TDAM Talks Podcast: Ready. Set. Stay the Course - Embracing investment resilience

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 this edition of TDAM Talks. I'm your host, Ingrid Macintosh, here at TD Asset Management. And this is going to be such a great conversation. This month we are marking the one-year anniversary of David Sykes , assuming the role of Chief Investment Officer here at TD Asset Management and Justin Flowerday  taking over as head of fundamental equities. Both are joining me here for a conversation. We're going to take a look at the year in review. Welcome, gentlemen.

DAVID SYKES: Hi, Ingrid. Really nice to be here.

JUSTIN FLOWERDAY: Great to be here, Ingrid.

INGRID MACINTOSH: Okay. I'm not going to go easy on you today, so I'm going to start with you, David. I want you to sum up your first full year as CIO in one word and then, of course, tell me about it.

DAVID SYKES: All in one word; “resilient.” And let me expand on that thought. So if I think back over the last year, I think about resiliency from our people. At the end of the day, our biggest assets are people on the investment team and at TDs and management who ride up and down the elevators every day on behalf of clients.

And I think sometimes we forget how difficult the investing climate and conditions have been. Certainly 2022 was not a good year at all for equity markets, for fixed income markets. It's been really difficult, but I think our people have been incredibly resilient. I've been really impressed by the focus that they bring every single day to really focusing on quality, to focus on the long term, to focusing on meeting our client needs.

I think that's been something that's really stuck out of my mind. And I think the other thing is really our clients. I mean, it's difficult for them. It's a tough spot, it's a tough situation. But I think they've been resilient. They've been communicating with us probably more than ever. We've been speaking to them, trying to guide and navigate through really difficult conditions.

And I think to me, it's the resiliency of our people, both our clients and our investment professionals.

INGRID MACINTOSH: Yeah, you're right. It's been a really incredible last 12 months. I don't think there's any correlation to the timing of you and Justin moving into your new roles. But even when we look at sort of 2022 year-to-date, what would have been the best advice you could have given yourself or investors?

DAVID SYKES: Yeah. So for this year, the best advice is to stay the course. I think we've all been surprised that if you look at, you know, equity markets, if you look at Canada year to date, so far up about two and a half to 3%. You look at the United States, S&P 500 is a proxy, up about 5%. If you look at the bond markets, whether U.S. or Canada up 2.5-3.5%.

And so staying the course, not going to extremes, I think has been the right strategy.

INGRID MACINTOSH: Certainly, in challenging markets as well. It's so incredibly important to have a broad toolbox with which to serve our clients. Can you talk a little bit about the capabilities that we've grown over the last year?

DAVID SYKES: Yeah. And that Ingrid that's one thing that I really do want to stress and that I think about quite a bit. I mean, obviously I've been a TD Asset Management for almost 26 years now, but I've really spent a lot of time on the equity team. But in my new role, I spent a lot more time focusing on our capabilities and our teams.

And I think about the complex, problems that our clients face. And I think about the solutions that we have. And as I spend more time with our award-winning fixed income team, you know, we have amazing capabilities at asset allocation. Think about our asset liability management team. I think about our trading team. We do have a full capability suite that relies on fixed income, whether it's active or passive.

If I think about asset allocation capabilities, if I think about commodities, I think about the technology that our portfolio analytics team brings to bear. If I think about our private debt capabilities, our mortgages, our infrastructure, or real estate. We literally have a complete set of capabilities, and I would say I tend to not like people who brag and pound their chests, but I would say spending time with these teams, you do realize that the talent we have is world class, and the investment performance proves that.

I mean, the numbers have been very, very good. And so, in my mind, the one nice thing from the year is just really getting to learn and understand those businesses and those people. And I've been incredibly impressed.

INGRID MACINTOSH: You spoke at the beginning about capabilities, but we're really talking about people, which is tremendous. Justin, I want to turn it over to you now and it's going to be the same question I'm going to ask you for one word about the last year. For our listeners, you moved from being the long-term head of fundamental equity research here at TD Asset Management to leading the overall Fundamental Equity Portfolio management team.

So that’s one word. And then maybe tell me a bit more about it.

