Brad Simpson On Rates, A Cautious Fed, And The Implications For Markets

cemagraphics Markets have been pushing to new highs amid signs that U.S. inflation is moving in the right direction. But will a more cautious approach on rate cuts from the U.S. Federal Reserve potentially impact that upward momentum? Brad Simpson, Chief Wealth Strategist with TD Wealth, discusses the outlook for rates, the economy, and markets. Transcript Greg Bonnell – We’ve got signs that US inflation is moving in the right direction, and major equity markets have been pushing to new highs. But you also have the Fed indicating that we may only get one rate cut from them this year. So can this run in equities continue in a backdrop like this? Joining us now to discuss is Brad Simpson, Chief Wealth Strategist with TD Wealth. Brad, great to have you back on the show. Brad Simpson – Greg. Great to be here. Greg Bonnell – Interesting times whenever you and I get together to talk about what is happening out there. So give me your view on what is happening right now. Brad Simpson – The irony is– and I think we’ll probably touch on this a little bit– if we rewound and look at an interview when I did back in January, the gist of it was we’re expecting six to eight rate cuts. And that’s what we were talking about. And you know, along the lines of, we started talking about, well, boy, what would it look like if there were none? And if we kind of look at that era in, going back in January, I think like a response– like, on a consensus, response would be, well, we would be in a very dire place indeed. And well, here we are in the second week of June. And we’re in a lot of places but dire isn’t one of them. Greg Bonnell – Not by the look at the equity markets. Brad Simpson – Yeah. So that’s why I think kind of the start of this is– I would look at it, is– a couple of nights ago, I had the privilege to get out and do some speaking with a bunch of our clients and answer questions. And one of the things was I said, like, let’s step back a little bit, and just let’s just do a run over the last couple of years and think of the things, like how we’ve had a war break out in Russia and Ukraine. We’ve had a war break out in Israel and Hamas. We have had runaway inflation, at one point at 9%. And of course, that’s now come off a bunch, but we’ll get to there. We’re working our way out of a pandemic, where we know it stalled the economy, all of those things. And you would think, OK, well, where are we right now? Well, OK, we’re record highs, to your thing, on the S&P 500. And we’re in an environment where much of what we’ll talk today is about interest rate cuts to try to slow things down a little bit. And so the remarkable place I think where we are right now, is if we added it up and said in an environment like this, which you’d map out– let’s just think about first in terms of volatility, things going up and down. We have understandably seen a lot of interest rate volatility. And check. And that makes a lot of sense with the inflation environment. The next one, equity volatility– there is none. I mean it oscillates between 12 and 16. Sometimes in a crazy day you’ll see 20, but then it’s back down to there. And I think the messaging around that is that one of the things we’re going to continue to do, if we look at the years coming ahead of us– and you and I have talked a lot about this– there is going to be angst and anxiety. And there is more strain and pressure in this world right now. And if we look at commodities volatility, same piece. And so if you look– for example, we could look at right now as a thing that– because part of our job is to think about where the risks are and where volatility could come from, when we look at Russia, Ukraine, and we look at the activity in Russia, that we do these scenario analysis of where we think that is. And we haven’t increased that as an escalating part of an area in war. But what we have seen in Russia is escalation of the use of tactics that are on the fringe but, as a whole, enables them to avoid using and drawing in NATO powers into that, into the war there. But it does have the process of escalating the activity that is happening geopolitically in the globe. While that’s going on, volatility is just nonexistent. And I don’t need to dig into Israel and Hamas to go, they can look at them you can see that happening. So you have to step back for a minute and say, well, why isn’t there any? And because– Greg Bonnell – Yeah, because the kind of thing– if you were sitting in a classroom two or three years ago and they said, if this was happening, this was happening, this was happening, what do you think would happen to the equity markets? And you probably would have got full points for saying, oh, it would be a choppy ride. Brad Simpson – Right. And one of the things I’ve tried to explain, too, in this client event I was speaking at was to say that one of the realities is that in an economy that, and even in times during warfare, is that people still get up. They still show up. They still have to buy groceries. They still have