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Many investors would likely want to put 2022 behind them and focus on the year ahead. Michael O’Brien, Portfolio Manager at TD Asset Management, tells Greg Bonnell why he believes 2023 may provide some much-needed optimism, but not without continued uncertainty.
Transcript
Greg Bonnell: Investors who are hoping for better returns this year may have to exercise some patience. Our future guest today says markets may have a tricky path ahead. Joining us now with more, Michael O’Brien, portfolio manager at TD Asset Management.
Michael, great to have you back with us. Obviously, this is– last year, I don’t even want to say the numbers. We just want to put it behind us as investors. What is the path ahead? We can be forgiven for hoping for better times, but you’re saying it may be a bit tricky.
Michael O’Brien: Well, I think better times are ahead. It’s just that we’ve still got a bit of wood to chop, I guess would be the way I’d frame that up. Obviously, last year, what caught us all by surprise was just how rapidly and how high interest rates were raised by the central banks.
Good news is we’re getting closer to the end of that story. But now the trick for 2023, when you think about it, is how can we get inflation back closer to that 2% target that central bankers are very clear they want to see? And how can we do that without a big impact on company earnings?
That’s a pretty tricky path to navigate. And so being realistic, I think there’s reasons to be optimistic. Inflation has been coming off the peak. It’s moving in the right direction. I’m just saying, I think we should be prepared for some bumps on the road here in 2023 because it’s not an easy task to soft land an economy. It’s not an easy task to bring inflation down without sending unemployment up.
So I think we just have to expect there’s going to be some trade-offs as we go through this journey, and it’s not– I guess put another way, I haven’t seen the all-clear sign to back up the truck and load into the markets here. I think we still need to be very discerning, pick our spots, and be disciplined about what we want to do.
The good part of this, though, if we want to put a little bit of a positive spin on things, is the next 6 to 12 months, it’s going to be tricky. But if I’m thinking of longer term, three to five years, when I look at today’s starting point where the Canadian market specifically sits, historically the market should trade between 15 and 16 times earnings. That’s kind of the long-term norm. Today, we’re trading at 12 and 1/2, so well below normal.
You think about the biggest part of our index, the banks is a great example. Historically, they trade 11 to 12 times earnings. Today, they’re trading below 10. What I see in that is with today as a starting point and a little bit of patience, over the next three or four or five years, I think we can have a pretty positive view over where Canadian equities are going. It’s just in the short term, there’s still work to be done. Central bankers are not finished with their task. And at some point, there are going to be some ugly headlines in the newspaper about unemployment rate ticking higher or whatnot. So we just need to be ready for that.
Greg Bonnell: Yeah, the work that needs to be done, perhaps the ugly headlines, they haven’t arrived yet. Is that a bit surprising? I’m thinking of the labor report we just got out of Canada, after all of those rate hikes of last year. Super-sized rate hikes. The labor market is still very resilient. What’s happening there?
Michael O’Brien: Well, it’s interesting you hit on that. I think a lot of investors right now are scratching their heads because I think collectively, we have all come into 2023 with a pretty similar playbook, which is the early part of the year will be difficult as all these interest rate increases hit the economy. But then things will get better in the back half. That was kind of a consensus view.
Now I think we’re all looking around at each other and saying, 100,000 jobs in Canada in December. What was the US number, like 300,000 or something. Recession doesn’t seem imminent. This is pretty resilient. And so now, I think we’re realizing this might take a little bit longer to play out. So it’s not this convenient first six months, difficult. Next six months, great. This could extend a little bit further.
And so the glass-half-full spin on this is I think we’re seeing, both in Canada and the US, consumers, households are much more resilient than maybe we gave them credit for. The glass half empty is this resilience is potentially forcing central bankers to be more aggressive than they otherwise would be, maybe forces rates higher than they otherwise would need to go in order to create the same end result. And so in other words, it could be a little bit higher interest rate environment for a little bit longer that brings us to the eventual destination.
Greg Bonnell: So clearly the big story of last year was inflation. The fight against inflation. What it could mean for the economy dominated the markets and all of our conversation with the markets. Clearly, moving into this year, still the dominant force. Do we get at a point in 2023 where we’re looking at other things, or is this just these big macro challenges that we’re going to have to sort of just wade through for the next while?
Michael O’Brien: Well, I think we had an unprecedented boom in 2020, 2021, in terms of the stimulus, both fiscal and monetary, that was thrown at the markets. So I think it’s only reasonable to think it’s going to take more than just 9 or 12 months for that to dissipate. I think there’s still a little bit of payback to come.
But yes, I think there are lots of reasons to believe that inflation may have already peaked. It’s trending in the right direction. I think there’s lots of good reasons to believe that the peak in the central bank rate hike cycles is pretty imminent. Maybe not too many more hikes to go.
It’s just we aren’t there yet. Once we get there, then there’ll be a whole new set of– a new wall of worry to climb. But I think for the short term, people are going to be glued to every inflation report. People are going to be glued to every comment out of a central bankers mouth, whether they’re in Sweden or wherever they are. That’s going to drive the market in the short term. But yeah, I think we can look forward to a new set of issues to worry about eventually.
Greg Bonnell: I was looking for a new set of things to celebrate, but yeah, there’s always a set of issues to worry about. When you talk about it being a tricky year, it’ll be sort of a tough one for investors, the sharp pencils, all that kind of stuff. How do you broadly play this kind of market? Is it about patience? Is it about not so much sitting on the sidelines, but picking your moments?
Michael O’Brien: Yeah, I think it’s very much about picking your moments, and also just understanding what it is you’re trying to accomplish. I guess what I always try to tell myself is don’t try to outsmart myself. Find the types of companies you want to own through the cycle. And if all the noise and all the concerns and the worries have driven them to a point where you can buy them at a fair price today, sometimes it’s as simple as that. Don’t try to outsmart yourself. At the same time, be aware of how much risk you’re taking.
And so it could be a company that’s very, very cyclical, whose earnings are highly at risk. Or it could be a company who’s viewed as a very stable company, but their valuation is very elevated. Both, though, you have to be ready or aware of the risks you’re taking in the portfolio.
And right now, I think that’s how I’m thinking through things. It’s more about what is the balance, the risks that I’m taking and the opportunity? Where is that in balance? Because there are still parts of the market where it’s a little bit skewed to the downside. Too much earnings risk. Paying too much for it. But there are places in the market that you can find where at least a portion of the earnings risk you’re taking on in this type of environment is already embedded in the share price.
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