Interest rates and inflation driving the S&P higher 'from a macro point of view,' analyst says

Colin Stewart, Quant Insight Head of Americas, and Jay Hatfield, InfraCap Founder and CEO, join Yahoo Finance Live to discuss the S&P outlook, the Fed, inflation, and yield curves, in addition to commenting on Jamie Dimon's predictions for interest rate hikes.

Video transcript

[MUSIC PLAYING]

EMILY MCCORMICK: Welcome back. Let's welcome in our panel to discuss today's trading action. Jay Hatfield is InfraCap founder, CEO, and portfolio manager, and Colin Stewart is head of Americas at Quant Insight.

But before we head to our panel, do want to get one final check of the markets before we get the closing bell on this Friday afternoon. As we can see here, the S&P 500 and NASDAQ looking like they are going to end in positive territory after a choppy session earlier. We do have the Dow Jones Industrial Average, however, still in negative territory, down nearly 200 points, or about half of a percentage point. And taking a look at the S&P 500 sector action, energy, information technology, and communication services are outperforming. And here's the bell.

[MUSIC PLAYING]

ADAM SHAPIRO: All right, we have a closing bell, and we have a gavel. Let's see where the markets will settle today because you know how we always say the last 20 to 15 minutes of the session is what you want to pay attention to? Why even trade during the day? Let's just have the last 15 minutes.

The Dow's going to settle down about 200 points, but look at this. The S&P 500 in the last bit of the session actually went positive. It'll close up about three points. NASDAQ's going to be up 86 points, a little bit more than half a percent.

Let's go back to the panel. And yeah, let me start with you, Colin, especially since your firm calculates mathematical relationships between factors in the real economy, financial conditions, and measures of risk appetite. For those of us who might have had to repeat calculus and not pass it, I'm taking a look at the S&P 500 right now. What's the risk appetite? Because it feels like there's a lot of fear out of there, even though at the last minute this went positive.

COLIN STEWART: Yes. As far as we're concerned, the mathematical relationship between the macro factors has a strong relationship to volatility. In fact, volatility such as VIX and German VIX are among the top negative factors that would drive the S&P down. And in fact, we have a separate volatility indicator that indicates that VIX could be rising from here.

But the balance of-- of the-- what's driving the S&P, from a macro perspective, is that. But on the other side, Fed rate expectations and inflation expectations are driving it higher. So this-- our sensitivity analysis suggests that the S&P right now is fair, from a macro point of view, at 4,772, but it likes Fed rate expectations and rising inflation but would fall on balance because of falling volatility.

EMILY MCCORMICK: Jay, one of the things that you pointed out in your note to us is that tighter liquidity, not interest rate increases, is the key driver of the volatility we've been seeing in tech and other risky areas like crypto. Explain more of what you mean by this and what this means in terms of what headlines investors should be looking out for coming from the Fed that may stir up more volatility in these market areas.

JAY HATFIELD: Thanks for having me on. What we view as the key driver of the shift to momentum stocks was really this unprecedented liquidity that the Fed was injecting. And the minute it became obvious that they were going to withdraw that liquidity, which is at the end of November, that's when you saw this rotation out of tech and into value started. So the Dow has outperformed the NASDAQ by over 7 and 1/2%.

And so that's the real driver is liquidity. That tends to drive momentum, and that tends to drive the risk premiums down. There's a urban myth that tech stocks have much more interest rate sensitivity than other stocks. But if you really do the analysis, and we've done that, and calculate the duration, which is the way to measure interest rate sensitivity, normal tech stocks that trade on the stock exchange have similar durations to value stocks. It's only private companies that have payoffs 30, 40, 50 years that might be a little bit sensitive to that. But that's not the key driver. It's really tight Fed.

ADAM SHAPIRO: Jay, there was something that jumped out in the notes that you sent us that I wanted you to help us explain and help us understand, which is, when the 10-year yield is above 2%-- and you used the word "significantly," So I'm curious if you can put that into context-- $52 trillion of global pension assets will rebalance and relocate-- reallocate into Treasuries. What does that do to liquidity when that moment happens?

JAY HATFIELD: Well, I mean, it doesn't have a big impact on liquidity. I mean, there will be-- I mean, there will be some selling of stocks. But then the-- if we're correct and there is a lid on interest rates-- so 2% on the 10-year-ish, and that would imply a 30-year of almost 3%-- what happens is, the pension funds, first, they need to rebalance every quarter. So if stocks have outperformed, they sell and buy bonds. But if bonds have underperformed, they're going to buy those.

But what we saw in the past is that the boards of these gigantic pension funds decide, well, why are we only 28% bonds when the 30-year's at 3% and our bogey's 6%? So we expect them to raise those allocations. And then the final reason we're not-- we don't think rates are going to infinity is, the rest of the world, particularly in Europe, is very slow, partly because of the blown energy transition. So we see US rates being very competitive globally as well.

EMILY MCCORMICK: Colin, earlier today, we had JPMorgan's CEO, Jamie Dimon, saying that there's a pretty good chance that there will be more than four interest rate hikes this year from the Fed. There could be six or seven. What do you think about this, and what do you think the market has priced in for now? Because it seems like for now, perhaps not six or seven are priced in. But could they be?

COLIN STEWART: As far as JPMorgan is concerned, it's definitely very comfortable with a rising interest rate environment. We-- we see them positively sensitive to rising interest rates with three-- about three interest rate rises over the course of this coming year. But as far as JP Morgan is concerned, the macro fair value of that company is $163 right now, so just little spot prices under-- under that given the balance of what it-- what the positive and negative drivers with Fed rate expectations and inflation on both-- on both sides.

ADAM SHAPIRO: Colin, one of the things you point out that can hurt the index the most would be higher volatility, but especially a widening credit spreads, say, in the EU or in emerging markets. Is that-- you know, how-- how much do those spreads have to widen to be a real potential threat?

COLIN STEWART: So as far as credit spreads are concerned, I would say that particularly the European credit spreads widening. That is the highest negative factor. So if that-- if they rise by one standard deviation, you're going to see the S&P fall by 9 basis points. If you have US high yield expand by one standard deviation, another 8 basis points, and [INAUDIBLE] in Europe a similar-- similar amount.

So it's really overall, across the interest rate perspective in the developed markets, it's going to be about a 24-basis-point fall in the S&P with one standard deviation move higher. What's more interesting, perhaps, is in the-- in China. If Chinese five-year credit spreads rise by a standard deviation, then-- then the S&P would fall by 15 basis points of-- all things remaining unchanged.