[MUSIC PLAYING] ANNOUNCER: The following paid commercial program is brought to you by TD Wealth. Welcome to Money Talk. I'm Kim Parlee. It's been a tough fall for the markets. The S&P 500 has given back all of the gains we saw in the summer and then some to the tune of about 15%. So where are things going from here? We really couldn't ask anyone better to come in and talk to us about this than David Sykes. He is Chief Investment officer at TD Asset Management. Nice to see you. DAVID SYKES: Thanks, Kim. Nice to be here. So let's start with the hard question first, where's the bottom? Ooh, that is the hard question. Well, we just finished baseball season in Toronto, so I'll paraphrase another baseball great, the Yankees catcher Yogi Berra, who said, the difficulty with predictions is they're about the future. But, to answer your question, we probably get into more of it. But, I think there's a bit more to go. I don't think we're at the bottom quite yet, and we can talk about the reasons why. Well, let's delve into them. And, there's plenty of headwinds in the markets, in terms of-- but I think the one that seems to have really-- the people pay most attention to is inflation. We're going to be getting some inflation numbers very shortly, as a matter of fact. But, just maybe to give us-- What do you see with inflation right now, and why does it matter so much? Yeah, so I think you've characterized it absolutely correctly. Inflation is the number one topic. Whether it's in your personal life at the gas pump, at the grocery store, if it's in capital markets, everyone is talking about inflation. That's the issue. To dig into it a little bit, look, two and a half, three years ago, no one would have predicted this global pandemic, a virus. It's been a horrible impact on the global economy. And we put a lot of fuel on the fire. We took interest rates to zero, quantitative easing, literally sending checks to our citizens in North America. And the end result of that has been higher and longer inflation than what we want. We peaked out at about 9.1%. We're headed lower. From our research and the work we're doing, I think we feel good about goods inflation. We see a lot of inventory building up at retailers. We're seeing corporate reports that say we're discounting pricing to try and clear some of that inventory. Supply chains are improving. They're not perfect, but they're improving. The difficulty is that that's about 40% of inflation overall. The other 60% is really on rents and on wages and salaries, and there, we do see some stickiness. We think inflation has peaked and it's going to slowly come down, but it's probably not going to come down as fast as people think, and it could be a little bit more persistent. So the trajectory is right, but it might take a little bit longer than we're all expecting. Then obviously, if you're taking a look at job markets, what's happening there, layoffs-- because obviously, if you have layoffs that come, that obviously is going to help, I think-- or does it help with wage inflation because you get these pockets where maybe they're pretty resistant and prices stay high? Yeah, one of the interesting aspects today is that you see growth slowing. I think it's very clear when the Federal Reserve hiked the last time, they said that they thought US growth would be about 1% for 2023. The ECB had talked about less than 1% growth. With zero COVID policy in China, growth is slowing. So it's not a great growth environment. But unemployment is incredibly low. We're still at 3 and 1/2% in United States, 5-ish in Canada. And so the labor market is very, very tight. And we really do need to see some loosening of that to allow those wages and salaries to slow. We can still have wage and salary growth, but right now, average hourly earnings are growing north of 5%, and that's too hot. And central banks around the world have said, look, we can't accept that. We're going to have to keep increasing rates, and we want that to cool off and bring down that demand side of the equation. And that's something you see in everyday life. I'm from [INAUDIBLE] times. I know you are too. No one can hire anybody. Nobody can get anybody. And so it shows up in every part of life. What then, do the central banks do because part of the reason the markets have reacted as rates have gone up, that inverse relationship we all talk about. So how much more rates are going to go up? So good question. We talk a lot about markets, and we talk about the equity markets. But let's not forget that the fixed income market is much bigger and probably much more important, particularly at this time, and that's really where our focus is. If you think back to the beginning of this year, interest rates-- overnight rates were virtually zero. They're at about 3 and 1/4% now. The two year rate has gone from something like 75 to 100 basis points at the beginning of the year, to above 4% now. KIM PARLEE: Which is massive. It's a huge increase. And you think about, yields up, price down, there's been about a 15% drop in fixed income this year. We think there's probably a wee bit more to go, but it's really going to depend on those inflation readings and on those job numbers. And it's just a predictive call that is so subjective at the moment. We're going to keep looking at data, not just from macro, not just from central banks, but also from companies. And I think that's going to guide us. But, I do have this feeling that our work is leading us to conclude it's going to be stickier and slower in its decline than we think. And so that's one issue for us that we're really watching. And when rates peak, I think that's when we'll feel good that equities can resume higher again. It seems as though the markets even feel a bit trigger happy right now, too, because every piece of data that comes out, the bulls are like, OK, now the Fed's going to pivot. And maybe that's not the question too, in terms of just that stickiness you talk about. Look, I don't think the Fed could have been any clearer at the Jackson Hole speech. It was an incredibly short speech, to the point, and it was, inflation's a problem. We're going to tackle this, just watch. I'm paraphrasing, but that was really the message. And I think, that's really going to be the message until we see some softness in the labor market, until we see core inflation really start to move down in a sustained way. And we're not seeing that yet. Is there any good news out there? DAVID SYKES: It is interesting, from an equity perspective, sentiment towards equity market is incredibly poor. It's difficult to find anyone who will say now is the time to buy. I mean, we look at all kinds of surveys. We look at various surveys of institutional investors. We look at cash levels, institutional, accounts across the country, across the world, everyone is bearish, really, really, really