Does a down market lead to buying opportunities? It’s complicated

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- We know as investors that markets have had a rough go so far this year. The S&P 500, of course, just recently entering bear market territory. According to our featured guest today, while plenty of stocks may look cheap on the other side of that, they're still pretty expensive if you look under the hood. 

Joining us now is Ben Gossack, portfolio manager at TD Asset Management. Ben, great to have you with us. Intriguing thought, let's start there, because when you see the sell off and the magnitude that we have lived through as investors this year, some people may be forgiven for thinking stocks are cheap. What's the Warning here? 

- Yeah, so thanks for having me. And I know it's a green day today, and I don't want to spoil the party. But we have seen major corrections in the S&P 500, the NASDAQ. We're talking 25% drawdowns, 35% drawdowns, and then for many people, underneath those indices, they've seen their stocks down 50%, 60%, 70%. People always say this is one of these weird industries, where anything else, if you saw a goods that you like, a car or a t-shirt, or something down 50%, it's an automatic buy. 

And yet, in our industry, with stocks, when it's down 50%, we start to ask questions as to why. And I think it goes back to, it's not the same item because we're always projecting forward. And I think that's the big message that I want to share is that, when we look forward and we look at forward earnings, the surprising thing, I think, for most people, is that earnings projections are actually higher today than they were at the start of the year, which is very surprising, given talk about a recession, ongoing crisis in Europe, the COVID-19 persistent lockdowns in China. It feels like everything's slowing. How is it that we could be projecting earnings higher? 

And what I'm saying is, stock prices have come down, earning projections have stayed up or slightly higher. It makes it look like the stock market is cheap. And what I'm saying is, it's important to understand why it's looking that way. Maybe the ease-- these earning projections that are being forecasted by the market aren't right. 

- What do you think the underlying dynamic is there? Are companies digging in their heels? Do they actually see better times ahead? Because you said, there's no shortage of risk. I mean, a big reason why we're seeing the sell-off is that there's a fear that there can be policy era, where the central banks just get a little too aggressive on tightening, a little too aggressive on rates, and you knock ourselves into a recession. 

- So like we faced in February 2020, when we had a novel virus come out, what did that mean? Governments want to lock us down. What does that mean to companies? Which companies can survive? What is very reminiscent today is, is there a soft landing? Is there going to be a hard landing? Is there going to be a recession? Can the consumer hold out? I think that raises a lot of questions as to what that path could be. Having said that, the earnings projections haven't come down, and it's because the management teams have been-- I think they're kind of holding out, hoping that things will turn better. When we'll see all this come to roost is in July, when we get the Q2 earnings. 

You've seen a little bit of this. So Microsoft has come out and said, hey, we sell a lot of software outside the United States, and the US dollar has been very strong, which means our overseas profits are getting smaller. We need to take down guidance. You saw that with Adobe last week. 

So it's slowly trickling in. But it is concerning that, when you look at analyst projections for any given stock, the earnings variability-- so the lowest forecast, the highest forecast is very tight. And so, it means, without dispersion, everyone's kind of thinking along the same lines, and you want people to have different forecasts. 

So to give you an example, the S&P 500, probably in the next 12 months, is trading about 15 times forward earnings. That's basically fair value, when we look back, going to the 1970s. But those numbers are going to start to come down. The question is-- that we're all trying to figure out is, how much has already been priced into those stocks, in terms of, it's just a mild slowdown or is there more to go. 

- During the pandemic, of course, the run that we saw in stocks-- you get all the acronyms, right? The Tina trade-- there is no alternative. With things shifting out there and the landscape changing, do we have alternatives now? 

- Yeah. So there actually is an alternative. It did feel when interest rates-- let's say, prior to the pandemic, a US government tenure would be at 3%. Even back then, we said, OK, that's not enough yield, we need more yield. Then that almost fell to zero. And yes, in that environment, there really was no alternative. And I think that's why lots of stocks you saw just sort of run up really high. But now, with a US government bond above 3%, many stocks now look very expensive relative to that government bond. So yes, there is a new alternative, it's US treasuries. 

In some cases, it might be US corporates. And I think that's why many stocks-- you've seen a fall in 50% 60%, 70%, because they got too expensive, not because they didn't have a good business plan, not because they're not winning new businesses. So many of these companies are still growing, top line 10%, 15%, 20%. They have great management teams. It's just that now there's a discount factor. 

So there was no time value of money during the last three years. So $1 today is worth $1 10 years. Now, $1 today is definitely worth more than $1 10 years out. Now we got a discount that back, and I think that's being forgotten and overlooked by many people in the market. 

- I've been in this environment. If you want to be bearish, if you want to be down in the markets, it's easy to find people to sort of support that view. Is that overly fatalistic? 

- So I think when you think about issues going on in Europe, and you're like, how can they avoid a recession? You look at the supply chain and issues in China, and you're saying, how long can they persist with this COVID zero policy? Because it just impacts supply chains and it's pushing up the cost of all sorts of inputs. When you think about the Fed-- the central banks around the world trying to address inflation-- and I think we can debate whether higher interest rates would pull more oil out of the ground, would make milk cheaper, and at what cost? So let's bring down this inflation. Will that cause job losses? Will that cause people to stop spending? All that creates all this uncertainty. 

But to your point, I'm arguing that that's kind of consensus. So we see that in investor surveys. We're seeing that in how people trade option contracts. And so this realization that it's easy to get bearish-- but I'd say the bearish feeling is consensus. And so what we're trying to do now is look for the pockets of opportunities and say, have we sort of built up this bearishness and can-- are there stuff to buy there, opportunities, things that have been sort of oversold? Again, going back to-- we have a very quality buy, so we're always looking for opportunities to buy quality companies at lower prices. 

But if people are feeling very negative and worried-- yeah, a lot of people are feeling that too. And so you don't have a special lens, or globe, or compass that's not being thought of in the same way as other market participants. 

- It definitely sounds like one of those-- the adage of sharpen your pencils kind of thing. When everything was just going up, it was easy to make money, right? You just sat back and bought an index. It sounds like the moment where you really have to do your homework. 

- Absolutely. Because there are so many things going on. So you could say, stock market-- a stock price is down 60%. OK, we'll reach that high level watermark that it was before. I think there's a lot of questions as to, can it do that. And specifically, there are companies like that in the tech sector. And then there's opportunities in terms of, can we see recoveries in certain areas, are some areas of the economy going to be impacted versus others. 

So yes, we've got to put on the little reading glasses. We've got to sharpen the pencils. There are always opportunities in the market. Having said that, my key message here is that-- you're going to hear a lot of people say that prices are cheap, valuations are cheap. 

My key message is, they look cheap because we haven't brought down the estimates. Start to watch the estimates come down. What I'm actually really looking forward to is, we've seen bad news, stock prices go down. The key tell will be, bad news comes, and stock prices go sideways or they rally. We're not at that yet, but that would be a key tell. That would be something I'd be looking for, a milestone to say that we've started to absorb a lot of this negativity. We're not at that yet, but those are the kind of things that I'd be looking for. 

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