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It’s been a scary time for investors, from sharp interest rate hikes and stock swings to high inflation and talk of recession.
In this episode, Scotia Wealth Management’s Chief Investment Officer Andy Nasr joins the podcast to walk us through these issues and explain why investors can take a lesson from Yoda and be patient during periods of market volatility (or potentially miss out in the long run).
Key moments this episode:
0:44 - Why Andy Nasr is like Yoda
1:15 - Economic outlook for second half of 2022
3:00 - Thoughts on recession or "Economic Voldemort”
5:35 - What do “bear market” and “correction” mean?
8:30 - How do inflation and interest rates affect market and investment decisions?
10:39 - What might happen next
12:03 - How does this compare to economic slowdown caused by COVID?
14:25 - The worst thing you can do during uncertain times in the market
15:20 - Keeping a big picture point of view
Stephen Meurice: If you’re an investor, and most of us are in one way or another, things are a little scary. The TSX, Canada’s largest stock exchange, is down more than 15% since March. Interest rates just went up again, this time a big jump of a full percentage point. Inflation. And increasingly, there’s talk of the “R word.” Recession. Well, our guest this episode is Andy Nasr — Chief Investment Officer at Scotia Wealth Management. And he’s here to talk us through the big picture when it comes to markets and investing and what might happen next. I’m Stephen Meurice, and this is Perspectives.
Andy, thanks for joining us again.
Andy Nasr: Thanks for having me.
SM: You're always a calming presence when we have you on the show. Kind of Yoda-like almost.
AN: Probably because I haven't had enough caffeine.
SM: All right, well, you always have this calmness to you. You have such a long-term outlook. You have like the perspective of a 900-year-old.
AN: I'll do my best to live up to those expectations.
SM: Okay, as I said, there's some scary stuff going on in the economy and the markets. Let's start with that big picture. How does all that turbulence affect the economic outlook for the second half of 2022?
AN: Well, you touched on a lot of it, Stephen. We've had, you know, this huge increase in inflation that's at multi-decade highs all over the world, in part, we've had overlapping crises that have contributed to that including the geopolitical events that unfolded in the first quarter of this year. And we've got higher interest rates. So, it's this combination of high interest rates and high prices that's exerted its influence on corporate spending, growth estimates, household confidence and that's why markets have sold off. There's a lot of uncertainty and as some of that policy uncertainty dissipates and we look forward to next year, we're hopeful that things will be a little bit more calm and that investors can get a little bit more accustomed to what should otherwise be, you know, markets that are really underpinned by stable growth.
SM: Right. So, you mentioned looking into next year, I guess we probably need to look forward to some continued uncertainty through the balance of this year.
AN: Definitely, I mean, look, the balance of this year is really going to be mired by policy uncertainty and whether it's the geopolitical situation or central banks’ commitment to increase interest rates to try to create more equilibrium with demand and supply, there's a lot that suggests to us that growth estimates will continue to be revised downwards. Whether or not we have a recession at the end of 2022 or even into 2023, the silver lining is that it may be a bit more of a shallow one in nature. Now that said, it can continue to affect investor sentiment and, you know, have a material impact on volatility, but we still got a lot of confidence that a lot of the short-term noise is just that. And that long term markets and economic growth will become a little bit more aligned.
SM: Right. So, you used that word, I think of it as the “He who shall not be named.”
SM: The economic Voldemort. There's some debate about whether, you know, we are headed towards a recession. What are your thoughts?
AN: I think you may be opening up the paper or turning on the television and people will talk about a soft landing versus a hard landing. A hard landing being characterized by recession. So, a period where the domestic economy contracts for a couple of quarters. It's very difficult to predict. But also, you have to ask yourself where the likelihood is. Is it likely that central banks are going to be able to increase interest rates so much and cause financial conditions to tighten so much on top of the higher prices that everybody's paying and caused the economy to glide a little bit lower and outright avoid a contraction. That's the debate. And there's a lot of uncertainty around it. Because one of the things that's influencing those high prices is all of the geopolitical uncertainty that's happening in other parts of the world. You know, we've seen commodity prices shoot the moon. We've seen all kinds of issues that have popped up with supply chains. So, to some extent, we're not sure that this blunt monetary policy instrument that exerts itself vis-a-vis higher policy rates is going to be successful in combating high prices, which means that they may have to stay in place for a little bit longer. At least until central banks are satisfied that prices are gonna go back down to whatever their long-term targets are? Which for most developed market economies is around 2-3%. And that may not happen until the end of 2023 or even 2024. So as all of this uncertainty starts to dissipate and we have a little bit more policy visibility whether its geopolitical visibility or you know some idea of where monetary policy is going to head next year. I think that's going to be one of the all-clear signals that improve risk appetite.
