Fed is ‘relentlessly moving toward tightening,’ strategist says
Stifel Chief Equity Strategist Barry Bannister joins Yahoo Finance Live to discuss the outlook for the stock market as investors await this week's Fed meeting.
- Barry, it's good to talk to you today. As Jared said, he said when Barry talks, we should listen given where things moved yesterday. And you've said the intraday relief rally we saw yesterday was a bit of a head fake and that there's more downside ahead. What do you see?
BARRY BANNISTER: Well, we first got pretty concerned about the market in May of last year in the very low 4,000s. And it looked like almost a ballistic path for the market where it climbed the stairs and then fell out the window. The market dropped very abruptly. And that's something we had been concerned about back to those levels of last early summer.
If the Fed does not turn more dovish, which I have no reason to expect-- we've not yet seen financial conditions tighten or credit spreads widen. There's no reason for them to turn dovish before the first rate hike in March. They would lose all credibility. So the Fed relentlessly moving towards tightening. How much is priced into the market? The big issue that we saw was that the 10-year real yield, 10-year after inflation on the Treasury-- called the TIPS or Treasury Inflation-Protected Securities-- we determined that there was a lot of convexity for the growth stocks. They were the more sensitive index to a rising real yield. And that's what we've seen year to date.
And so we've been watching that. We're also watching economic indicators. Some of the value trades got ahead of themselves given that we felt inflation pull back, that the Purchasing Managers' Index would pull back and that China's stimulus would be somewhat lacking. In other words, they're doing just enough to avoid a debacle, but not a lot. And so overall, we still would wait on the market. I think the defensives are the better place to be in the next couple of months of this quarter. And then we'll reassess towards the end of the quarter what the potential is for growth stocks, perhaps, to rebound if inflation moderates and the Fed is cautious, to a degree, about the balance sheet and the interest rate path.
- Jared just pointed to that 4,200 level that you're watching, the S&P 500, as you look to more downside. How long do you think it takes until things shake itself out? Are we talking about the end of Q1? What kind of timeline?
BARRY BANNISTER: Yeah, the end of Q1 is when things become a little more clear. The Purchasing Managers' Index, the PMI for manufacturing, is kind of the Swiss army tool of economic indicators. It does correlate on a year-over-year basis with industrial production, S&P 500 earnings growth, and the year-to-year S&P 500. That index, in the first few months of this year, is going to fall out of bed from almost 60 to barely above 50.
Also, the dollar is very important. That has a way of tightening global dollar liquidity. You translate all the money in the world into dollars. The dollar is strong. Global liquidity is tightening. The Chinese yuan is the currency to watch. We have been seeing how strong that currency has been because of their large trade and other current account surplus.
But China has an incentive. And of course, the market forces them to push the currency down, which drives the dollar up to disinflationary shock, not particularly great for value, eventually not great for oil prices. Ukraine's kind of in the background. It's very, very important for oil and gas prices. I don't think Putin intends to invade, but he's got a valid point about Ukraine not joining NATO ever. So that hasn't been resolved yet. And that's a potential real issue for the market. You could see a severe winter on account of that.
- You know, Barry, even as we continue to move on forward through earnings season as well and get some of the companies' forecasts, many of them pointing back to pre-pandemic levels that they're looking to see either revenues or profits grow on top of. And so with that in mind, how will investors who are hearing about some of that growth versus those pre-pandemic norms-- how do you believe they'll trade on those scenarios, even with some of the headwind risks that you mentioned?
BARRY BANNISTER: Well, if Hollywood made a movie about the pandemic fiscal and monetary response, it would have to be called "Overboard Part Two." The spending at the fiscal level on COVID was just excessive, $5.8 trillion. $5,800 billion were appropriated 12 months, March of '20 to March of '21. To put that in perspective, if you inflation-adjust the cost of World War II plus the Marshall Plan to rebuild Europe plus the Global Financial Crisis fiscal response plus the Great Recession fiscal response back in the prior decade, all of them combined was less than $5.8 trillion.
And then the Fed, of course, did QE4 at a rate 45% larger than Ben Bernanke's QE3 had ever been back in 2013 and had to eventually soak up that money on the back end. In other words, overnight reverse repo became 12 months of QE. So when you look at how much over-replacing income in fiscal and stimulus to drive down risk premiums drove up the market, it's a very high bar for the market to cede. And I think that's going to be a real problem for earnings growth and beats versus miss rates. And you're seeing it in the market today.
- Well, Barry, it's great to get your insight today as investors try to make sense of the most recent moves. Barry Bannister, Stifel chief equity strategist.