Conventional wisdom has it that rising interest rates are a drag on equity markets. Kim Parlee speaks with Brad Simpson, Chief Wealth Strategist, TD Wealth, about this potential headwind, and whether there may be a bear market in the making.
I want to start, if we could, we can show here the S&P 500, the Dow, the NASDAQ, the TSX. They're all still pretty close to all-time highs, maybe a little bit off. But if you look beneath the surface, it's been tumultuous, to say the least. How concerned are you that we could see a much wider sell-off?
There's nothing like an adjustment at 10% to 15% in Spotify to get one's juices going a little bit. So--
Well, listen, if I was a long-only equity manager, I would say that I'm not that concerned because there's a lot of very positive things about equity markets. The headwinds that you mentioned in tech markets, for one, which is really where this tumult is coming from is that-- the bottom line is that the tougher times we get for these kind of tech and kind of big growth names, it's actually a real positive in other areas of the market. And I would say it's actually very good.
For the last decade, it was really hard to come by growth. And this made investors chase a really small number of companies that were delivering it. I like to think of that as kind of a skinny rabbit strategy. And that's in an ecosystem that isn't really healthy and it's hard to keep going. In '21, we've really started to see a shift to really a system where there was more abundance.
And with that, the S&P, if you look at the returns from '21 in the S&P 500, both financials and cyclicals outperformed tech, where non-cyclicals underperformed. And that's kind of a perfect result if you like to see a healthy equity market. And then when we look at '21 and really dig in, you'll really see that most of the returns was all driven by earnings per share growth. And we started out the year at a PE multiple at 22-and-a-half times.
We go through 12 months and the market almost doubles and we got a PE multiple of 21-and-a-half times. Again, that's super positive as well. But the problem is that I'm not a long-only equity manager, I'm an allocator of capital. And if you're-- and if you do that for a living, you got to kind of hope for the best, but you also got to plan for the worst.
And large sell-offs rarely happen with the things that you're worried about. They happen with the things you don't see coming. And it's those type of unknowns that you got to really be prepared for and where I spend a lot of my time thinking about.
- I want to get further into that, Brad. I do want to bring up, though, a chart that you sent us. And this is taking a look, I think, at the S&P 500 returns during rate hike periods. Because at the end of the day, the abundance you talked about is often the abundance of money and low rates, which is changing. So if you take a look at his chart, tell me why should we pay-- what we should be paying close attention to.
Oh, yeah. Look, as interest rates are set to start going up in 2022, I think investors and even non-investors kind of intuitively know that low interest rates have been a real punch bowl for markets. So you start seeing that start to be taken away a little bit and we start to climb the wall of worry.
So all we did is we said, OK, let's go back to the early 1980s when we saw that really big adjustment in inflation and interest rates. And say, let's look through that period of time up until now, when the Fed was raising interest rates and what impact that it had.
And really, what we did is you do that-- every one of those big orange line spikes that you see up on the screen is showing that during rate increases, the market was actually behaving really well. And on average, through all the Fed rate hikes at the initial stages of it, the rate of return is, on average, 6%, which is hardly a calamity.
So it sounds like there's still room for equities, and it sounds like you're still more positive on equities than not for 2022. But I know that you've actually brought in a list of things we need to watch, and this is quite the list. You've got a list of 22 market headwinds and then market tailwinds. Why don't we go through, just because I'm a little sadistic. Let's go through the headwinds first.
Sure. If you look at the headwinds, boy, there's no shortage of them, right? I mean, you'll see lots of things about expensive valuations and central bank tightening and potential for policy mistakes. Big one, the removal of quantitative easing. Of course, we're seeing the pandemic and we're in the middle of that-- of a spike in that right now.
And of course, inflation and labor shortages, and a growth slowdown in China. And the kind of geopolitical things happening in the South China Sea and along the border of Russia and Ukraine. And there's no shortage of things that can keep you up at night. And I think there's some things that are really quite grave concern.
All right, well then let's shift then. Because as I mentioned, it does seem as though you're still bullish on equities for '22. So tell me why with the tailwinds.
- Yeah, sure. Because I mean, really, the other side of this is we have strong credit conditions, we have an abundance of liquidity. There's still a strong-- there's still a strong risk appetite. There's strong consumer demand out there. There is-- there is still rising corporate earnings, which still tend to be really strong, even on the back of some of the best that we've seen in the year that we just went through.
We've low debt servicing costs, strong employment figures, and really, very little sign of any temper tantrum like we saw back in 2013. And so, we write up all those and you kind of look through equity markets, there's a lot to still feel very good about as we enter this new year.
- Brad, I've only got about 10 seconds. Tell me, just for people just holding the course, what do they need to keep in mind?
- Look, at the end of the day, as we enter a new year, we all want to make predictions. And I think as you know, for us we think that's a pretty fruitless adventure to do. Really, the thing that-- we think the most important thing is you enter this as any year. First and foremost, make sure you have a well-crafted, appropriately priced asset allocated and risk diversified portfolio.
And then when uncertain things happen, know with certainty how you're going to make decisions. And if you stick to those two things through good and bad times, you'll see that many years that you go through are going to work a lot better for you than not.
- Brad, sage advice. Thank you very much.
- Thanks, Kim.