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The Fed ‘is not finished with its interest rate hikes’ amid high inflation: Strategist

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Opimas CEO Octavio Marenzi and Clearnomics Founder and CEO James Liu join Yahoo Finance Live to analyze inflation fears, the pressure of rising gas prices, and the Fed's interest rate hikes.

Video transcript

- Here was that closing bell on Wall Street.

[NYSE CLOSING BELL]

[CHEERING]

- That was the closing bell sponsored by tastyworks. Let's take a look at where things ended the day, Dow, S&P, and NASDAQ all in the red, like Jared was just saying, the NASDAQ the big loser of the three major averages, off just about 3%. We're seeing that reflected in the tech sector, the XLK among the worst performers. That's also off just around 3%. S&P closing down 2%, Dow off 1 and 1/2 percent. We also got some pieces of econ data out this morning, the consumer confidence index falling once again in June. And, really, we're seeing that movement to the downside in the markets as a result of that data point.

Well, for more on this, let's bring in Octavio Marenzi, Opimas CEO, and James Liu, Clearnomics founder and CEO. James, first to you, another day, we're seeing tech out of favor. We saw that reflected in the NASDAQ, the XLK off just about 3%. What do you make of the selling that we're seeing in the tech sector and this rotation out of the growth names, once again?

JAMES LIU: Well, Shawna, you're basically seeing this day-to-day rotation between tech and the former high-flying sectors and those that are responding to inflation, like energy, materials, and sectors like that. And, really, what the market is looking at today, which reflects the two most important indicators right now, which are oil prices, which, of course, drive that headline inflation, it drives gasoline prices and the impact on consumer. And the second is consumer expectations, which is, even if we resolve higher gas prices, even if those do come down over the next year, will this already be baked into consumers? And so, these are the two most important factors right now. Right now, there's still no light at the end of the tunnel. However, there are reasons to look at valuations here and think that there are some more attractively valued parts of the market, now that things have come down so much.

- And we'll circle back to that in a minute. But, Octavio, let's get the same to you in what is driving this down day?

OCTAVIO MARENZI: Well, I think what's really driving it is that inflation fears remain, and the Fed is gonna have to step in more aggressively and drive up interest rates further. And that's very, very bad for tech stocks. Tech stocks, in general, are very sensitive to interest rates. So much of their earnings potential is in the growth in the future. And as you discount that as a higher interest rate, just as stocks become worth less. And that's gonna carry on. I don't see any end to that. I think the Fed is not finished with its interest rate hikes, by any stretch of the imagination. I think they've got a long way to go still. And that's gonna be very, very bad for equity markets, in general, but I think the tech stock and sector in particular. So I'm not expecting any turnaround anytime soon here. I think this is a down market that's got some legs, and it's gonna go on for some time to come.

- And, James, in terms of what is most attractive to you right now, what is that, and what criteria are you using?

JAMES LIU: Yeah, It's difficult. There's basically two areas, and it's really value. That's kind of where everyone is kind of hiding, in some sense, because of the reversal from growth to value that's occurred over the last year or so. And then the second's looking at valuations. So, tech, of course, is unloved right now, you look at a day like today. However, it gets to a point where once, at the index level, you're down 25% to 30%, the sector overall can start to become more attractive. And so, this is, to be clear, not sort of a day-by-day, week-by-week type of play. This is a much longer term play. Because, overall, if you do think that eventually inflation will subside, which I think most folks still hope will happen, then at some point, the pain that you're seeing in tech and these formerly high-flying areas could start to reverse. And you've already seen the reversal in the performance of areas like energy, for example, over the last couple weeks. So, over time, we'll start to see that kind of stabilize between those two types of sectors. And that's kind of what we're playing for here on out.

- Octavio, you just said that the Fed has a long way to go, it's bad for the equity markets, but you could see the markets in a downturn here as a result. How bad is it going to get? Well, I think you have to look at how far the Fed is gonna have to increase interest rates to get inflation under control. And I think, so far, the increase has been very, very tepid. This has been very, very small increases so far, basically. We've got the Fed Fund Rate still under 2%. That's historically a pretty low number. The last time we had inflation this high, the Fed had to raise the Fed Fund Rates all the way up to 15% and more, and had to keep it above 10% for two or three years to get inflation under control. So I think that's the kind of scenario that we're looking at here, that the Fed is gonna have to increase that Fed Fund Rates and other interest rates above 10%. And that is what it's gonna take to get this inflation under control. And that means we're in for a long, negative ride in the equities markets and in the tech sector, in particular.

