The bill to raise the U.S. debt ceiling has been passed by the House and is now in the hands of the Senate. David Sykes, Chief Investment Officer at TD Asset Management, speaks with Kim Parlee about the short and long-term implications for markets.
Transcript
Kim Parlee: The US debt ceiling deal struck by President Joe Biden and speaker Kevin McCarthy has passed a major hurdle as it clears through the House, but the process is not done. Here to give us his outlook for what lies ahead, especially for the markets, is David Sykes, Chief Investment Officer at TD Asset Management.
I know you’re not going to completely opine just on the debt ceiling. There’s more to it, but let’s start there. There is a vote coming. One vote has already happened. The deal has been struck. Are we expecting this to go through? Are we feeling optimistic at this point?
David Sykes: Yeah, I think the quick answer, Kim, is yes. I think this is going to go through. Every few years, the debt ceiling becomes an issue in the United States, and every few years, we spill a lot of ink and a lot of time thinking about it and what could the possible ramifications be. And if the debt ceiling limit was not raised, the ramifications would be incredibly serious.
But I think cooler heads have prevailed again this time, and it looks like this should pass. Of course, the Senate has to still vote. And the sort of drop dead date would be Monday, June 5th. That’s when Treasury Secretary Yellen has said we officially run out of money.
Kim Parlee: Yeah.
David Sykes: And so I think it’s a safe bet, at this point. You never know till it’s over. But it looks like we’re in a good spot.
Kim Parlee: Yeah. Yeah, I hope that it’s over. I’m so tired of talking about it, and I’m sure many Americans are too.
Let’s step back and take a look at all the big issues out there in the markets right now. And I think this is– and maybe it came from you or some of your team. This is the most unloved bull run we’ve seen, or run, I’ll say, up in the markets in the past little while. What are you looking at right now with the market? There are so many factors that almost seem at cross purposes to understand what’s going on.
David Sykes: Yeah. And look, that’s always the case. People say, well, markets are easier, markets are hard. They’re always confusing and complicated in cross-currents. But I think it’s fair to say the starting point should be economic growth. And I would say, very much globally, it’s confusing.
I mean, if you look at the largest economy in the world, the United States, you know, there’s some slowing, but there’s a lot of resilience as well. You really see slowing in the manufacturing side of the economy. But on the other hand, Services is doing incredibly well. People are traveling again, hotels, airfares. The job market is incredibly robust. We’re not seeing a lot of job losses there. And so the United States is slowing, but it’s been pretty resilient. I think surprisingly so.
If you go to the second largest economy in the world, you go to China, there was a huge euphoria after the COVID lockdowns ended. We really saw people getting back out and spending. But today, we’ve got some economic data that really showed that euphoria may be over, and the economy is really slowing in China.
And then closer to home, in Canada, you know, rates have gone up considerably. But resiliency is sort of the name of the game. And there was a GDP number today that was very strong, led by consumer spending. And so mixed, confusing signals there, I think overall slowing. But I think it’s been more resilient, a little bit stronger than we would have thought.
Kim Parlee: And so what is that going to mean from the interest rate picture? How are the central banks going to take those mixed signals you talked about?
David Sykes: Yeah, and I think that’s the interesting part. I mean, we’ve talked about this before, but interest rates have risen dramatically, not just in North America, but across the globe. And we would have assumed by now you’d start to see more of a slowdown. The economy is a little bit stronger. Rates are considerably higher. And I do think that means inflation a little bit stronger for a little bit longer.
So probably, you’re looking at one or two more hikes in the US. That’s what the market’s pricing in– probably a pause in June. Maybe they go in July. I mean, we’ll have to see that all play out. But I do think that means rates are going to be higher for longer, and inflation still remains the topic. It’s all about inflation.
Kim Parlee: It’s interesting too. And I think so many of us are expecting the other shoe to drop. Because it’s how much time I think it takes for those higher rates to really dig in– so those mortgages that get renewed at a later date and those car payments that get renewed at a later date. I mean, I’ve heard some numbers from people, and they’re astronomical. When is it going to actually impact consumer confidence?
David Sykes: So interesting. To your point, I think everybody in this always-on society wants things now. And I think, from a monetary policy perspective, interest rates have gone up a lot. You’ve seen money supply really roll over. It’s starting to head down. But it takes a while for things to transmit to the real economy.
