Market strategist: Value stocks 'do have lots of room to grow'

Equity Strategies for Research Affiliates CIO Feifei Li joins Yahoo Finance Live to discuss opportunities in the current stock market environment.

Video transcript

- Let's discuss the Fed first and foremost and the impact that we had seen yesterday. Even with some of the commentary that had come through from Fed Chair Jerome Powell, we're particularly-- are you expecting the markets to continue to latch on to the outlook that has been set forth from the FOMC?

FEIFEI LI: Sure. So the monetary policy this year is going to be a lot less supportive because inflation is high and the Fed thinks the economy has built up enough momentum to continue growing. So based on their yesterday press conference released, there is actually nothing really surprising that is likely to end asset purchases in March and start increasing rates and even consider to shrink their balance sheets $99 trillion balance sheet to what the end of 2022.

So I think much of those have been expected by the market. I think what would be a big surprise to the market is if the demand side from consumer spending, shifting to inventory restocking stays pretty resilient, inflation keeps going up or staying high, even after some maybe two or three rates hike. And the Fed may go even more aggressively. I think that would be a really bad news for the market.

Of course I think Fed is very flexible. Everything they do will be gradual. And it's also very dependent on the labor markets, unemployment rate is 3.9%. Seems to be very supportive of a rate hike. But overall it's a very bad news, not very bad news, but it is not good news for stock market, through both discount rate channel as well as cash flow channel.

You know, when investors buy a stock, it's really paying the value of future discounted cash flow. When the discount rate is high, you know the value of stock drop. On the other hand higher interest rate always increase the cost of financing for corporations, preventing them from investing, so basically reduce the future earnings growth and the dividends payout. So that's why I mean--

- Let me pick up on that point you just made about interest rate hikes and the expectation of investors. I mean you're saying that there weren't entirely any surprises from yesterday. But we have seen wild swings in the market. It's not just about a little choppiness. But we're talking about down 1,000 points, ending in positive territory. You saw another swing yesterday as well. What do you attribute that choppiness to?

FEIFEI LI: Well, I would say it's actually the market is not very rational. Investors tend to react to shorten news, even when the price may be already kind of embedded in the current, you know, multiples. I think you know if you look at academic literature, it basically talks about retail investors tend to trade too often, too much, reacted to news overly aggressively. And a lot of transaction cost, they are actually better off by just buy and hold indexing fund.

So when they read economic data, you know, from the retail sales plunged in December, it's a signal to sell, sell, sell. Today there is good news about GDP growth. It's buy, buy, buy. Right overall, all those news come and go. Lots of them are just the noise.

I think investors really should have a long term perspective. Focus on what is a reliable indicator for the next three year, five year, or 10 year horizon, rather than the next week, next month. It's actually very hard to predict the return over short term horizon.

- And so which sectors would you be leaning into at this point.

FEIFEI LI: And so long term reliable indicator, typically we put lots of you know weight on valuation multiple. We do think buy low, sell high is a viable strategy. So if we use this particular matrix, value stocks, cyclical stocks. They still have ample room to go up. They are priced really cheap about, like 1/10 cheapness versus their growth counterparts.

The valuation gap between growth and the value stock is why it is that we have never even seen during tech bubble. So value stocks, cyclicals, also have a very big exposure to economic growth. We are still in the economic expansion stage, right?

So those stocks will benefit from higher earnings growth, overall high GDP growth. So that's why we have lots of faith in financials. They also tend to do well during high interest rate environments, financials, industrials, energies, I think those, and their estimates and their value of stocks do you have lots of room to grow.

- And we have seen a movement in that direction. Feifei Li, it's good to talk to you today. CIO of Equity Strategies for Research Affiliate.