JUSTIN FLOWERDAY: So, listening to what David said when he said 26 years and I was just thinking, okay, I'm just past my 23-year anniversary and, you know, I came up with the word “continuity” as the key word. And you think about what has changed. I mean, look, I know the people. I know the people in the research team.

It's a phenomenal team filled with really great analysts. I know the people on the PM team and it's a rock star team of PMs that I would put up against any other team in the world. So no real surprises there. Thinking about would take up some time for me is: dealing with some of our partners across TDAM and again I know our partners across TDAM

JUSTIN FLOWERDAY: And I guess one of the things that has surprised me is just the extent to which we we all rely on one another. Right. And so, you know, how much I rely on our partners in risk, and our partners in distribution, and in product, and in communications, and we all kind of work together to try and provide great solutions for our clients.

And none of us can do it alone. And so just the extent to which we all work together has been quite eye-opening to me.

INGRID MACINTOSH: Yeah. And certainly, you took the helm at the beginning of what was, you know, has been 12 months of remarkable equity market volatility. Can you talk a little bit more about that your perspective on what we've seen and what we can expect going forward? So, your thoughts on that?

JUSTIN FLOWERDAY: Sure. You know, it's it was it was quite a time to jump into this role. We saw bonds and stocks both have a very difficult and challenging year. And, you know, some of our clients have been put in situations that are very challenging. It's not something we haven't seen before. But I think it was probably one of my first times being out there speaking with clients and understanding on a very personal basis, some of the challenges that they've had looking ahead.

You know, we're not - I don't think we're through this. And I think there's a lot of work to be done to get the economy and some of the excesses in the economy out. There is a lot of the impact of the interest rate hikes last year have still yet to be felt. And we're going to feel that this year.

Inflation continues to be somewhat of a problem for the Fed and they need to continue to address that. And obviously, we have the banking crisis. But we've chopped a lot of wood. And so, if we're using the baseball analogy, if we're looking at nine innings of a game and the end of the game means we're off to a new cycle, we might be inning six or seven.

So we've done a lot of the work and I'm very optimistic about 2024 and 2025.

INGRID MACINTOSH: I think as you were discussing the backdrop over the last 12 months, we were talking about some of these big macro themes that have been affecting the equity markets. And as listeners are listening to this podcast, we're still quite recently going through something more ground level with respect to some of the financials that we've seen in the U.S..

Can you talk a little bit about that and your perspectives on what we've seen?

JUSTIN FLOWERDAY: March has been quite the roller coaster and happy to kind of recap that turn of events. So, Silicon Valley Bank was the catalyst for everything and, you know, this was a situation where you had a classic case of asset liability duration mismatching. And so, you know, Silicon Valley, most of the clients there are companies that are in the technology world, and a lot of them are startups.

Throughout the crisis, meaning the the COVID-19 pandemic, we saw a whole bunch of money being raised for all of these companies as technology became so important to everybody's lives on a day to day basis. And a lot of great new ideas came out there and all the money that was raised was piled into deposits at Silicon Valley Bank Corp because they were the banker of choice for this community.

JUSTIN FLOWERDAY: And that deposit growth is really, really great. The challenge is what do you do with that? And as your member, deposits are the liabilities for a bank. And so when you talk about asset liability duration mismatch, you have liabilities which are very short duration. And what they did is they took the money, the inflows of deposits, and they invested them in long duration treasuries.

And that mismatch really ended up causing them to have some issues because as interest rates rose, the treasuries declined, and they had their assets actually became worth less than their liabilities that caused them stress. There was a run on deposits. Eventually the bank failed and was taken over by the regulators and that turned into an issue for Signature Bank, which the next day failed.

That turned into an issue for Credit Suisse, which had just reported some regulatory findings, that there were some control issues, and then Credit Suisse failed. And so, we've ended up having this little mini bank crisis. The good news is-the Fed's been there before, and they came in and took out their big fat firehose and pumped a massive amount of liquidity into the market.

And they calmed things. They pumped $300 billion into the banking market and things have seemed to calm down for a little bit. I don't know if we're totally through this for now. Things look good. We're going to hear from a lot of these commercial banks in the next few weeks over earnings and we'll find out how the deposits situation is and whether some of the outflows have started to slow down.

