In a recent interview with Bruce Cooper of TD Asset Management, the CEO and CIO discussed his outlook for equity markets, the dollar, and monetary policy. Below are highlights from our conversation.
Do you believe investors should be stepping into equity markets right now?
We want people to take a long-term perspective … If people have a 10-year or five-year perspective, it's absolutely the right time to have exposure. The backdrop for equities is very good. Global growth continues to be excellent. We saw that again with the GDP numbers out of the United States, which were very solid. It's kind of a Goldilocks backdrop for equities because you've got strong growth with low inflation. The strong growth is contributing to earnings growth and low inflation is keeping interest rates low, which keeps multiples high, so it's really is a very ideal combination of circumstances for equities right now.
Between international, U.S., and the Canadian equity markets, which market do you see as having the greatest upside potential?
Our preference has been for international. We like global better than Canadian this year; global includes both the United States and international. When we talk about international, what we really mean is EAFE [Europe, Australasia and Far East]; Europe is the biggest component of that. We like global over Canada, and within global, Europe has been our favourite region and that continues to be the case. There you've got a nice combination of things, the economy is pushing ahead – we've experienced slow growth in Europe for most of the decade, but by European standards, the economy is growing quite nicely today. You continue to have a benign monetary environment, the ECB came out and extended their QE [quantitative easing] program, they indicated that interest rates are going to stay at zero for as far as the eye can see. Valuations in Europe are at a discount to North America. We think earnings growth is going to be good.
Interestingly, I think the political backdrop is more constructive now than it has been for a while. … I think the election in France is kind of an interesting event; President Macron is very focused on labour market reform. In the short term, I think that gives the market optimism and if he's actually successful that could be quite a powerful event to give corporations way more flexibility, which should continue to drive earnings. … Combined with all those other things – like the economy is doing well, earnings are good, the stocks trade at a bit of a discount, the monetary backdrop is good – add all those things together and we feel pretty comfortable with it.
Is there a particular region in Europe that you favour?
We don't look at Europe on a country-by-country basis because each country has its own sector biases … We like Europe generally, then we look at it bottom up, company by company.
What type of returns are you expecting from international markets?
We talked about high-single-digit returns over the next 12 months within international.
South of the border, U.S markets are at or near record levels. What are your thoughts on U.S. markets and do you think this positive momentum has room to rally further?
It's certainly very powerful, what is going on in the United States right now. You've been in this kind of low-growth economy for most of the period since the crisis and it's not that we've rocketed out of there but we are at the higher end of the range and the economic backdrop is very good. The thing that is just so striking is the broad earnings picture where the numbers continue to be outstanding. The first half of the year, we saw double-digit earnings growth and we're in the middle of the third-quarter earnings season as you know and the earnings thus far have been very good. Certainly [last week] was kind of an eye opener where we had all these bellwethers just shoot the lights out [such as] Amazon, Microsoft, Google, and Intel. These are big numbers that are being put on the board here.
We've advocated always that Canadians should have exposure to the U.S. market and part of the reason is the greater sector diversification. In the world, the most interesting thing that is going on economically is the explosion of technology – there's so much innovation going on, and really the centre for almost all that innovation is the United States. For our clients, we want to make sure they …have exposure to that.
With major U.S. markets, are you expecting high-single-digit returns over the next 12 months?
From here, obviously, we've had a big move this year. We'd probably be more in the mid-single-digits from here.
What are your thoughts on Canadian markets?
We've been more cautious on Canada.
Why?
A couple of reasons. We had tended to believe that the economy in Canada wouldn't be as strong as the United States. To be honest, in the first half, the Canadian economy was very good but we were not convinced it was sustainable. We're seeing signs recently that the Canadian economy is probably gearing down a little bit.
What signs are those?
I think on consumer spending and on the investment side of the economy … I think with oil, even though oil has rallied recently – it's up in the $50s [U.S.] – I don't think we are going to see the kind of spending in Alberta and the oil sands generally that we saw over the course of many years. The other piece is household debt is relatively high in Canada. That doesn't mean you get a disastrous outcome but I think it's realistic to expect that consumption will slow over the coming months and years.
You know, I think it's interesting in this regard, the OSFI regulations that … are put in place for January 1st, clearly the regulators are trying to slow the housing market, which I think is the right thing to do. Slowing the housing market in Canada will have an economic impact because that has been a big driver of growth.
So put those things together and we anticipate that growth will be a little slower in Canada. I think in the end, the Bank of Canada reflected on that when they came out with their announcement [last] week… they also did not raise rates and in their commentary, suggested that it would be a while until they did raise rates. Obviously, the Canadian dollar is taking it on the chin for that reason but I think that's just a reflection of the fact fundamentally the Canadian economy is not as strong as the United States. The U.S. went through a long period of deleveraging at the household level at the same time the Canadian household leveraged up, so I think fundamentally the U.S. consumer is healthier than the Canadian consumer.
Within Canadian equities do you favour growth stocks over value?
That's always a tricky one in Canada because you know when you think about growth globally you think about things like technology, whereas Canada is obviously somewhat underrepresented [in that sector] so we do like the banks in Canada. In this low-interest-rate environment, we think the yields are very attractive, we think the dividends will continue to grow, we think the economy is strong enough that credit quality will continue to be very good – interest rates have ticked up a little bit, that's good for margins at the banks, so we like the banks within the Canadian market.
Can you comment on valuations?
Let me make a comment on [global] valuations broadly: there are no bargains in this world, and with that statement I am covering equities, credit, and real estate. We're in an extended bull market which started in the first quarter of 2009 and here we are in the fourth quarter of 2017, so it's been a long bull. Stocks are up a lot, interest rates are down, and credit spreads are in so there are no out-and-out bargains. I tend to look at valuations within equities as being at the upper end of fair. I guess a simpler way to say that would be valuations are fairly high but we wouldn't view them as high enough to be a barrier to further gains, which is why I said earlier that we still expect stocks to go up.
