On the Money


Looking beyond the traditional portfolio

September 28, 2020

Myles Zyblock, Chief Investment Strategist, explains his view on the economic recovery and alternatives as a third pillar in your portfolio with the potential to generate a positive return over time.


Mark Brisley
Managing Director and Head of Dynamic Funds

Myles Zyblock
Chief Investment Strategist


Mark Brisley: You're tuning in to On The Money with Dynamic Funds, a podcast series that delivers access to some of the industry's most experienced active managers and thought leaders. We're sitting down to ask them the pertinent questions to find out their insights on the market environment and navigating the investment landscape.

Welcome to another edition of On The Money. I'm Mark Brisley, Head of Dynamic Funds. My guest today is a recognized strategist in North America regarded for his investment insights that blend the tools of finance and psychology in order to capture major inflection points in financial markets. He has over 25 years of experience of guiding and advising on asset-allocation for a diverse set of institutional and retail advisors across North America, Europe, and Asia. Myles Zyblock provides top-down strategic investment ideas and inputs for portfolio managers and analysts here, at Dynamic.

His investment views are shared broadly via regularly read research reports and regular appearances on Canadian and US financial media programs. Today's discussion is going to focus on the current environment over the last six months where we have seen one of the most dramatic falls market-wise and economically, and one of the most dramatic recoveries in our history. Economic forecasts are in flux, earning forecasts are moving all over the place, and the future course of the pandemic in more supporting stimulus is unknown. It's going to be a thoughtful and insightful conversation. Myles, it's great to have you with us today.

Myles Zyblock: I look forward to it. Thanks a lot.

Mark Brisley: Let's jump right in with an update from you on where you see equity, fixed-income markets, and the global economy today, and how does that compare to when we started this COVID crisis and pandemic?

Myles Zyblock: So far, it's been one heck of a ride in 2020. We've seen some pretty violent swings in the prices of stocks and bonds. By late March, for example, global stocks were down by more than 30% for the year. They've rallied very hard off of that bottom, and are now about flat on a year-to-date basis. The US has been doing a little better than the non-US equity markets. There were also some big dislocations in bond-market-pricing during the first quarter's financial turmoil, but that's settled down with global bond prices rising and helping bonds generate total returns of just over 6% to this point in 2020.

High quality and long duration has offered leadership in the bond market. Now, as for the economy, it is starting to climb its way back from a very deep hole. In the second quarter, we saw GDP growth rates fall dramatically all over the world. For the G20 countries as a whole, GDP slumped by about 18%. Very few countries were able to escape the impacts of the viral spread and the lockdowns, but the third quarter has taken on a more optimistic tone. This turn, I think, can be attributed-- in part, at least, to huge policy stimulus.

Literally trillions upon trillions of dollars in both fiscal and monetary policy stimulus. It's also due to the fact that the world is adjusting to some new ways of doing things. People are wearing masks, they're moving around a little bit, and I think they've gotten much more comfortable doing things online whenever possible. I wouldn't be surprised to see a snap-back in third-quarter GDP growth when countries start to report their numbers over the course of the next several weeks. Timely activity indicators, such as retail sales, housing activity, industrial production, they're all pointing to a sizeable pop in GDP.

North America alone could see GDP rise by more than 20% at an annual rate, in the third quarter, and corporate earnings growth, starting with the Q3 reports, is likely to begin to reflect this gathering economic upturn. It's getting better, but there's still a long way to go to get back to anything that resembles normal.

Mark Brisley: Myles, I think one question that so many people, probably around the world, are struggling with right now is, how much of a disconnect is there between markets and economies? And why is it so important, right now, for people to literally and clearly understand that the market is not the economy and the economy is not the market?

Myles Zyblock: That's a really good question, Mark. I've often shared my view that the economy is a very different place than the market. Over long periods of time, obviously, fundamentals matter for the market but there can be periods of time that are measured in years, if not decades, where the market prices seem to disassociate themselves with fundamentals.

Sometimes, we just don't understand that the fundamentals we may be looking at have nothing to do with market fundamentals.

Let me just give you an example of that where a lot of people think that they should be, just say, investing in European equities because the European economy looks like it's about to turn, but, in fact, if you're looking at the European benchmarks, you're really investing, largely, in a large basket of financials and energy which aren't reflective of that economy at all. The same can be said about most markets, that the market structure can look very different than the economic structure. People are always saying, "Should I buy Japan because Japan looks like it's going to turn?" Well, you should probably buy Japan because you think, the global exporters are going to do well because the Nikkei is full of exporters. These are some of the things I think people need to keep in mind when they're talking about the economies and markets. They can, at times, be very different things.

Mark Brisley: Given that our audience is just largely Canadian, let's talk a little bit about here, at home, and what some of the big risks and opportunities are going to be for the Canadian economy as we work through this?

