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After a mild decline in equity markets recently, the S&P 500 and Nasdaq are right back at their all-time highs. Kim Parlee speaks with Damian Fernandes, Portfolio Manager, TD Asset Management, about whether stock prices may continue to rise, or if they are due to for a pullback.
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[MUSIC INTRO PLAYING]
- Damian, great to have you with us. I just have to start with what is going on with these markets? I mean, why do we see the markets just keep on going up?
- Thanks, Kim. And great to be having this conversation with you. It's a question we receive all the time. What is driving this?
And if you just take a step back and you think about the big picture, there are a few things at play. First of all, we're in the early stages of an economic recovery. Right now-- we had Q2 last year was the hard stop, quarantine. And every quarter since then, economic growth has accelerated.
This year, particularly if vaccines, which we now have evidence are efficacious, you can see continued economic growth. In fact, given all this pent-up consumption demand, given how much stimulus in the system, you probably could be staring at one of the best GDP growth years in two decades. So that's point number one.
Secondly, we're not waiting for it. We're in the midst of an earnings recovery. Q4 earnings were actually positive year-on-year. If you strip out the energy and the sectors that were impacted by the pandemic, airline stocks and retailers, they were actually materially positive, high single digits. So we've talked about economic recovery, we talked about earnings, we talked about the vaccine, really strong data for the vaccine.
And I would end that off by saying, monetary accommodation is still extremely easy. The Fed's still buying $120 billion of bonds a month. Those are gargantuan numbers.
The way I think about this, if I just gave you those four items, and I told you, what do you think markets are doing, I don't think it would be a surprise for you or myself if you said markets continue to trudge higher. And I think that's-- as people are acclimatizing to those big macro variables, I think that's what's happening here.
KIM PARLEE: But let's take a look. We've got a chart here that I know that you helped us bring in. But it's a look at, I think, the frothiness one would you say of what we're seeing right now. And it looks as though that you look at it on a P/E basis, we're approaching what we saw back in 2000. So, I mean, talk me through what we're seeing on the screen.
DAMIAN FERNANDES: Sure. It's just a P/E chart of the S&P 500 going back a few decades. And yes, it looks like we are moving up. But maybe just another-- let's take a step back and think about a lot of words getting thrown around like bubble, and overbought, and really ebullient conditions.
And I think a bubble is when an asset is trading above the fundamentals. And when you look at what you think a P/E multiple is, a P/E multiple is a heuristic. It's a shorthand for valuation.
And the first thing you have to consider is, what underpins valuation? Well, it's rates, right? So when you compare the P/E multiple today to the P/E multiple in the late '90s, the early 2000s in that tech bubble, rates were 5% and 6%. Today, they're 1% in the US and Canada.
Think of it this way. At a 1% yield, how long does it take for you to recoup your capital? It takes 100 years, right? 1%, 100 years for you to get back your money.
So today's P/E multiple of 23 times, that's 23 years. And I know in an absolute sense, it seems really expensive and elevated. But on a relative basis to where fixed income yields are, it is quite attractive versus history.
It's just another a way of saying that if you as a participant believe rates are going to remain really low for an extended period of time, I think the path of least resistance is probably the equity market moving on higher with earnings. And maybe the multiple doesn't expand, but the multiple is more than justified at these levels. And I wouldn't be surprised if people are convinced that rates remain really low that you could even-- it's not out of this world to see them moving higher, the multiples, that is.
- Yeah, the multiple. And it's a really good point. I think when people look at charts, you need to look at what the variables were when these things happened. And hearing the rates you know at 5%, 6% in 2000 versus now really does paint a good picture.
You talked a bit about earnings, Damian. You said that they're coming in better than expected. I wouldn't mind just jumping a bit to sectors and stocks. What are you going to be watching as we start to get into this, finger crossed, reopening cycle starting to happen?
- Yeah. I've got both fingers crossed here, Kim. Look, I think the most important thing is, has consumer behavior fundamentally changed if we reopen? Right now we know there's a lot of pent-up demand, we know there's a lot of stimulus in the system, we know people are itching to get out and actually try and spend that-- spend and experience things that they haven't been able to, spend money on things, whether it's vacations, whether it's personal services, and so on.