What do you see as potential risks that could derail the markets positive momentum?
I think the trade picture is one that worries us. We are in the middle of the discussions of NAFTA and it seems fairly evident from the press reports that negotiations are not going well. I'm not sure that would have a necessarily huge global impact but it would have an impact on Canada for sure, and Mexico, for that matter. My own bias is I'm in favour of free trade. I think it's been a very powerful tailwind for equities over the course of 30 years … because companies have been able to allocate labour and capital very efficiently, and frankly they've been able to manage their taxes quite efficiently. All that has driven very strong earnings growth over a very long period of time. If NAFTA is killed, the way I view it, that would be the third incident of moving against free trade, with the first being TPP, and the second being Brexit. It all of a sudden starts to look like a trend.
I think the market would then look very carefully at rhetoric that emerges from the administration around China. There are members of the U.S. administration's advisers, including Robert Lighthizer, [who has been] involved in negotiations on NAFTA and who historically has written some negative things about U.S. trade with China. So I think if there was an extension of both the policy action and the rhetoric against free trade, I think that's a definite risk to the market. … Within Canada specially, we do worry about the high level of household debt and I think that could mean a protracted period of slow growth, so that's one to monitor. With a longer, a much longer time horizon, I think … the wealth dispersion, which has given rise to Brexit and the election in the United States – wealth disparity is something that I think is going to, could drive politics for a long period of time and could have market consequences, but that's really three, five, 10 years down the road.
Shorter-term people will be watching interest rates because the classic way to short-circuit a rally is for rates to go up. Our perspective is that we expect inflation to stay very well controlled and rates to remain relatively low for quite a long period of time.
Are there upcoming meetings with China?
Not that I'm aware of. The only reason I bring up China is I think [during] the presidential election, trade with China was a pretty big issue, I think Mr. Trump called out China pretty frequently. So he called out Mexico a lot and he called out China a lot. Obviously, we're dealing with Mexico right now with NAFTA, … but it strikes me as conceivable if you dealt with NAFTA, that he would turn his sights to China just because that's what he campaigned on. Coupled with that, is this idea that there is this person, Robert Lighthizer … basically he's working for the President on the trade file and if you go back and read Lighthizer's writings, … he is very antagonist to free trade between the United States and China, and particularly China's presence in the WTO [World Trade Organization]. The President has been antagonist to China, one of his top advisers has been antagonistic to China – so it's just something to watch.
The dollar has already fallen quite a bit relative to the U.S. dollar in recent weeks. Is there further downside risk? Do you have a target?
We don't have a particular target but we continue to be negative on the Canadian dollar versus the U.S dollar.
Even at these levels?
Even at these levels, and it relates partly to that economic momentum I described earlier … we think growth will be better in the United States than it will be in Canada. For that reason, I would anticipate, I think at a central bank level, rates will go up in both Canada and the United States but my bias would be they could go up a little bit more in the United States than in Canada. Think about the NAFTA issue: if NAFTA is killed I think that's way more negative for Canada than it is for the United States, and I anticipate that the Canadian dollar would fall on that.
With respect to interest rate hikes, is the Bank of Canada on hold until 2018 ?
The broad framework I've been using is that central banks in North America – so both the Fed and the Bank of Canada – are trying to recalibrate from an emergency setting to a neutral setting. When I think of a neutral setting, I think of a real rate for the bank rate of around zero, so real rate meaning after inflation, so inflation is running around 1.5 per cent in both Canada and the United States so I kind of got this notional target in mind that the central banks need to get the bank rate to something like 1.5 [per cent] over the next 12 months. Bank of Canada is at 1 [per cent], we've got to get it to 1.5 [per cent], to me that sounds like two lifts some time in the next 12 months.
You know, I would expect they would lag the U.S. in this regard, so I think the Fed is likely to raise in December. The Fed in my mind [will do] two or three increases and the Bank of Canada [will do] two … My bias would be that the U.S. would raise rates a little more than Canada, they will raise a little more and start sooner so if the Fed is going to start in December, I can easily imagine the Bank of Canada would be a bit later than that.
Could dividend stocks be under pressure?
We've liked dividend stocks for a long time. They still have a very important role to play in this low-interest-rate world. Even with the increases I'm talking about, which takes you to 1.5 [per cent] at the short end, you know, that still means that dividend-paying equities are giving you a more attractive steam of income than bonds. So I think the backdrop still remains pretty favourable for equities in that regard.
The second-largest sector in the TSX composite – the energy sector – do you have any recommendations on it?
Selectively, there absolutely are opportunities within the energy sector. There is a lot of skepticism in the market around energy stocks. They have not participated in the broad global equity rally this year as we know. I think you want to be selective, focus on what we think of as quality. In the energy space, quality really means you are a low-cost producer, your assets are in a politically safe jurisdiction, and you have a strong balance sheet.
What is your positioning on gold?
What we say about gold is we think gold's role in a portfolio is to provide insurance against the risk of extreme outcomes … Every part of the globe is contributing to growth, [the] North American economy is strong, we don't think there is a strong need for insurance … We're not enthusiastic about gold right now.
Your recommendation on fixed-income securities?
Our outlook for fixed income is we expect low-single-digit returns, which is like coupon-like returns … What we say to our clients is the role of fixed income is to deliver you a modest amount of income and diversification … We would expect equity returns to be higher than bond returns over the next 12 months, for sure. In the case of international equities, we expect them to be much higher.
This interview has been edited and condensed.