SM: We've talked a lot on the show about that balancing act that central banks have to execute where they're trying to combat record high inflation. New numbers from the US this week showing still continued really high inflation there. I imagine Canada’s seeing the same thing. So, trying to slow down the economy while also you know trying to execute that soft landing that you were talking about. And some things are just beyond their control, the geopolitical situation, you know supply chain issues, all of those things.
AN: You're absolutely right, it's threading the needle or should I say, “Threading the needle we are.” Yoda speak.
SM: Let's talk about the markets, that is your specialty. As I said something like 15% decline in the TSX since March. Probably similar declines in other major markets. We hear terms like correction and bear market. What do those mean exactly? Do they have actual technical definitions and is that what we're seeing now from your perspective?
AN: Well, bear markets drop of more than 20% and intra-year corrections are common. They usually happen in any given calendar year and the order of magnitude is roughly 10-15%. So, have we corrected? Yes, absolutely. It's not just Canadian equities, it's equities all over the world. And in fact, equities have had one of the worst starts to a calendar year going back decades, fixed income has not done much better. Interest rates have gone up and that's created all kinds of consternation and angst for fixed-income investors. So seemingly there has been no where to hide as everybody is looking for some safe place to park money while all of this gets sorted out. That in and of itself is creating a little bit of an opportunity and I can maybe contextualize this a little bit. The average decline, the peak-to-trough decline for equities during the recession, and when we look back at the US for this data because it goes back a little bit further, is around 25-30%. Now we're down close to that.
SM: So, we've seen the worst or we're close to hitting that bottom.
AN: It doesn't mean that things can't get a little bit worse because if all of a sudden, you know, investors really overreact to these negative headlines and concerns about where things are going to head, then you could see a little bit more downside. So, you could make the argument that equities and investors are starting to price in, because they've sold equities, and you've seen multiples contract, they're starting to price in some of this recessionary risk. Where we haven't seen it yet is in earnings estimates. Earnings estimates still look a little bit too high and they're projecting mid-single digit, double-digit growth depending on the region that you're looking at. And it just stands to reason that companies are going to be challenged to maintain their margins when costs are going up, wage costs are going up, input costs are going up. So, this old notion that the cure to high prices is high prices could show up through a reduction in demand, which ultimately might put a bit of a dent into those growth estimates and cause a little bit more of a downward revision or downward trajectory in equities. But it's important to remember that equity is always bottom during recession, not after, not before, but during. And you know, even if we have a bit of a technical one, that'd be a good sign because we'll set the stage for what should be more buoyant growth in 2023 and beyond.
SM: Can I just take one step back? How do inflation and rising interest rates affect markets and investment decisions? Obviously, the anticipation of a potential recession is a big factor in what's going on in the markets and everything is interconnected. But how do inflation and increasing interest rates specifically affect market decision making?
AN: That's a great question. You know, one of the things that we always tell investors when we're going through periods of volatility like this is don't try to time the market. Be diversified and if you're diversified, you'll get the opportunity to redeploy capital and compounded at higher rates from a long-term point of view so you can achieve your objectives. The challenge is you have to have some idea of where interest rates and inflation are going to head. Because if you don't, how can you possibly ascribe fair value to the things that you're putting in your portfolio and how can you recognize when there's a disconnect between what prices are today versus what that fair value estimate should be. Now, when you look at equities, most people apply a multiple to earnings and I said that investor sentiment for equities had soured. So, what we've seen is multiples have come down. What that means is people are willing to pay less to get exposure to earnings and earnings growth because there's a lot more uncertainty there. If you do have a long-term view for equities and you use whatever assumption you think is reasonable in terms of a normalized cost of capital that helps you discount dividends or earnings or cash flows, you'll see that there are some really good short-term opportunities. Not short-term opportunities, but opportunities that are present today when you look at high quality companies that you can put in your portfolio. So, it helps establish fair value across asset classes and it works the same way for fixed income. It works the same way with real estate. When you look at fixed-income investing, if you lend money to somebody, whether it's a government or a corporation, and you're trying to figure out what the value of the bond is, you're discounting the interest payments that you're going to get along the way and the money that they're going to pay you back. And when interest rates are moving up, those cash flows become worth less. That's why there hasn't really been anywhere to hide. It’s the uncertainty that's really affected equities. It's higher interest rates that have affected fixed income investing. And all of this is proven to be challenging. Now, when we think of what is going to happen next. You know, we talk about central banks pushing interest rates up and there's a lot of debate about where they're going to settle and what's going to happen with short-term interest rates. From a long-term point of view, interest rates and inflation moving the same direction. And I'm talking a really long-term point of view and it's an important relationship that most people tend to overlook. And you can think of this very simply. If we actually thought that inflation was going to average 10% a year for the next 10 years, we're not lending money out at 5%. Why would we? Our purchasing power would get eroded. And even when you look at the interest rate expectations, you know, when you look out beyond short-term maturity. So, if you're going to look at a 10-year or 20 or 30-year bond, you'll see that fixed income investors do not anticipate that inflation is going to hover around 4 or 5 or 6% long term. They think it's going to be above average short term and then gradually drift back down to something that approximates 2-3%. So, these are part of the factors that are contributing to what we call the difference between fundamentals, what we think is going to happen long term versus sentiment, all the things that are affecting gyrations in these asset prices, short term. That's what creates the opportunity.
