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As markets trade at or near record highs, are corporate earnings justifying the recent run in stocks? MoneyTalk’s Greg Bonnell discusses with Damian Fernandes, Managing Director & Portfolio Manager with TD Asset Management.
Transcript
Greg Bonnell: Well, we’re in the thick of earnings season. US markets are trading in record territory, but as investors pore over the results, they may be asking whether these high valuations are justified. Joining us now to discuss, Damien Fernandes, Managing Director and Portfolio Manager at TD Asset Management. Damien, great to have you back on the show.
Damian Fernandes: Always a pleasure, Greg.
Greg Bonnell: So let’s talk about markets and record territory, earnings coming in to sift through. Do we think, from what we’re seeing from these corporations, that these valuations for the market are justified?
Damian Fernandes: Yeah, it’s market at record highs, and I loved your opening comments talking about the outlook for the S&P and the MSCI just before I left my desk. So global developed markets – the S&P is not a new, all-time high, but global developed markets are, and there’s this level of excitement – like, ebullience. People are happy.
But interestingly, this bull market’s been a long time coming. What I mean by this, right, if you just look at what’s happened – if you rewind all the way back to December 2022, so literally almost two years ago – that was the highs in the market that we had for 250 days. The market went down, you had this big correction in 2022, and then it’s in the middle of Q3, 2022, the markets are moving up.
It took over 300 days to get back to where we were two years ago. So we’re looking at this, and right now, the immediacy, right – it’s like, the market’s rallied 20% in the last few months, and that’s what’s captivating people’s attention, but this bull market’s been coming for a while and we’re breaking to new all-time highs.
But in that whole period, revenues have grown, we haven’t had a recession, earnings have improved, inflation has fallen. So if you just ask me – if you gave me those variables, if I didn’t know anything else – you told me that inflation is no longer giving the Federal Reserve and central banks agita. We know that they’ve ended their hiking campaign. We know that we haven’t been in a recession.
We know that earnings continued to expand – earnings bottomed in Q2 last year. I would say the market backdrop should be positive. So I’m not really surprised that we’re breaking out or making new all-time highs.
Greg Bonnell: So it’s interesting – that’s the broader market. But as we get these earnings coming in, as we can see, some names earn their way through…
Damian Fernandes: Snap.
Greg Bonnell: …and rise. Some names – like Snap and others – aren’t seeing the business improve, so they go down. So let’s talk about some of the good and the bad, I guess. Meta as an example – Meta’s quarter seemed to impress the Street.
Damian Fernandes: Meta was – Meta last – I think it was last Friday – and so it was up 20%. And you calculated this out. So Meta added close to $200 billion of market cap – $200 billion. The market cap or the wealth creation that day was larger than 435 companies in the S&P. That’s just egregious.
And it could be a sign of the times, but when you looked under the hood and you looked at the earnings, sales were up 25. Earnings were up close to 40. For the first time ever, Meta announced that it’s going to pay a dividend on a recurring basis. It’s buying back 3%, 4% of the shares outstanding.
So now, dividend mandates that were previously – you’d said we have to only buy dividend stocks – Meta now falls into that bucket. So you’ve expanded the potential sellers, and the underlying business is growing fine. Margins have moved up, so I worked this out, and even though the move – the 20% move, $200 billion of market cap creation – when you look at next year’s numbers, the stock is still trading at 21 times.
It is not – the market – like, the move is egregious, but the fundamentals aren’t. So look, I’m not pushing – I’m not saying that Meta is the greatest thing. I’m just saying that…
Greg Bonnell: But you run the numbers…
Damian Fernandes: You run the numbers, and this isn’t some speculative tech stock. We’re talking about over $1 trillion of market cap that is compounding at a very high rate. So compared to Snap today, right, which disappointed.
Greg Bonnell: I have to ask you about the risk for a name like Meta. After all, I mean the stock already had a great run. It pops 20% in one day, it creates this much wealth, and the numbers look good, but what do you need to be aware of?
Damian Fernandes: Well, the risks for Meta, or Alphabet, and these businesses is really twofold. One, obviously, is that right now economically, the data supports us moving into a soft landing or maybe even a no landing, which could be a risk, right – a risk on the other side that things are too hot. But the real risk for them is that if we do see a recession, we see a reduction in advertising spend.
That’s their core. That’s their bread and butter. That’s the core business. Like, Meta has aspirations for the Metaverse. That doesn’t matter. What matters is, are people spending more engagement on their platforms that they can promote ads on? That is how they generate money. And so that’s the big risk.
