Recent inflation data is raising expectations the interest rate tightening cycle may have run its course. Justin Flowerday, Head of Fundamental Equities at TD Asset Management, tells Kim Parlee why equity markets may still be facing periods of volatility.
Print Transcript
What does it mean if inflation is slowing? What does that mean for for a for public equities?
Yeah. So, I mean, let's let's think about what we've had in terms of data. I mean, we obviously had us and CPI, CPI and Canadian CPI come out recently and it's showing a slowing trend and we're getting a cooling of inflation and it's.
Still increasing, but it's at a slower rate.
That's right. Yeah. And we're getting to a point where it's becoming a little bit more palatable. And so as you think about what that means for the short term interest rates and decisions by the Fed and Bank of Canada, it's it's given them enough evidence to say, okay, maybe we'll stay on hold for now and see how the data comes in. And then, you know, as that translates to the equity markets, I would just say they're following the bond market, they're following yields. And, you know, it becomes really tricky and can be quite volatile because you're getting days when yields are moving around ten, 20 basis points and you're getting 50 basis point moves in a month. And what that means for equity investors or any investor in risk assets is that the risk free rate that you're using is the ten year Treasury yield. When that's moving around so much, it gets really, really difficult to get comfort that this is the fair value for any individual stock or the market. So I would expect volatility to remain.
Yeah. Can I. Is there anything just that we just talked about the fall fiscal update from a personal finance standpoint, taxes. And I'm not going to ask you about that, but did you hear anything from a deficit standpoint that makes you kind of pay a little more close attention?
Yeah. So so we were actually quite pleased. We thought it was a fairly responsible update and we didn't hear anything that scared us. And I think going in, there was some skepticism that we may hear about some bigger initiatives. And so I would just say it was disciplined. There was a narrow focus to the initiatives that they're bringing forward. And so nothing came out that really scared us.
Good. And I know we're going to talk a bit about earnings and some of the themes that you've been hearing in terms of what's been coming out of companies at this term. I have not heard. But, you know, the challenge right now for the central bank has been a stronger labor market. And the fact that, you know, they keep doing what they're doing and that they're not seeing, you know, unemployment numbers move up a little bit. Right. And you talk about labor hoarding, right?
Yeah. So so labor hoarding is a thing. It became a thing after Covid. And so what you had was a whole bunch of companies that let go of employees when they saw demand fall off a cliff. Yeah. And they tried to hire them back. And it was really painful and a difficult experience experiment. Expensive and expensive. And what it has led to is a theory that, you know, there are some some companies out there that are a little bit less sensitive to incremental changes in demand in terms of cutting costs. Yeah. And could that be a factor? You throw on top of that, some of the new on shoring trends that are taking place and we're building manufacturing facilities. And, you know, on top of that, some of the demographic trends that are taking place, there's an argument out there we can degree agree or disagree. It's probably a debate for another show, that there's maybe a structural supply demand imbalance in terms of labor in the market. We can debate that on another show. But for now, what that means is are companies currently trying to see how demand comes down to.
Try to smooth it out themselves.
And not making that kind of rash decision, saying, okay, I see demand starting to fall down. I'm going to cut. No, they're waiting around and they're seeing. And that causes some difficulty for the central banks who are just trying to say, no, we need to get inflation down. Wage inflation has to come down and it's probably not moving as quickly as they'd like to see.
That's interesting. What else are you hearing from from companies in terms of just the trends I was saying in earnings?
Yeah. So, you know, earnings season, Q3 wrapped up. It was it's always a good season. Companies always you know guide lo in that yeah and then beat so you had 80% of companies beat on earnings you had I think 60% of companies beat on revenues and you know at a high level, earnings grew year over year for the first time in several quarters. So that's a positive when you take out the Magnificent Seven. Earnings were actually down 4%. So they're up 4% with magnificent seven down 4% without revenue didn't grow as quickly, but it was still up. And you know, when you think about some of the trends we're hearing, I point to the consumer and and how different cohorts are doing as as a trend that came out quite clearly to us, I would say we heard from several management teams that the lower income cohort is weakening and they've drained down their excess savings and they're starting to see decisions which are slowing consumption trends across a whole bunch of different sectors. So we heard it from Walmart. We heard Home Depot come out and they said, look, purchases of of over $1,000 are down 6% year over year. So some difficulty in terms of low end consumer. Other than that, you know, some of the guidance came in a little bit weaker. So trends for Q4 and for next year, estimates are starting to trend down a little bit.
