Market rally appears as if ‘we un-priced an earnings recession’: Strategist

SoFi Head of Investment Strategy Liz Young joins Yahoo Finance Live to talk about what to expect from the markets during earnings season.

Video transcript

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- Joining us now to tell us how investors should play the market on a week like this is Liz Young, SoFi head of investment strategy. Liz, nice to see you as always. Those tech earnings, what do you expect we'll learn this week?

LIZ YOUNG: Yeah, they're looming large, right? And we've kind of come into this I think expecting that tech is not holding up the best. We've seen plenty of headlines about cost cutting, about layoffs. So I don't think that the market is hoping for outlandish beats on these earnings.

The other thing that I would say too is that although these are the companies that we've been used to kind of pulling us out of the mud for the last couple of years. They got hit pretty hard last year. I don't think that Big Tech is going to be what pulls us out from this period.

So I think earnings are definitely important. As far as sentiment goes this week, I don't think that investors should expect anything outrageous from a beats perspective and actually from the whole market on that front because we've got fewer companies than average beating on earnings. And those are beating on earnings that are already lowered. So we're not in a great setup for earnings. This is still expected to be the first negative quarter since 2020.

- So Liz, how does that set us up for the rest of the year given the fact that earnings have been weak, like you're saying, so far into the quarter you're, not expecting things to really shift for the remainder of the earnings season? What does that mean for broader markets here over the next couple of quarters?

LIZ YOUNG: Yeah, so usually there's a formula. The market breaks first. And obviously we had a pretty bad 2022. I wouldn't rule out another big drawdown in 2023 as some of this gets digested. But then usually earnings go.

So if this is in fact, the first negative earnings growth quarter, if we have two of those in a row, that would be an earnings recession. I don't think that is entirely priced into the market yet. So if we do have worse earnings than expected or we've got it looks like two quarters of negative earnings growth in a row, I think the market does need to come down from where it is right now.

I mean, we're trading close to 18 times forward earnings on the S&P. That's really high. And it's been a pretty big risk rally in January. It's almost as if we under-priced in earnings recession. So I think there would be a little bit of digestion, which probably causes some downside as we see those numbers come out.

- MLIV Pulse survey shows 70% of 383 respondents say the S&P has not hit its low. Do you think we'll retest some lows later this year?

LIZ YOUNG: Look, I'm not going to call levels on the S&P. But what I will say is, again, I think that valuations are a bit high here. And also remember, yes, this has been a strong rally in January, but it comes after a pretty painful December.

So the NASDAQ was already down 9% in December, up only-- it's 11% up in January. But that's just partially even making up for what happened in December. Now as the market digests whether or not we actually have a classic recession and whether or not earnings are worse than expected and operating margins are getting compressed, that's where I think you see another flush down.

The level that I would be watching is in that 3,500 mark. Now that is close to the October lows. But that's where I would want to start nibbling. And that's where I would get actually bullish on some of the more cyclical parts of the market.

- There's lots of focus is going to be on Jerome Powell on Wednesday afternoon. Big anticipation of just a 25% basis point hike this time around. What are you looking to hear? What are you hoping to hear from the Fed Chair on Wednesday?

LIZ YOUNG: Well, one thing I would point out to investors is that I do think the hiking cycle is maturing, meaning they're closer to the end of hikes than they are to the beginning obviously. But as that hiking cycle matures, it means that it just starts the economic pain in the cycle because there is a lag.

So it is good that we might have some clarity about what the Fed is going to do as they get each hike behind them. We're expecting 25 this week, maybe another 25 in March, and then that's it, where they get to a top rate of 5%. But it doesn't change the fact that the economic data and everything that's going on activity wise still needs to digest all of the tightening that's occurred for the last 9 to 10 months.

So there's still a lot to be said. I do think that Jerome Powell will start to shift his narrative from inflation to jobs, because once we look at the labor market-- that's the piece that has become sticky, wage growth is sticky, services inflation is sticky. In order for that to come down and not get stuck at too high of a level, we do need the labor market. And what I think he wants to see is that the labor market comes a little bit more back into balance.

- But will we see that at the end of the week? The layoffs so far been mainly isolated to the tech sector with the exception maybe Hasbro and 3M and maybe a handful of others. Will we see anything that resembles pain in the jobs number?

LIZ YOUNG: I don't think we're going to see anything that sends off alarm bells yet. I think that it's still a little bit too early for that. To your point, most of the layoffs that have occurred were in tech. That makes up a pretty small percentage of the labor market. And we're not entirely sure that all of those people are actually filing for unemployment benefits. So you may not see that come through entirely.

I do, however, think that some of those announcements from big industrial companies could be the canary in the coal mine. So you want to be mindful of that and make sure that you're watching as it may bleed into other sectors. It certainly did bleed into Financials already.

So it's not any more just isolated to tech. It's in tech and financials. And then we want to watch that industrials piece if it starts to hit kind of the machinery part of the country, what I would call the Rust Belt and those companies.

- All right, Liz Young, great stuff, SoFi head of investment strategy. Thank you.