The decision by U.S. President Joe Biden to drop out the 2024 presidential race has put this year’s election campaign into uncharted territory. Michael Craig, Managing Director and Head of Asset Allocation and Derivatives Team at TD Asset Management, looks at the changing political landscape and the implications for markets.
Transcript
Kim Parlee – The decision by US president Joe Biden to drop out of the 2024 presidential race has put this year’s election campaign into uncharted territory. While the future of Biden’s tenure is now clear and VP Kamala Harris his likely successor, many questions still remain, including about the US political landscape and the broader implications for the markets. Let’s bring in Michael Craig, managing director and head of asset allocation at TD Asset Management. It’s not boring, is it?
Michael Craig – It certainly is not. No.
Kim Parlee – You know, and it’s one of these points, we get so many historical things happening so quickly, it’s almost hard to digest, and I think let alone for you, as someone who does this, for the person who’s watching, who’s looking at their own portfolios. What are you watching right now, given what I just said, with President Biden now out, Kamala Harris now the Democratic front runner? It looks like it’s fairly cemented in at this point as well, too. What are you watching?
Michael Craig – So I don’t think there’s a big change in policy going forward. I don’t think Kamala Harris is going to really deviate massively from what Biden was already trying to push forward. I think she will do a better job at articulating it. And so we’ve gone from somewhat of a coronation a week ago to a race. You can kind of see different asset classes starting to absorb what’s happening.
And I would say, on margin, those assets that rallied with the prospects of a Trump victory have come off a little bit. But I think, for now, it’s important. A lot has changed, as you mentioned, week over week. You can’t really get too kind of dug in on any particular outcome right now. And so from our perspective, it’s kind of really trying to see where they’re going to prioritize policy, and get a sense of what things would look like in November based on who wins the White House and also who wins down ticket.
Kim Parlee – And I guess also, you and I were chatting beforehand, and nobody has a crystal ball and nobody knows. But if it goes from a coronation to a race, the opportunity for conflict gets higher too because you actually have a race now.
Michael Craig – Yeah. I mean, no matter who wins in November, a large slice of the population is going to be very upset. The overlap in policy is at a multi-decade low. We have never been alive at any given time in the previous decades to see a period where both parties are so diametrically opposed on policy. That’s a huge problem. Like, democracies typically don’t work without a center kind of holding the two flanks together.
And so as the race becomes closer, there will be more and more in discussion about whether it was fair, or whether we had voter fraud or what have you. And I think this leads to a risk that you’re going to have some civil unrest come November.
Kim Parlee – Yeah. And it’s always been an issue with the US and a two-party system, which is much more polarizing, I think, than others. But that’s another day. You mentioned there were some asset classes that are moving at the margin on news of this. And I think part of that is people trying to figure out what are the implications for policy and what’s going to happen. So maybe just take us through what you’re seeing at the margin right now.
Michael Craig – So certainly, what was beaten down over much of this month has been European equities. As of Monday, they really took a bit of a V turn higher on the prospect that it’s now a race. And because Europe would be one of the areas that would really be affected by tariffs. And so you saw European equities rally quite well to start the week.
Crypto has been interesting. Crypto, real strong up leg with selecting JD Vance as a vice president candidate. Crypto has rolled over as the threat of more regulation comes into play. So a couple of examples. On the bond market, it’s actually been pretty– for all the talk about bonds selling off with the Trump victory, bonds have actually rallied this month.
For us, these kind of other flightier asset classes may be not the best place to look for a signal, but I think the fixed-income market is telling you that you don’t be aware of inflation or rates kind of going materially higher with either candidate winning. The bond market has actually been quite calm.
Kim Parlee – And again, maybe just out of specifics into what you’re seeing in the markets, when you think about energy policies and NATO, what was perhaps the people thinking? What might be tilting now in another direction?
Michael Craig – Well, you certainly are going to get less risk of tariffs with a Democrat victory. Other areas, though, you are going to have more regulation. And so energy has been another area that has been poorly traded this week just because the risk of inability to exploit resources.