Myles Zyblock: Just to give you a little backdrop, Canadian GDP contracted at about a 38%-annualized-rate in the second quarter, and it was affected, I'd say, just as much, if not more, than many other countries around the world, by the spread of the pandemic. Consumer spending and exports were hit really hard, and as we all know, these are important parts of the Canadian economy, but like most other countries, growth rates across the Canadian economy are firming. This is despite, let's call it $106 billion in income lost due to the struggles in the labor market. Again, like many other countries, we've seen policymakers step in to bridge the gap for the private sector.

In fact, Canadian incomes have risen during the pandemic largely because government transfers have more than offset lost income from the private sector. Again, to put this in perspective, the government has offered $224 billion of income support, and, again, that compares against the $106 billion lost in employment income, so on net, incomes have grown in Canada.

I don't think the policymakers in Canada, or anywhere for that matter, are finished with their stimulus plans. The Bank of Canada says that interest rates will stay pinned at near 0% for the foreseeable future, and they continue to buy bonds in the secondary market at a pace, they say, of about $5 billion a week. The government also says that those who were receiving benefits through Service Canada will automatically transition to an EI Program, or an Employment Insurance Program, once they've received the maximum, say, serve benefits.

The details on that have not been fully worked out yet, but needless to say, the deficit in Canada-- the government deficit, isn't likely to shrink by all that much in our immediate future. The major risk for the Canadian economy, I think, at this stage is no different from that for any other economy. We're entering flu season, kids are back to school, we don't have access to a vaccine or any convincing treatment. This means that a significant outbreak, again, could put us back a few steps on the way to an eventual recovery.

Mark Brisley: Let's talk about that for a second, and obviously fully understanding you're not predicting the future, but there's a lot of concern around more economic recovery, second-wave issues, elections, all the rest of it. In your experience of what you've seen so far, however, do you just accept now that further stimulus from policymakers around the world would probably kick in again if necessary? And would you expect to see the same from policymakers here, in Canada?

Myles Zyblock: There's every indication that policymakers will continue doing what they have been doing over the last several months. The Federal Reserve, for example, has signaled that they're going to continue to buy bonds, that they're going to keep interest rates low and hold monetary policy settings at a very accommodative position for a long time to come. I think there's a chance that we'll also see another sizable fiscal package out of the US within the next few months. It could be anywhere from between one to two trillion dollars of support. The election drama looks like it might be slowing down the progress on a new package, but I do think it will eventually happen.

Again, we are seeing this all around the world-- in Europe, Japan. The policy authorities are doing their best to offset the lingering effects of the pandemic, and I suspect they will continue to do so until they can see some light at the end of the tunnel. To me, really, that light is a producible vaccine or a successful treatment.

Mark Brisley: You've talked a little bit, too, about what we saw just before Labor Day with the Fed monetary policy announcement down in the United States and basically needing to achieve certain inflation and employment targets. Does that also have an impact, do you think? I mean, you've already talked about the impact that's going to have on lower-- for longer rates, does that also have an impact on if we were to go through the second-wave scenario, the impact of more stimulus, is this is a foregone conclusion?

Myles Zyblock: In late August, the Federal Reserve tweaked their operating mandate a little bit, and are now focused on trying to achieve an average inflation rate of about 2%. What does that mean? That means that today, the inflation rate is below 2%, and if it spends time below 2%, they're trying to then spend some time producing inflation above 2% so that over time, on average, you get something around a 2% inflation rate. Let me just put this in context. Since, basically, 2012, the inflation rate has averaged, in the US, about 1.5%, so it's below this 2% average, and that's almost 10 years.

They've been working hard to try to get to 2%, never mind get above 2%. Again, what does this tell me? This tells me that given the current operating environment, they are going to keep interest rates at very low levels for the foreseeable future. Many of the board members of the Federal Reserve have even suggested that we could see interest rates stay near zero for the next two, three, four years. Obviously, the pandemic, if we were to get a much more violent second wave, this would only encourage policymakers to keep their foot on the gas pedal for an even longer period of time.

Mark Brisley: Why don’t we just move away from that previous discussion for a second, Myles? Because I know you spend a lot of time, also, on the global currencies, so we could get your views on the direction of the Canadian dollar and the US dollar, and other global currencies of consequence in your mind.

Myles Zyblock: I guess the big story in 2020 so far is that, at least in trade-weighted terms, the US dollar has started to weaken. It's losing some of its value against the value of currencies of its main trading partners. I hear stories, for example, that the US currency is weakening perhaps because they haven't done as good of a job of managing the COVID situation as have other countries, or that other countries are doing better, economically, than the US. I really don't think that is the case at all. The US currency is still viewed by currency investors as a safe-haven currency. It's an important currency like the Japanese Yen, and when the economic environment tends to be more challenging, then currency investors tend to park their money in the US dollar. That puts a bid under the US dollar and tends to drive the value of the US dollar higher.