What about sectors? And when you when you come out like I know. You've got we can talk about industrials and real estate technology, but industrials, you're thinking things are looking okay.
Yeah. So industrials is a really great sector for us because it's such a diverse group of businesses and you have a whole bunch of different end markets. And you know, I'll go back to the the onshore near shore in French or and whatever you want to call it, there is activity that's taking place. And every time a new chip plant gets built in Arizona or a new air conditioning plant to supply the chip plant with air conditioners.
But it's all happening here.
It happens here. And so these industrial companies end up finding new verticals to sell their goods into. And it's you know, it does present probably an opportunity that isn't just a one year kind of time frame. Yeah. Real estate. Real estate. You know, there's there's pockets that concern us. And, you know, we would be avoiding certain areas of the retail mall space.
So you see all the distribution centers going up on all the malls, not doing so well.
That's right. That's right. We would we would probably be avoiding some office exposure outside of the main court. You got main quarter offices doing great outside. Maybe avoid some of that. And then you mentioned technology a lot. Yeah, I mean, I think technology is a theme that has excited everybody this year and there's still pockets that are very exciting. And when you think about the exposures to A.I. and not just the chips, but the productivity tools and companies that are presenting new opportunities for companies to protect margins and the data infrastructure, software companies, lots and lots and lots of good things happening there.
What do you think about my last question? We've got about a minute, but the the soap opera that is open is Sam Altman, because I think I kind of like they fired him. They brought him back. Now the boards fired, Now he's back. And I'm just like, okay, So.
Yeah, so it's what.
We all the entertainment value is there something interesting?
So, so it's great entertainment. I would say there's one big conclusion that that that is really positive from my standpoint, which is the future of AI is in a much better spot today than it was a week ago. And, you know, when you think about the development of of you've got this nascent technology which has been kind of initiated by companies like Open AI and others, and with any company like that, it's a very young company and it doesn't have a corporate governance structure that is super robust. And then they start dealing with with Microsoft, which is a much larger company with a it was trying to move and commercialize AI. And so you get some friction. And so what's happened in the last week I think is really positive because you've essentially compressed the time frame, which could have been about a year or 2 or 3 years for open AI to mature from a governance standpoint. And it happened in a week. They've got Larry Summers now leaving the board. We've got San Sam Altman back in leading the organization. And so I'm I'm extremely excited. And I think that the future of AI today is probably in better hands than it was a week ago.
Yeah. So, I mean, let's let's think about what we've had in terms of data. I mean, we obviously had us and CPI, CPI and Canadian CPI come out recently and it's showing a slowing trend and we're getting a cooling of inflation and it's.
Still increasing, but it's at a slower rate.
That's right. Yeah. And we're getting to a point where it's becoming a little bit more palatable. And so as you think about what that means for the short term interest rates and decisions by the Fed and Bank of Canada, it's it's given them enough evidence to say, okay, maybe we'll stay on hold for now and see how the data comes in. And then, you know, as that translates to the equity markets, I would just say they're following the bond market, they're following yields. And, you know, it becomes really tricky and can be quite volatile because you're getting days when yields are moving around ten, 20 basis points and you're getting 50 basis point moves in a month. And what that means for equity investors or any investor in risk assets is that the risk free rate that you're using is the ten year Treasury yield. When that's moving around so much, it gets really, really difficult to get comfort that this is the fair value for any individual stock or the market. So I would expect volatility to remain.
Yeah. Can I. Is there anything just that we just talked about the fall fiscal update from a personal finance standpoint, taxes. And I'm not going to ask you about that, but did you hear anything from a deficit standpoint that makes you kind of pay a little more close attention?
Yeah. So so we were actually quite pleased. We thought it was a fairly responsible update and we didn't hear anything that scared us. And I think going in, there was some skepticism that we may hear about some bigger initiatives. And so I would just say it was disciplined. There was a narrow focus to the initiatives that they're bringing forward. And so nothing came out that really scared us.
Good. And I know we're going to talk a bit about earnings and some of the themes that you've been hearing in terms of what's been coming out of companies at this term. I have not heard. But, you know, the challenge right now for the central bank has been a stronger labor market. And the fact that, you know, they keep doing what they're doing and that they're not seeing, you know, unemployment numbers move up a little bit. Right. And you talk about labor hoarding, right?
