'I don't buy into the stagflation narrative:' strategist

RBC Capital Markets Head of U.S. Equity Strategy Lori Calvasina joins Yahoo Finance to discuss her opposition to the stagflation talk, predictions for the S&P 500's price target next year, and the future of supply chain pressures.

Video transcript

BRIAN SOZZI: Investors have embraced this earnings season despite talk of hyperinflation and supply chain challenges, sending the major indices to fresh highs. But have we reached a short-term peak in this investor optimism? Lori Calvasina is the head of US Equity Strategy at RBC Capital Markets and joins us now. Lori, good to see you, as always, here.

And this optimism, at least from my standpoint, is a little surprising here. I've got companies out here today cutting their revenue outlook. Still worrying about high levels of inflation and supply chain bottlenecks. I mean, how long will this optimism in the broader market continue?

LORI CALVASINA: Well, thanks for having me. It's always fun to talk to you, guys. And look, I think we have to put everything that happens in this reporting season in the context of where investors' heads have been at. So we recently conducted a survey of our analysts. We also conducted a survey of investors. We did both of these at the end of September. And what we saw for both of those was that both the buy side and the sell side think that supply chain pressures are going to start to get better in the middle of next year, not right now but the middle of next year.

And as we've gone through-- and to be honest, I haven't really gone through today's numbers all that much. But as we've gone through everything up until today, we're not really hearing anything that tells us that that's not the right call. We are seeing little bitty glimmers of optimism here and there. Not pounding the table, saying things are getting better by any stretch. But a few illusions here and there to things getting better next year and how companies will be well positioned when that happens.

And for now, buy and large companies are still able to manage through these pressures-- not everybody. The ones who can execute are getting dinged pretty mightily. But for the most part, the beats are still very strong. And then I would just add one last thing, which is in the color on demand. Yes, there are some revenue softness here and there.

But when you look at companies that are saying they might have had trouble hitting some of those revenue numbers, they're still saying that underlying appetite is fine. So we don't see any problem brewing in the broader economy. Just some pickups related to these supply chain issues.

BRIAN CHEUNG: So Lori, that's really interesting because that means that the prevailing story here is that-- it's managing through the supply chain problems. If you manage that, well, you're going to beat expectations. You're going to have solid margins. And you'll be rewarded on the stock. But doesn't that mean that there could be some pressure valve for when these pressures do alleviate?

Let's say, for example, the ships can flow through the ports just fine in the second half of next year. If that underlying demand is still there, does that mean that we're going to rock it higher. So I mean, I guess, why would there be a stagflationary kind of narrative happening when there's that possible pressure valve there?

LORI CALVASINA: Well, look, I don't buy into the stagflation narrative. I'm not going to lie. I mean, if you look at consensus forecasts for next year on GDP, I don't actually make that forecast. We leave that to Tom Porcelli at my shop. But if you look at how the consensus has been tracking, it's moved down from 4.4% to 4% for next year, in real-terms. Your long-term average is 2 and 1/2%.

Yes, the growth rate has come in a little bit. But that is not stagnant. I mean, that is a very, very healthily growing economy. So look, I think that what we've got from these supply chain issues is a near-term earnings problem. I think it's something we do have to monitor in the first half of the year. Earnings growth is only tracking at 4% or 6% in the first two quarters of next year. So companies do have to keep managing through for the market to continue to move up.

But the reality is that the underlying economic backdrop simply is not stagnant. I really just don't buy into that stagflation argument at all.

- Hey, Lori. We also don't seem to be seeing any sort of pushback from consumers on the prices. I mean, rhetorically, we've heard a lot of pushback. A lot of people have been complaining about it. But they also keep paying those prices, at least that's what it looks like. So how does that play through to earnings both for this reporting season but also going forward?

LORI CALVASINA: Well, if you go back to kind of the first big week of this reporting season when all the big banks were starting to come out, we heard from a couple of the big ones, big national US banks that we're talking about consumer cash balances. And they were talking-- I remember one of them talked about people who had gotten stimulus payments and people who hadn't. And both of their account bases had, well, above average levels of cash in their checking accounts.

I mean, that's just a great sort of real-time way to think about the cushion that consumers have to absorb some of these higher costs. And if you talk to economists, they'll tell you that consumers savings are still very, very strong relative to history. Now that's not going to last forever. But it does look like-- what I'm seeing in the data is that we've got enough to probably get us through to the alleviation of those supply chain pressures late next year. So there's time. There's enough in those bank accounts right now. There's enough of that savings to kind of get consumers through this rough spot. And what I heard from the banks is that we're not really close to tapping that out yet.

BRIAN SOZZI: I like Brian Cheung's optimism. That supply chains will ease, Lori. I'm going to roll with it here. What's your upside target for the S&P 500 next year? I know you're at 4,900. But I have a lot of execs telling me-- target CEO at our All Markets Conference yesterday said supply chain bottlenecks will probably start easing in the back half of next year. If they do, what does that mean for the broader market?

LORI CALVASINA: So look, I think we're going to have to take this step by step. But I do think investors are already anticipating the alleviation of some of that pressure in the back half of the year. So we have to put earnings growth in the context with valuation multiples. So I think we're going to have a good solid year of earnings growth next year. A good solid year for the economy itself. And I think that's really going to help markets move up.

But we're in sort of the 9% return camp as opposed to something like the 15%, 20% return camp on the S&P. And I would say, a couple of reasons for the moderation are one, at some point, investors will stop looking at 2022 and start looking at 2023. And actually then economic growth is expected to slow down to about 2.3% back to slightly below-average-type levels. So I think as investors see that cooling off, they'll kind of move away from the cyclical trade. Move back into more defensive areas of the market. That'll cool the market's hills a little bit.

The other thing we have to worry about is the Fed. So what we typically see with Fed rate hikes, not only do you get sector rotation away from cyclicals and value and back to more sort of safer areas like secular growth, but you stop seeing multiples expand in the market. And you actually do tend to get a little bit of multiple flattening or contraction, depending on what PE you're looking at during Fed-hiking cycles themselves.

And I'm not going to sit here and tell you exactly when I think the Fed is going to start. But our economics team does think it's going to be sometime late next year. And I think investors will start to worry about that a little bit in advance. And so that'll cool the market a little bit from a multiple perspective.

BRIAN SOZZI: I'm sure they will begin to worry that much-- is for sure. Lori Calvasina, head of US Equity Strategy at RBC Capital Markets, always good to see you.