champpixs
U.S. Markets are being tested after making record-breaking highs. Michael Craig, Head of Asset Allocation and Derivatives at TD Asset Management, says there are plenty of potential risks in the current environment, but there are also signs the recent rally may still have legs.
Greg Bonnell: We got US markets making new all-time highs, the S&P 500 closing above $5,000 for the first time. But of course, the question for investors becomes, will the rally continue? We got signs that the Fed may be keeping rates at elevated levels for longer than some expected. Joining us now to discuss it all, Michael Craig, Managing Director and Head of Asset Allocation and Derivatives at TD Asset Management. Michael, great to have you on the program.
Michael Craig: My, pleasure, Greg. Great to be here.
Greg Bonnell: This is one of those situations that, I mean, what a terrible situation to be in. You’ve got US markets at all-time highs. But of course, as investors, we start to wonder, OK, what is propelling the rally? And what could get in the way of the rally? How should we be thinking about this?
Michael Craig: Yeah, I mean, it’s all about time horizon, and where you’re referencing it from. I mean, yeah, we’ve had a pretty strong rally over the last few months. But over the last two years, we’re basically now just above water. We really just — we’re in a two-year kind of consolidation, seventh longest on record, if you will.
So, I mean, look, things have moved a lot, but they’re not grossly expensive. And I think if you think about where we’ve been over the last few years, it’s not — we’re not — certainly not frothy, if you will. So I don’t think — you know, people — well, I wish I’d caught the rally. You know, this fourth-quarter rally came after a pretty marginal — or pretty material sell off in Q3. So I mean, there are certain areas where there’s a bit of froth in the market in terms on the tech side.
But broadly speaking, you know, inflation is coming down. We’re not seeing major unemployment tick up. And we’re going to — likely get Fed hikes — Fed cuts this year. So that’s a pretty sanguine backdrop for risk.
Greg Bonnell: It does feel like, when we look at this headline number in the S&P 500, that, sort of, we’re baking in this perfect scenario where, as you said, inflation comes down, you haven’t done too much damage to the labor market, and the labor market is pretty strong south of the border. You haven’t damaged the economy, at least not the US economy. Everything seems to be going just wonderfully. That’s the kind of stuff, for me, that I start to wonder, is it too wonderful? I mean, what do we need to be aware of?
Michael Craig: Look, it was not without risk. I mean, certainly, you could have — any one of those events kind of can trip up, we’ll have inflation tomorrow. Seasonally, January inflation has been a lot hotter over the last 20 years than not. I mean, I’m not — I don’t think this changes the overall direction of where inflation goes. But more heated inflation print tomorrow is going to put a put a dent in the market. And certainly, the Fed has now dialed back expectations — or the market has dialed back expectations for cuts. So it’s not without risk.But the point is, is that any time you have an asset start to make new highs, that typically isn’t the end of where it goes. You tend to see a continuation, or a momentum. And there is still a tremendous amount of capital that’s tied up in cash. So you know, this is — the thing for investors right now, we’re going from fear to greed quite quickly, right? And I think that’s where you start to see things start really moving if people start reallocating out of cash into the market.
Greg Bonnell: How do you allocate in a market like this? So you try to figure out, OK, there’s something happening, and stocks are on the rise. We can’t dispute the fact that these are record highs for the S&P 500. But do you think longer term, like, what do people need to think about in terms of allocating capital? Because you can get excited in times like these, obviously.
Michael Craig: Yeah, I mean, look, we are still coming out of– we still have very restrictive monetary policy. And that has historically broken things. So the next 12 months isn’t without risk. But I would say that on a kind of a 12-month-onwards basis, it’s a pretty exciting time. There’s a lot of really amazing technologies that are going to drive productivity, particularly in the US economy, but globally.
And if you — the way to make money off productivity is owning equity. That’s where you — so whether it’s generative AI, obesity drugs, new types of pharmaceutical treatments, material science, electrification, like all these kind of themes that are happening right now, this is going to drive profits. And so it’s — to me, I knew I wouldn’t want to be underweight that, right?
