As some in the market speculate on what the Fed’s next move on rates may be, others are focusing their attention on when cutting cycle may begin. Michael Craig, Head of Asset Allocation at TD Asset Management, discusses the potential implications for investors.
Transcript
Greg Bonnell: Markets have moved higher as investors consider whether the US Federal Reserve is finished with its rate hiking cycle. But can that positive momentum continue? Joining us now to discuss, Michael Craig, managing director and head of asset allocation at TD Asset Management.
Michael, always great to have you on the program. Let’s talk about what we’ve seen in the markets recently. November has a reputation for being a good month for stocks, so it didn’t disappoint last week. But I think investors are wondering, too early to tell which direction we’re moving? And how do we read it?
Michael Craig: Yeah, so short-term seasonals will probably kick into play, and have a nice rally into year-end. It doesn’t resolve the overwhelming challenges fundamentally with the economy. But I think that’s going to be more of a 2024 story now, as we kind of roll into the end of the year. So a lot of data last week showing employment slowing.
I think we’ve seen the peak in interest rates now. That’s been priced into the market. And so there’s been some relief. So you have a window and more of a tactical perspective, but I think in the back of your mind, you’ve still got to worry about what’s coming through next year. And that will likely see slow down to recession in various parts of the world.
Greg Bonnell: It’s the back of the mind worries that always get me as well. I accept — I’ll gladly take the past couple of days that we had and the action that we’ve seen. Let’s walk through some of those worries.
Michael Craig: Well, in Europe, to start, you’ve got a situation where they’ve been actually quite clear that they’re finished hiking. But inflation is still quite high. And their inflation calculations are based off oil, which has been quite a bit higher. So Europe’s really in the worst spot right now. They don’t really have pro-company policies anyways, so it makes for a tough backdrop for growth.
The other extreme would probably be the most positive, would be the US. Lots of money flowing into the Rust Belt. Lots of development of reshoring. And still, quite a strong economy, even though there are some indicators that are slowing, probably in the best spot.
And Canada is somewhere in between, where we obviously have gearing to the commodity side, and that’s been helpful. But we do have that overarching risk with household debt that’s also showing some degree — starting to show that the consumers are starting to slow down their purchases, and that is weighing on growth. So I would say, US probably in the best position, Europe in the worst, and Canada is somewhere in between.
Greg Bonnell: Now, we did hear from the Fed last week. I wanted to get your thoughts on that, Jerome Powell coming. They held for a second consecutive meeting. That’s understandably some of the enthusiasm in the market, as to they might be done at this point. What really stood out for you from Jerome Powell? At this point, he can’t call all clear. That would be a bit of a tactical error, I would think.
Michael Craig: They definitely want to keep the option open to hike again. But I think, from much of his commentary, and certainly, the way the markets traded afterwards, that the market’s taken this to perceive that the hiking cycle is over. Historically, when you look at when the Fed does stop hiking, that tends to be quite a bullish environment for bond yields.
And last week being no exception, yields rallied, went lower. Prices higher. And so I think that’s now — now the question is not about whether there’s more hikes coming through. It’s all about, when do they start cutting. And this is where the market’s been all over the place this year. Right.
Like all over. No one really has a good feel for this. And the way we look at it is, it’s likely nothing. And when they do start cutting, it won’t be small. It’ll be strong. So I think it’ll be in a period of wait-and-see for some time, followed by an area where I wouldn’t be surprised to see 200 to 300 basis points of cuts. I’m just — it’s hard to say whether that’s in June of this year or June 2025. But that is where — that’s the next kind of area for the market to focus on in terms of when that’s going to happen.
Greg Bonnell: I’m fascinated by this idea that they can be very aggressive to the downside. That wouldn’t have any reverberations to the market. Would that simply be an acknowledgment that we got inflation either at two or coming back to two? We don’t need to be restrictive, so you can just take the knife to the rates?
Michael Craig: Well, so they’ve been quite clear that they’re terrified of cutting and having inflation re-accelerate. So they will want to see inflation breaking down. I would just say, looking at the inputs in deflation, I would expect to see inflation roll over pretty hard over the next six months, regardless. All the cyclical, all the goods-based inflation, that’s all come off. The job markets are starting to soften, so you think wage pressures will start to abate. And then it’s a question of rents.
And again, these are very slow-moving series. But once they get moving, it’s like a freight train. Once they get moving in a direction of lower, they’ll continue on that path for some time. So I think it’s just a matter of time.
They just don’t want to preempt it and see that re-acceleration of hiring and wage gains — wage pressures. And so that is the give and take. But this is all quite fluid. And again, I think over the next six months, it’ll be quite clear that its growth is the challenge, not inflation.
Greg Bonnell: How does that set us up on the equity side, then? Because there’s one thing to say, OK, we’re at the end of the rate hiking cycle. This has been hard on the equity markets, hard on the bond markets. But then if the next act is a soft economy, how do we see stocks performing?
Michael Craig: It’s all a question of how much easing you get on the fixed-income side. So I think that, look at the top line of the US market. It looks OK this year. When you actually look under the hood, it’s really just been a handful of stocks that have performed incredibly, as you showed in the video earlier, that have added to this. And most stocks have generally not done much this year.
About 280 stocks in the US have underperformed the market. About 250 are actually down in the year. So when you take out that slice of large-cap, mega-cap growth, everything else — valuations, actually, aren’t too bad. And so outside of a systematic ’08 scenario, which I don’t think is going to happen, stocks don’t look too bad. I think we’re going to be in a bit of indigestion, I think, in the first half and that sets you up for a better second half.
I think when we’re sitting here a year from now, I think the market’s higher. But there is going to be a path that’s a bit — it’s going to be a tradable path, on the downside and the upside. And I think that’s what investors need to be thinking about going into 2024.
Greg Bonnell: One last question for you. I want to ask about the bond side. Just a couple of weeks ago, we were just watching that US 10-year yield flirting with 5. Gets above it, pulls back. I think the last time you were on the show, you said, I don’t have any predictions, but I wouldn’t be surprised to see a 10-year yield get past 5 in this environment. That it’s going to be a bit choppy. Could that chop come back again, or have we seen the worst there?
Michael Craig: Ugh. It’s kind of a fool’s errand to try and tell you that it’s going to be smooth sailing from here. All it takes is one random data print, and the market is selling off again. My sense is that, with fixed income, it’s not like buying an equity where you’re hoping for some catalyst to take it higher. When you’re buying fixed income right now, you’re earning now pretty attractive yields, and you’re terming that out for a long period of time.
So for any type of conservative investor, when you’re looking at — let’s just use in Canada, the banks are yielding 5-6%, given the bank. Overall yields on bond funds at 5.5-6%. Pretty attractive environment for income investors. So if you can stomach a bit of price volatility, it’s not going to affect your income flow. It’s a pretty interesting environment for investors in that part of the market.
And I would say of all things right now that look attractive, that would be one area that stands out because we have had this repricing. And a lot of that yield now, you’re getting in fixed income, people think, oh, it’s inflation. Actually, it’s mostly, it’s above it. It’s the premium above inflation.
The market is only expecting 2-2.25 inflation for the next 10 years. So when you see a Treasury trading at 4 or 5, depending on Canada or the US, a lot of that is yield after inflation expectations. That’s been negative for about 15 years. It’s been between -2 and 0, and now you’re getting north of 2%. So quite an interesting period of time for fixed-income investors.
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