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Episode 1: COVID-19 market update: Craig Maddock on markets, our outlook, and our strategy



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Craig Maddock is Vice-President and Senior Portfolio Manager of the Multi-Asset Management team at MD Financial Management.

Alex [00:00:03] Hello, listeners. Thanks for joining us today. My name is Alex Cheung, content manager with MD Financial Management. For this first episode of the MD Market Watch podcast, I had the chance to speak with my colleague Craig Maddock, vice president and senior portfolio manager of the Multi Asset Management Team here at MD. We had a very interesting conversation about current events, how the COVID-19 outbreak has impacted global markets. The international response where he thinks things are headed and what MD has been doing to protect client portfolios to ensure that they still can achieve their financial goals. Hello, Craig. Welcome and thanks for finding time in your schedule to join me today. I know it's a busy time for everybody. I think a lot of people are gonna be very interested in what you have to say today.

Craig [00:00:42] Thanks, Alex. Happy to be here.

Alex [00:00:44] So let's get right into it. What's happened out there to the markets?

Craig [00:00:48] Yeah, markets have been obviously extremely volatile, Alex. We had a good start to the year with Jan producing some pretty positive results for equity markets. And then about the end of February, we saw equity markets fall off quite substantially. And since then, equity markets around the world are off somewhere in the neighbourhood of 30 percent. Of course, we've seen lots of volatility. So depends on the day you actually look at this, whether it's slightly better, slightly worse than that. But all told, from peak to trough, but a 30 percent decline in equity returns. It's been a pretty challenging environment for everyone to sort of look through as to what's going on, you know, prior to the outbreak - Markets look pretty good. As I mentioned, January was not a bad month. Our outlook from a January perspective, even from the beginning of the year perspective was that we would see reasonable growth around the world in 2020. Multiples were quite high on equity markets. So, you know, we weren't expecting a banner year in 2020, but we definitely were expecting a decent year in 2020. We would have expected equities to outperform fixed income. And that's on the backdrop of, you know generally we were seeing pretty stable markets overall. Risk levels were quite low. Employment around the world was pretty good. If you wanted a job, you pretty much had one. Key risks, such as things like Brexit and the trade wars had diminished. So we were set up for a pretty good year. And then of course, unfortunately we've seen coronavirus come on pretty strong and now we've seen the strongest and probably fastest correction that we've ever seen in markets. You go back to some of the major corrections. You know, the Great Depression, The financial crisis, the I.T. bubble, even the crash in 87. Sure they were big, in magnitude as order as far as declines in markets, but never this fast and never this steep. So it's just been a really, really quick event as the COVID-19 events have really taken the world to a totally different place in responding in very different ways. Course to throw in the middle that bit of an oil shock. So OPEC a few weeks ago had a meeting and decided that they would pretty much disband OPEC2. And as a result, you're going to see a flood of oil to the markets. So Saudi Arabia and Russia being at the heart of that, pretty much committed to depressing the price of oil. So on top of the fact that we've seen a major downturn as a result of COVID-19, on the back of that, we've also seen oil drop about $40, so far this year, trading around $20 again, also very volatile. So, you know, don't hang your hat on that number. It's going to move around quite a bit. But I know that's the word of the day is just lots of volatility, lots of movement, lots of change to the situation and a significant change to our certainly base case as we started in the beginning of the year. And of course, on top of oil markets coming down quite substantially, equity markets coming down quite substantially. We've seen interest rate markets react and respond as well. So they were pretty much early movers with interest rates coming down in the magnitude of about one hundred and thirty basis points or 1.3 percent on 10 year bonds. And the U.S. So far this year, that's a major move. And we've seen interest rates not only come down from a U.S. perspective, but pretty much around the world. And then on top of that, and in particular, with respect to what happened with oil, we've seen credit spreads or the price of riskier bonds move out quite substantially and in particular in the areas of oil.

Alex [00:04:01] We're working on an update about China and where they are at this point that should hit soon. Quickly, what are we seeing there?