INGRID MACINTOSH: It's like throwing a rock into the lake. No matter the size of the rock, the ripples can be huge. I think that's what we've experienced. But the sense I'm hearing is that it's under control. And again, with the focus that we would have on quality, that's the kind of precisely the kind of thing you're trying to avoid, right?

JUSTIN FLOWERDAY: Absolutely. I mean, the bigger impact longer term is simply that credit creation probably starts to get hit a little bit. And the banks willingness to go and extend credit when they're having some balance sheet tightness becomes a little more difficult. And so could we see a bit of a credit crunch over the next few months and see a limit to the amount of credit that gets extended to customers?

Sure. And that's a headwind for the economy and it's probably worth a couple of rate hikes and the Fed knows that. And they're going to take that into consideration in terms of their policy as we go forward.

INGRID MACINTOSH: So almost a quasi-rate hike, as you say. I know. Pivot back to you, David. I want to talk about the challenges the markets face, both at a macro and micro level, how from an asset committee perspective, are you thinking about it and how are you navigating this environment?

DAVID SYKES: When I think about broad asset classes. You know, we have our wealth asset allocation committee. As we look out over the next 12 to 18 months, I would say it's a cautious environment for sure. For the first time in the committee's history, we are maximum overweight fixed income. We think the Fed and other central banks are closer to the end of their tightening cycles and we think it's a better environment for fixed income and for bonds. On the equity side, we are underweight equities overall.

I think there are pockets of opportunities just in alluded to, you know, some of the issues we've seen in the U.S., I wouldn't necessarily throw the baby out with the bath water in the case of all financial institutions, I think some are exhibiting pretty good value at the moment. But overall, from the equity standpoint, underweight, a little bit concerned about the economic growth ahead as Justin mentioned the full impact of quantitative tightening and of interest rate rises hasn't hit the economy yet.

DAVID SYKES: So we do expect a slowdown in growth which is going to impact corporate revenues and we think also impact corporate profits. And then on the alternative side, for real assets, we're a little bit neutral there to slightly underweight, a little bit cautious on Canadian real estate, but feel quite good about our infrastructure, mortgages, and private debt teams.

So, you know, that's broadly what I would say. But just picking up on one of Justin's items, you know, the key for us is quality. It's always quality, quality, quality. And, you know, you can look to this year and to say, look, if a quality company has a sustainable, repeatable business model, doesn't have a lot of debt, they've done just fine.

But if you look at companies that have a lot of debt, don't have a sustainable business model, necessarily need funding, you know, long duration tech, it's not been it's not been a great year at all. And so, the message from us is, you know, that diversified portfolio with a real focus on quality.

INGRID MACINTOSH: Over the last year with the bumpy ride that we've seen, we've seen so many investors and advisors take money out of the market, even long-term money, money for people's retirements and put it on the sidelines, you know, certainly to become a more, more attractive option to sort of pay to wait for the market to turn. So, talk a little bit about that. But also, what would you and the Asset Allocation committee expect to see before you say, okay, we're ready now to overweight equities again?

DAVID SYKES: So on the first part of that question, I think at the end of the day, a lot of people feel as if they can read the tea leaves and they can time things and I think people might think they can do that. But I think empirically, historically, that's proven very, very difficult. You know, the advice I give is to say, look, why don't we try and match the investment horizon to the investment approach?

And if, you know, people have a 30-day investment horizon or a three hour investment horizon, that's a very, very different approach to having a five, ten, 15, 30 year. A lot of our larger institutional clients, you know, have a very, very long-time horizon, and we haven't seen that shift necessarily to shorter term products. It's really been about, you know, staying the course diversified, balanced portfolio.

That's the advice I would give. You know, And on your second question, with every single time you've seen a significant tightening cycles by central banks around the world, it causes some stress, some strain, whether that was long term capital management, whether it's a SNL crisis, whether it was, you know, the mini banking crisis this time round, what usually marks the beginning of a next up cycle for sure is a pause in the rate increases.