So I want to see if that continues. Because if that does continue, that pent-up demand is just like a coil spring, that coupled with just what we're seeing with infrastructure spending and what we're seeing with inventory rebuilding. If that continues, I think it's a benign environment, it's generally a good environment for stocks.
But if the virus has fundamentally changed consumer behavior, where it's an initial-- an initial increase and then just a subsequent withdrawal, or more importantly, if we have different strains of the vaccine that scare consumers again or force us to quarantine, all of those things can weigh in.
But right now, I'm optimistic, both fingers crossed that as the vaccine-- as we have-- I call it "inoculate and rotate," as more inoculations are there, we can get the path of some normalcy. And as that happens, as the economy opens up, you will see consumption, earnings growth, all of those things that are market supportive take hold.
KIM PARLEE: So without a inoculation and rotate that you're talking about, what are they rotating out of? What sectors have had their run?
- Yeah, inoculate and rotate. I think the way to think about this is that what business models, what companies have seen their earnings and cash flows impaired temporarily, which in a reopening, if we get back to normal, we'll see a return, so financials, credit card companies, even oil and gas companies.
To certain degree, oil and gas companies have filed capital discipline. We're seeing demand for oil increase. WTI today was above $60 at one point. And so all of these things are very supportive off cyclical sectors.
The things that they're rotating out of, I think there's-- I don't want to-- there's this idea that maybe technology doesn't do that well. I, in fact, think that the pandemic has probably accelerated some trends, accelerated transit payments, so think Visa, MasterCard, accelerated trends of e-commerce. In Canada, Shopify today was up a lot.
Amazon has basically brought forward all that spending. If you weren't an Amazon Prime customer last year, chances are you joined Amazon Prime last year. And it's going to be hard for you to leave that after you see the value of those services.
So I think what people are rotating out are more not really technology, but more of those very defensive sectors, consumer staples. I was joking the other day. I think I'm up to my eyeballs in sanitation or Lysol wipes. We just don't need anymore if we're going to be opening up again.
So things like that, where people have crowded into defensive names, I think those are at risk as people move into seeing where the cash flows are growing. And the cash flows are definitely growing in these reopening trades.
[MUSIC PLAYING]
- Damian, great to have you with us. I just have to start with what is going on with these markets? I mean, why do we see the markets just keep on going up?
- Thanks, Kim. And great to be having this conversation with you. It's a question we receive all the time. What is driving this?
And if you just take a step back and you think about the big picture, there are a few things at play. First of all, we're in the early stages of an economic recovery. Right now-- we had Q2 last year was the hard stop, quarantine. And every quarter since then, economic growth has accelerated.
This year, particularly if vaccines, which we now have evidence are efficacious, you can see continued economic growth. In fact, given all this pent-up consumption demand, given how much stimulus in the system, you probably could be staring at one of the best GDP growth years in two decades. So that's point number one.
Secondly, we're not waiting for it. We're in the midst of an earnings recovery. Q4 earnings were actually positive year-on-year. If you strip out the energy and the sectors that were impacted by the pandemic, airline stocks and retailers, they were actually materially positive, high single digits. So we've talked about economic recovery, we talked about earnings, we talked about the vaccine, really strong data for the vaccine.
And I would end that off by saying, monetary accommodation is still extremely easy. The Fed's still buying $120 billion of bonds a month. Those are gargantuan numbers.
The way I think about this, if I just gave you those four items, and I told you, what do you think markets are doing, I don't think it would be a surprise for you or myself if you said markets continue to trudge higher. And I think that's-- as people are acclimatizing to those big macro variables, I think that's what's happening here.
KIM PARLEE: But let's take a look. We've got a chart here that I know that you helped us bring in. But it's a look at, I think, the frothiness one would you say of what we're seeing right now. And it looks as though that you look at it on a P/E basis, we're approaching what we saw back in 2000. So, I mean, talk me through what we're seeing on the screen.
DAMIAN FERNANDES: Sure. It's just a P/E chart of the S&P 500 going back a few decades. And yes, it looks like we are moving up. But maybe just another-- let's take a step back and think about a lot of words getting thrown around like bubble, and overbought, and really ebullient conditions.
