Escalating trade tensions and concerns about the magnitude of a global economic slowdown have caused bonds to rally and stocks to stumble in recent weeks, leading investors to wonder whether the bull market in equities may be close to an end.
The Globe and Mail recently spoke with Benjamin Tal, deputy chief economist at CIBC World Markets, to get his perspectives on the economy and markets. Here are excerpts from the conversation, with an expanded version available to subscribers online at tgam.ca/inside-the-market.
The bond market appears to be indicating that we may be headed for a recession. What are your thoughts?
I suggest that every economic recession over the past 50, 60, 70 years was helped, if not caused, by monetary policy error in which central bankers were adjusting for inflation that maybe was not there and raised interest rates way too quickly. The Fed is telling us maybe we are going to cut, and even the Bank of Canada did not close the door on cuts. The fact that we are talking about cutting is the reason why I am more optimistic about them not repeating past mistakes and inverting the curve in a way that will lead to a recession. I don’t think there will be a recession. I do suggest, however, that 2020 will be a very difficult year.
For the U.S. this year we are forecasting 2.4 per cent growth, and next year – that is where the test is – 1.5 per cent, and sometimes in 2020 it will feel like a recession. In Canada, our GDP forecasts are 1.5 per cent for both 2019 and 2020.
Have we seen a bottom in bond yields?
I believe that so much negative news is priced in at this point. If I had to take a bet, do I want to long the bond market or short the bond market? I would, at this point, short the bond market if I have a one-year investment horizon because I think inflation expectations will go up to around 2 per cent. I think the trade dispute between China and the U.S. might get worse between now and the next few months, but eventually it will be resolved. I think that bond yields will rise, as opposed to go down, over the next year.
How do you see the U.S.-China trade dispute playing out?
I believe that eventually, after playing hardball, we will see a trend that we have seen already. The trend is the following: Trump creates a crisis, he runs with the crisis, he solves the crisis, declares victory and the resolution of this crisis is only marginally different than the previous situation. Look at North Korea, look at [the United States-Mexico-Canada Agreement], which is not really different from the original NAFTA. I believe there will be a resolution with expectations that this will rally the stock market and be negative for the bond market. When this will happen? I really don’t know, but I think within the next year, and we will have to ride this volatility.
I don’t see it as a trade war. I see it as a war against China’s progress, especially in the high-tech sector, against China’s development. You see, China has something called ‘Made in China 2025’ – they give you a list of all kinds of high-tech sectors and say ‘we want to globally control these sectors.’ If you look at what Trump did, the first wave of tariffs, $50-billion, most of it, almost 90 per cent of it, was aimed at ‘Made in China 2025.’ It was not aimed at T-shirts going to Walmart, it was aimed at the high-tech sector. The purpose of this policy was to actually attack China where it is most vulnerable – its future. It’s basically trying to slow down China’s march toward China 2025. That is the hidden agenda, if you wish.
The second wave of tariffs, $200-billion introduced recently, is more consumer-goods related. The question is, what is going to be China’s reaction to it? China cannot fight on tariffs because they don’t import as much but they have many non-tariff options.
The Chinese take a very long-term view. They think in terms of intergeneration, not in terms of quarters. They may say Trump is a blip, Trump will go away, we will ride this wave. Their aim at this point is to really bide time. How do you do that? You stimulate the economy. Also, they have been using currency. The Chinese currency is down against the American dollar by 7 per cent over the past year. The fear is when you devalue the currency, money will flee the economy. Between 2015 and now, the Chinese built this wall of capital control. Money is not leaving China the way it used to. It is very difficult to get money out of China now. So if you close this avenue for which money can flee the country, then the devaluation is not as dramatic in terms of impacting the economy. Ask any real estate developer in Toronto or Vancouver, they will tell you Chinese money is not coming the way it used to. All of a sudden the trade dispute between China and the U.S. is impacting the condo space in Toronto – everything is interconnected.
How can investors make money in this uncertain and volatile environment?
I can give you all this analysis and one tweet can change everything. The question is: Is the bond market the place to be, or is the stock market the place to be? I think the bond market is expensive at this point.
During this period of time, I would like to take advantage of the fact that interest rates remain low, that’s why I like dividend-paying stocks. If your investment horizon is more than a year, dividend-paying stocks will benefit from that. To bide time, you can focus on domestically oriented companies in the U.S. and Canada that are less impacted by the volatility from the trade dispute. I think the sector that might surprise to the upside is the energy sector.
Do you believe the S&P/TSX Composite Index can rebound to a new record high after the trade dispute is resolved?
I don’t see it going up dramatically, I don’t see it going down dramatically.
What is your outlook for interest rates over the next few years, is it lower for longer?
I think we are very close to a peak in interest rates for both countries. I don’t think there will be a need to resume higher interest rates in any significant way. There is no reason to believe inflation expectations will rise at this stage of the cycle.
The number one issue is wages. Wages are not rising to the same extent as they used to, and the question is why? The answer is that the wage mechanism is, in many ways, broken. I think there are some major structural issues that are unfolding. First, the fastest growing segment of the labour market now is people 55 and older. More people are working less, that’s disinflationary.
Second, let’s say you are in your 60s, at this point in the game you are not after the next dollar, you don’t go to your boss and say I want this raise. If you are in your 20s, that is exactly what you do. The fastest growing segment of the labour market is the one that is not asking for a raise, that’s disinflationary.
The last point: The best way of getting a wage increase is to jump ship – you move to a different company. If you are in your 40s, 50s and 60s, you are not changing jobs. The older the labour market gets, and it’s getting older, the less dynamic it becomes, another disinflationary force. All these forces are disinflationary and are structural. To me, that suggests that inflation expectations will remain relatively subdued and therefore peak interest rates will not be very far from where they are now.
Have we seen a soft landing in the housing market?
Montreal is doing well, Ottawa is doing well, reflecting many local factors. I think that Vancouver will continue to slow down.
In Toronto, most of the damage was in the low-rise segment of the market. I think that [weakness in] the high-rise segment is coming, I think that given supply and the fact that investors will not be buying as much in the high-rise segment, we will see some softening there. None of it is a free fall, all of it is basically undoing a crazy environment from 2015 and 2016. This is a very healthy adjustment, and when we reach this point – I think we will reach this point within the next six months – we probably will stabilize and go back to a relatively normally functioning market, not a strong market but a healthy market.
Finally, last year, you accurately forecast the Canadian dollar holding in the mid-70 cent range relative to the U.S. dollar. What is your forecast?
I think if there is a bias, the bias from this point is weaker. By the end of 2020, I see the Canadian dollar in the neighbourhood of 72 cents. If we lose a few more cents, I think that’s fine.