And then more likely you start to see rate cuts. And I don't know how far away from that, but I wouldn't say that we're a month or two away. But I suspect, you know, given another 6-to-9-month outlook, I think you're going to see central banks start to really question how much more they have to go.

And in fact, you perhaps even cut in if you start to see that come through in declining earnings numbers. I think what will surprise folks is that as earnings go down, the market will actually rally because it's looking further into the future to say, you know, with interest rate declines coming better days ahead, the market's a discounting mechanism.

So those would be sort of the keys that I would look for.

INGRID MACINTOSH: Not a crystal ball, a well thought out plan and a well thought out process. Let me wrap us up, as we always do with a little bit of a lightning round, give me the one word that comes to mind, but then give me a little bit more. So, I'm going to start with you, Justin. I'm going to go with the I word: inflation.

JUSTIN FLOWERDAY: “Scary,” but coming down. So, we got a surprise resurgence early this year in January and February, and inflation started to kind of reaccelerate. I think what SVB and the banking mini crisis has done is going to put a bit of a damper on inflation. We're going to resume the trend in the back half this year towards 3%.

And so I think we've probably seen the peak in this re acceleration. Who knows? But my bet is that we start to resume our trend back towards something that's more reasonable for the Fed.

INGRID MACINTOSH: Okay. 

DAVID SYKES: Rates. I think on rates it would be our view that we've seen the peak. They certainly come down a lot but probably stable to slightly lower from here.

INGRID MACINTOSH: Okay, Justin, we've just had a budget.

JUSTIN FLOWERDAY: Budget let's stick with “B” for big. It was big. There was a lot of spending there. And you know, the governments in a bit of a tricky place because they're doing some catch up spending in the health care sector. That has added a huge number. They're also planning to spend a ton on green energy initiatives and that's really lifted the spending.

And, you know, they need to fund it. And so they've looked to start taxing dividends for Canadian corporations as a way to generate some more revenue. They're going to increase some taxes on the buybacks for Canadian companies. That's an increase in revenue, a slight headwind for the Canadian banks in terms of earnings, but nothing super meaningful, nothing that concerns us to too much.

INGRID MACINTOSH: You went right to where I was going to ask. It was who's it going to hit? Thank you for that. I'm going to give you one last one, Dave. It's going to be a hard one here: Hockey playoffs.

DAVID SYKES: Well, I think you're talking with the Leaf's, but my one son is still in the hockey playoffs. My younger guy is out of the playoffs, but I would say the lightning round one word for the Leaf's is good Leaf's, good luck in the playoffs, but I wouldn't bet on it.

INGRID MACINTOSH: I don't even think you were born the last time they made it all the way, so I'm just going to say anything last but here and I would think you probably just both come off of March great and had lots of time with your kids. Any must read books or must watch TV for our listeners, just a little insight here.

JUSTIN FLOWERDAY: Ooh, okay. You're looking at me- books. I read “The Bourne Identity” once again over the holidays, over the March break. But if I was to give you the last really good book I read of "The Price of Time” by Edward Chancellor- it’s A History of Interest Rates. Really, great read that talks about, our star in the natural rate and why staying below the natural rate of interest for a long period of time causes huge issues for the economy.

And so relevant for where we're seeing ourselves today.

INGRID MACINTOSH: That is sounds like an incredibly riveting read right up there beside The Bourne Identity. David, what about you?

DAVID SYKES: You know, from my perspective, I tend to read a lot sitting in the parking lot outside hockey rinks. And so a few editions of The Economist, a really good perspective on sort of future world order and some of the moves that China may be making. So I'd recommend that one.

INGRID MACINTOSH: There's a lot there. I feel like we could unpack that. Another whole podcast. Gentlemen, thank you so much for joining me today. Thank you so much for the tremendous work over the last year. Our investors, Thank you, our advisors, Thank you.

JUSTIN FLOWERDAY: Thanks very much and great, great to be here.

DAVID SYKES: Thanks. I appreciate it.

INGRID MACINTOSH: And for all of our listeners, you can also find our recently published asset allocation Perspectives on TD Asset Management site, along with more of our latest thought leadership and commentary. You can follow us on Twitter at @TDAM_Canada  and on LinkedIn at TD Asset management . Thanks, and have a great day.