- Can we get back to 2%, Octavio? Or is there a new norm ahead?

OCTAVIO MARENZI: I mean, that's a great question. You know, I think there's all sorts of variables in play there, in terms of efficiency gains, and productivity, and China opening and closing, and things like that, that, basically, have been driving prices over the course of the past 10, 20, 30 years, depending on what time horizon you take. And some of that has been sort of deflationary in nature. So, China opening up 40 years ago had a big deflationary impact, in the sense that things got cheaper. They produced a lot of really cheap stuff. And that effect is sort of drying up now, I think, more than anything else.

You could make the same argument about sort of IT efficiency gains over the last few decades that also is deflationary, as you have an efficiency gain that people can simply produce more for less. So those things seem to be drying up and run their course. So we might be sort of facing a situation where we have permanently higher inflation. And the only way to really get that under control is to jack up interest rates and stop the money supply from growing. But I doubt that this Fed really has the stomach for that.

- Obviously, James, as we look at inflation, this bellwether when it comes to consumers, consumers really the strength of the US economy, what are you keeping an eye on there, being that gas prices, although they have ticked down slightly, still too high for most consumers?

JAMES LIU: Yeah, well, that's right, Rochelle. I mean, it really is about gas prices. Because that's the most, kind of, obvious thing that consumers look at. It's very salient for them. And that's really where it affects the consumer pocketbook and the psyche the most. And I think the fear is that that gets, then, baked into consumer expectations, based on the data that we saw today and the other consumer sentiment data that we've seen over the last few months. And that creates this inflationary spiral.

, However that's different from what will cause inflation to go down, right? So even if oil prices stabilize or even decline a bit from here, you look at headline CPI and it's 2 and 1/2 percentage points above core CPI. Core CPI, which excludes energy, is still 6%. And so, in order to bring that down, you would need all of those factors that we were worried about over the last year, which are computer chips, supply chains, all of those issues, to start to come down, as well.

So it is the case that the Fed is responding. And they will need to respond further in order to make sure we don't get this inflation spiral in expectations. However, we do need these underlying factors in the economy to start to turn over, not just in energy, in order to see actual inflation rates start to moderate.

- Octavio, Russia's war on Ukraine certainly is something that investors are closely watching here in the US. We had some developments over the last couple of days at the G7 meeting. We're seeing the pressure on Russia being-- increasing, I should say, with a number of new sanctions here targeting the country. How significant do you see that being, I guess? How big of effect will that have on Russia? And what does that mean here for US equity markets?

OCTAVIO MARENZI: Well, I think so far, all these sanctions have basically rolled off the Russians' back like water off the back of a duck. It seems to have had no impact whatsoever. So the ruble, now, is trading at a much higher level than before the invasion, you know, lost about 50% of its value. But now, it's stronger than it was before the war. The Russian equity markets, the RTS Index, is basically back to the level it was before the invasion. So if you look at over the course of the past three months, the RTS Index in Russia is the best performing equities market in the world. It gained over 74%. So if you were really smart, you would put your money there.

The other thing is that interest rates in Russia, they spiked. They went from 9.5% before the war all the way up to 20. And now they're back down to 9.5. So everything seems normal. Now, Russia even defaulted on its debt now, at least technically. But the yields on Russian government debt have remained really low, or relatively low. I mean they're are 8.5%, but they haven't spiked the way you would've expected to see for a country that's defaulting on its debt. So you would've have expected 30%, 40% interest rates there, if they could access capital markets at all. None of this has happened.

So I feared that these additional sanctions, now the G7 is talking about, is putting a cap on the oil price for Russian oil or banning Russian gold exports, is gonna be more of the same. It's not really going to affect Russia at all. And I would say, it seems like the Russians have sort of anticipated all these moves. And they thought through this and said, if we invade some place, what is gonna happen, and have a playbook, almost, it looks like it. And they're playing it in a very smart, shrewd way. And I have to give the devil his credit there that they've been able to do that very, very effectively. It makes the West look a bit flat-footed in comparison, I must say.

- It sure does. And perhaps they knew they'd have help from China and India, continue to buy their energy. Thank you, Octavio Marenzi and James Liu, appreciate you both.

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