Craig [00:04:09] Now, of course, I mentioned COVID-19, and certainly where that really started to take place was in China. Everybody's certainly very familiar with that. But the important thing from an investment perspective is the impact that that's had on the global economy, both on consumers and ultimately on businesses. China right out of the gate took a very profound move and locked down an entire city. And then multiple cities, in an effort to try to prevent the spread of COVID-19, I think there are moves were prudent, but definitely set the stage for other countries around the world to try to follow suit. At the same time, recognising that very few countries would have the wherewithal to be able to do what China did and shut down entire cities, which meant that as it did spread out of China, which is clearly what's happened, the effects might be, and so far appears to be much more significant or potentially much more significant than even the results we've seen in China, with respect to the case count, and sadly, ultimately the death count. And that has now responded to, although maybe not the exact same stringent measures as was certainly done in China. Most cities, whether it's cities state level in the U.S., provinces here,  municipalities are taking extreme measures to shut down business activity and ask all of their residents to stay home. So that's pretty much taken most of the global demand. You know, think of consumption off-line and is expected to be off line for an extended period of time. Certainly our physician clients would probably have better information and understanding as to how long we might in fact, need to self isolate in order to diminish the risk of spread of COVID-19. We certainly viewing it ourselves in terms of months as opposed to weeks, which means it's going to be an extended amount of business activity that's really taken off-line, which has a profound impact both on the global economy, but also, of course, on all individuals. Certainly from our perspective, we needed to act both quickly and decisively around what to do. So we had started the year, as I mentioned earlier, that the base case was for a rise in equities relative to fixed income off the back of reasonable assumptions around company growth and corporate growth. At the same time, pretty low interest rates, which would support equities over fixed income. We had to very quickly. As things started to unwind from an equity market standpoint, change our position, moving from an overweight position in equities to being slightly underweight and not just equities, but we had sort of mild procyclical stance on our positioning across our portfolios. We'd act quickly to eliminate that overweight position and set our portfolios up for a prolonged contraction in return.

Alex [00:06:41] So we've obviously made some adjustments at MD and I want to talk about that a little bit more, a little later in the podcast. But before we do, I think it's important to look at what policy makers around the world have done and get some other perspective on what that means for markets going forward.

Craig [00:06:55] The easiest way to sum this up is these are extraordinary measures for extraordinary times. We have seen a pretty much a global shutdown on non-essential services. You know, the order of the day is go home, stay home. If you don't need to get out and interact with others, please don't. That, of course, has led to, you know, massive layoffs, unfortunately. In airlines, hotels, restaurants, think of conferences that would have been going on right now that have been cancelled. You know, my daughter's home from school and I would say is probably likely to be so for for the rest of the school year. Just today, we've seen new jobless claims in the U.S. Adding on the last couple of weeks, we're up to 10 million so far. And, you know, that's a big number and likely to continue to climb. April 1st would have been rent day for a lot of Americans and a lot of them would not know exactly how they're going to get the funding to pay that rent, which has triggered estimates of something in the neighbourhood of 15 million mortgage defaults are potential through this downturn. So it's just been the impact is massive and it's not so much, the virus is obviously has a toll in and of itself, it's the response to the virus in an effort to slow it down that has caused a lot of people to not have work at this time. So the government has definitely stepped in, as said governments, governments around the world have stepped in with real extraordinary measures. So things like cutting interest rates, there's been two emergency rate cuts by the U.S. Treasury already, a very significant rate cut. So if you think about wanting to borrow, if you did want to borrow right now, borrowings really never been cheaper. So that's fantastic in a sense of the potential for a recovery and even the cost of debt has gone down for many people. So that will certainly make it more affordable and the chance of recovery becomes much higher. But quite frankly, with people not working and for the extended period of time when people's incomes have been materially impacted, who really can borrow anyway, save for perhaps some large multinationals who will certainly thrive and survive in this environment and may be able to use some additional debt to get them through and and help themselves and help their employees. We've seen, you know, and that's that's recent. But over the course of last year and a bit, we've seen over 80 global central bank easing moves since last May as an example. So almost a year ago. So global short rates are down a lot over 80 basis points from their peak in 2019. So, significant monetary policy action to make sure that everything possible is affordable and that's going to definitely be important in the recovery. But I would argue that's the second stage of the recovery. The first stage of the recovery is, quite frankly, trying to make sure that businesses do survive and that individuals come out of this as strong as possible, given the measures that have had been taken and as far as shutting down, not essential services.

Alex [00:09:34] What about fiscal policy?