You’ve seen three large bank failures in the United States, but still, the economy is chugging along. I think it’s very much a delayed reaction. And generally speaking, interest rates, money supply contraction, these are going to take maybe 12 to 18 months to be felt.
And on the consumer side, I do think consumer confidence has come off a touch. I think it’s very clear consumers are feeling less confident than they were, say 6 or 12 months ago.
But I think, as a theme for our group, it’s really about, let’s be patient. You know, we’re cautious at the moment, but the data keeps being a little bit stronger than we expect. But I think as the next few months and quarters unfold, I do think you’re going to see that slowing theme continue.
Kim Parlee: And you’re going to see that in earnings, I assume. Because that’s the one thing that’s been happening is people keep bracing for this earnings slowdown. There have been pockets. Actually, I’d say there’s been lots of smaller slowdowns. But at the same time, you get things like this huge AI boom, and it seems to distort the whole picture. So I don’t know. What are you expecting on the earnings front?
David Sykes: You know, on the equity side of the equation, at the end of the day, stocks go up when earnings go up.
Kim Parlee: Yeah.
David Sykes: And I think we’ve just finished the earnings season. And it wasn’t the strongest earnings season on record by any stretch, but it was certainly better than expected. But to put it in some context, for this year, 2023, in the United States, we’re looking for top-line revenue growth something like 2% and earnings growth something like 1%. That’s not exactly a vibrant picture of earnings growth. And there is an expectation in the market that next year, in 2024, revenues pick back up again, 5% growth, and earnings are expected to rise 12%.
I think we think that’s a little optimistic thinking about all the headwinds we’ve talked about– rates, money supply, inverted curve. Commodities may be telling us something. Energy prices have headed down recently. And so I think we’re still a little bit cause for concern here, a little bit cautious on the corporate earnings outlook.
Kim Parlee: Yeah, the commodities piece is interesting. It’s pulling back. Commercial real estate, I know that’s something that comes up, I know, in a lot of conversations now everywhere. What’s your take on it?
David Sykes: So it’s a concern, for sure. I think the main concern is a lot of commercial banks in the United States are lenders on the commercial real estate side. You have seen some impairments, some defaults in the United States, and that gives one cause for concern.
I think, from our approach, though, it always comes back to this notion of quality. And if you’re in that commercial real estate space, it really is about quality covenants, quality assets. And I think if you are a tier one, class A type property next to public transit, good tenants, long-term leases contracted, I think you’ll be just fine. But there are definitely going to be pockets outside of that quality spectrum I’m referring to that you could see some wobbles.
Kim Parlee: You have the Wealth Asset Allocation Committee. You take a look at where the most opportunities lie within what you look at. And the first piece we’ll look at is equities. And right now, I understand you’re remaining a modest underweight.
David Sykes: Yeah, from the committee’s perspective, I think it’s fair to say that we’re cautious on an economic outlook basis. Looking at equities in general, I think it’s fair to say modestly underweight. And really, the reasons behind that are what we talked about in terms of slowdown of corporate earnings.
But just to get a little bit into the details on that, on the Canadian side, we’re neutral, a little bit more optimistic there. And I think you’ve seen the Canadian banks report. The results were OK. I don’t think they were stellar. I think expense growth a little bit higher there.
But if you look at the energy space in Canada and the banks and the financials, some of the dividend yields are very, very attractive. And as we know, over the long run, 20%, 30%, 40% of your total return comes from that income dividend component.
Kim Parlee: As long as they stay there.
David Sykes: As long as they stay there. And with those companies, we’re very confident. And so neutral on the Canadian side. A little underweight on the US. You know, lots of issues going on. Not so much the debt ceiling concern, but this overarching theme that interest rates, inflation a little bit stickier. And that is going to bite. It is going to hurt the consumer. It is going to hurt corporate earnings as we look out the next 6 to 12 months. And on the international side, slightly overweight China. Pretty optimistic about the long-term growth there.
So from an equity perspective, modestly underweight, a little bit cautious, but that’s how it sort of lines up in the sub asset classes there.
Kim Parlee: Let’s talk about the next asset class, fixed-income, maximum overweight.
