Nattakorn Maneerat
September was a brutal month for equities. Could markets strengthen this fall or are rallies just bear traps in disguise? Kim Parlee talks to Brad Simpson, Chief Wealth Strategist at TD Wealth.
Transcript
Kim Parlee: Maybe you could just start off by saying it’s not just our imagination. It’s been a bad year– 2022.
Brad Simpson: Look, it’s wonderful to be here. I like to even try to put it– even in some context that I think when we talk about markets, and bear markets, and bull markets, it’s lost in translation, almost a little bit, is that typically people have their money invested in their portfolio and think about it in portfolio terms. And I think that’s one of the things that makes this year so challenging and difficult is that folks build investment portfolios and want to build and many follow a principle of being diversified. And this has been as tough a year, in recent memory, for even a diversified investor on record. And you’ve got to go all the way back to 1932 to find a time where the traditional 60/40 portfolio had a worst year through the first three quarters of a year. And that gives you, I think, a really tremendous framework for investors, how difficult it’s been.
So from your most conservative investor, with all the difficulty with interest rates rising and what’s happened in bond markets, to aggressive investors that are wholly in equity, both of them of have experienced losses. If you look at of a traditional benchmark portfolios of all fixed income or all equity, losses are in between 10% and 15%, regardless of if one was conservative and one was far more aggressive. And that tells you just a ton of just how tough it’s been.
Kim Parlee: Part of it has just been inflation, which reared its ugly head in a hurry and rocketed up again. And we’re watching every print, of every CPI right now, to understand where it’s going and what’s happening. And I mean, I can name 16 things in a day that tell you things are moving in different directions. But do we need to prepare ourselves for a new normal, and what this could be when it comes to inflation?
Brad Simpson: And I couldn’t agree with you more. The first one is, when it comes to inflation, you can almost find whatever data point you want to show you what you think it’s going to be next. And it just shows how much volatility there is in the economy right now.
And so I think the starting point maybe there is almost kind of back up a little bit and say that that– one of the things we have to be really careful of is recency bias here. And that is taking what’s happening right now and extrapolating that forward as the new way it’s always going to be. And I think in a really hard, kind of interesting way to look at that is if you think if we went back 6 to 9 months ago, when we really started digging into inflation, what we were talking about was so much of it on the supply side, kind of your core goods, if you will. And one of the big numbers you heard constantly was, as an example, was used car prices and how expensive they were, and how difficult they were to get.
And the last week, we saw CarMax (KMX) come out, which is a really good way to kind of if you wanted to see just what is the health of the used car market right now. And they came out, and they missed on almost every single metric that you want to think of in the second quarter. And if you read through the notes of what they were saying is the ability for purchaser of people to purchase used car right now, it’s becoming a real challenge. And that’s because the higher rates and the bigger expenses in household income starts to weigh things down. And we’re seeing that in a lot of the areas that were originally the concern for inflation.
And then you kind of fast forward to where we are today. And one of the big ones we’re talking about, and is one, is rent. And rent has a dramatic impact on inflation. But one of the things, I think, you also got to be careful of how some of these things are measured. And one of the things that where the Federal Reserve Board does was to get to that CPI number and that rental component is actually phone, and they ask people, well, hey, if you were going to rent your house, would you rent it more for tomorrow than you would for today? And you’ve got to be careful. For us, one of our key tenets in our philosophy is to embrace human behavior. And people in their day to day lives will see that prices are going up. Prices are going up. So, of course, you ask them if you’re going to rent your house, you’re going to say, yeah, I would. Of course, I’d raise rates, the amount of rent I would pay if I could. But if we go up and we look at the Zillow index, and Zillow index actually goes out and it actually looks at the rental listings and what the trends are there. And those trends are starting to slow down, and they’re actually starting to soften now.
And my point with all of that is that there’s a lot we’re going to have to work through with these inflation numbers. But I think we have to be really cautious on taking the immediate where we are today and saying, let’s extrapolate that forward. Because as we start to go through the next year or so, we’re going to see a lot different scenario here in that we’re going to see a lot of this really slow down. And we may be on the other side of inflation a year from now, where we’re talking about how do we get things going again. And I think we’ve got to be careful of that.
Kim Parlee: I’ve only got about a minute here, Brad, but I love the fact that you told me we’re not going to extrapolate, but I’m going to ask you to extrapolate. And tell me what you actually see moving ahead. And I think when you think about monetary policy is backward looking, I mean, they’re reacting to data that already happened aggressively. But to your point, we could fall into something that we’ll be wishing for some inflation in a little while to kind of kick things up again. So do you have a sense of recession hard, soft landing? What you kind of see over the next 18 months?
Brad Simpson: Yeah. A couple of things there. First and foremost is that I would say that I think a good thing, a reasonable thing, to do with here would be to expect a recession. And then the second part is, and there was a piece that our Chief Economist, Beata Caranci, put out a couple of days ago, saying that’s a natural course of the business cycle. And I think we have to start reminding ourselves not to be so afraid of this, this is part of how the cycle works. It’s how we price things, and it really sets up asset prices in a good way as we go forward.