And I think a bubble is when an asset is trading above the fundamentals. And when you look at what you think a P/E multiple is, a P/E multiple is a heuristic. It's a shorthand for valuation.
And the first thing you have to consider is, what underpins valuation? Well, it's rates, right? So when you compare the P/E multiple today to the P/E multiple in the late '90s, the early 2000s in that tech bubble, rates were 5% and 6%. Today, they're 1% in the US and Canada.
Think of it this way. At a 1% yield, how long does it take for you to recoup your capital? It takes 100 years, right? 1%, 100 years for you to get back your money.
So today's P/E multiple of 23 times, that's 23 years. And I know in an absolute sense, it seems really expensive and elevated. But on a relative basis to where fixed income yields are, it is quite attractive versus history.
It's just another a way of saying that if you as a participant believe rates are going to remain really low for an extended period of time, I think the path of least resistance is probably the equity market moving on higher with earnings. And maybe the multiple doesn't expand, but the multiple is more than justified at these levels. And I wouldn't be surprised if people are convinced that rates remain really low that you could even-- it's not out of this world to see them moving higher, the multiples, that is.
- Yeah, the multiple. And it's a really good point. I think when people look at charts, you need to look at what the variables were when these things happened. And hearing the rates you know at 5%, 6% in 2000 versus now really does paint a good picture.
You talked a bit about earnings, Damian. You said that they're coming in better than expected. I wouldn't mind just jumping a bit to sectors and stocks. What are you going to be watching as we start to get into this, finger crossed, reopening cycle starting to happen?
- Yeah. I've got both fingers crossed here, Kim. Look, I think the most important thing is, has consumer behavior fundamentally changed if we reopen? Right now we know there's a lot of pent-up demand, we know there's a lot of stimulus in the system, we know people are itching to get out and actually try and spend that-- spend and experience things that they haven't been able to, spend money on things, whether it's vacations, whether it's personal services, and so on.
So I want to see if that continues. Because if that does continue, that pent-up demand is just like a coil spring, that coupled with just what we're seeing with infrastructure spending and what we're seeing with inventory rebuilding. If that continues, I think it's a benign environment, it's generally a good environment for stocks.
But if the virus has fundamentally changed consumer behavior, where it's an initial-- an initial increase and then just a subsequent withdrawal, or more importantly, if we have different strains of the vaccine that scare consumers again or force us to quarantine, all of those things can weigh in.
But right now, I'm optimistic, both fingers crossed that as the vaccine-- as we have-- I call it "inoculate and rotate," as more inoculations are there, we can get the path of some normalcy. And as that happens, as the economy opens up, you will see consumption, earnings growth, all of those things that are market supportive take hold.
KIM PARLEE: So without a inoculation and rotate that you're talking about, what are they rotating out of? What sectors have had their run?
- Yeah, inoculate and rotate. I think the way to think about this is that what business models, what companies have seen their earnings and cash flows impaired temporarily, which in a reopening, if we get back to normal, we'll see a return, so financials, credit card companies, even oil and gas companies.
To certain degree, oil and gas companies have filed capital discipline. We're seeing demand for oil increase. WTI today was above $60 at one point. And so all of these things are very supportive off cyclical sectors.
The things that they're rotating out of, I think there's-- I don't want to-- there's this idea that maybe technology doesn't do that well. I, in fact, think that the pandemic has probably accelerated some trends, accelerated transit payments, so think Visa, MasterCard, accelerated trends of e-commerce. In Canada, Shopify today was up a lot.
Amazon has basically brought forward all that spending. If you weren't an Amazon Prime customer last year, chances are you joined Amazon Prime last year. And it's going to be hard for you to leave that after you see the value of those services.
So I think what people are rotating out are more not really technology, but more of those very defensive sectors, consumer staples. I was joking the other day. I think I'm up to my eyeballs in sanitation or Lysol wipes. We just don't need anymore if we're going to be opening up again.
So things like that, where people have crowded into defensive names, I think those are at risk as people move into seeing where the cash flows are growing. And the cash flows are definitely growing in these reopening trades.
[MUSIC PLAYING]