Yeah. So so labor hoarding is a thing. It became a thing after Covid. And so what you had was a whole bunch of companies that let go of employees when they saw demand fall off a cliff. Yeah. And they tried to hire them back. And it was really painful and a difficult experience experiment. Expensive and expensive. And what it has led to is a theory that, you know, there are some some companies out there that are a little bit less sensitive to incremental changes in demand in terms of cutting costs. Yeah. And could that be a factor? You throw on top of that, some of the new on shoring trends that are taking place and we're building manufacturing facilities. And, you know, on top of that, some of the demographic trends that are taking place, there's an argument out there we can degree agree or disagree. It's probably a debate for another show, that there's maybe a structural supply demand imbalance in terms of labor in the market. We can debate that on another show. But for now, what that means is are companies currently trying to see how demand comes down to.
Try to smooth it out themselves.
And not making that kind of rash decision, saying, okay, I see demand starting to fall down. I'm going to cut. No, they're waiting around and they're seeing. And that causes some difficulty for the central banks who are just trying to say, no, we need to get inflation down. Wage inflation has to come down and it's probably not moving as quickly as they'd like to see.
That's interesting. What else are you hearing from from companies in terms of just the trends I was saying in earnings?
Yeah. So, you know, earnings season, Q3 wrapped up. It was it's always a good season. Companies always you know guide lo in that yeah and then beat so you had 80% of companies beat on earnings you had I think 60% of companies beat on revenues and you know at a high level, earnings grew year over year for the first time in several quarters. So that's a positive when you take out the Magnificent Seven. Earnings were actually down 4%. So they're up 4% with magnificent seven down 4% without revenue didn't grow as quickly, but it was still up. And you know, when you think about some of the trends we're hearing, I point to the consumer and and how different cohorts are doing as as a trend that came out quite clearly to us, I would say we heard from several management teams that the lower income cohort is weakening and they've drained down their excess savings and they're starting to see decisions which are slowing consumption trends across a whole bunch of different sectors. So we heard it from Walmart. We heard Home Depot come out and they said, look, purchases of of over $1,000 are down 6% year over year. So some difficulty in terms of low end consumer. Other than that, you know, some of the guidance came in a little bit weaker. So trends for Q4 and for next year, estimates are starting to trend down a little bit.
What about sectors? And when you when you come out like I know. You've got we can talk about industrials and real estate technology, but industrials, you're thinking things are looking okay.
Yeah. So industrials is a really great sector for us because it's such a diverse group of businesses and you have a whole bunch of different end markets. And you know, I'll go back to the the onshore near shore in French or and whatever you want to call it, there is activity that's taking place. And every time a new chip plant gets built in Arizona or a new air conditioning plant to supply the chip plant with air conditioners.
But it's all happening here.
It happens here. And so these industrial companies end up finding new verticals to sell their goods into. And it's you know, it does present probably an opportunity that isn't just a one year kind of time frame. Yeah. Real estate. Real estate. You know, there's there's pockets that concern us. And, you know, we would be avoiding certain areas of the retail mall space.
So you see all the distribution centers going up on all the malls, not doing so well.
That's right. That's right. We would we would probably be avoiding some office exposure outside of the main court. You got main quarter offices doing great outside. Maybe avoid some of that. And then you mentioned technology a lot. Yeah, I mean, I think technology is a theme that has excited everybody this year and there's still pockets that are very exciting. And when you think about the exposures to A.I. and not just the chips, but the productivity tools and companies that are presenting new opportunities for companies to protect margins and the data infrastructure, software companies, lots and lots and lots of good things happening there.
What do you think about my last question? We've got about a minute, but the the soap opera that is open is Sam Altman, because I think I kind of like they fired him. They brought him back. Now the boards fired, Now he's back. And I'm just like, okay, So.
Yeah, so it's what.
We all the entertainment value is there something interesting?
So, so it's great entertainment. I would say there's one big conclusion that that that is really positive from my standpoint, which is the future of AI is in a much better spot today than it was a week ago. And, you know, when you think about the development of of you've got this nascent technology which has been kind of initiated by companies like Open AI and others, and with any company like that, it's a very young company and it doesn't have a corporate governance structure that is super robust. And then they start dealing with with Microsoft, which is a much larger company with a it was trying to move and commercialize AI. And so you get some friction. And so what's happened in the last week I think is really positive because you've essentially compressed the time frame, which could have been about a year or 2 or 3 years for open AI to mature from a governance standpoint. And it happened in a week. They've got Larry Summers now leaving the board. We've got San Sam Altman back in leading the organization. And so I'm I'm extremely excited. And I think that the future of AI today is probably in better hands than it was a week ago.