David Sykes: Yeah. And this is something relatively new for us. I mean, at TD Asset Management, we like our bonds, but we’ve never been maximum overweight fixed-income. And I think that really sends a signal. And the signal is this. In the last 10 years, yields have not been this attractive in the fixed-income market. And if you look at domestic government bonds, yields are 3.5% to 4%. We think that’s an attractive place to get income. But in addition to that, if we’re correct about the slowdown to come, that really means you’re going to get a capital gain on top of that. And so we really do like that government domestic fixed-income portion.
I think on the corporate credit side, spreads are still pretty tight. We’re surprised that they haven’t moved a bit wider. So there’s not as much value there. So we’re modestly sort of neutral in that corporate credit space.
And on the high-yield side, we’ve really been surprised. We thought high-yield spreads would have shown much more stress, and they haven’t yet. So there’s a modest underweight in that high-yield component. But again, I think if we look out 6 to 12 months, I think we feel more confident. We can purchase those securities at a much better price 6 to 12 months down the road.
Kim Parlee: Interesting. Alternatives, you are neutral. And that’s a big basket of diverse stuff too.
David Sykes: It is. And alternatives is this huge catchall phrase. But really, it’s an alternative to public fixed-income and public equity. And so when we talk alternatives, we really think about real estate. And in the Canadian context, people think office towers. That’s one component. But it also includes things like industrial complexes, retail shopping. It also includes multi-unit residential.
We’re very excited that we’re starting to see some green shoots in multi-unit residential. You’re really starting to see that come back. And people know all of the stories about Canadian housing and the lack of supply and immigration growth. We feel quite strongly there that that’s a good place to be.
You know, there are some concerns around office. Clearly, vacancy rates are still low. And how does the return to office look? It started, but we don’t know exactly where that’s going to land.
The other area that we’re quite passionate about is our commercial mortgages space. The yields there are very attractive. These are very short-duration mortgages– really great outstanding record.
And the last one I would highlight that we’re overweight is infrastructure. We think the infrastructure needs across North America and across the planet are going to be massive in the next 10, 20 years. And so on our infrastructure side, overweight there, and quite excited about those returns.
Kim Parlee: Interesting with the infrastructure, though. I think also just valuation was a concern for some, because a lot of people see that the same way.
David Sykes: Yeah. And I think that’s a concern. And people can get very hyped up, but there’s a disciplined approach there to say, look, quality assets, great contracting, diversified, long-term nature. And I think we’ve got a fantastic team that does a great job there.
Kim Parlee: I know you do. What else is on your radar? When you just kind of, again, step back, is there anything we haven’t talked about that perhaps there’s some context that’s missing?
David Sykes: Yeah, I think there’s always one thing. And I think the trouble is you don’t know what that is. You know, we didn’t know COVID was coming. You didn’t know the debt ceiling would go this far. So there’s always that unknown. But I think the one thing that’s sort of on my mind more than anything is what does future growth look like?
We’ve got this issue where demographics are real. They’re alive and well. And if you look at the European situation, China situation, the United States, there’s going to be a lot less growth, I think, in the future than we’ve seen.
On the Canadian side, we’re quite lucky. Our immigration policy, I think, is really going help our labor force growth. And you mentioned it earlier. I’m not sure it’s all about AI, but if we can finally get productivity growth, I think that puts us in good stead.
But it really leads me back to this notion of still a lot of uncertainty. What you really want to do is make sure you’re diversified, you have quality, and you have income. And I think if you have those components in a very broad portfolio, you’ll do OK. But I don’t think it’s going to be the returns we’ve seen over the last decade.
Kim Parlee: Yeah. And it’s been tricky too. And as you alluded to earlier is that the discipline of finding things is important because, also, the breadth of the market has been a bit wonky.
David Sykes: That’s a really important point. If you look at the S&P 500 this year, it’s up almost 10%. And so, clearly, something’s going on. The issue, though, is that 99% of that return has been in six stocks, and they’re the big, big, big stocks. And so it’s names like Amazon (AMZN), Apple (AAPL), Nvidia (NVDA), Microsoft (MSFT). And they’re roaring to all-time highs.
That’s fine, but it gives us concern, because you’d like to see some breadth in the market. You’d like to see cyclical stocks, the energy companies, the miners, the financials, lead us into the next bull market. And so that lack of breadth gives us some concern.
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