Like I said, the US dollar has been weakening this year, and currencies like the Australian dollar, the New Zealand currency, the Canadian dollar have been strengthening against the US dollar, and I think it's truly because the demand for safety is starting to moderate. Why are we seeing that? Well, I think it's because of the epic amount of policy stimulus in the system.

I think it's because of what I've discussed earlier in that global economies are starting to improve, so people are much more willing-- or at least currency investors are much more willing to take on more currency risk, and in doing so, they are moving towards what we call the 'cyclical currencies', like I said, like the Canadian dollar. I think that will continue to be a support for the Canadian dollar and other currencies of that ilk for the next several quarters. Again, this is all assuming that the global recovery continues, which I suspect it will unless we get some very surprising data with respect to the pandemic.

Mark Brisley: Based on what you've shared with us so far, and your views on things like currencies and rates, I think a good question that would be important among our listeners would be, what lesson can an investor take from the market volatility and just the overall experience that we went through over the past six months in an unprecedented year like 2020?

Myles Zyblock: I believe that 2020 has offered just one more example in, I'd say, a laundry-list of similar examples throughout time, that the future is highly uncertain. That sticking to a well-defined, long-term game plan is most important, and much less costly than looking into your crystal ball to try to see where the next inflection in market prices might be. 2020, I think, reminds us that financial markets are volatile, but at the same time, that they can be very rewarding through time. In these periodic bouts of chaos, I think it's really critical not to lose sight of our long-term portfolio goals.

And if, for example, equities are part of that plan, then stick with them, knowing full well that there will be periods of time when things are tough. The same goes for your bond investments. Again, why is sticking with this strategic plan or a strategic investment plan so important? I think it's because so many studies have shown that moving things around-- buying and selling in ways that often get you away from your strategic plan, are really toxic to a portfolio as returns through time.

The point is that with a strategic investment plan, there's really no need to invest based on what the bond or the stock market is doing today, or what it did yesterday. There's no need to act based on emotion, you have that long-term plan to help guide you through time.

Mark Brisley: Myles, I wanted to shift to something that I know is important to you, and that is you’re a fan of effective and efficient portfolio construction. I think what we've been through this year, especially for investors that are looking for income in their portfolios, it's become a difficult topic to handle, and certainly warrants people seeking advice. Should investors continue to look beyond the traditional portfolio of just stocks and bonds given the environment we're in? I know you've talked a lot about the use of alternatives within portfolios, and shifting away from that mindset of the traditional 60% equity, 40% fixed-income portfolio creation that we've been used to for so many years.

Myles Zyblock: I think if you look at how alternatives have done, say, just over the last six to nine months-- and I'm a big fan, as you know, of alternatives as a third pillar in your portfolio, but it's hard to answer with precision how alternatives have done, and I don't want to skate that idea. It's difficult to answer because the liquid alternative space is very diverse. It represents anything and everything that provides investors with daily liquidity but it's not traditionally classified as a long-only stock or bond investment. This could include gold, currencies, equity long/short strategies, and the list really goes on.

It's further complicated by the fact that so many so-called 'alternatives' in the marketplace are anything but alternative. That they behave just like stocks and bonds you already own. I truly believe, when you're looking at a third pillar to reinforce your portfolio, that being alternative investments, you need to define these alternatives by their behavior. They should be something that have low performance-correlation to stocks and bonds, and that are expected to generate a positive return through time.

Let me just talk about these alternatives because, again, I do find them to be very valuable for portfolio construction. Talk about a few of them. Gold bullion, that classifies as an alternative, as a liquid alternative, in fact. Bullion is up by 26% this year. Keep in mind, I'm not focusing on gold because it's up in a tough year. I'm focusing on gold as an example because it has a relatively low correlation to the performance of stocks and bonds, and it has gone up over time. It just so happens that gold is up by quite a bit this year.

Alternatives, if you're looking around the universe, long/short credit might be another helpful example of an alternative strategy. I can't vet all long/short credit products, but Dynamics' long/short Credit Fund has a low correlation, traditional asset classes, and it's up about 4.5% in 2020. Other ideas, like long/short equity-- again, I don't want to speak to all these different types of alternatives out there, only the ones that I know well.

Again, it's a very diverse universe. Dynamics Alpha II is a well-known long/short equity fund. Its biggest drawdown this year has been 4.4%, which compares, I think, very favorably to the 35% sell-off in equities, and why? I call it long/short equity, or we call it long/short equity, but it's designed to be something very different than a long-only equity fund. Again, as I see it, the alternatives that are doing relatively well this year are those that continue to do what they're supposed to be doing, and that's being a source for independent returns in a portfolio. By independent, I mean returns that are not directly connected to what the stock or the bond market is doing. A well-structured alternative tends to beat to its own drum, and I think it can add a great flavor to a portfolio, especially now when, for example, bond yields are so low or people are concerned about where the equity market valuations are.