Craig [00:09:36] So on top of the monetary policy, which as I said is definitely beneficial longer term for the businesses and consumers, there's been a massive amount of fiscal stimulus and arguably we've been in need of some fiscal stimulus to really keep the economy going for a while now. It's unfortunate that we needed is something like a coronavirus to unlock the potential spending of governments. Arguably, they're now spending significantly more yhan would have otherwise been required. Maybe it is about the right amount to help get us through the thick of this. But it was I think an important notice is just the fact how fast it came. So think back to the financial crises. It took months and months before the governments could figure out how to bail out the financial services industry. The U.S. Was able to approve over 2 trillion dollars worth of spending in a matter of weeks in order to help people out to get through the worst. So I think that's going to be an important move. Will it be enough? And that is the big question. Clearly, it will help a number of businesses and a number of individuals. It probably will not help them all, in which case there are still going to be some negative implications to the economy as a result. You think of, you know, kind of where that really shows up the most. So I mentioned, you know, non-essential, but really there's discussions now around, you know, first it was no groups of ten, more than ten people. Now it's no more than five. There's really not many businesses that can escape that and be as profitable and function as well as they would have. So this is definitely probably the most well, it is the most major economic shutdown we've ever seen globally, which is going to have huge repercussions on GDP - gross domestic product. So you think of all the goods and services that are produced in the world. Estimates are they're going to pare back significantly over the next couple of quarters, which will have profound impacts on profitability, on earnings and ultimately, of course, investments.

Alex [00:11:22] So from what's been presented by the media, I think most people are preparing for and expecting things to get worse before they get better, at least from a outbreak perspective. And from what you've told me today, it sounds like things might play out similarly for the markets based on your analysis. How does MD see things playing out?

Craig [00:11:38] Yea - I definitely agree, Alex. Our view certainly from a pandemic perspective is that things will get worse before they get better. Obviously, everyone's trying to look and see how we can flatten the curve and looking at the experience out of China and see how that might relate to other markets around the world. We definitely believe that as a result of not only the health situation getting worse and the strain on the health system getting worse, the economic impact and the second order impact of that. So think people who are sitting at home not productive today, even if the coronavirus settles down and we get to a normal state and people can go back to work. Not everybody's back to work right away. And even their psyche is going to be slightly different. So our base case now is that things will continue to get worse, deteriorate and there'll be more confirming information that looks bad over the coming month. You know, weeks, months, hard to say exactly what you think of employment numbers going to continue to get worse. Default rates, even possibly bankruptcies are going to get worse. So those are all bad things from an economic standpoint. And then longer term, just what changes do we actually see within businesses? Do they hoard more cash to protect themselves against events like this? Do they change their balance sheet structure or do they take less aggressive risk in trying to manage their companies? All these things can be longer term impacts. So we certainly think it's more prudent right now to be defensive as opposed to be aggressive. That doesn't mean take your entire portfolio to cash. It means take some risk from an equity perspective out of a portfolio. Keep it aside until you find what is arguably a better buying opportunity. It's not really buying opportunity the way we're looking at it. But just when is the probability of success over a 12 to 18 month period look far more probable, which would be at the point when a lot of the bad news seems to be absorbed by the market. Because there's two mechanisms at play. One is things that might get worse. The second is how is the market already priced into that? So when we saw the drop, 30 percent drop in equity markets, which suggests that equity markets think a lot of bad things are gonna happen in the future and obviously instantly repriced that risk. The question is what's priced in now? We don't think the market currently is priced in all of that risk and that there are more bad things to come. At the same time, it's not to suggest that policy makers, governments can't step in with even more stimulus. The U.S. Government came out and basically talked about quantitative easing, which is their willingness and ability to buy bonds and other financial instruments to support markets. It's pretty much unlimited. So in the past, when they used the quantitative easing techniques out of the financial crisis, there was always numbers and limits and they moved it around a little bit and came out with new rounds of it. This time it was pretty much, you know what, QE infinity will basically spend and do whatever it takes to fix the issue, which is profound. So that helps to put a bit of a floor under markets right now and under risk assets. So will they let corporate bonds fail? Possibly not in some cases, possibly in others, but depends on how deep it gets, how far, how bad before we start to see the light and then start to see things turn. Of course canada's a unique situation. Mentioned earlier around OPEC+ disbanding that had a significant negative impact on the price of oil. Canada's economy is certainly linked to the price of oil. We do still as a country export significant amount of oil. It's an important part of not only our economy, but also our stock market, so to the extent that that challenge continues and we continue with extremely low oil prices, that has an even more negative effect on countries and stock markets like Canada.