And so, again, I think it’s really too early. I think the biggest takeaway is that it’s a coin toss. Nobody knows anything. And we have a lot to play for. And I think that, in many ways, the giddiness from the Republican convention–
Kim Parlee – And the Trump trade.
Michael Craig – And the Trump trade. I mean, it’s amazing we had this kind of peak sentiment four months before the election. It does tell you, it’s going to be an exhausting four months in terms of those who watch politics because I think we’re still lots of ebbs and flows going forward in terms of how this plays out.
Kim Parlee – Yeah, it’s exhausting, and some people might turn it off. We’ll have to see where it goes. One thing that I know, people kind of tend to focus on politics because it grabs the headlines. But you know, there’s some really exciting things happening in the market, though, just in general, putting that aside, in terms of some of the staggering moves we’ve seen in AI and biotech. And maybe you could just kind of say, what are you seeing right now that’s really interesting?
Michael Craig – Well, first off, the politics is definitely the front and center. It’s important for investors not to lose sight of what we are experiencing. And what we are experiencing is really a fourth Industrial Revolution. The amount of– the likelihood to see a material step higher in productivity growth over the coming decade is there. And coming out of this post global financial crisis, very, very tepid growth, very, very loose monetary policy, QE, all that.
And now we’re going to a period where, hey, there’s a chance we’re going to see major productivity gains, whether it be AI, robotics, biotech, life sciences, investing in climate-resistant cities, et cetera, et cetera. Makes for an investment standpoint much more interesting environment, where now we’re going to see, I think, earnings really run.
And so I think this is, for investors, I know you turn on cable news and it’s doom and gloom. You’re really missing the point, where the future is quite bright, particularly for investors. And it’s a period, I think, where we’re going to see, with higher productivity means higher earnings. Higher earnings means equities do quite well.
Kim Parlee – It’s interesting because I love hearing that stuff. It’s fascinating. And then I also look at the markets, which maybe some of them are near all-time highs. Most are close. And then you say, more productivity, more earnings, more great things. And I just keep wondering. It just keeps moving up. And at some point, people, I think, just naturally want to say, well, when will it sell off, right?
Michael Craig – Well, the thing, if you look at the S&P as an example this year, yes, the bulk of the gains has been just from a handful of stocks. Most companies haven’t seen a material rerating in any of their earnings or valuation. And so if we look at it, at some point that will start to broaden out. And you’re going to see other companies that haven’t seen big returns this year start to catch a bid.
And so I think it’s important. I mean, looking at the overall index, I think, does hide. It’s actually not a great way to look at markets anymore just because it is so skewed to a handful of companies. And we’re not even talking about what’s going on in Europe, what’s going on in Canada. And so this is where a diversified approach to doing these things makes so much sense because you don’t want to buy high and sell low. So many investors make that mistake. They chase price versus actually looking at, where is capital going, and where is the opportunity set in front of you.
Kim Parlee – Let’s talk about your various outlook for all the asset classes. And right now, let’s start with fixed income, where you have a neutral. And this is a change.
Michael Craig – So this is a step back. Beginning of the year, I guess our base case was, inflation was going to slow and growth is going to moderate, right? So below trend growth in inflation and in growth. Fixed income has started the year quite poorly but has recently rallied. And we’re up about 4% since the spring.
Our thought process here is yields are still pretty attractive. All-in yields still around just under 5% on a balanced fixed-income portfolio. But we are going into a period of unknown, uncertainty, if you will. And I’ve always been trained, when you go into the fog, and when you’re investing, sometimes you just bring it home a little bit, raise a bit of cash, have some optionality.
The market might zig or zag. Longer term, we’re quite bullish, but we just want to get through this period and have a bit of cash just to take advantage of–
Kim Parlee – The flexibility, yeah.
Michael Craig – … dislocation asset prices. And so with fixed, the thought process is, yields are still pretty good. Credit has really tightened. The value in corporate bonds from a spread basis isn’t quite there like it was earlier this year.
I don’t think it’s going to happen. If we go into recessionary conditions, fixed will do fantastic. So I think, for a longer-term investor, no issues. But we shouldn’t be shocked to see a degree of volatility in fixed income. And there has been– I don’t buy into this narrative, but there has been this narrative that Trump’s going to lead to higher longer-term rates.
