Inflation will become a headwind for a 'pretty big drop in the market': Key Advisors Group Partner

Eddie Ghabour of KeyAdvisors Group and Author of "Common Sense Bull" joins Yahoo Finance's Brian Sozzi and Karina Mitchell to break down the latest market action.

Video transcript

KARINA MITCHELL: We will stay on the markets and bring in our good friend Eddie Ghabour. He is from KeyAdvisors Group, and the author of the "Common Sense Bull." Eddie, thank you so much for being here. I'm only half-joking when I ask you this question. Do you think Fed Chair Jay Powell has finally got the message that inflation isn't transitory, because everybody else has, except maybe Janet Yellen? What comes out of the Fed? What do they say this week about when they start tapering, and maybe more importantly, when they start rate hikes?

EDDIE GHABOUR: Well, this is a huge week for the Fed, because I think, at this point in time, if they don't admit to the fact that inflation is here to stay and it's not transitory, they're going to lose a tremendous amount of credibility. And so the thing that the market's going to watch very closely is are they going to accelerate their tapering plan? Are they going to talk about raising rates next year? You know, and if they change that to show a more hawkish tone, because inflation has certainly exceeded what they said was going to happen, then that's going to cause a little bit of a sell-off here in the near term from a market perspective.

But I've gotta tell you right now, so many people came into this quarter so bearish in September that I think any dips are going to be bought here in the fourth quarter. We continue to be extremely bullish in the fourth quarter. I can't imagine a scenario of more than a 2%, 3% drop in the equity markets, in my opinion, before they're bought. And then next year will be a completely different story, because inflation will then become a headwind, not a tailwind, for not only economic data, but a potentially pretty big drop in the market.

BRIAN SOZZI: A pretty big drop. How much are you looking for there, Eddie? And then, off of that, I mean, do you the Fed should be out raising interest rates in the first half of next year, because of the inflation you're talking about?

EDDIE GHABOUR: Look, I think the Fed has put themselves in a really bad spot, because, by delaying the tightening process, that means they're going to have to accelerate it. I don't expect them to actually say they're going to raise rates in the first half of next year. However, that's our expectation going into next year, is that they should, because, if not, the problem's only going to get worse. The longer you delay the tightening process, the hotter inflation gets, and the bigger hit the consumer is going to take, and then, ultimately, the market at some point in time.

I expect a 15% to 20% drop in the equity markets in the first half of next year, because, if you look at the backdrop, we're going to have decelerating GDP. It is almost mathematically impossible for the consumer to have as much discretionary income next year as they did this year, because gas, food, and housing is through the roof, and rents are through the roof. So, if you have decelerating GDP and a Federal Reserve that's tightening, or tapering, that's, like, the worst equation for the market. And we're going to see, in my opinion, a 15% to 20% correction. I think it'll be healthy. I think you may see some great opportunities at that time. But, as an investor, you should have had an amazing 2021. In my opinion, playing defense as you head into January and February next year is a must. We're doing that for our clients.

BRIAN SOZZI: So, Eddie, you're looking for up to a 20% plunge in stocks in the first quarter of next year. What stocks do you like try to get out in front of that?

EDDIE GHABOUR: So, first Half of next year, not first quarter. So, you know, you could start to see that sell-off materialize in the second half of the first quarter, and then, really, going into the second quarter, because earnings, when you do the comps on earnings second quarter next year, and try to compare it to second quarter of this year, it's not even going to be close. So we're going into this year. We've been overweight energy. We think, fundamentally, energy, still, even when we see a sell-off next year, could potentially still be very strong, because those rise in oil prices is one of the reasons why you could see that sell-off. But, if we do get a reset next year, you know, it's going to really be all about what sector took the biggest hit, and, fundamentally, what's going to do best in the back half of 2022. It's too early to make that call right now.

KARINA MITCHELL: Where do you see natural gas in all of this?

EDDIE GHABOUR: We're very bullish on natural gas. You know, I think the one thing that is crystal clear, again, is, and I guess maybe that's why my Twitter handle is @CommonSenseBull, is we do look at things fundamentally every day, but then take a common sense approach to looking at things and not overthinking it. We haven't even hit the cold season yet, and Europe uses natural gas so much that we cannot see a scenario, or a catalyst, where natural gas does not go up. It's very volatile, and you can see, it's been just under $5, to, I think, $6.20 was the peak here recently. And we've seen a nice little sell-off in natural gas right now. I personally bought some natural gas for myself today. That's not a recommendation. I don't know their scenario. But I'm very bullish on natural gas.

BRIAN SOZZI: Eddie, what if Fed Chairman Jerome Powell doesn't get reappointed? Do you think that adds to the market pressure you're talking about?

EDDIE GHABOUR: It does. Look, the one thing the market hates is uncertainty, and at least with Chairman Powell, you know what you have. So, if he does not get reappointed next year, that's going to add even more fuel to the fire of downside pressure in the equity markets, because we don't know who that new person would be, and more importantly, we don't know what that person's track record is in regards to how they would handle monetary policy. The bottom line is no one wants to say the word "tighten," but we have to, or inflation is going to just continue to rise, and really hurt these families that, right now, are already feeling the pinch. And, unfortunately, we're telling clients, it's going to get worse before it gets better.

KARINA MITCHELL: And I want to ask you, really quickly, about labor and wages, because they're also a big piece of the puzzle. We've seen that employment costs are up. What are you looking for in the October jobs report, because enhanced benefits ended in September? So do we see a rise, and if we don't see a rise, what does that mean near term?

EDDIE GHABOUR: I do think you're going to start to see the labor market get stronger and stronger, especially with kids back to school, with certain benefits falling off. But understand that employers have to pay up. You know, the labor market right now, the labor costs are continuing to rise. We expect them to continue to rise. And, again, that's extremely inflationary. Companies have been able to pass some of these wage increases to the consumer, and that's why earnings have been pretty good that we've been hearing on. But, next year, it's going to be a different story, again, because those labor costs, as they go through the roof, are going to get passed to the consumer in regards to inflation and slow down discretionary spending for next year in what I think is going to be in a big way.