Alex [00:15:11] What about for the longer term?

Craig [00:15:13] Of course, longer term, all the stimulus that we're looking at. So whether that's monetary policy, as I mentioned, very low interest rates, fiscal spending, so just massive amounts of money being spent to help people, you know, whether that's sending them checks in the mail, whether that's E.I. provisions, being able to get access to unemployment insurance right away or in greater amounts or help for small businesses or even large businesses, all of those things will go a long way to help. You put all that together in the end, you have to expect that at some point in time, if the coronavirus settles down and we get back to call it "normal", whatever normal looks like, at the end of it, we would expect all of that stimulus to actually be very favourable towards stock markets. And certainly with interest rates being exceptionally low, it would favour an investment in stocks over bonds to generate returns through time. Now, at the same time, we've tried to do a lot to calculate how low could the stock market go, what is the trough, if you will, for the bad news that may be expected to come? We've done a lot of comparisons to past market environments. We've restructured the S&P 500 U.S. equity market in today's terms. So it's obviously its [a] very different composition of the market today than it was back in 2008. But we've used as an example to try to get a sense of of how bad could things get. It's currently trading somewhere in the 16 times forward, P.E. Multiple. We think a trough of somewhere closer to 12 is more likely, which would suggest further potential downturns to markets from here before we see that turnaround. And then at some in point time and if you if you do have a long term focus, 18 to 24 months. It's hard to not think that you would get paid quite well by buying into equities right now. We just think there's more risk in the short term and we're managing portfolios based on that.

Alex [00:17:02] We've been busy. We've published several updates that everyone can read on But why don't we do a recap here? I think it would be a missed opportunity to not go through that with you since we have you on the podcast. What have we done to best position client portfolios?

Craig [00:17:15] I think it's important to say that, you know, defence in a portfolio starts long before a crisis or an event happens, so, you know, all of our portfolios start off with a very solid portfolio, construction strategies that were designed to provide meaningful downside protection in the event of a downturn. Our philosophy has always been centred around achieving our clients objectives. But while prudently managing investment risk, we started from a strong foundation that was designed to give clients the ability to meet their long term goals. So, you know, thinking out 10 years plus, our portfolios were already built to sustain this type of negative shock to the environment or the economy and work through it well. So I think that's the key is we started with a strong foundation and then we build on that and build on that part is that, you know, in real time, as we're seeing the markets change, as we're seeing the economy change around us, we have to be able to respond and our tools for responding to that, our ability to adjust portfolios on a tactical basis. And I mentioned earlier and, you know, sort of 12 to 18 month is our typical time horizon. So all of our tools, the way we've set our processes up, it's to try to see, you know, what, in the next 12 to 18 months, what's most likely to happen across a variety of different assets. And with that backdrop, how do we better position portfolios? Beginning of the year we were positioned, as I mentioned, slightly overweight equities to take advantage of what we believed to be a good environment for stocks to outperform bonds as things change fairly quickly. So did we. Our normal process is to meet weekly and update our portfolios on a gradual basis as new information comes in. We move to daily meetings in early March to respond to the rapidly changing environment around us and to the new information that was coming in more than daily. And as a result, we de-risked our portfolio. So we've gone from an overweight equity position to an underweight equity position. In addition, across all of our funds, we've conducted additional stress tests, analysis. So we had designed defensive strategies to begin with. We wanted to make sure that those strategies were, in fact, showing up the way we would have expected in the downturn. And when we found environments or portfolios where that protection wasn't as strong as we liked. We've made changes to portfolios. So those changes would look like things, like raising some cash in funds and equity funds where we believed that we needed to add some additional protection. We'll be changing the composition of portfolios. So in certain cases, we've added more consumer staples or more defensive components to portfolios to make sure that if our belief is true and things do in fact get worse before they get better, and we wanted to make sure that the protection that we've built into our portfolios at the front end was enhanced based on what was going on in this current environment. It would mean today that on a traditional portfolio we're probably about 6 percent underweight equities or the equivalent thereof. So think of a 60 percent equity portfolio. It's running right now at about 54 percent equities. Maybe just in contrast, so years ago when we were going through the financial crisis and we were making tactical decisions, we were about 10 percent underweight on that similar portfolio at one point in time. So it gives you an idea that things are bad currently in contrast to what was going on the financial crisis. But we haven't de-risked portfolios quite to the same extent. And the main reason for that is with all of the financial and monetary stimulus that has been put into the system already, a lot of the work has been done to repair things when the coronavirus issue does settle down versus in the past when that policy response was yet to be determined and we needed to take further action at that time.

