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Inflation could be lowered to 2% if investors 'believe in globalization': Strategist

Raymond James CIO Larry Adam sits down with Yahoo Finance Live to examine the outlook for a soft-landing amid inflation, the Fed's interest rate hikes, defensively positioning tech and energy stocks, and what to tell from mortgage patterns in the housing market.

Video transcript

RACHELLE AKUFFO: Well, for more on the markets and the reaction so far, let's bring in Larry Adam, Raymond James CIO. Good to have you on again, Larry.

LARRY ADAM: Thanks for having me.

RACHELLE AKUFFO: I want to start with-- of course. So in terms of what the markets are digesting, and reacting, and, in the case of Powell's comments, not reacting to, what are we seeing here?

LARRY ADAM: You know, I think the market's grown accustomed to the fact that this is a pretty challenging environment. We're still in the camp that even if we do see a recession, it's going to be mild. And historically, in mild recessions, you have the equity markets contract about 24%, 25%. And the max when we were down about 25%. So I think we've priced in that mild recessionary environment.

SEANA SMITH: Larry, what do you think about Powell's comments specifically today, saying that there's, quote, "no guarantee" that the Fed can avoid a hard landing? I know you're saying that any recession will likely be mild, but how does the market look at comments like this?

LARRY ADAM: Yeah. Well, I think they put it like we do-- it's a very low probability. Obviously, there's no guarantee that we can't have a hard landing. If oil prices continue to go higher, that would be a big risk that we'd have to be mindful of if we had this self-fulfilling prophecy.

And I think you can't overlook-- that if everybody simultaneously got negative on the economy and we all stopped pricing, that would lead to a recession. It could be more damaging. And when I say all of us-- CEOs are individuals like you and I, right-- so that would be both business and consumer spending stopping. But again, that would be a pretty long way from here for that to be a really hard landing.

DAVE BRIGGS: And to the point about accepting some type of a new norm, do you think we ever get back to that 2% target inflation?

LARRY ADAM: Well, I think it will take some time. I think you're seeing signs right now that inflation has hopefully peaked and is starting to decelerate. I mean, you see that in inventory levels-- I mean, even some of the companies that have reported today. You're talking about inventory levels of businesses that are 15%, 25%, 30% more than they were pre-pandemic.

And I think you're going to have to see a lot of discounting. I mean, just look at the next two weeks-- we're going to have Amazon Prime, and a lot of companies are going to jump on that as well. And then they're talking about having another one in the fall, and then on top of Black Friday. So I think when it comes to goods pricing, you're likely going to see the price increases start to decelerate as we go into the back half of this year.

And you're seeing it in other things, right? Freight rates are coming down. Industrial commodities like copper are coming down. Used vehicles-- they're all coming down. And I just think we have to be patient and you will see it come down. Longer term, look, if you believe-- and I'm a professor of international finance-- if you believe in globalization, if you believe in technology, I think we eventually could get back to that 2% level.

RACHELLE AKUFFO: And speaking of technology, you do say in your notes about being careful about painting sectors like tech with this very broad brush of sort of pandemic darlings, non-pandemic darlings, and really being more selective. What are some key distinctions that investors should be making in this sort of environment?

LARRY ADAM: Yeah, I think the biggest thing that I try and warn people of is extrapolating what the market's talking about. And to your point, when we were in the pandemic, everybody wanted these stay-at-home names, and they forecast that these earnings would continue to increase at the pace they were during the pandemic. And I think you have to be careful of that.

But on the other hand, you're seeing some of the, quote, "reopening" trades that everybody thought would benefit, they're actually struggling as well. So I think you got to be careful not to paint those broad strokes on those different names. And you've got to look for opportunities in the market.

And the three sectors that we continue to like are energy, financials, and then health care. And, really, the reason for that is that those have the most attractive valuations. When it comes to energy, for example, if you look at the amount of cash flow versus their earnings, it's tremendous, which means that they're going to be able to do other things like dividends and buybacks. When you look at financials, you've seen this week, they have the ability to increase their dividends, increase their buybacks. Those are other things that I think investors are overlooking that can help propel those sectors higher.

SEANA SMITH: Hey, Larry, when you take a look at the market overall, there's lots of talk about what's the necessary catalyst in order for markets to move higher. A lot of people have been talking about reining in inflation. That's obvious. Is there anything else that's on your radar just in terms of what would make investors more positive about the economic backdrop and about the markets right now?

LARRY ADAM: Yeah. I think you said in the lead-in, I think there's been so much negativity priced into this market that it won't take much to hopefully turn it around. And some of the catalysts that I think could happen during the second half of this year-- I mean, you named one. It would be inflation if that came down, if oil prices just didn't increase as much as they've increased during the first half of this year.

I think if you look at the Fed, if they start to ease some of this rhetoric that they're going to be as aggressive taking, as of right now, interest rates up to about 3.5%-- if it's not as aggressive as that, that's a positive. I'd watch China. I think you're seeing the signs that they are more fully going to reopen.

And when you look at some of the earnings that have come out, what have they talked about? The fact that demand over in China has been a little bit weaker because they've been shut down. So I think that could be a good thing for earnings.

And then one thing I would watch is the midterm elections-- if you look back historically, midterm election years, no different than this year, tend to be challenging. But once you get close to and you get through the midterm elections, you typically do see a year-end rally. And I would expect that to happen this year.

DAVE BRIGGS: And finally, Larry, Jared talked to us a little bit about the bond market on an interesting day there. What is it signaling to you?

LARRY ADAM: Yeah, I think that we've probably had a peak in interest rates. And I think you're likely going to see them decline into year-end and then as we go 12 months from now. I think the economy is slowing to what you're talking about. I think inflation is coming down.

And I think all of them are going to lead to lower interest rates going forward. And I think that that's actually a good thing for the economy, because you've started to see it have a negative impact on, for example, the housing market. And I think it's a good thing for the equity market, because, as interest rates come down, sectors like technology should do better going forward.

RACHELLE AKUFFO: And you're talking about the housing market and, perhaps, sometimes we're extrapolating a narrative from some of the big headlines-- what are you watching for in terms of signals in the housing market?

LARRY ADAM: Yeah. I think it's foot traffic that people are actually going to them. I think it's those mortgage applications. I think it's confidence in there. Those are all critical things that we continue to watch.

One point I always tell people is everybody asks me, why's there this big disconnect between confidence and the hard data that we're seeing? Because, truthfully, a lot of the hard data hasn't been all that bad. And I tell people that the main difference is that when it comes to you and I dipping into our savings that we've had during the pandemic, that's not a great thing. That's not a great feeling. That kind of leads those confidence numbers down.

But the fact is we're still dipping in there and still spending. So I think that that's really what leads to the difference that you're seeing in a lot of those confidence numbers versus where the economy still is.

SEANA SMITH: Larry Adam, always great to get your perspective. Thanks so much for joining us-- Raymond James Chief Investment Officer.