After a blistering start in January, February has sent chills to stock prices, giving the S&P 500 its worst weekly decline since January 2016. Is the longest market winning streak over? Or is volatility back in the market? Kim Parlee talks with Rob Pemberton, Head of Fixed Income, TD Asset Management.
Rob, we've seen a pretty significant sell-off in the past few days. And keep in mind, the markets have been at all-time highs. So we're not used to seeing these kinds of sell-offs. What sparked it? Why are we seeing this right now?
I think really what we're seeing is a market reaction to the recent spate of positive data, particularly that coming out of the US, where we've seen really positive job numbers. We've had the impacts of the tax reform start to feed through. And in the inflation side, we're seeing some pressures in the wage part of the economy, which could mean that we'll see higher inflation as we move forward. I would not say that this is meaningfully higher in terms of what our expectations are.
Now the interesting thing for the indoctrinated maybe-- or unindoctrinated-- to understand this, if inflation goes up, the idea is that the central banks then will match rates to go up. If rates go up, that tends to have a dampening effect on the equity markets, at the very least. It seemed as though last week, and even continuing a bit today, is that people thinking that rates may go up more quickly, perhaps, than people had thought before.
And the market may speculate that. If I look at the market and what's priced into it right now, I think we've seen a modest rise in interest rates. And we've come off such a low base that many investors feel it's aggressive.
When we look forward, though, bondageddon is not in our forecast. And we absolutely expect to see gradual interest rate increases by central banks globally and a modest removal of the excess stimulus that has been provided. And that may have implications to equities, as the discount rates change and how people look at where and how capital will be generated will change.
But if I look at 2018 from an equity perspective, expectations are for earnings of about 155 on the S&P 500, up from 133 for 2017. So that's about a 16% rise. When I look at how that breaks down, about 50% of that comes from earnings. And the other half, approximately, comes from the impacts of the tax changes we've seen in the US marketplace.
So there's already a lot of really good news priced into the marketplace. And the modest pullback we saw last week is something we haven't seen in some time. So it does have investors a little unnerved.
If I frame it out since late 2016, the S&P 500 has not had a negative month, from a return perspective, since October, plus or minus, 2016. So a very long run. And I understand why people might feel a little nervous after last week's sell-off. However, this is just part of the normal fluctuation within markets. And we really don't see this as a sign of a bigger change in the way the markets are pricing things.
Yeah, and I guess it's uncomfortable. We're just not used to this anymore. It's been happening for a while.
I know I've talked to you, and I've talked to your team, and I've talked to Bruce as well about the kinds of things that you're putting in place. And the very essence of what you do-- you've infused into your strategies upside and downside on both sides.
Absolutely. And in an environment like we're facing right now, it's clear that the thoughts that we've had in how to protect on the downside for investors-- what we call downside capture-- is something that is really playing out and is helping the portfolios which we manage. And our key process and philosophy continues to be focused on high-quality companies who continue to have strong balance sheets, very, very strong free cash flow, and can grow that over time. In an environment like we're in today, those are the types of investments that are going to pay our clients in the long run.
Rob, thanks very much.
Thanks very much, Kim.