The market might believe that story. I don’t think it’ll last. So we’re taking more of a tactically cautious view, short term. But longer term, quite supportive of the asset class. Fixed-income yields are well above inflation right now. For most of my investment career, it’s been the opposite. So not a bad time for income investors to clip that coupon.
Kim Parlee – OK. Second, let’s talk about equities. Neutral overall, but then there’s some nuance, obviously, within equities.
Michael Craig – Yeah, again, on the equity market, we’ve had a nice run. We are going through a period of high uncertainty. The fall tends to be a bit of a more challenging seasonal period for equities. We are fairly neutral in terms of a policy, but we’ll be looking to add on any weakness. And that’s kind of the viewpoint right now, is just take some profits, go into it with some flexibility. But certainly on a 12-to-18-month view, quite optimistic.
Kim Parlee – And just some nuance, let’s say, between US, I understand it’s a modest overweight versus Canada, which is a neutral.
Michael Craig – Yeah, we’ve been overweight, US, materially this year, much of this year, taking a little bit of profit on that. And the US has outperformed Canada by about twice as much this year, just to give you some context. And we’ve also had the tailwind of the weakening Canadian dollar. To start the year, if we looked at returns, if we froze the returns today, you’d be like, well, those are great returns for a year, let alone six and 1/2 months.
And so, again, like the equity markets, going into the fall, still hold them. For a typical investor, rather than being at 63%, we’re at 60% equity. So not a huge shift. But we do like the market and do like the US.
Kim Parlee – What about alts? And this is an interesting one, again, for people. Some people are still slower to get into some of the alt side, price discovery a little different than, obviously, public equity. So what do you see there?
Michael Craig – So with alt, we’re really talking about private assets, commercial mortgages, commercial real estate, infrastructure, private debt. On the alt space, I love infrastructure. It’s just structural, long. Infrastructure will constantly see capital go to it to develop it. It is going to be a kind of a thematic thing for probably the remainder of my career.
I really like commercial mortgages. All-in yields right now, give or take 7% for very short-term paper. So call it three-year average term. Certainly, real estate, we’re hoping it’s seen the trough. Commercial real estate, particularly office, has been quite soft. But that seems to be starting to stabilize somewhat.
And so again, from a multi-asset portfolio, really important to think about alts as another source of both capital gain and income stream and tends to offset a lot of the risk from the public markets. And so key part of a portfolio, but we do like infra and commercial mortgages.
Kim Parlee – I should mention I’ve only got about 30 seconds. But you and I were chatting in the break just about– I mean, a lot of people are waiting for a pullback and waiting for something to happen because we’ve seen these steady gains in the markets overall. And you’re saying you still see a lot of cash on the sidelines.
Michael Craig – Yeah, there is. I think a lot of investors– look, 2022 was a really tough year for everybody. There was no place to hide. ’23 was a bit of a roller coaster. We had the regional banking crisis, but you saw the Fed reaction. And then come October of last year, we really were pushing clients, this is the time to invest. And since then, you’ve seen a pretty momentous drive higher.
I think one thing investors need to think about is we’re not in the 20-teens anymore. We’re not in this low-growth, slumbering world. We’re in a world where, all of a sudden, you’re seeing real increases in fixed-capital investment, and that’s going to lead to bigger productivity growth. And I started my career in the late ’90s. That was the tail end of the last big gains in productivity.
If you look at the returns in 1990s, they were pretty spectacular. I would think we’re in the early innings of that type of environment again. It will have bumps in the road, no question. But this is a period of time where, when you see those types of gains in productivity, equities tend to do much better than historical trend returns.
And so for investors who– the biggest risk for investing is not having the money when you need it, not necessarily who’s going to win the White House in a few months or policy. It’s about making sure you’ve got what you need when you need it. The more time you spend out of the market, the more risk is that you’re going to have to actually work longer than you otherwise would have if you’d stayed invested. So our message to investors is, make sure you think about what you’re trying to achieve. And–
Kim Parlee – And matching, yeah.
Michael Craig – This is not a market to be out of.
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