jobs. Governments still function. Governments still need to borrow. So it means there’s government debt markets and borrowing goes on and economies continue to move. And so one of those is just a structural reality of, these are one of the pieces that would go on. And I think that is a good starting point. And the second one goes along the lines of where we are today, is there’s the big barometer of trying to figure out ultimately where the economy is going to go down the road, which is going to drive over the long term, earnings per share in an equity market. And it’s ultimately going to drive which way interest rates are going to go. One was inflation. And as we saw yesterday in Canada– or, excuse me, in the United States, we saw that we’re getting into that kind of 3.2 year-over-year number, kind of surprised at– it wasn’t soft. But when you dig into it a little bit, we’re in a pretty good spot there. Greg Bonnell – Maybe we’re going the right way. Brad Simpson – Yeah. Greg Bonnell – Maybe we’re on the right direction. Brad Simpson – Right. Now, the areas of concern are the areas that have been driving, has been labor. And labor continues to be really strong. But if you think about it in terms of, it’s at 4% now, now it was at 3.7%, then it was at 3.8% and 3.9%. So the direction of that is slowly starting to go up, which is what you would really want to see on that side. And so if we start going through that, the reality is that there’s a lack of volatility. And then we’ll dig into US and Canada and all of that. But the reality is that there’s, from the last few years, still an enormous amount of money in the system. And that money in that system is, if you want to think it as the globe inside of a bucket, money is in that bucket, and it’s still sloshing around. Some of it spills out the sides. But at the end of the day, until it works its way through the system, there’s an enormous amount of money already in bond markets able to trade every day, in equity markets being able to trade every day. And then, which I know you’ve had a lot of people on here talk about this– so we won’t dig into this– but on the sidelines, there is an enormous amount more of it of that money creation that is actually just being held off the side that hasn’t entered into the system. And so how do you explain it? It’s really down to those things, is that you run on– an economy still runs even in the times and periods of angst and elevated– in crises, in times of warfare. And on the other side, it’s just ultimately the law of capital, is that when there’s that much there, that much of a supply, how much of a demand on it it’s going to make it– and clearly, from how things are trading, there’s still a lot of supports in financial markets globally. And that’s why we are where we are today. Greg Bonnell – How do you allocate, then? I mean, I know this is the question, ultimately, you have to wrestle with. How do you allocate in an environment like this with capital on the sidelines like that? Brad Simpson – Well, I think the first one I think you have to look at is that the temptation, the temptation of short-term interest rates– if you look at all the options in front of you and you see this great short-term interest rate and a short-term cash deposit or a GIC of some sort, and you go, well, I got 4% to 5% and there’s very little risk in that, why wouldn’t I do that? And I think that– and so what I think that your starting point is, is that almost any measure of what you’d want to talk about if you wanted to look at US, which is maybe the best economic story globally– remember, all our dialogue are still going to be pointed to the desire to have it to slow so that you can start dropping interest rates again. In Canada, we saw Bank of Canada drop interest rates. We saw them– and also come out and say there’s more coming. And we’ve talked a lot about that, these “more are coming.” So we probably won’t see one next month, but we’ll probably see a couple after that. And so in Canada, rates are going to go down. And so one of the things is how do you invest? For starting points, you have to look at those cash positions. And remember that as interest rates go down, you put yourself up to reinvestment risk. So the likelihood interest rates in the short term are lower than they are now, 12 outs– are exceedingly high. I mean, you have the governor of Bank of Canada saying, we’re lowering interest rates. There’s no crystal ball action going on here. And so I think how do you invest at the start out is you have to look at that and go, OK, if I’m going to step out, we are currently overweight fixed income markets. We continue to think that fixed income markets here, particularly in Canada, because things are slowed a lot faster than it is in the United States, that you can allocate into fixed income. And you can allocate into government bonds, for example. You can get a tremendous yield in the short term like that. And if you went out and said, I’m going to go out and I’m going to ladder out one and two and three– so no, not pulling out any crazy strategies