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Earnings: 'Everything has been better than feared', strategist says

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David Lefkowitz, UBS Global Wealth Management Head of Equities Americas, examines the July earnings season weighed against the Fed's latest interest rate hike and the market outlook amid recession concerns.

Video Transcript

RACHELLE AKUFFO: Well, for more on the markets, though, let's bring in David Lefkowitz, head of equities Americas at UBS Global Wealth Management. So, good to have you on. First, starting by digesting everything that the markets have really had to take on this week, obviously, big earnings, also GDP and the Fed rate hike. What's your big takeaway for the week?

DAVID LEFKOWITZ: Yeah, I would say the big takeaway is that everything has been better than feared. I would say the earnings season has been OK. It certainly hasn't been unusual-- an unusually strong earnings season. And in fact, we're clearly seeing forward estimates get revised lower. But it seems very clear in hindsight that investors were expecting something even worse.

And we never thought that we were going to see earnings falling off a cliff. We were expecting to see earnings growth continue to slow. And that is coming through. But clearly, just given the more bearish positioning, that has led to some gains. And then you throw the Fed-- I would also say that was also better than feared. I think the Fed kind of hit the ball right down the fairway. They raised 75 basis points, as everybody was expecting. And they articulated a path that was mostly consistent with what they've said before.

Now, what was different is that they didn't get incrementally more hawkish. And we have seen them getting more hawkish at previous meetings. So that was a downside risk that didn't materialize. So I think, again, kind of summing it up, I think earnings and the Fed better than feared in combination with pretty cautious positioning. And that's been the fuel for this rally.

DAVE BRIGGS: Are the markets overreacting to a potential Fed pause that is far from certain at this point?

DAVID LEFKOWITZ: I mean, I don't think so, in the sense that if we do have a soft landing in the economy, I think markets here look kind of fairly valued. I think you're not going to see, in a soft landing scenario where earnings don't-- you're not going to see an earnings collapse. You'll see earnings continue to slow down. And it may be only very modest growth in earnings next year.

And then applying a reasonable PE, you get to ranges that are right around where we are now. So I would say at these levels, I think the market is kind of pricing in that soft landing. Obviously, the downside risk--

DAVE BRIGGS: But do you see it, David? That's a big if, yeah.

DAVID LEFKOWITZ: Yeah, so yeah, look, I mean, we think it's a close call between soft landing and recession. Obviously, that's not a bold statement. But look, I would say the downside risks have clearly gotten higher. And the risk-reward in markets is not great in the short-term. Look, obviously, for the long-term, I think we've been saying this very consistently. After the decline we've seen, investors should expect pretty healthy returns from markets over the next several years, probably a better outlook than we've had in some time.

But I don't think we're kind of out of the woods at this point. I think we're still going to have to contend with exactly how quickly will the economy slow down. And I think it's still an open question of-- you know, the market is not taking the Fed at its word in terms of how many rate hikes they will have to do. Does the Fed ultimately have to do more than the market is currently expecting in order to get that inflation back closer to its target?

SEANA SMITH: Well, David, so far, this earnings season, like you said a couple of times, better than feared. It seems to be enough, at least for investors right now. We're seeing that reaction in stocks. That's been the story for the last two weeks. In terms of what's been priced in when it comes to earnings, would you say earnings are appropriately priced for the slowdown that we could potentially see over the next couple of months?

DAVID LEFKOWITZ: Yeah, I think so. As I was saying, I think our earnings growth numbers are, for this year, 8%, for next year, 3 and 1/2%. And I think that's very appropriate in the context of a soft landing scenario. And I think if you apply a reasonable PE, 16 and 1/2, 17 times, to those forward earnings, you get basically where we are today. So if we do slip into recession, I think there's clearly downside.

But I also, at the same time, it's hard to see how there's a lot more upside from here, just given the headwinds that we know are out there, biggest, and first and foremost, all the Fed rate hikes and the interest rate increases. You know, it's, the economy is going to continue to decelerate.

And I think for to get a real sustainable rally further from here, I think you'd have to get to the point where we can bank-- start banking on the reacceleration in economic and corporate profit growth. And I think we're definitely several few, if not several, quarters away from that happening. Maybe not several quarters, but that's not going to happen well into 2023, probably the back half of '23 at the earliest.

RACHELLE AKUFFO: So, David, given the signals that we're seeing from earnings and from this recent data that's now come out, what's your strategy in terms of how to position a portfolio in this sort of environment?

DAVID LEFKOWITZ: So, within equities, we think you want to take a little bit of a barbell approach. I think from a sector perspective, we still think energy looks very interesting here. There's no short-term easy solution to the very tight oil markets that we have. We just haven't invested very much in exploration and production in terms of the energy space in some time in eight years, really. And oil markets are-- and oil prices are likely going to remain somewhat elevated.

And you look at the energy sector. It's got an 11% free cash flow yield looking out to next year. So I still think that's an interesting place to be. I think you want to balance that with some defensive exposure. We like the healthcare sector. You know, obviously, we just were getting a proposal on drug price changes. We think these changes, if they're enacted, are going to be very manageable for the industry.

And it finally creates certainty for the industry, which we haven't had for some time. And that could lead to a boost in valuations. I think focusing on quality companies also makes a lot of sense. Those companies tend to do quite well late in the economic cycle. And I think you want to be careful of some of the more cyclical areas. Like, materials is one that we are underweight. So if I had to sum it up, you know, I think you want to have a balance-- some balance in your portfolio, but definitely a focus on higher quality companies.

DAVE BRIGGS: All right, David Lefkowitz, UBS, have a great weekend, sir. Thank you.