bearish. And historically, that's been a really good contrarian indicator. And so, I'm not sure if the time is now, that is a really bright spot to say, you know what? Really when people are fearful, you might want to think of being maybe a little bit on the greedy side. Now, part of the reason I think maybe they are fearful is that we've seen things turn. I'm just thinking if I go through the companies, Intel has announced layoffs. You go through the names. I think we were in a blackout period, not in the past couple of weeks, now we're starting to get the news with earnings and forecasts. And I think it was you that told me, way back, first we're going to see a rate compression valuation of markets, and then we're going to see the earnings hit the next step. What are you expecting to see? Yeah, so we have seen that PE multiple compress in the market, for sure, this year, but we haven't really seen the earnings compress yet. We're just getting into Q3 earnings season. So far there's been some positive, probably more negative, though, to be fair. You're starting to see the interest rate impact hitting. You're starting to see top line demand softening a little bit. You're starting to see some margin compression for companies. Their input costs are going up slightly faster than they can increase the top line. And so you're starting to see that. Now, it depends on the industry, it depends where. But just to give you a rule of thumb, if in fact, we are going into recession, I think it would be my best guess that we are, generally speaking in a recession, earnings needs to decline about 15%. And so earnings estimates for the future peaked this June. And we've been revising down slowly, slowly, slowly. We're down about 4% or 5%. So we need to get down 15% on average. That's probably going to take us another six, seven, eight months. Somewhere, probably in the first half of next year, we think those earning revisions would bottom. The interesting part though, is you have to have a bit of courage as an equity investor because the market generally bottoms before those estimates bottom. And so it's tough using history as a guide. It's averages. It never works out perfectly. KIM PARLEE: Things rhyme. Things rhyme, but they don't exactly match up. But, that would be the rough rule of thumb, and I think we're just starting to see those earnings revisions come in. It's going to be a few more months or quarters. Is there anything-- because I know you've been doing this for a while-- is there anything-- no comment on your age. I've been talking to you for a while. Is there anything that feels different, like, fundamentally different than other cycles than you've seen before? You obviously have lots of exogenous things coming into it, but you when you hear from the companies themselves, does anything stand out? I think the one thing that sticks out is what we talked about before is the mismatch on the labor side. There's just such a demand for labor. Job applications are huge. They're just massive. And companies are having a very, very tough time finding that labor supply. And the quandary in my mind is why hasn't that participation rate in the labor force ticked back up again to historic averages? It's an interesting question. I mean, are people taking an early retirement because of COVID? Are people not willing to go back to the workforce because of COVID? I'm not sure, but that's what's different to me this time is that labor force is really, really tight at a period you would expect it to start to soften a little bit. We've seen a little bit of weakness in the labor market, but not what I would have expected by now. What about-- when you think about strategy in terms of how people are thinking about how to navigate. I mean, it's pretty interesting what you said about having the courage to get into the market before things-- you start to see that turn around. And of course, timing the market is hard, I'll say, for people who are trying it out. I mean, you're professionals. It's what you do. What should people think about from a strategy standpoint? From a strategy standpoint, for us and what we try to do, it's a very simple one, and it's cash flow. We want quality businesses to generate cash flow. If we're going to lend money to a giant corporation and get our principal and interest back, we want to make sure they're generating cash flow and they're growing that cash flow. It's the same with the equity side of our business-- cash flow, cash flow, cash flow. We always preach cash flow. Same in our alternatives, in our real estate investing, in our infrastructure. We want those companies to generate great cash flow, grow it, return it to us. But this, probably more than any time, is when you want that safety. Cash flow is what's going to protect your valuation. It's what's going to protect those payouts to you, the shareholder. We really want to pay attention to cash flow. We always do, but I think now it's more important than ever. Is there something just maybe for people to get in terms of the resilience of the cash flow? When you say cash flow, it's like, I get it. I get it. I get it. But, how do I know that my cash flow tomorrow is as safe as it is today, and how do you figure that out? Yeah, the trick for that is really around the business model. How is the business organized to fight off enemies. And those enemies could be macro, it could be a recession, it could be competitors. What's the competitive advantage? What's the mode around that business? Maybe it has a recurring revenue model. Maybe it's one particular industry that's very concentrated, but what gives it that staying power? Is that those cash flows are dependable and recoverable. We always look for that type of business, but I think now it's more important than ever. All right, any last thing for people to keep in mind for bear markets? Yeah, look, it's been really tough. Let's not sugarcoat it. I mean, markets have down a lot. US markets are down 25%, 30%. Canadian market's off 10%, 15%, year to date. Bonds are off 15, it's been tough. KIM PARLEE: Is the worst behind us? I think so. I can't guarantee, but I think so. But I think what I've been doing and what I've been doing for a number of years with our whole team is thinking about what companies generate cash, they pay it out, they compound it, we'll get through this. We've been through a lot worse. I've been doing this for 25 years now. There is another side to this, but it's not going to feel very good for a while. But you remember, you have to be in the game in order to get that compounding, those returns. And from my perspective, it's all about asset allocation, diversification, and quality. Those are the big three areas to focus on. KIM PARLEE: Always a pleasure having you here, Dave. Thanks so much. Thanks, Kim. David Sykes, he is Chief Investment officer at TD Asset Management.