in GICs, because you’re not able to time the market in an effective way. And I think it’s often a fear response. People, you know, are a little bit concerned. They don’t know what to do.
And so you automatically pull back to safety. But I can tell you, as someone who’s done this a long time, when you sort of feel the worst, that’s when you actually don’t want to be safe and you want to invest.
INGRID MACINTOSH: And some of those best days that we’ve seen in the markets have occurred from the lowest points. And if you miss some of those days in the long run, and I think even now when you look at the coupon maturity profile of fixed income, the return profiles are even more attractive for one of our more safe investments. What about some of the other risks?
So what are you know, as I as I sort of get you to wind up a little bit here, what are the risks out there that no one is talking about? What’s keeping you as a chief investment officer for an organization managing over $450 billion? What is keeping you awake at night?
DAVID SYKES: So I think probably the big one is that if you look at previous hiking cycles and again, this isn’t just the Bank of Canada, it’s not just the Fed, this is a global phenomenon. If you look at central banks around the world, whether it’s the ECB, the Central Bank of Norway, the Reserve Bank of Australia, if you look at, you know, New Zealand, if you look at Mexico, I mean, this is a global phenomenon - rising interest rates.
And in any past cycle, whenever rates have gone up and we’ve hit a recession, there’s some type of financial crisis. You know, there’s going to be some event that’s going to happen, there will be stresses and strains, nobody knows what it is. And that’s always what worries me, because something will hit and the issue will be what is it, where it is.
But that’s the big one that keeps me up at night. I won’t pretend to know what it is, but in all previous rate hikes, cycles like this, when you enter a recession, there is some type of financial crisis to come. I’m going to say small-c crisis. It’s not that, you know, financial markets will start functioning, but there’s something that will basically say, okay, it’s time to stop.
And now we can pivot and start to bring rates back. And that will be the good days ahead. But it’s getting to that point. That’s what worries me.
INGRID MACINTOSH: It’s that inflection point. Well, I’m not going to let you end our conversation on a risk story. Let’s talk about some of those opportunities that no one’s talking about. What are you most excited about?
DAVID SYKES: Well, I mean, I think if I look out, you know, right now, I think everyone is on the same page about earnings revisions. And I think we’ll probably get to a point in Q1, Q2, maybe Q3 where you’re going to see revisions bottom out. And people at that moment will be saying, you know, things look pretty bleak. There’s all kinds of issues, but it’s really that moment where you want to take advantage of the long term.
I think we’re there in fixed income. I think fixed income is a maximum overweight for us as, you know, we look through the full year of ‘23. I think as you mentioned, Ingrid, you’re going to get some really good coupons. Think high fours, low fives, which I think will be a nice, meaningful return. But I do think on the equity side, we have to get through a bit of pain here in the next three, six months, but there will be a rebound.
And on the Alternatives side, again, there are some amazing investment opportunities globally, whether it’s in industrial real estate, whether it’s in infrastructure projects that we have investments in around the world that really generate, you know, we think high single digit diversified returns that are really going to help the portfolio. So from that standpoint, you know, there’s lots to worry about.
And obviously I’m worried in my role and, you know.
INGRID MACINTOSH: We pay you to worry.
DAVID SYKES: Yes, that’s what I do. But I think we need to realize it’s usually at those moments when you really feel the maximum pain, those are the opportunities. And I think we’re going to see those in ‘23.
INGRID MACINTOSH: So I’m going to wrap us here, David, with a greater days ahead sentiment here. So, David, thank you so much for joining me. Terrific pleasure.
DAVID SYKES:Thank you, Ingrid. It’s been great to be here. Thanks so much. And we’ll see what ‘23 brings.
INGRID MACINTOSH: Awesome. And for our listeners, you can find a recently published Wealth Asset Allocation Committee Perspectives on the TD Asset Management site, along with more of our latest Thought Leadership and Commentary. Also to receive the latest expertise and updates from TD Asset Management, you can follow us on Twitter at @TDAM_Canada, and on LinkedIn at TD Asset Management. Thanks everybody and Happy New Year.
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