SM: It's interesting how much sort of the psychology and the expectations or anticipation about what's going to happen next affects decision making now, which then has an impact on the actual economy and on the stock markets.
AN: We've had this global health crisis, right? This tragic event that was met with unprecedented fiscal and monetary policy stimulus. We spent our way out of the health crisis and even though a huge chunk of the global economy was locked down, you saw a tremendous rebound in GDP. But before we got there, you saw a significant improvement in risk appetite because the amount of stimulus put in place equated to over 30% of global gross domestic product. This time around, if we end up with the slowdown, the one difference is we might not see as significant of a fiscal policy response. So even though it could be technically a more shallow recession because we don't have this pervasive structural imbalance from a global point of view that we need to address. It could be a bit of a more gradual decline, but also a bit more of a prolonged rebound. So not to suggest it's going to be as jarring as the global health crisis, but it may take us a little bit of time before we get back to where we were. And ultimately, before we get that all-clear signal for companies and households to feel a little bit better about spending. We forget that when central banks stop, they don't stop and then cut, they stop, pause, read the tea leaves and then debate whether or not they're going to cut their interest rates.
SM: I guess we don't need to get into the debate about whether the pandemic stimulus maybe contributed to some of the situation that we're in now around the inflation situation.
AN: Well, I mean we are where we are. We have high prices at multi decade highs, all over the world, in some cases all-time highs. And I think that's a reflection of the fact that we did stimulate the economy quite significantly during the pandemic. But also, it did reverse a lot of the improvements that we were seeing in supply chains at the beginning of the year. You know, at the beginning of the year, our view was supply chains are going to get a little bit better. Central banks don't have to be real aggressive with increasing interest rates because it looks like we're going to have, you know, some normalization in economic growth and inflation. And then when Russia invaded the Ukraine and that humanitarian crisis ensued, prices just went berserk. Supply chain issues got worse and that's what's made it so much more difficult for economic participants to contend with that combination of high prices and high rates.
SM: Okay, so given everything that you've talked about, what are you telling your clients, what are you telling investors? Should they be, obviously, I guess they should be expecting more volatility. Is it time to change strategy?
AN: So, the message to investors is continue to be diversified. As we look forward, there are opportunities in today's market. The worst thing you can do from our point of view, and this is mathematically true is go to cash and try to time things, right. And we've shown this statistically, and there's all kinds of reports and evidence that, you know, demonstrate this. But if you miss just the 10 best days in the market, whether it's Canadian or US market, you would cut your returns in half. And that's 10 days over the last 15 years. So, volatility has been amplified on the way down. You better believe it's going to be amplified on the way up, because when investor sentiment improves it's going to improve materially and we'll have a whole bunch of false starts along the way. But ultimately, you have to believe in long-term growth if you're buying companies in their ability to grow their corporate profits and that's still the case for us.
SM: What kind of herbal tea do you drink to stay calm during these crazy times?
AN: I don't know if I'm as calm as you think, Stephen, I've got no hair! But we're trying to remain calm and I think it's important to try to just have a big picture point of view. You know, not get too fussed about what happened short term. This occurs time and time again, right. It occurs during corrections, it occurs during recessions and bear markets. We always tend to blow things out of proportion is probably the best way to put it. You talk about that “R word” if it becomes a bigger part of the narrative and it starts to affect household spending and sentiment, which it is today by the way, that has a multiplier effect in a knock-on effect. And you can see how quickly people can get worked up and investors can get worked up and they just, they sell everything and that's what creates these downdrafts.
SM: Well, as Yoda once said, “The fear of loss is the path to the dark side.”
AN: That's not too far off.
SM: Andy, thanks so much for joining us once again. We really like when you come and share your expertise with us.
AN: I really appreciate it, thank you.
SM: I've been speaking with Andy Nasr, Chief Investment Officer at Scotia Wealth Management. And hey, this is our last episode of the season. We’ll be back in the fall. And honestly, season 3 looks to be our best yet. We already have some new episodes in the works. And these timely, quick turnaround interviews we’ve been doing lately – we plan on bringing you even more of them. So, if you haven’t yet, follow us on your favourite podcast app. And have a great summer. We’ll see you next time.