Alex [00:20:45] So, Craig, you mentioned increasing the frequency of the reviews to a daily basis and looking at things more often because the situation is so fluid. Detail some of that analysis.

Craig [00:20:54] So things we would be looking at would be similar to the normal data that we're looking at. So think of that being, you know, economic data. So what I mentioned, unemployment rates or job losses, those are key and critical pieces of information at this time. Another useful piece of information is PMI or Purchasing Managers Index results. These are surveys that are done, which gives you a gauge around sentiment of companies and whether or not they're looking to expand or contract their production next month as an example. Now, a lot of this data that we look at, it's difficult to determine whether or not it's clear and accurate. So even job information, oftentimes these are slow moving indicators. You'll pick up on a new monthly piece of information, you'll compare it to the previous month and you'll look for the longer term trend and make some decisions on that basis. Even now, we're having to dig in deeper around. Well, when was the cut off data point for a particular aspect that we're looking at? And do we think that data point accurately reflects all of the new information? And when I see new information, there's just new information coming in all the time. So as cities have come off line and have shut their businesses, even that process, it wasn't like it all happened on one day. It's still happening. So the frequency of the information and the data that we have access to is just changing so rapidly. And no surprise, as are markets. One thing I didn't mention earlier was around the VIX, which is a measure of volatility in markets. And if you think of volatility markets, it's really the difference of opinion expressed by two different market participants. So there's lots of internal discussions now. Even though we are positioned to be very defensive right now, it's not like when we talk to our team, everybody's on exactly the same page and believes the same bullish, bearish case, if you will. And that's the same with a lot of other market participants. You can find extremes where some market participants are suggesting right now that we're gonna see a recession, the likes of the Great Depression. You're seeing others saying we've hit the bottom already. And with all the stimulus that we're seeing in the economy today, we're going to see things bounce back. We've to try to peel back all of those layers, all of that information, digest it ourselves and make the best decisions we can for physician portfolios.

Alex [00:22:58] That's great. And before we wrap. Was there anything you wanted to express to our clients?

Craig [00:23:02] I think the key thing is that we are managing the portfolios in real time. So I mentioned before that we have a very strong foundation of building portfolios that are resilient to withstand market corrections. I've been at MD now for 21 years, so I've lived through a lot of different environments, so that I've lived through the I.T, bubble, the financial crisis and now this situation, which is certainly not just a major impact on the financial markets, but it's certainly having its toll on our physician clients. To me, it's important to know that the portfolios that we've built, we'll get our physician clients where they need to be and that they can continue to practise medicine, and do what they need to do on a day to day basis and not worry about their finances. And then with respect to all of the new information that's coming in every day, our team is working hard every day to process that information and adjust portfolios as necessary. So I hope our clients can take comfort and be confident that we're on top of the issues and we'll do everything we possibly can to make sure that their investments are well looked after.

Alex [00:24:04] That's quite a bit of information. So so thank you very much, Craig, again for joining us and providing all these insights.

Craig [00:24:10] Oh, you're very welcome. It was my pleasure. And before we end, I'd just love to take the opportunity on behalf of everyone at MD to give our thanks to all the doctors, the health care professionals and the other essential workers that are taking care of Canada at this time. Thank you very much for being on the front lines.

Alex [00:24:26] Yes. Thank you very much. We really do appreciate you all. For our listeners. If you have any questions about what we spoke about today, questions about your portfolio. Please don't be shy. Reach out to your MD Advisor. She or he would be happy to hear from you at this time. If you liked this podcast, please be sure to subscribe and check out our market commentary content on You'll find blog posts, videos and much more featuring Craig and members of his team. Thanks very much. Bye, everybody.


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