Hello and welcome to The Download. I’m your host, Dave Richardson. I am really pleased to be joined by a special guest today, Dan Chornous, Chief Investment Officer at RBC Global Asset Management. Dan, welcome back to the podcast.
Thanks for having me, Dave.
So we’re a day in front of the first debate in the U.S. presidential election, through the month of September. As people have come back from summer vacation, we’ve seen an uptick in volatility. Some concerns about the valuations of some parts of the market. Some disruption in high-yield fixed income markets. October historically has been one of those times of year where you often see movement in markets. So I thought I would ask Dan to come on and give his view of the market, what he’s looking at, as the chief investment officer of a firm that runs hundreds of billions of dollars of assets around the world. To put it in the perspective of what we should be thinking about as average investors, looking at these markets as well. So, Dan, welcome and thanks for being with us. What are you looking at, Dan? What are you thinking about when it comes to investment markets and where we’re sitting right now? About a month out from the U.S. election and in the midst of perhaps a second wave of COVID around the world. What are you paying attention to, and what do you think investors should be paying attention to?
It’s probably worth starting with the economy, but also reflecting on what you just said --- that September and October are historically among the most difficult months. I think Mark Twain had something funny on that. But we’ve seen this, and there’s so much to work with in that regard in 2020. You mentioned the election, but of course, the pandemic that seems to have taken a little bit of a back slide through the beginning of September. And obviously you all read this stuff in the paper, I won’t recount everything, but there are a lot of avenues for this back slide. Back to school, more back to work, some prior relaxation of social distancing measures by governments, etc. Apparently, a dry fall might have had an impact. This isn’t just in North America, though. You’ve actually seen worse numbers coming out of Europe. So that’s very, very unfortunate. But, you know, it seems that these waves will define this period until a vaccine or therapeutic is able to put this well behind us. So I think it’s important, though, to understand that despite these threats, the economy is growing, and it’s already recovered two-thirds of that huge decline of the lockdown period of March, April and May. Now probably the next leg of it, recovering that last third, is going to be much more difficult than the prior two-thirds. And there will be more threats accumulated along the way. But you look at the employment data, and it’s actually quite strong. Unemployment is falling, jobs are being created. And, you know, the economy will finish this year with probably the worst numbers in history, perhaps even including the worst years of the Great Depression. Something like minus six in the United States, and minus seven in Canada for GDP. But recovery caught 3.4 growth in the U.S., and next year 4.5. So, you know, there still is momentum, but there’s also a cycle, and we appear to be into a weakening stage of that within an overall recovery trend.
So, Dan, do you expect the markets to be particularly volatile through October and perhaps even beyond the election, which may or may not be determined on November 3? Is that something you think investors are going to have to get somewhat comfortable with over the next several months?
I think so. If you look at the stock market and the quality of the correction that we have, it actually acts like a positive refresher. A cooling-off period after a hot summer, as opposed to the beginning of a tip into something much more pernicious, like a bear market. You mentioned high yield bond markets. Actually, the credit markets have been relatively stable through this. Of course, there’s volatility there, too. But when really nasty things happen, you usually see it happen first in the credit markets. We’ve got our eye on that very, very closely. And, of course, there are reasons why you should be concerned about credit, as this period of weirdness in the economy stretches on, and people will find it more and more difficult to satisfy their prior commitments. But the credit market is solid. Spreads are average to low by historic comparison; much lower than they were three, four months ago. So the fact that it’s holding in there, I think is sound. If you look at the internals of the stock market — look at market breadth, for example, the new high new lows — we’re not seeing an awful lot there that says, wow this is the beginning of opening the trap door. So that’s not what seems to be happening out there. Of course, we take every day on its merits, but so far, this looks like a cooling off. Cooling off is a good thing. We were seeing a couple of things happening. In the U.S. stock market in particular, which has not only led, but acted quite differently than other world stock markets. And I think that’s something you might want to consider now when you’re doing your asset allocations. So a couple of things happen in the United States. First, we’ve got huge gains in a narrowing part of the market. These were the mega cap, global technology stocks - the five biggest companies in the world. And we could all name them and probably