WBND - Brad Simpson On Why A Bond Bull Market Is Still In Place

2023-10-04 06:52:00 ET

Summary

• Why the bond bull market is still in place.
• Markets priced 'everything for perfection': Now what?
• Hard landing or soft landing?

September has been a challenging month for investors as they face numerous headwinds, including economic uncertainty, sticky inflation, and soaring bond yields. Brad Simpson, Chief Wealth Strategist at TD Wealth, explains why bonds could become more enticing in the current market.

Transcript

Kim Parlee: September has been a challenging month for investors, with markets facing numerous headwinds, including economic uncertainty, sticky inflation, and soaring bond yields. Earlier I spoke with Brad Simpson, chief wealth strategist at TD Wealth, and asked him about his thoughts on the current state of the markets.

Brad Simpson: I mean, let's face it. There has been an awful lot of things that have gone wrong this year. And yet market has priced everything for perfection.

Kim Parlee: Exactly.

Brad Simpson: Like that's the -- if anything will catch you off guard, that's the one. And so usually when you're pricing something for perfection, rarely does -- kind of Murphy's law. It's not always going to work out that way. So I think that for us, I think especially I think maybe if you want to say perfection, that would apply really for the equity markets. And I think if anything, a lot of the activity we've seen is on the fixed income side would be the area that's putting the strain on.

Kim Parlee: Yeah, and in terms of perfection, you're right. We've seen the economic data. We're still seeing strength where a lot of people weren't expecting it. But you could say the same for rates. And even you think about the US debt was downgraded. And all these things you'd think would cause more tremors than they do on the equity side.

Brad Simpson: Yeah, on the equity side, and I think it's been pretty well documented that equity returns so far this year have been driven by, let's call it seven to eight stocks. And particularly if we're going through the perspective of the S&P 500, and when we're seeing the market, that's what.

And so that's the good news. But when it comes to equity investors, typically people don't own seven stocks, right? And so if you take those names out, I think your average investor's experience is very different than what the headline is going to say. And I think being cognizant of that, that starts to change the story a little bit for sure.

And then I think if we take a look at the fixed income side, we have been anywhere this year between maximum overweight fixed income to overweight fixed income, which is where we are today. And to date, that hasn't looked like a really great place to be. And so I think that for us certainly has been a big part of our year so far.

Kim Parlee: And so tell me about that call then. Are you still committed to that outlook?

Brad Simpson: Yeah, look, I think it's back to what you said, is that if we look back at the beginning of this year and all the turmoil that we were going through, and you're dealing with working down inflation, and a war in Ukraine, and you're going through all these things. And you looked at that and say, well, boy, you're going to see all these interest rate hikes that we're going through.

We get to the spring of this year, and let's say a 10-year US Treasury was yielding about 3.8%, somewhere in there. And you'd think, well, it will probably start working its way down more, right? You raise interest rates to 5.25%, slow things down, and you see all the things that would be signs of it slowing.

And here we are September, and let's call it ish, a 10-year Treasury is yielding somewhere between 4.25% and 4.5%, which is not really where you would think it would be. So I call that -- this has been a speed bump, but we haven't hit a brick wall.

Kim Parlee: You've got a chart here I want to bring up. If we bring it up, take a look. I think this is returns, year-to-date and quarter-to-date. Tell me what you're paying attention to and what we're looking at right now.

Brad Simpson: Well, look, really what we do on my team is say, how do you build diversified investment portfolios for individuals with different levels of risk? And in this term, if you look at what your returns are going to look like if you're an aggressive or a growth investor and you're primarily in equity markets, it's been a pretty good year.

If you look at clients who are more conservative, who are more inclined to be having more fixed income, you had a 2022 where we had one of the largest bond market corrections that we've had in the history of markets. And then you go, well, this is an event that is a real rare occurrence, which it was. Then you lead into a year like this one, and you go, well, we think that there's going to be a lot of rally here and a lot of the return is going to make its way back again.

What this is showing is that for a conservative investor, you're up about 3% this year. You're about 3.5%. For a balanced income, I think it's 4.5% for a balance. I mean, that's a good start.

But what we're showing on the quarter-to-date returns, kind of this April where all of a sudden interest rates started to back up again, you saw it stall. And then you even saw some of your returns were given back.

And I think the important part is that we are still really comfortable with fixed income. And we were maximum overweight. We're overweight. And the only reason we went from maximum overweight to overweight was actually saying, we think there'll be somewhat of a market correction, a stock market correction along the way. We want to start raising some cash so we could be going in there.

But the bottom line is that we think at a 10-year Treasury that where it is today, we think that this bond bull market is still very much in place and that we think it still makes an awful lot of sense. And the key is it is much better to be early than it is to be late or not at all.

Kim Parlee: Yeah, tell me what you're seeing then if that thesis remains intact in terms of what your outlook is. The debate is hard or soft landing. What do you see?

Brad Simpson: Well, I think that's when this really starts to get tricky, right? First and foremost is that if we rewound where we were nine months ago, you would think that a lot of the commentary and discussion, and even from us, we're talking about is that you're going to start seeing the potential of interest rates -- and this is going back January, February of interest rates starting to go down and getting closer to an environment where you're going to have a recession. This is what you expect is going to happen.

