As market volatility returns, why it’s important to stay calm

* On sentiment, are there concerns about the state of the economy south of the border? Joining us now to discuss what investors should be keeping in mind during this heightened volatility is Damian Fernandez, Managing Director and Portfolio Manager with TD Asset Management.

* Damian, thanks so much for joining us. Right off the top here, two days of drawdowns. What do you make of this market action?

* I think-- Greg, thanks for having me-- just as a favor, maybe when we're in a bull market, you also invite me on. Because I feel like whenever--

* I think you've been here in bull markets, too.

* I know. I know. We're in a bull market. Let me put some context to that. We're having a very conventional drawdown in markets. What I mean by that is year-to-date, even including today, the S&P is up 14%, the NASDAQ is off 3% today. But it's just back where it was in June-- June 8, if memory serves me, less than 60 days ago.

* So every year, the market has these 10% drawdowns at a certain degree of frequency. You have a fair degree of bullishness that people get really excited, and then the reverse takes place where people have to moderate their expectations. And that's coincided with, as Anthony said-- he did a great job of highlighting some weakness we're seeing in labor.

* And now, the market is looking things. But big picture, we're still on track. The market is still up double digits. The TSX is still up 7.5%, including today's drawdown. And the risk factors at the start of the year-- and I can talk about really hot labor market, wage gains, inflation, a Federal Reserve and central banks that were still applying the brakes in terms of their monetary posture-- all of those big macro variables are in reverse.

* There's evidence of a soft landing. The Bank of Canada is cutting rates. The Federal Reserve looks to cut 50 basis points in September. Inflation is falling. Wage gains, like you saw from the employment report today, average hourly earnings are down-- they have a 3-handle on them. They had close to a 5-handle last year.

* So I look at it right now, and I just think we're having a very healthy correction. And I don't want to sound blasé when I say this-- I know a healthy correction, the market's off-- what I mean by "healthy correction" is bigger picture, if you're underweight equities, these are buying opportunities.

* We're having a conventional pullback. Fixed income is providing ballast, right? Last year in 2022, both equities and fixed income fell. This year, fixed income is doing what it's supposed to do. It's providing insurance in a drawdown. So I think we're just having a conventional pullback exacerbated by summer low liquidity trading.

* A lot of fascinating things you said there. I want to hone in on one thing you said, because I heard rumblings of this the other day as well. I think you said Fed September, 50 basis points. Is the market starting to think that, perhaps, by the time we hit that September meeting, it's going to justify Jerome Powell not moving by 25, but moving by 50 in that first cut?

* Well, before today's drawdown, there was some probability of 50. Right now, after today, given the drawdown, we are looking at 50. The market's basically holding the Fed to the-- feet to the fire and saying that this is-- what we worry about, and I want to talk about risks, too-- what you actually have to worry about in the market right now. Is non-linear risks, right, where you have a significant drawdown in financial assets, that causes a pause in activity from CEOs, from corporates, and that actually starts that vicious circle.

* So the way the Fed insures against that, it provides easing, right? So right now, what goes with easing, you reduce financial tightness, you create some confidence in the marketplace. Right now, it's just a sentiment-driven game. What you don't want is a sentiment bleeding-- because the economic situation-- we saw this in earnings. We haven't even talked about earnings-- but earnings, we're in the midst of Q2 earnings.

* Yes, there's been significant price moves in some names, but the actual year-on-year earnings growth is positive. The S&P ex-Mag Seven, for the first time since 2022, actually has positive earnings growth. I think there's a lot of things happening under the surface that aren't being fully appreciated. And I think the Federal Reserve is now on an easing path. And that, too, is supportive for risk assets and for investors.

* Well, let's talk about putting that in context for investors in terms of a strategy. I believe your mantra-- I don't know if you say this every morning when you wake up, but I've been told your mantra is keep calm and compound on. Explain that to us.

* Well, the day-to-day volatility in the market should be viewed as investors as opportunities. What do I mean by that? I fully believe that if the evidence is we're convinced we're going to recession, you should take corrective action. We're not there yet.

* So the idea of keep calm and compound on is that, when the market is throwing out opportunities like today, when it's off 2%, 3% and significant names are off a lot, if you've done your fundamental research, if you feel comfortable with the free cash flows that these companies are generating, if you believe we're not going to go into recession and a soft landing accompanied by Fed easings there, compound on is literally you're getting a chance to enter the market right now, and potentially at a good entry level.