The second risk, too, for all of these companies – and you had their CEO in front of Congress just last week, in front of a panel – is that there’s always a regulatory risk around these things. And as these companies get bigger and bigger, there’s always significant regulatory angst where they feel that these companies are exerting too much influence. And, for instance, Meta is in a bad position because both sides of the political parties hate it for different reasons.
One for not enough content moderation, one for too much. You can’t – like, you have Zuckerberg, and he’s sitting there in this panel, and you’re like, how can you win?
Greg Bonnell: Let’s talk about what hasn’t been working because a lot of the big tech that worked last year is continuing to work, including Meta. Energy, materials, health care – what’s going on there?
Damian Fernandes: So if you look at – so it’s 11 sectors, right, across the market. Earnings are actually up 4%. Sales are up 3%, earnings are up 4%, so we are actually having margin expansion. Like, OK, it’s middling along. 4%– not that great. But when you actually break it down by those sectors, it’s really interesting because energy and materials are off more than 25%. Health care is off 15%.
So if you strip out those – we’re not trying to have fun with numbers, play with numbers – but if you strip off those sectors, the rest of the market is growing double digits. And when you look at energy and materials, I think – like, all your viewers understand this – oil is struggling to break $75. Oil was $80 bucks last year. So obviously, energy companies are beholden to the price of oil and what they can sell at, and so that’s weighed on the earnings outlook there.
Materials companies – your biggest customer in China is actually facing deflation. CPI is negative for the past few months there, so some struggles there on an economic revival.
And then the other sector, which I thought – which is kind of unique – was health care. But when you look into the health care earnings, you’re like, why is health care off 15%? That’s a pretty big number for what should be a stable sector.
And it’s really one company. It’s Pfizer. Pfizer in Q4 of 2022 generated $1.10 in earnings. This year, they’re generating, I think, a little over $0.10, so earnings are down 90%, and that’s all because – we understand, right?
Like, they had a big, humongous gain from the vaccine and vaccine take-up. As that’s ebbed, they’re just not – like, people have slowly moved from COVID and the vaccine take-up has been much lower. Pfizer is way down health care earnings, but going forward, the rest of health care is doing fine.
So I actually think the earnings outlook is quite positive when you look at how the sectors – we talked about tech, obviously, but even just consumer discretionary industrials – they’re all growing earnings, high single digits. And it’s these unique sectors that are tied to materials or energy that are actually pulling down the earnings number.
Greg Bonnell: Now, you talked broadly about risks in the form of a recession that could hit advertising spending – some of these big tech names that are working. What about on the other side, the risks – and you said the word no landing. What if there’s no landing? What if the Fed doesn’t feel like it has to get aggressive on cutting rates?
Damian Fernandes: So last year, people were preoccupied. Last year, the market climbed the wall of worry, right? People were waiting for this recession. It’s almost like waiting for this recession to manifest, and it just didn’t happen. The market – SVB in March last year – we didn’t have a contraction in lending.
And so all of these data points were supportive. What’s actually happening – and I know you’ve been talking about this – is that the growth that’s been coming out has actually been much better than expectations. We had a blowout jobs number last week in the US, right? Over 300,000 in payrolls. The estimate was 250.
Initial jobless claims are sitting at five-decade lows. The labor force has grown twice in size, right, and so you have – consumer confidence was out last week. So the risk, I think, right now, is the market’s been very comfortable that inflation is falling, and that almost motivates the Fed to stay on hold, maybe even cut, if inflation is falling.
But the risk right now is if the underlying economy is actually growing much faster than trend, and they have this really wonderful – this real-time estimate. The Atlanta Fed actually publishes it. Real-time GDP, the point estimate right now and we’re just a little over a month into the quarter – has a four handle on it. Like, real GDP is tracking it.
Greg Bonnell: This isn’t what we were expecting.
Damian Fernandes: We were expecting 1 and 1/2. It’s tracking at four. Now, like this, we’re still very early and it could – but these things, I can tell you, if we end Q1 with a four-handle in GDP, the Fed’s not cutting rates. The Fed might be flirting with maybe even, this is getting too hot, and I might have to preemptively – I’m not advocating that. I’m just thinking that.
And I think the market as no landing is a worry because if growth continues to grow above trend, that puts pressure on the Federal Reserve and keeping rates where they are where they’re restrictive, or just not cutting rates. And I think that would be a surprise.
