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Luc de la Durantaye, chief investment officer, CIBC Asset Management.
I think the equity market, I don’t believe we’ve reached the bottom just yet. I think we’ve had a first leg that triggered the initial correction, which was one that was mainly driven by valuation. We have generally an inverse relationship between inflation and valuation, and then the rising inflation has put downward pressure on valuation. So that was the first leg down in the equity market. We probably have corrected, depending on the market, certainly the U.S. market was the most expensive, but we have made a significant degree of correction in valuation from overvalue to say fair value to this point.
The next leg will be because of high inflation and more sticky inflation, the central banks have shown their colors that they were focusing on inflation, no matter what the impact on growth would be. So the next stage would be what damage and how much damage do we do on earnings, which is going to be evaluated by investors. So, we think that analysts are still too optimistic about earnings and they need to be revised lower. So that’s the next leg and some of the signals or signposts.
But obviously, the other signpost or signal to monitor is inflation itself. The central banks are not forward-looking. They want to see confirmation that they will control inflation. This is something very important because central banks, and particularly the Fed, had lost a degree of credibility when they had the narrative of transitory inflation. They obviously were wrong about the transitory aspect of inflation. This time around, they can’t make a second mistake by preemptively thinking that inflation has peaked, and they would lose credibility if inflation has not peaked. So, the risk is that they over-tighten relative to under-tighten. That means that there’s maybe more downside to earnings given those circumstances.
We would be looking at earnings, but we will also look at the progress that central banks are making towards inflation. Unfortunately, some of the numbers of inflation remains elevated and it could remain elevated for a little longer on two fronts. One is from rents and owner’s equivalent rent, which is an important component of inflation, these numbers are lagging and they haven’t even started to peak yet. It’s going to take a while for this component of the CPI to turn, but even if that starts turning, and interest rates have hurt the real estate market.
The other component is the labor market. The labor market remains relatively tight on different fronts. The unemployment rate is at historical lows, somewhere around 3.5%. Job openings are still quite elevated versus what is available, and because of demographics changes, the availability of worker is not increasing. We have a flat to a fairly flat participation rate, which means that the easing in the market has to come through a decline in job opening and potentially also a rise in unemployment. So those are slow-moving data and we think that there’s still a degree of work to be done on both fronts of inflation, therefore, that brings us back to let’s be patient before going back into the equity market.