Greg Bonnell: Markets have been increasingly pricing in a soft-landing scenario for the economy. But our guest today says that still means there’s going to be a landing of some sort, and investors may be too optimistic about the prospects for growth. Joining us now to discuss, Emin Baghramyan, lead of quantitative portfolio management at TD Asset Management. Great to see you again. Great to have you back on the show.
Emin Baghramyan: Thanks, Greg. Thanks for having me.
Greg Bonnell: All right. So if our theory is, that we’re going to put to the test here in our conversation, that perhaps investors are a little too optimistic about the prospects for economic growth for a soft landing, what are we looking at to give us that sense?
Emin Baghramyan: Well, amidst the current optimistic outlook regarding global economy, we at the TD Asset Management’s Quant team take a bit more measured perspective on the global economic growth. While it is true that economic conditions – they prove to be more resilient than many believe, especially considering the amount of monetary tightening we have seen over the past few years.
However, we’re seeing that there are a few emerging signs that people need to consider when they’re making judgments about global economic growth going forward. The first sign is that while, indeed, the interest rate sensitivity of the economy has been greatly reduced – and that’s because over the past decade, people, companies, state and local governments took the advantage of a very low interest rate that we have seen over the past decade and locked in into these low, long-term interest rates.
However, there’s not really much of an evidence that there is no sensitivity at all. And we think that the brunt of the negative impacts of the monetary tightening is yet to come. So there’s some time lag. The lags have a bit increased. But the negative impacts of the monetary tightening, we think, is going to come.
And we look at the sources of economic growth. Recently, we can clearly see that manufacturing is in recession. If you look at all the manufacturing PMIs from US, to Canada, to Japan, to China, to Europe, they are in deeply contractionary territory. And the main source of the economic growth has been consumer spending on services.
And we think that the service sector has been benefiting still from the lagged impacts of this reopening that we saw post-pandemic because when we think about this, governments have greatly underwritten the consumer incomes during the pandemic. Unemployment rate didn’t shut up. People’s incomes were not hurt.
They’ve actually been supplemented greatly by zero interest rates that central banks have provided around the world, plus enormous amount of fiscal spending, and the payroll protection loans, and things like that.
So incomes were steady and people had nowhere to spend their money. And a brunt of this spending went into goods and renovation. And that created this boom in goods spending. However, over the past year or year or so, where people now have a chance to direct their marginal dollars into things that have been missed out, and they couldn’t spend things based on social distancing, such as travel, entertainment, restaurants, dining out, and things like that, so the consumer spending has been really, really strong in that area.
However, if we look at the forward-looking indicators, for example, restaurant and hotel bookings, they are already showing signs that we’re in the final innings of that source of economic growth as well. So we believe that services sector will also slow down. And it’s not only that.
If we continue looking at the leading indicators such as credit growth – for example, if we take the senior loan officer survey, which measures the bank’s willingness to lend to consumers, to corporations, we’re seeing that there’s deeply contraction where the lending standards are being tightened sharply. And that usually foreshadows a slowdown in credit growth. And we all know that if there’s no credit in the advanced economies, usually economic growth feels the brunt.
Greg Bonnell: So we’ve got a few indicators there. And that’s pretty interesting about in terms of – perhaps, we will finally start to see those lags take part in the economy. When you take a look at the market performance, though, I mean, up until this month, it’s been pretty strong. But you say there are some risks around the so-called Magnificent Seven. Take me through the Magnificent Seven.
Emin Baghramyan: Yes, indeed. I mean, if we look at the performance of, let’s say, a very broad basket, such as S&P 500, it looks like it’s collaborating the positive message that the general sentiment is in the market participants that economic growth is OK.
However, if we look below the surface, we can see that the majority of those gains didn’t come from – it wasn’t a widely participated rally. We have to first remember that this double-digit gains in the S&P 500 and almost 35% rally so far that we’ve seen in the NASDAQ is coming on the back of the very similarly deep correction that we saw over the past year.
S&P declined 25% last year and NASDAQ was down more than 30% last year as well. But if we look at what has actually increased, it’s these so-called tech companies. And in the chart that we currently see, that a few companies, the so-called Magnificent Seven, are responsible for the majority of the gains that we saw in the benchmarks.
For example, if we take a very broad average, let’s say Russell 2000, that has equal weighted and we look at the performance of that, we can see it’s basically flat so far. And it’s running at the 10% annualized returns over the past few years, which tells us that the average stock or median stock has not really participated so far in this rally. And that’s not a very good sign of the coming health of the economic growth going forward.
So what that did, though, it made the benchmarks quite vulnerable to the developments of this so-called Magnificent Seven. What if something happens? What if the investors are overly optimistic? That we usually have seen throughout the history many, many times, that investors get very optimistic on something very positive, such as, currently, the AI is being this driving force, where people feel extremely positive on these companies’ outlooks.
However, what if it doesn’t pan out as rosy as many expect and we see this de-concentration of the benchmarks that can basically cause big risk for people who tend to invest in the broad benchmarks such as S&P 500 or NASDAQ? That is why we at TD Asset Management’s Quant team think that it’s a very good time, actually, to look away maybe from traditional cap-weighted benchmarks and look for alternative strategies.
Greg Bonnell: What would some of those alternative strategies be in an environment like this?
Emin Baghramyan: In this environment, it would be strategies such as that favor, for example, low-volatility strategies that tend to invest in the companies, that tend to be more defensive, and less-benchmark-oriented, and a lot more diversified both on individual company names, both on sectors or regionally. Another interesting strategy would be to invest in dividend-paying stocks and multifactor strategies.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.