How investors are digesting Fed changes, inflation, and earnings

Sean O’Hara, Pacer ETF Distributors President, and Brian Vendig, MJP Wealth Advisors President, join Yahoo Finance Live to discuss investor uncertainty amid volatile markets and world events, the Fed, interest rate hikes, and outlines for an economic recovery.

Video transcript

- OK, before we check the markets, heading toward this closing bell in less than a minute, I want to let you know the folks that are going to help us understand what we've witnessed today are standing by. We have Sean O'Hara, Pacer ETF Distributors president, joining us, along with Brian Vendig, MJP Wealth Advisors president. And we are going to ask them about opportunities that might be created from what we witnessed today.

But let's look where the markets are setting up, because talk about a swing. The Dow was off more than 1,000 points at one point. It is going to settle, most likely, in positive territory, up about 900 points. The same with the other two indexes. Let's take the closing bell, and then digest it right after this.

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- And that is the closing bell this Monday, January 24th. And what a volatile day of trading it was. As Adam was mentioning, taking a look at the swings that we saw in these major stock indexes, the S&P 500 closing up by about 0.3 percentage points. At session lows, that index had been off by about 4%. The Dow, of course, had been lower by more than 1,000 points at its own lows, as well. That index is going to settle higher by more than 100 points, or about 0.3 percentage points. And the NASDAQ composite really recovering losses here. Had been down as much as 4.9%, now closing higher by about 0.6%.

Let's turn back to our panel to digest what exactly happened during today's session and where we might be heading. And Brian, I'll turn this first question over to you. What do you think this massive swing in the indexes suggests about the markets and where we may be headed?

BRIAN VENDIG: Sure. Thanks Emily. I think today's market action really puts a head on the uncertainty that investors are dealing with because we have a bite-sized sandwich to get through around that. On the bookends, we have Russia, Ukraine obviously going from late Friday into the beginning of today as a concern. Of course, everyone's waiting to hear about the Federal Reserve policy.

And I think the markets have been extremely concerned about the number of rate increases, paired with balance sheet tapering. And then also, we've had a mix of earnings. So when you put all those things together, it's not surprising that you have a day like today, where the market is completely schizophrenic. And I think more will settle in as we get through the course of the week, especially with comments coming from the Fed on Wednesday.

- Let's talk about that, Sean, because we're all going to be paying attention to Jay Powell on Wednesday. But what we witnessed today, was it too soon to be bottom fishing and looking for opportunity?

SEAN O'HARA: Well, thanks for having me. You know, I think the only thing that's certain is that, when interest rates rise and when you have an inflationary cycle, P/Es have to go down. There's an inverse relationship there. The question is when, and how fast and how far. And so we had a little bit of a panic sell this morning, probably more than anything driven by what's going on in Ukraine and Russia, and the potential fear of that war.

But I also think that there's a certain amount of sentiment in the market that's starting to wake up to the multiples that are being paid at the top, in the big mega-cap names in these indexes, which control such a big share of the overall asset weighting, that when they struggle, then they really do pull these indexes down, even an index like the NASDAQ 100 or the S&P 500, where there's more names than, say, the Dow Jones, which only has 30. And so I think for investors, you know, we've made an awful lot of money the last couple of years. It's been driven mostly by multiple expansion.

We are going to have higher interest rates. Inflation is going to be a problem for a while. And history tells us that we'll see P/E contractions. And so I think in this environment, where the money will be made is by buying stocks that are of high quality, that pay dividends, that generate a lot of free cash flow and have a high free cash flow yield. They will tend to do better in a rising interest rate, rising inflation market. So I don't think you need to be scared away of investing in equities. I just think you need to rethink your strategy and have a forward-looking strategy, as opposed to trying to continue to do what has been working for the last two or three years.

- Brian, as we head into this January Fed meeting, monetary policy statement and press conference, what do you think the market needs to hear in order to remove some of the uncertainty around what the Fed's next move is going to be, and exactly how hawkish and how tight financial conditions are going to be this year?

