Even as the U.S. economy remains strong, the shift from the mid- to late-cycle phase may have implications over the intermediate term for investors. Kim Parlee speaks with Ben Gossack, Portfolio Manager, TD Asset Management on his outlook for corporate performance for the remainder of the year.
What happened to the Canadian banks happened to the markets. It wasn't just them uniquely. And Ben always brings me a list of the bad and the good. And generally, I think, just with the market sell-off, people thought there was more bad than good happening, right?
Yeah, we actually had quite a lot of volatility last year. Around this time last year, we also had a big sell-off. Then the market ran to new highs in September, and then we had about a 20% contraction into December. Then you get the spring back.
And from my perspective, we're pretty late in the cycle. There's a lot of good items for why this cycle can extend. But I think a lot of people are looking for confirming evidence that we're going from late cycle to contraction.
And so there's many things that people thought could take us there. One was the Fed hiking too much, a China slowdown. We have trade concerns. We've had Brexit. So people-- I mean, we actually have certain areas of the market that have slowed. Automotives have slowed. Industrials have slowed, but it hasn't contracted.
And so there's a couple items that I've been looking at that are in sort of our "glass half empty" bucket that could move to the "glass half full" bucket.
OK. So overall, I'm going to tell you this. This list that he had-- it was too long to show you, but essentially was a 3-2 ratio, I'm going to say roughly-- three for every-- three bad, two good. And he talked about-- everything from Italy, Brexit, -- or EU tax, I should say-- on global tech companies-- there's lots of stuff in there.
But there's two things that are in the bad category that you think could maybe move over to the good. So the first one is what?
So the first one is US housing. US housing is an activity, and the economy is not that big. It's more about what it means once we add new houses. So I buy a house. All of a sudden, it's empty. I have to fill it with furniture, with TVs. I have cable service or Netflix. I start to use online food delivery. This has a massive positive multiplier on the economy, which is 70% consumption. So if we see more housing activity, this is a very positive indicator.
And so what is "glass half full" about this chart?
So what we're looking at-- the blue-- the white chart is an index of US homebuilders. This is their value. You can see, from January of last year, it's been a one-way down to the bottom in December.
What you're looking at in the blue line is the 30-year interest rate. So what I've done is I've inversed it. So if rates go up, that means the affordability of housing-- it'll cost me more to get my mortgage-- that will hurt demand. And so we've seen rates spike last year, and so that really tempered housing activity. And if you're in the business of building homes, that's not really going to help your earnings.
But since December to now, we've seen almost a 40-basis-point pullback in interest rates. So what we're seeing today is that the stocks-- the value of these homebuilders-- have spiked up. We have not yet seen the data in the actual housing starts. And so stocks move in anticipation of data. They're a forward indicator. And so the data that we're still getting from the government is still back in December.
So if this can improve, that's a good sign for consumption. It's a good sign for the consumer discretionary sector. It's good for banks-- their mortgage banking business. If we're not making new houses, there's not new financing attached to that. So that could mean that this cycle could extend a little bit longer than what people have expected, which would also be good for the markets.
Second one you have here is semiconductors. So let's bring up his chart. Tell us what it is and why this one's interesting.
So the thing about technology-- you have software. You have hardware. And then we have semiconductors. They do sort of the brain power work. And they're typically also a leading indicator. When the market takes off, people put in new orders. That requires semiconductors. And so you can see, from 2016 to 2017, has been a great time to be in semiconductors.
We're looking at-- it's called the SOX index. It's about 30 stocks-- kind of like the S&P 500-- and they're weighted by their value. And this was being driven by we need more data centers for the cloud. You can think of smartphones. You can think about all the content that now goes into your car to help you with your driving. That all requires semiconductors, and so it's been a great run.
But with the US-China tariff situation, with an oversupply of data centers, a slowdown in automotives, a slowdown in the economy, that has really pulled back on these semiconductor stocks. And right now, they're working through all the excess inventory.
People would say, oh, semiconductors don't perform well in a contraction. Maybe we're really getting close to the turning point. But as you can see by the chart--
It's popping up again.
We've had a nice snap back. Again, we're moving in anticipation of some type of framework deal between US and China. We have an expectation that earnings will bottom in about Q2 of this year. And there's also this expectation that we'll have a better half next year.
I guess the other question also, too, is that, when the stocks spike up ahead of-- in anticipation, are the valuations running ahead of where they should be as well?
Right, so we are moving ahead of the confirming evidence, but it is a positive sign. We need the follow-through. But again, what it means from a big picture perspective is that this cycle, although has been long, can last a little bit longer than what's expected. And again, that that's a good sign, then, for equity prices.