Do I think you should own a basket or an alternative investment, or a diversified basket of alternatives, as I've defined them? Absolutely. The answer, to me, is yes. This is not because I necessarily believe stocks or bonds are a bad idea right now, or that alternatives are a great idea right now. I want alternatives in a portfolio at any time. This is because they not only build performance resilience in a multi-asset class portfolio but will also help to reinforce the trajectory of a portfolio's return through time. It's for exactly this reason why global pension endowment funds now have portfolios with 30%, or greater, exposure to alternative investments. I think, properly structured, they are a critical third pillar, in addition to stocks and bonds, in order to build successful portfolios for the long-term.

Mark Brisley: I'm glad you mentioned the use of alternatives in the institutional world, especially with respect to pension plans. If I was to summarize what you just mentioned about adding in alternatives to existing portfolios, it's really to add diversification to the portfolio, mitigate risk, and decrease correlations where possible. Is it safe to say that's exactly what these pensions and institutional investors have been using it for as well? And that there's no reason for a retail investor to not think along those same lines, given the environment?

Myles Zyblock: Yes, that's a great point. If you just think about the pension world as a whole-- and I'm just going to generalize a bit, but the pension world has very strict guidelines on what it can do and the outcomes it needs to generate to meet future pension liabilities, and those are fixed. Basically, pensions, right now, have a return target of about 7%, 7.5%, and they believe for them to achieve those long-term return targets of 7%, 7.5%, they think they need a very healthy helping of alternatives, and exactly like you said, for the reasons-because alternatives are an independent return stream from stocks and bonds, they generate some resilience for the portfolio.

If you think about it like a car engine, they give you an extra cylinder in that car engine so that if you have problems with one or the other of those cylinders, the odds of achieving your goals are still pretty high. Again, yes, the pension funds, they've been building positions in these alternatives, and they are helpful in helping them achieve their long-term return targets.

Mark Brisley: I can’t let you off this call-- and it's probably a good question for me to wrap up with, asking one of the big issues of the day, which, of course, is the upcoming US election. When we first scheduled this conversation between you and I, we didn't realize there'd also be, now, a vacant seat in the US Supreme Court and all these other things that are ramping up towards November the 3rd. How should investors manage their expectations around the impact of this event? And for that matter, other geopolitical events on the markets as we go into the final months of this year?

Myles Zyblock: The elections are great cocktail conversation. Definitely, the US election is great cocktail conversation. It's effectively a soap opera that seems to be going on there. I don't think the election should change, in any way, how people manage their portfolios.

Historically speaking, elections don't really have a long or lasting impact on the market. Sure, there can be volatility surrounding the days of the election, into and leading out of, but, ultimately, the earnings fundamentals are the more important thing to focus on. Just think about this. On both sides of the aisle right now, like I said, they're not arguing about not spending, they're arguing about how much to spend. They're both thinking stimulus, whether it's a Democrat or a Republican, in order to help the economy, given the challenges being faced because of the pandemic.

Now, I just want to give you a reminder of a bit of a history lesson. Just think back to 2016, and you can go and Google the news articles of the time going into that election, every single expert out there was telling you that if Trump wins the election, the market is going to collapse. 11 o'clock or thereabout-- I can't even remember the time that Trump, his win was decided, but it was late at night, and the overnight markets in Asia, the futures market for the US, fell by about 5%, and by the next morning, basically, the market, as it opened, was back effectively to flat. The point being that-- and here's where we are today, up a lot since the 2016 election.

The point being that I really don't think it's prudent to adjust your portfolio on an election outcome. The only way I might change my mind is if there's any legislation of any sort or any laws that are enacted that will materially threaten the functioning of the business cycle, and there, you take steps accordingly. As I see it right now, I don't really see anything that comes out of this election that will threaten the business cycle.

In essence, I'm not convinced that any investor should be taking any significant steps, either way, because of the election. That's not just with respect to the US election, I will say that with respect to every election out there. Whether it's the Japanese election, the European election, the Canadian election, any types of elections. That's largely just noise for investors, and they should really just forget about that and move on to bigger and better things, like their strategic plan and how to hit their long-term goals.

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Mark Brisley: Wow, our conversations are always insightful and much appreciated. I want to thank you for the time you took to share your views with us today, and it was great having you here.

Myles Zyblock: Thanks a lot.

Mark Brisley: I want to thank all our listeners, as well, for joining us. I think so much of what Myles talked about also lends itself to the fact that, as always, we recommend that you talk to a qualified financial advisor. Thanks, everyone, for joining us today.

You've been listening to another edition of On The Money with Dynamic Funds. For more information on Dynamic and our complete fund lineup, contact your financial advisor or visit our website at dynamic.ca.

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