in order. They define a growth style and not a value style. So as part of that, the premium valuation of growth stocks versus value stocks went to an historic high. That’s a bit of a concerning thing because it distorted our knowledge of what’s happening in the stock market. If we look at the indexes, we think the U.S. stock market is on fire! If we actually look at average stocks, they did nothing like that. And when you get these valuation premiums that are probably not sustainable, you want a period of cooling off. That’s also been seen in just market sentiment numbers. People are getting too excited about this. And usually what happens after a period of too much excitement? We all get that excitement. Excitement moves in a difficult way. Or seen during this, though, is a bit of a recovery and relative strength in areas of the global stock market that haven’t participated yet. That’s not bleeding through the value in any sort of sustainable way. But we’re seeing much better activity out of the global or non-U.S. stock markets. And that’s encouraging. Ultimately, we’d like to see some sort of recovery in value versus growth. If for no other reason than it opens up more opportunity for more stocks to rise. That doesn’t appear to be in place yet, though. If you look for the normal signals of that, you’d look for a steepening of the yield curve. We’re not really seeing that. You look for recovery and inflation expectations. To the extent that that’s happening, it’s more technical. We don’t think that there really are people fearing inflation yet. Really what you look for is evidence that a durable, stronger economic recovery is falling into place. And that’s not really what’s happening right now either. Just more of a laboured recovery with some threats around it. So more of the same going forward. And there will be corrective periods and we appear to be in one of those. But as far as asset mix goes, to us, stocks still look like the favourite.
Yes, I think a really important point you make for investors is that the stock market is going to adjust over time. It’s not going to be a straight run higher. It never is. There are always shorter-term factors that come into play, emotions that correct the market. And it’s a healthy part of the process, which, again, is why people should think of investing as a long-term process versus speculating in gambling. That is, trying to figure out what way the market is moving day to day. That investing is much more about taking what the market gives you over time, which has historically been very good. And right now, as you say — and as you said I believe the last time you were on — things certainly favour stocks over bonds and cash in the coming years.
Dave, can I just follow that up for a second? That’s an extremely important point that you’re making, and it’s something that we’ve done a lot of work on and think about always. Not only over the short term or the intermediate term, but for many years, the way we invest has to change. Interest rates are below 1% almost everywhere, and in some places, even below zero. Central banks are committed to keep those rates at low levels, at least over the next year or two years. And structurally, it’s hard to see why they should rise a whole lot. So maybe they go back to 2, 2.5, maybe even 3% going forward, but nowhere near the levels that we grew used to for the last ten, fifteen, twenty years. And therefore not the levels that are embedded in our investment plans. That is because of a structural change. We have an aging global demographic. We have the emerging world that has partially or largely emerged. So trend line growth rates are going to fall. Inflation will still be low. And all those things say, ok, interest rates are going to be at very, very low levels. When I say low levels, I’m not talking low levels relative to last year. I’m talking about low levels for out of the last century and a half. But this is a durable, important thing. And why is it so important? Because whether we call it a balanced fund or not, our investment accounts, our savings accounts, our retirement accounts, our education savings accounts, they’re a blend of different assets. We use some bonds, some stocks, maybe some real estate, whatever. You put all those things together based on a forward view of what the returns will be. And when we blend those together, how they will affect portfolio volatilities. This is all changed because of low interest rates. Bonds don’t give you the safety net that they used to. They don’t give you the income that they used to. They don’t give you the safe haven that they used to. So the simplest thing one can do is say: I used to earn 4% on my bonds, sometimes a little more. I’m now going to earn 2% or less. Where can I go to get returns? Everywhere, returns will be lower, but they’ll be significantly higher over the longer term in equities than they will in fixed income. But equities always bring the risk of correction and sleepless nights. This is where time horizon comes in. It’s so important right now. If you can look past these corrections, if your time horizon is beyond seven years and hopefully beyond ten years — and it is, for so many of us, because it’s retirement savings very frequently we’re talking about — you can accept that volatility. You can use periods where equities are weak to add to positions and through the cycle run higher average equity positions than you did in prior cycles.