* I think that everyone should do their own fundamental research on individual names, but we try not to panic. Our desk tries not to panic, in names that-- has the fundamental thesis changed? Are we moving into recession? And the big picture things, I just don't see it.

* Let's talk about that, the soft landing. This is the scenario that's been baked into the markets, right? That we will be able to get inflation under control-- inflation is moving the right way-- by "we," I mean the central banks. I'm not a central banker.

* You get inflation under control. You're able to cut rates. You haven't done too much damage to the economy. Therefore, you're soft landing.

* When we got a bit of economic data, including the jobs today, some manufacturing stuff yesterday, it seemed like there was some on the street that started to question that soft landing. You still see a path to it?

* Well, I think the base case is soft landing. The market's panicking because there's now a probability that the soft landing might be somewhat worse. But that shouldn't be viewed as the base case, right?

* And the market's panicking actually incentivizes the Fed to rethink whether it has to ease faster and more quickly. So these things almost are related. But the base case should be a soft landing.

* And let me put some numbers to that soft landing. Anthony did a great job, as mentioned, on providing context on the jobs numbers, but we created 114,000 jobs.

* Pre-pandemic, that was a good number, right? We have hourly earnings right now growing 3.7% year-on-year. That is not inflationary, especially that yesterday nonfarm productivity was out. And that was very supportive.

* The fly in the ointment that we'll need more corroboration on was yesterday, you had the ISM manufacturing index. And that was actually pretty weak. But I'm not sure if something's changed, because when you compare jobs to the ISM jobs data, it's hard data.

* You count the number of people who are employed, the unemployment rate, the ISM is sentiment. You ask purchasing managers, how are they thinking about their order books? And I don't know how to explain this, but since the pandemic, there's been a general negativity in the sentiment data that hasn't been corroborated by the hard data.

* And I think there's some likelihood here-- I'll look at the ISM next month to see if we have some degree of bounceback-- but we are having a very conventional-- at the start of the year, people wanted jobs to come off the really red hot pace they were growing at.

* And now we're here, and people are like, oh, my god, we're panicking. It's going to fall off a cliff. And the economy just doesn't work that way, right?

* We're in the midst of earnings releases-- the sour point is that the consumer companies, particularly the low end consumer, looks to be challenged. But whether it's industrials or even, to a certain degree, tech, they've all had upward revisions. They've all raised guidance. So they're not raising guidance if they're seeing the economy deteriorating in real time.

* So final thought, Damian, I want to ask you, as you mentioned, August is a month of low liquidity. We've already had some volatility and excitement to start the month. What do investors need to do when they take that deep breath and think about the weeks ahead until we get back into the serious season of September?

* Greg, you and I are in Toronto. The weather, it's really nice outside. Maybe stop staring at the screens, and pick up a book, or listen to the nearest podcast. August, and particularly-- August and September, historically are very volatile months.

* And that's just a combination of low liquidity into the summer coupled with event risk, like we had today with the jobs number, is magnified, right? That's really what's happening here. And, yes, we can point to geopolitical things that are happening, but those are always present.

* And what normally happens is the seasonality improves as we move through the year-- October, November, December are actually very strong months. So I'll get back to what we were talking about, just overall allocation and positioning.

* I actually do think right now that if you're underweight equities and your overall allocation and where the keep calm and compound on, where you want to get to in terms of you're actually getting a chance to start dipping your toe. If you were underweight fixed income and you were overweight equities, you're seeing evidence that fixed income is providing you some comfort right now.

* So sometimes, the incentive to panic is right there. And right now, today, people are like, oh, my god, we're on the cusp of a recession. But to repeat, there's 114,000 jobs created. To repeat from the jobs number today, they have a metric called the diffusion index.

* It's the number of industries that are hiring, expanding employment, less the number of industries that are reducing, firing, reducing employment. That's at 53%. There's still more industries expanding employment than are cutting workers.

* I just think that, look, we're in a seasonally illiquid period. Not everyone's there. And we've had a huge run in markets. So it's very, very consistent that we'll see a pullback.

* And that pullback could be a few percent lower. But, depending on your positioning, and if you've done the work, if you find interesting opportunities here where companies can grow cash flow, that's our remit. That's what we're looking for.

[MUSIC PLAYING]