Lesley Marks on the stock market and Europe

(Runtime: 8 min, 51 sec)

Text transcript

Speaker 1:

Equity market has certainly been a tough place to be fixed income as well, but we’ll talk to equities, and we’ve seen a fair amount of decline year to date. Do you think that we are at the point of maximum pain in the sell-off? Hard to call bottoms, of course, but what are some signs and signals that you’re looking for?

Lesley Marks:

So, there’s two ways I would answer that question. The first is just to get some perspective or give some perspective, I should say, and when you look at the sell-offs that have happened in history over the last almost 100 years, there’s been six periods or six years where we’ve seen a greater than 20% decline in equities. And remember, we almost hit that, not in Canada, but in the U.S., we sort of bounced at that 20% decline, but I just picked that number, because a lot of people look at 20 as a bear market or it’s just a milestone number that a lot of people focus on. In five of those six cases, the following year resulted in a greater than 20% increase in equities, and so the only time in history that we saw multiple years in a row of declines of greater than 20% was in the Great Depression, 1931-32 period.

Lesley Marks:

And so unless you think that we’re heading into that type of environment, and I don’t think that we have the conditions that would set us up for a great depression here, as I said, I think of this as more a post-COVID dislocation that’s impacting markets and we need to get back to regular times here. I don’t think that we’re heading into a multi-year decline in equity, so let me start there. Now, the second thing I would say about that is, I’m not just giving trivia here, there’s a reason why markets do bounce typically after large drawdown years, and it’s what I like to refer to as the good old-fashioned business cycle.

Speaker 1:

Sure.

Lesley Marks:

Which is exactly what I think we are experiencing right now, which is, things get overheated, inflation runs hot because the job market is tight, there’s too much demand and not enough supply, and I know a lot has been spoken on your podcast about that, so I won’t go into details about the supply and demand issues today because I don’t think we have time for that, but when the central banks remove liquidity, the intention is to impact demand, obviously they can’t impact supply, to bring demand and supply more into balance.

Lesley Marks:

So, I think that that’s what eventually happens, and then you start to see prices start to come back and inflation gets under control, and then we start the next business cycle and the market obviously discounts into the future, so equities would start to rally once they start to believe that we’ve hit the bottom and now we’re going to hit economic growth because the central banks have stopped tightening. So I think that’s a good segue into what I’d be focused on, coming away from the statistics and the way it’s worked over the last 100 years, there’s three things to focus on to say, “Are we there yet?”

Lesley Marks:

The first is liquidity, which I touched on. I think once the market perceives that central bankers, The Federal Reserve, the Bank of Canada, are done hiking, then I think we have one important setup for equities to bottom, and I think that a lot of the increases of interest rates have been priced into the market, and we’re probably getting close to thinking that we’re at the point that the central bankers will have gone far enough, that inflation is perceived as under control. The second is earnings, and earnings is really probably the next shoe to drop, if there was one for equities, which is the revision downwards of earnings, that is really only just starting, and it’s very difficult to know how far we’re going to need to go when it comes to earnings. Now in Canada, it’s been interesting because overall TSX earnings, that’s been the one market where earnings have been revised upwards because of energy.

Lesley Marks:

So it’s actually been a good tailwind for Canadian equities, and it’s a big part of why Canadian stocks have outperformed global equities. The third one is sentiment, which is another factor that I don’t think we’re there quite yet, which is that maximum pessimism where you just get the sense that everyone has thrown in the towel on equities, that feeling that equities are never going up again, that maximum level of fear, and while we’ve had people be very negative on the market, I don’t think we’ve hit that maximum fear gauge. So as you know, none of us have the crystal ball, it’s hard to predict the point in time when all of this comes together, but those are the three things that I’m really focused on to converge to say, I think we’ve hit the bottom here.

Speaker 1:

Right. And based on your explanation there, you think that on the liquidity side, we’re fairly close, but with both earnings and sentiment, we might have a little bit to go.

Lesley Marks:

Exactly. And what I want to clarify on the liquidity side is, I’m not saying we’re at the end of the Fed hiking cycle.

Speaker 1:

Right.

Lesley Marks:

What I’m saying is, what is priced into the market is almost what we think will probably be the maximum tightening that we expect to experience.

Speaker 1:

Perfect. Maybe we’ll turn to Europe now, we were talking a little bit about Canada, perhaps we can come back to the U.S., but in Europe, it feels as though it’s probably a little bit more negative, a tougher environment. I’d say that the war in Ukraine has gone on longer than most people had initially expected, and there’s lots of collateral damage or potential collateral damage to the European economy as a result. Do you think Europe is able to avoid a recession under these circumstances?

Lesley Marks:

Well, I’m glad you asked about Europe because it’s topical today, on this day for two reasons. The first is, we just saw the German inflation print, which hit 8.7% year over year, and the expected number was 8.1, so I think it’s a sign of things to come in Europe and really highlights the extent of headwinds that this region is going to experience, and there’s really a confluence of events here. The first is obviously Russia’s invasion of Ukraine and the collateral damage that that is causing in the region, in two important areas: one being energy and the second being agricultural commodities, which impact the price of food. So I think to the extent that we are seeing the impact on inflation of those two issues, it’s going to be very difficult for Europe to avoid a recession.

Lesley Marks:

Another factor that’s really impacting Europe is that Europe, particular Germany, is very impacted by the lockdowns in China, which is an important market for Germany, and so I think that, in that context, it’s everything coming together at once to be a strong headwind for Europe, which was already a lower growth market. So I think that Europe is a region that is going to continue to need fiscal support, as the region goes through what, as you said, has been a longer conflict than any of us expected. And consensus earnings growth for the region for Europe is only 3% this year, and it’s been revised down significantly year to date. We could see earnings growth turn negative for Europe. It’s also one of the slowest growth markets by expectations at 2.8%. Again, I think 2.8 is going to be a really hard number to hit for the year, and so I think Europe is going to continue to face significant headwinds and we’ll need a very different fiscal and monetary support package than we’re seeing in North America.