What do you think, though, Dan, about someone who is 65 or 70 years old, and already in retirement? A very challenging market. Low inflation creates a positive for them because cost of living perhaps doesn’t increase as much as it traditionally would through a 15, 20, even sometimes 30 or 40-year retirement. But what do you do if you’re that type of investor, if you’re in that position in your life, and bonds are just not going to produce the kind of returns they have?
So, again, another good point you make is that we can take some relief out of the fact that real costs of living aren’t going to rise much. That would even be a greater threat if we had higher interest rates and higher growth, but much higher inflation. That makes future planning even that much more difficult. So there are a few things that older savers can do. One is be patient. Two is don’t panic. We saw in The Wall Street Journal in March or April of this year that over 20% of savers over the age of 65 sold all of their equities during March of 2020. You know, you have to have tremendous sympathy for these people. Those are, in some cases, unrecoverable losses. This is where I think, frankly, the value advice comes in strongest. During these bad times, don’t lose your head. You can move beyond sovereign bonds. And again, you build diversified portfolios. A diversified portfolio is the key here of investment grade bonds. There’s higher yield, and there’s returns to analysis that are available there. You can even blend in some small amount of high-yield bonds or emerging-market bonds, and boost the yields there, too. And more and more, we look to things like absolute return fixed-income funds. We’ve had very good success at BlueBay with these, and they produce much of the total return of fixed income. They blend nicely with other fixed income products to modify the downside in a bad time. So it’s a range of things in fixed income that move beyond sovereign that can give you a bit of a bump. And then as you move into the equity markets, it doesn’t have to be all high-flying technology stocks at one place. Certainly, probably you want to minimize that. Again, a very broadly diversified portfolio. You might want to emphasize those with very stable business plans and rather high yields. Low vol has got knocked around a bit through the corrective phase. But the elements of the way that at least we’ve built low vol still appeal to me. If you’re looking for low volatility rather than just buy stocks that in the past have demonstrated low volatility, why not construct a portfolio out of companies with business plans that should exhibit low volatility? So it’s not an artefact of past stock market performance as a reflection of the go-forward business plan. There are things that we can do to boost our returns. Perhaps we have to accept a little more volatility, but it doesn’t have to be an all-or-nothing type of proposition.
Yes, there are two things that we continually emphasize on this podcast for investors. One is get great advice. Getting good advice is a really, really important element, even for someone like yourself or myself who have worked in the industry for decades. It is still a good idea to have a sounding board, or to have someone who has an expertise around all elements of financial planning, not just the investment piece to help guide the decisions you’re making. But then there’s diversification. And again, what’s the big advantage of being an investor in 2020 versus 1990 coming into retirement -- if we were in the same situation back then -- is the amount of options that you have. Easily and professionally managed options that you have to build a truly diversified portfolio. Not just in stocks but as you say, in fixed income for retirees. It would be lovely if things were a little bit different, but given the market backdrop, at least people have that choice and that ability to get that advice and to get the investment management to build the portfolio. So in that respect, being open to those ideas is really going to help retirees.
No question, and I think that hopefully they have taken advantage of some of these big moves, and in how we manage portfolios over the last 10, even 20 years. Globalizing portfolios, and moving beyond sovereign bonds into credit markets and certainly in equities. Moving far beyond just the large cap Canadian/US equity markets: into the global markets and the emerging markets, into different capsizes and different styles. And you get to blend all these things together, and hopefully affect more attractive outcomes in terms of at least most of your prior total returns, but perhaps with a lower level of volatility.
Great. Well Dan, that is a fantastic overview of what people should be looking at in markets right now. And for people who are saving towards retirement, or already in retirement, more detail than we got into last time on what’s changed. What’s different, the different approaches people need to think about, and the different options that are available to them as well. So Dan, always a pleasure catching up with you, and I look forward to having you on again in the not-too-distant future. Thanks for your time, Dan.
Thank you very much. Stay safe.