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As the U.S. economy shows signs of resilience, investors are having to digest growing uncertainty about the Federal Reserve’s policy path.Anna Castro, managing director and head of retail asset allocation at TD Asset Management, said the important thing is not the timing of the rate cut; You remain invested.
transcript
Kim Parley – Well, what a difference some inflation reporting can make. Recent U.S. consumer and producer price data show that inflation remains somewhat sticky, raising questions about whether the Federal Reserve is unlikely to cut interest rates in June. My next guest said it’s not the timing of potential cuts that matters, but whether you continue to invest.
Anna Castro is a senior portfolio manager and head of retail asset allocation at TD Asset Management. She joins me now. Glad you’re here.
Ana Castro – Thanks. It’s great to be here.
Kim Parley – You have some great diagrams. We love charts, so thank you for bringing them in so we can look at them. But first, I feel like market watchers tend to be a little obsessed with inflation data and the timing of the Fed. Maybe just before we say it doesn’t matter, it’s just what happened?
Ana Castro – So you’ve seen some of the more stark inflation data, particularly in the United States. We have always believed that at this stage, the last mile so to speak, the road to the Fed’s 2% target will be bumpy. It’s funny because I’m often asked which month is the Fed going to cut interest rates for the first time? But what’s really more important is that we’re at the peak – given the signal, we’re at the peak rate. More important is the magnitude and speed of long-term interest rate levels over the next 12 to 18 months.
Kim Parley – Well, again, time doesn’t matter. We have to see what actually happens once they start and what happens afterward.
Ana Castro – Especially since inflation overall, while still high, has slowed. So it’s no longer up or in the high single digits. Another thing that makes them more confident about waiting or being patient is that the labor market is slowing down. But overall, it’s still solid and healthy.
Kim Parley – interesting.
Ana Castro – This is a good place to wait.
Kim Parley – OK Now you’re saying, let’s not focus on the timing of interest rates and so on, but rather on what companies are doing and how profitable they are. We’ll see the graph. I know you’re going to pull this out, but it’s a nice looking chart. But please tell me what you saw.
Ana Castro – So the shift now is no longer about worries, about inflation, but about growth prospects. Economic growth is therefore driven by the consumption patterns of governments, businesses and individuals. So we know that under these circumstances, individuals’ balance sheets are generally healthier than they were before. They have jobs. So what’s really important right now is focusing on the health of the business.
Generally speaking, profitable companies will continue to be able to spend their capital expenditures, continue to pay existing workers, hire more workers, pay down debt, and raise capital and grow. That’s why it’s important to focus on company profits.
Kim Parley – Well, let’s look at them. Let’s open up the chart because it shows up this cute little groove. You can see they’ve bottomed out and look like they’re starting to pick up.
Ana Castro – Yeah, so using the largest publicly traded U.S. stocks – U.S. companies – as a proxy, we get S&P 500 earnings per share growth. The blue line shows that overall, expected earnings growth actually bottomed out sometime late last year. Looking forward, growth is expected to be approximately 10%.
What’s more important is that orange line you see there, actual or reported EPS growth is above the blue line. So these companies actually reported better than expected, or even beat them.
Kim Parley – From a company’s perspective, this means good PR. They performed better than people expected. Let me ask you, because you have another chart here that I think shows something interesting. Because a lot of what’s going on in the market right now is people are like, this is artificial intelligence, and there’s a lot going on. But it seems to be expanding at the same time.
Ana Castro – Right, that is it. So what we see in this chart are actually earnings revisions. One year later, what’s the view? How analysts and company management indicate their expectations for earnings growth. So, yes, what you see here is that the orange line Information Technology has indeed been the source of the earnings growth correction over the past few months compared to the gray line.
But you also see the blue line, where we’ve highlighted consumer discretionary, financials and industrials. These companies have greater exposure to cyclical risks and are sensitive to interest rates. You’re seeing an inflection point. They’re doing better, which means company managers are becoming more comfortable with the outlook they see for interest rates, economic growth prospects and inflation risks. Their view on earnings growth is starting to improve.
This is a good thing because it also shows evidence that there are always winners and losers. We have broad indexes here, but there are many cycles within each industry. What you see is that even if we have higher-than-expected inflation, or in this case, interest rates remain elevated, those quality companies with strong balance sheets, strong management teams, resilient business models can Thrive longer in this environment.
Kim Parley – I think it all comes down to, it’s your wheelhouse, it’s about proactive management. It’s about finding those companies that can thrive in this environment. But I think it’s still an optimistic conversation.
Ana Castro – Yes, because I want to emphasize that this is not just about one asset class or one industry. There is value in having a diversified portfolio. Yes, there is always noise. There will be something. You might see an inflation surprise, geopolitics, or some news that worries you about the economy.
But now it’s not just the macro, it’s also the micro. Because you have all these themes, it’s important to have a team that can look across the universe for all these different exposures that are beneficial to your portfolio, whether it’s equities, fixed income, real estate, infrastructure or currencies. This way, even short-term fluctuations may lead to long-term buying opportunities that set you up for success.