here, just a simple of doing that– or if you went and said, I’m going to look at a little bit even higher yield, if your risk warrants it, right? Good Canadian corporate, investment-grade securities, go out kind of two or three year in something in there, laddering that out, this is one of the historical high in opportunities there. If we wanted to look in fixed income, that alone there is a place to invest. And we think that that’s– for us, we think that makes an awful lot of sense. Why? We’re overweight fixed income. I know we’ll go through others as well. But that’s your starting point. And we think that makes an awful lot of sense. And what’s the wind at the back of that. The wind at the back of it is that Canada is slowing. The number that we’re seeing from the inflation here is we are in around that 2% zone. When we look across the board, what we’re going to see is– I haven’t read the new TD economics report that you’ve had there, but we do work an awful lot like the Canadian consumer. It could be on the margin changing. But at the end of the day, they are stretched. So their spending is going to start to slow– is slowing, and that’s going to have an impact, ultimately, on the interest rate market here, too. Greg Bonnell – Quickly, we’ll talk about the equity side of it. Brad Simpson – Sure. The equity side of it is– I think, again, maybe it’s back to the, you’ve got to know that technology has been the hot space when you’re talking about income packages, like we were off the top of the show here. No secret the S&P 500 is trading at its highs. And looking at that, first and foremost, we think you need to build a diversified investment portfolio. Then you go, oh, then he’s going to sit on the fence. No. Look, overall, if you look at the big batch, start as a neutral. When you’re out in an environment that we are here, we can be maximum of overweight equities or neutral overweight equities, and for much of the reasons that we’ve kind of mapped out here. There is low volatility. There are high valuations when you look at the S&P 500 writ large. We’ll break that down a little bit. But when we start working our way through that a little bit, we continue to think that being overweight United States makes a lot of sense. We think you want to use a barbell strategy there. So you do want to have those momentum names. And you want to have that are influenced by the AI and the semis. And now increasingly, you’re seeing how can the semis benefit the software companies, and what does that look like. And having exposure there, that, we think, makes a lot of sense to be able to do. What we don’t think makes an awful lot of sense– I was going to read this at the punch line, but we’re publishing kind of like an educational piece slash update about private capital on Monday. And I have this chart where I go, you know, on all security classes, private capital– or private equity has outperformed S&P 500, public equities, global equities, all of it. Put all your money in that. No, right? All the environmental things that made that happen during that time may not play out perfectly in the next three to five years here. And so the principle that we have is, is that you don’t know what the future is going to bring. You hit weights on things and go, how much do I want to allocate? There is a lot of wind at the back, and you don’t want to stand in the way of what’s going on in technology right now. You want to be allocated there. On the other side of the coin now, when we look at it in terms of saying looking at momentum securities versus what we would call quality securities, kind of dividend-type of payers, and looking at small caps, which is more closer to your main street and drivers, they have underperformed. Their valuations are quite good. Last time I was on here, I was talking about how the equal weighted S&P 500 index has started to outperform the S&P 500, which is really skewed to the technology names. That was a real positive. That outperformance has really narrowed after this great run that technology went on in May. That doesn’t mean that making sure you’re allocating across that spectrum doesn’t make an awful lot of sense. And it does. You have, on the other side, if you rewound me here a year ago, I’m drawing a picture of Europe that is dire. And I don’t want to overstate this. It’s not like, pull out the bottles of champagne and say things are way better. But they’re improving. And as they improve with the valuations that they have there, we think that warrants another look. So we have changed our weighting in that area of the world, and so we have more weighting towards there. And we think that makes an awful lot of sense, too. And so making sure you’re allocating along those lines. And Canada is a little bit like Europe’s cousin, right? It has many of the same metrics, kind of the cyclicality on one side. You have a lot of financials. And so Canada is in a very similar boat to that. And so while we continue to build, we think that makes a lot of sense, too. Original Post

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