This is where — this is where — how you build wealth is being invested in these types of things. And I think that’s something investors — you’ve got to keep your mind on that longer term, because that’s what you’re buying into. And that’s going to dominate the short-term ebbs and flows of the market.
Greg Bonnell: And we’ll talk about what the Fed might get up to this year and when we expect those rate cuts. Interesting, some of the conversations I’ve had in recent days — this is an interesting idea that — no one’s calling this. But if you can have rates at this level and still have — and I’m still talking south of the border, because we’re in a weaker situation here — still have a very strong labor market, still have a very strong economy, and you’re getting cost pressures under control, does the Fed need to be all that aggressive this year?
Can they wait? They seem to say, give us some time. Let us wait. Do they mean it? Could they wait longer than we even think?
Michael Craig: First off, they want to be absolutely certain that inflation is not going to re accelerate when they start cutting. So that is foremost concern number one. And that’s why– that’s why they’re trying to push back a little bit on– and I think Powell probably would like to go in March, but I don’t think he’s got consensus with the governors, and that is– so then we push that out a bit. But inflation’s coming off.
And so, you know, if inflation starts to fall, your policy is even more and more restrictive, because it’s you know, the difference between inflation, and Fed funds becomes wider and wider. And so you actually have more and more restrictive policy. You have to act. Otherwise, you are going to have financial accidents if you don’t. So there is general absolutely logic to why they will likely cut this year. But it is in that inflationary story.
The second thing I would say, last year, huge drawdown in savings and tremendous fiscal deficits. Those two things really drove nominal GDP last year. So people — why are we having all this growth with high rates? Well, because governments outside of wartime drew — or massive catastrophes, ran massive fiscal deficit, particular in the US. And you know, after COVID, people had a lot of money because of wealth transfers.
So we still are adjusting to this post-COVID world. It is forcing investors to think a bit more broadly about their playbooks and not kind of rely on pure historical patterns and assuming it’s going to happen now. But tying that all together, it does get you to a situation where policy will be very restrictive as inflation falls this year. And they are going to be forced to act, I believe.
Greg Bonnell: Where does this leave us with fixed income? When we talk about all the attention right now being on the equity side of things, and interesting things are happening, if we take the Fed into consideration, what’s happening? How should we be thinking about that part of the portfolio?
Michael Craig: Hey, look, you know, 5%, you can term for a note for 10 years. For income investors, it’s a pretty sanguine outlook. The levels of expected inflation rates versus bond yields today are just under 2%, the highest it’s been in a long time. So you’re earning income well above implied inflation. So it’s still a pretty strong backdrop. I would say, credit corporate bonds are a little bit rich, if you will, when you start looking at spreads. So there isn’t without drama.
But broadly speaking, I mean, it has done nothing this year. It had a very strong end to last year. This year has been kind of neither here nor there. But I think as you start getting a feel for when we’re going to see rate cuts, and I think there will be more sharper in Canada, you know, fixed income will perform just fine.
Greg Bonnell: Let’s talk about some of the things that you think about that might be outside of the box that everyone’s talking about. I feel like we have a box of things of investors we’ve been paying attention to. We’ve been paying attention to inflation. A geopolitical risk doesn’t seem to get us all that nervous at this point, despite we have some serious things happening around the planet. Are there things that you’re thinking of longer term? It’s like, I need to keep my eye on this?
Michael Craig: Well, certainly, I started my career as the — professionally, as the equity bubble burst from the TMT bubble. And so it’s — you just — as you’re starting out, you just remember, you know, senior PMs, kind of how they were behaving in that environment. It was hard. I do worry that we do have some of the catalysts for another bubble in the equity markets. We’re not there. But it’s something that we be mindful of.
As the market starts to overprice, the productivity gains from new technologies, you can get something that– so this would be a risk. It’s not a core view but something that’s back of mind. Trying to ascertain what policy looks like after the November election, I spent a lot of my energy these days, in terms of our team’s energy in terms of what we should expect in terms of trade tariffs, taxes, and what have you. So those are a couple of things. And then ultimately, what do things look like in the commodity markets in terms of electrification, and when do we start seeing copper move will be another area that — I don’t think it’s a 2024 theme but something that’s — we’re watching closely in terms of resource scarcity, if you will.