But in the meantime, you have to think about it is that the potential for a harder landing, the market certainly has been trading like it’s expecting it to be so. And I think you have to think about it in those terms is that’s what the central banks want to see. They actually want to see that there is this concern and see the market starting reacting that way, because what they were seeing in the summer was they kept saying, hey, we’re serious. We want to knock inflation down. We want to slow things down, but the market wasn’t listening to it and participants in that market weren’t.
And so I think I would say, yes, to the recession. The jury’s out if it’s going to be hard or not, but the market is certainly there. And I think once you kind come to terms with that, then that should kind of dictate how you’re going to build the allocate capital as you go forward. And I think that can make all the difference in the world.
Kim Parlee: Let’s talk about equities, fixed income, commodities, real estate. It’s been tough. Do you see more downside on the way?
Brad Simpson: I think the real starting point for equities would be that stocks won’t bottom until yields top. Once you’ve seen a new trend for the 10-year Treasury in the US to stop going up, and I mean that over more than over a few days, which would be pretty short term swings right now, that’s going to be your starting point.
One of the things that happens in a bear market is that bear markets ultimately break people that say, I keep buying every time it goes down. And once it kind of breaks, that’s usually you’re at that kind of sign. So I think for equities, we would look at it like this is that I think the next move here is just look at what companies are going to do. We know that their earnings per share is going to start slowing down, and there’s adjustments that need to be made there.
So if you take a look at the S&P 500 right now, and say it’s trading somewhere between 16 and 17 times, and you said like, look, OK, what if earnings estimates come down by 5% and that would bring a multiple down to around 15 times, which would make it about 3,300. And so that gives you probably a pretty good floor of where the S&P. You kind of look at the TSX and say it’s at 12 times. You take that sort of 5% off earnings per share estimates going forward. You take a point off that. That takes the TSX down to somewhere around 16.8. And that gives you what your base is for our North American equity markets, anyways. And I think any market like this, it’s good to kind of know what you think what your downside is.
Kim Parlee: It certainly is. And, again, we’ve got the charts up while you were talking. And those lines go below the bottom of the floor where the charts are right now, so it lets people know what they need to be expecting. If you could, just quickly, maybe just from a commodities and real estate standpoint. I mean, anything that we should be thinking there? I mean, on the one hand, with less demand, commodity prices tend to go down. And then you get OPEC doing what it does. And that tends to push oil up, so there’s lots going on.
Brad Simpson: Yeah. If you kind read some of the OPEC stuff today said, well, they’re going to cut down production because they want to help hold the price high, so they can help sort greater infrastructure bill down the road. I had to see the humor in that a little bit. Look, the bottom line is that in market, in the market terms today, is indeed you see commodities falling off because of your working to slow the economy down, that should occur. But all the constraints that were there in the actual capacity level is still there. And so, for us, we think there’s still a real intrinsic part of your portfolio. While the short term trading of it is going to be pretty volatile, we still think that makes a lot of sense in portfolios over the mid and long term, for sure.
And then, when we’re looking over at real estate, I think that’s real estate is a really good one to watch for two reasons. One, on this kind of the question on inflation is that the two things to watch, whether it’s economy is going to go from here is labor on one side and housing on the other. Labor, we’re starting to see a few cracks there, which is a negative positive, if you will. On housing, I think most of a way to look it is that the run up that we saw in, through much of COVID, we’re going to probably give back somewhere between 40% to 50% of that. And from peak to trough, I think we’ve already seen a pretty good part of that move already. But on that front, there’s probably more to come. But, ultimately, time will tell.
Kim Parlee: Let me ask, then, in terms of what you see, in terms of you’ve given us some good levels from equity markets and commodities and what you see, but let’s turn it around. If people are talking to you, and I’m going to tell people, do your own research or talk to somebody like you or get some advice. How do you manage through the volatility over the next little while?
Brad Simpson: Well, I think the starting point is that one of the things I think that the way I would look at the world is that this is a tremendous point right now to actually be an investor. And the difference between being an investor and one who is just in speculating which way a fixed income or an equity market is to go kind of changes everything. And so for our kind of lens is to say that if you are an investor, and why are you investing? Well, for most of us, I think we invest because we have future goals that we want to have. We want to have more money there to build, to utilize up against those goals.
And so I think that if you look at it in those terms, I think you have to actually take a look at your investment assets and go, OK, when do I want to use these assets– 2 years from now, 5 years from now, and 10 years from now? And then, what are my immediate needs? And then allocate up against that in that way. And if you’re doing that, boy, that interest rates have moved up an awful lot. There’s a lot of opportunity in duration or in government bonds where yields are today. And so I think there’s certainly an area there where you could be building out and holding those in your portfolio. Thinking about equity markets, we think of actually how much they move down. If you’re not going to be going out and cashing it out in the next six months, there’s a lot of opportunities out there to build to allocate. And currently, with equity markets, we’re neutral, but we start getting to some of the levels that I talked about earlier. I would think that we would start expanding that from there and starting to move our allocation even more to equity from this neutral that we are today. And I think, really, the same standpoint falls when it comes to real estate, as well.
And so I think that my messaging in there, and what I would say to people, is that in the short term here that there’s going to be more volatility. We live in volatile times right now. In investable terms that, in many ways, this is an environment that if you think about things more along the lines about it’s a longer term, and it’s more businesslike, it’s actually a pretty good environment.
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