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With a soft landing considered a best-case scenario, are current earnings estimates too backward-looking and not representative of true forward expectations? Kim Parlee speaks with Ben Gossack, Portfolio Manager, TD Asset Management, about the uncertain economic road ahead.
Transcript
It’s been two-plus years since the first wave of COVID-19 and we are still dealing with supply chain problems. And that’s contributed to a multi-decade high inflation rate. So have we seen the worst of it? Joining me now is Ben Gossack, portfolio manager at TD Asset Management with some thoughts on what he is watching to determine that very issue. It’s nice to see you.
– It’s great to see you in person.
KIM PARLEE: I know. It’s a bit weird as we all get kind of used to seeing each other again. You have a chart, I know, that you brought us to help illustrate whether these global supply chain pressures are abating. So let’s bring it up, and maybe tell me why it’s caught your attention.
– Sure. So trying to monitor supply chains, very complicated, you have different countries, different networks. So we have a chart that was published by the New York Federal Reserve. They released it at the beginning of the year. And what’s really nice about this chart is that we can look at everything from a standard deviation perspective. So anything between plus or minus one standard deviation is not really statistically significant.
KIM PARLEE: Which I could say basically happened all the way up to 2019, it looks like.
BEN GOSSAK: Right. And zero is average pressure. To give you some perspective with COVID, because we had to shut down the economy, it was a three standard deviation event. And then what’s been surprising is just how persistent the pressure has been. And in fact, it might surprise people that at the beginning of the year, it had gotten worse to a four standard deviation event, and that’s just the compounding of the Delta and the Omicron waves. And now it was easing, but it did get worse with the crisis in Eastern Europe and the lockdowns in China.
KIM PARLEE: So it looks to your point, sort of neutral, really bad with COVID-19, then, surprisingly, to your point, worse after COVID-19. But it is trending down on the top right-hand side of the page. So is that good news?
BEN GOSSAK: And that’s the good news. The short answer is at the margins, yes, we are at unprecedented levels, but we are easing. And then day after day, we’re getting better news out of China. And that’s starting to — we’re going to see good start to flow. And so the big issue and the reason why we’re at such high standard deviations is that the delivery times have just blown out, and it just compounds and compounds. So supply chains are complicated. Someone’s customer’s is another’s supplier. And if you can’t get a part, you can’t ship a finished good. And it just builds, and builds, and builds, and builds.
KIM PARLEE: Ask anyone who’s trying to buy phones, computers, cars, anything. So the supply chain looks as though the pressures are coming down a bit. They’re still elevated, though, to your point where they are. But I know that you were taking a look to see what’s happening in the retail sector at the same time to see that as a bit of a disinflationary factor. So what are you seeing there that could also help bring that pressure down.
– So the issues in supply chain created a scarcity of goods. All of us were sort of locked in our homes, changed our spending habits from services to goods. When you look at good spending, it’s well above trend. It put a lot of pressure on the retailers, better to overpay to have something on your shelves than have nothing on your shelves. And so they double, tripled ordered, paid up for whatever transportation costs.
And so what we were worried about and what we’ve been worried about since last year is that when the supply chain started to ease and product started to flow, would customers still want that product? Would it still be in season? And so what we’ve kind of been seeing in the last couple of weeks is retailers coming and saying, oh, no, the inventory has come in and it’s building up, and customers have shifted their preferences.
– And so now they have to clear out that inventory or whatever and get rid of it, which could be more disinflationary I assume.
BEN GOSSAK: Yeah. So the fact that we’re starting to get goods coming in and getting to average pressure for the supply chain would help goods inflation, and that was what was driving core CPI so that’s taking out gasoline and food costs.
And the fact that retailers — so having so much inventories will be depressing to margins, and that’s the lifeblood for a retailer. So you’re going to expect discounts and promotions in order to move that product. We’ve seen that from the major retailers. They’ve made that announcement. That should also bring down the prices that we’ve seen for goods.
KIM PARLEE: If people are paying less for goods, they have more money maybe perhaps to spend on other things. And I know that you still like services. You still like the travel side of things right now. You manage the TD Active Global Enhanced Dividend ETF, which has been winning awards, I believe, and the TD Active US Enhanced Dividend ETF. Can you tell me what is interesting within those ETFs and why they’re in there, what you see in them?
BEN GOSSAK: So while we — goods was above trend spending. Obviously, services, because they were shut down, we were below trend. Today, we’re only getting back to trend, and we expect that we’ll probably see an overshoot.
Now, as you said, lower prices for goods is helpful. Having said that, gasoline is more expensive, food is more expensive. But while we are seeing inflation in services, and in particular travel, it’s an inflation that most people are willing to tolerate and defer the consequences of that because travel was withheld from them for so long.
KIM PARLEE: I just got to go somewhere.
BEN GOSSAK: And they just got to go. And they know they’re overpaying, but they want it, they get utility out of it, and they’re willing to overpay and put that on their credit card, defer that to next year. So again, companies we’ve talked about before, Hilton, American Express, they tend to benefit from the travel-related services that people are willing to pay no matter what the costs are.
KIM PARLEE: What about the market overall because we’ve seen some very significant pullbacks this year? Obviously, technology and some of the high flyers have really come crashing down. But you say just because prices have gone down, that doesn’t mean now is still a good time to get in. And you’ve got some — with regards to PE.
– Right. So let’s say a stock was $150 and now it’s $100 or $80, is that a great deal? And so when we look at the market, you’re hearing people say, oh, we’re a fair multiple. It used to be 23 times earnings. Now it’s 18 on expectations for this year. In the next 12 months, it’s about 17.
What does that mean from a historical perspective? The market trades at a 15 times PE. Since, let’s say, 1970, that’s a mean PE. And I would argue that we should pay more for a dollar of earnings in the S&P because the companies that make up the S&P are of higher quality.
KIM PARLEE: Yeah.
BEN GOSSAK: But having said that, you have seen the retailers have to take down their expectations. We saw a surprise from Microsoft to take down earnings. And what may actually surprise you is that expectations for earnings today, given all the bad news that we’ve been hearing, are actually higher than they were at the start of the year. And that tells me is that the numbers are stale.
And so it might not be until we get Q2 reporting where management might have to take down their expectations. So while people might tell you that the market’s cheap or it might look cheap from a historical perspective, it’s the E’s that have to get adjusted, and they look like they’re going to trend lower.
KIM PARLEE: Ben, always a pleasure. Thanks so much for joining us.
– Great. Thank you.
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