We started writing in the spring of this year that we don't think that's going to happen, that we don't think there's going to be this recession. We don't think we're going to see interest rates back their way down. So that was the good news.

So then the next part you have to say to yourself is, you hit a soft landing all over the place. But what does that mean, right? You know what I mean, right?

So a couple of weeks ago, I just got back from a vacation where we went to Germany for 10 days I would argue that Germany today is in a soft landing, right? Well, guess what? That feels a lot like a recession. They're in a manufacturing recession. The services are slowing. You walk down the street, you see For Rent signs on buildings, all the rest of it.

And my point is that a soft landing may not be what you think. So what we want to do is define it. Like what would you know then?

Kim Parlee: It sounds almost fun.

Brad Simpson: Right.

Kim Parlee: It's not.

Brad Simpson: No, no, that's right, it's not. So instead what we said is, so a senior portfolio manager on my team, Fred Wong, came up and said, well, let's define it. What would we know it to be true?

And so we pulled out something that was called the Beveridge curve, right?

Kim Parlee: Right, let's bring it up because you got another chart for us.

Brad Simpson: So the Beveridge curve is not what you think it is.

Kim Parlee: I had high hopes. It's not it.

Brad Simpson: It's not that. It's not nearly as fun as this. And basically, if you could go back to the mid-1950s, this is something that central banks have been using to analyze what is the health of the economy since then.

Kim Parlee: And just so we're clear, just as we're looking, this is plotting unemployment rate against job vacancies.

Brad Simpson: That's right.

Kim Parlee: And there's a lot of red lines, and there's a plane. And there's no time here.

Brad Simpson: Ton of fun. So look at the black little dotted line that goes through that. That's the average trajectory of an economy. The green lines are the movement of that economy and what does that look like. And in that is the relationship between your vacancies and unemployment.

Kim Parlee: OK, and that red line is then just the chaotic data that came in?

Brad Simpson: So what we're seeing here is that, for 70 years, you could run along that line for vacancies and jobs. And the peak there is the peak of COVID-19. That relationship departed in a way that we've never seen before.

And so when you're saying -- one of the things we're always talking about is, what are you watching? Well, we are watching employment. That's the big one. We're watching the consumer and employment. And you can see those two really go hand in hand with one another. Kind of throw in your housing, and you get everything you need to know or what's the thing that's going to decide where you're going to go.

So when that relationship is that broken or that apart...

Kim Parlee: There's a reversion.

Brad Simpson: Yeah, ultimately it's going to revert back to that. So all we're showing here is that the strength of the labor market has continued to astound everybody. And what we're seeing here is you can start to see that this is starting to work its way back.

Kim Parlee: I'm going to ask if we can bring it back up just to look. Yeah, because you can see like you said, your plane, I can see here flying around. But I guess July 2023 we're seeing, is that line, that red line?

Brad Simpson: Yeah, that's where we are there. And so what we know is this plane will land and that when it lands, as you know, one of the things we're always saying is no one can predict the future. What we know is this, is that we're going to define if we're a hard or a soft landing the closer and closer we get to those green dots, we get to that landing point. This has not been anywhere near that landing point.

And so that's really going to determine where we go from there. And so in the meantime, but what you do know, what's going to get you there, is that if you look across the global economy, you can see, to varying degrees, slow down, slow down, slow down, at different levels and different degrees.

But that's one of the most difficult things I think most investors have to get to understand is that the reality is central banks are trying to slow things down. They've done a really good job with it.

Inflation was 8.3%. We're in that 3.5% to 4% zone now. That's been a real success. We have the difficult things now. They're going to continue the pressure on until we get there.

Kim Parlee: I've only got about two minutes here, Brad. But I do want to ask you just in terms of deterioration. One thing we've noticed, of course, is China and what's happening with China and the decoupling that's happening.

And it's almost like there's an economic decoupling. There's a political decoupling. It's just right across the board, and the impact that could have. That builds, I think, into your thesis as well.

Brad Simpson: Yeah, look, over the last, I'd call it the last 18 months, pretty consistently in our portfolio strategy quarterlies we've been working on this theme that this is a really, really significant, if not monumental shift we're in the middle of right now, I mean like the kind of stuff you see every few decades. And if we went back on what does that mean in economic terms and investment terms is that when we started on January 1, a lot of folks were saying, OK, the pandemic in China is over. They're going to open back up again, and we're going to see 5% and 6% growth.

Well, we're seeing about 2% growth there. And when you look at our TD Economics heads and look at ourselves and where we're looking on, we're talking a couple of hundred basis points growth down the road. And the reason for that is they've got an awful lot of headwinds there.

And so if anything, I think the best thing to learn from China right now is that we need to start adjusting our thinking, the way we look at things. And I think there are a lot of investment clients out there that have portfolios built for an environment that actually doesn't exist any longer.

And I think making those changes and looking down and saying, what is my investment aspirations over the next five years, and building a plan up against that based on the new reality in the world that we live in, which presents a lot of investment opportunities. But you've got to change the way you look at things. As we always say with risk management, you need to adapt. Think about it in that way.

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