BRIAN VENDIG: That's a great question, Emily. I think what investors are looking for is getting clarity on the pace of the change, and also thinking about how open the Fed is going to be in being flexible and adaptable with their policy decisions. I mean, the Fed, as many have said before, is in a very tough spot. They know history has shown that, if they move too quick on interest rates, it adds to the risk of moving the economy into a slowdown and the risk of a recession, which we don't think is on the horizon, but they're definitely sensitive to.

And at the same point in time, they're also trying to manage the unknown regarding the timing and sequence of supply chain inefficiencies resolving themselves over the balance of the year, which should cause headline inflation to come down. And obviously, that's something that they hope for. So from our view, I think the markets have priced in that we'll see a 25 basis point increase in March, we'll see another one in June.

But I honestly believe that the market's been way too pessimistic about the second half of the year, and pricing in rate increases that might be unrealistic, considering that there's still an opportunity for full-year inflation to come down. We think that the Fed has a chance to maybe do three rate increases this year, but the third might not come till December. And we also have to keep in mind that we do have midterms elections, as well. And they like to maintain, historically, their independence around that time period also, from a political perspective.

- Sean, if you were to follow what Brian just shared with us about interpreting whatever that statement says and what Jay Powell says on Wednesday, how do I, as an investor, you know, then put that to use on Thursday and Friday? Because we talked about it last hour, we knew back in November, Jay Powell signaled that we were going to finish the taper in March and that we were going to have liftoff. So I guess the big question is, what has changed? Nothing's really changed.

SEAN O'HARA: Honestly, I don't think anything's changed, other than some of the rhetoric around the outside from, you know, three to four. You've got some folks going on some of the TV shows saying that they think they're going to have six rate increases next-- this year. And so the Fed is, as the other member of the panel said, they're sort of in a box. If they make the first two cuts and then things slow down, then they might have to retreat. But if they make the first two cuts and the economy seems to be fine with that and sort of gets up off the ground and starts to grow again at a fairly rapid pace, then they'll continue, which might be viewed as a negative.

So there's a whole bunch of variables that need to go into our thinking. On the fixed income side, I don't think you want to own government bonds, and you don't want to own duration in this environment to any great extent. So I would be buying adjustable rate securities, like floating rate or bank loans. I'd buy high yield in this market, because they tend to-- high yield securities tend to do well in a rising rate, rising inflation environment. And then on the equity side, if we are going to buy this notion that the Fed is going to raise, and you're worried at all about inflation, then I think you need to rethink your stance on whether you're overweight growth, which has been great, or whether you start to shift to more high-quality, value type names in this environment, which tend to do better in those types of cycles.

- Brian, we got purchasing managers indices out from IHS Markit this morning, and the composite PMI for the US was at an 18-month low. Given the flow of economic data that we've been getting and what we'll likely be getting out of the Fed this year, is there a risk of a recession? Or are we going to keep growing into the end of this year, at least?

BRIAN VENDIG: Emily, we do not think that there's a risk of recession in 2022. We definitely recognize that there's been a slowdown in economic data, and definitely, over the last couple of months and weeks, we know that that is tied to the impact of the omicron variant globally, as well as domestically. We are optimistic about the reopening still for the services part of the economy this year. It wasn't fully reopened last year. We think there's a good probability of that happening this year.

We also think that, in light of all the noise that has happened in the markets since December into this year, we also want to look at smaller companies as an opportunity. I agree with Sean that you want to have parity within your portfolios based on valuation between growth versus value, specifically in the cyclical side. But don't forget small-caps, as well, I think is an opportunity, as well as looking at the private markets in real estate, which is also another great hedge for inflation while trying to add some predictable cash flow to your investment.

So again, I think these types of corrections are normal in a market, in a market that's concerned about policy changes and the path of the global economic recovery. We think that the market can weather through these changes. The path of the recovery is still in place. And I think investors should take out their shopping list right now and think about the balance of the year.

- Brian Vendig is MJP Wealth Advisors president. Sean O'Hara is Pacer ETF Distributors president. Thank you both for joining us.