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Earnings and Fed policy 'double whammy' for markets: Strategist

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BNP Paribas Chief Market Strategist Daniel Morris appears on Yahoo Finance Live to discuss the Fed, market volatility, and tech stocks.

Video Transcript

ALEXIS CHRISTOFOROUS: Let's stick with the markets and the Fed and bring in Daniel Morris, chief market strategist and co-head investment at Inside Center for BNP Paribas Asset Management. Daniel, big day here for Wall Street. We've seen all the volatility this week heading into the Fed decision. I'm curious what you're going to be listening for in particular during today's Powell press conference.

DANIEL MORRIS: Well, it really is, for us, it's crucial what's going to happen with the balance sheet as the Fed hikes. I mean, clearly, the markets have priced in five hikes, frankly, for next year. So if you've got any indication that you're going to get five hikes, really, that shouldn't have too much impact, given that that's what is priced in at this point. There's much more uncertainty, though, around what we're going to see on the balance sheet runoff, the timing, the speed.

And if we look at what's happening, particularly with growth shares, with tech stocks, we think, really, that's the key variable that's driving the downturn we've had in growth stocks, is the balance sheet, because we really think that's what's boosted valuations over the last couple of years. And to the degree you unwind that boost from QE, and you move to QT, you may see a reduction in those valuations.

ALEXIS CHRISTOFOROUS: And in terms of earnings season, another big driver for the market recently, it's sort of been a mixed bag. We got some better than expected results from some big names this week, namely IBM and Microsoft, Apple still to come. We've got Tesla after the bell today. But how would you characterize earnings season so far?

DANIEL MORRIS: Well, perhaps we got a little bit spoiled last year. We had pretty much every quarter with significant earnings beats, very positive surprises. In addition to that, you had very positive earnings guidance. Now that was biased a bit because you had a lot of companies that stopped providing guidance because there was so much uncertainty around the pandemic. But those that did provide guidance tended to be optimistic and probably the story of if you've got something good to say, you're more likely to say it.

Now, in fact with this earnings season, the actual results that are coming in are not bad. You still have positive surprises, even if they're lower than you had for the previous quarters. What's really changed, though, is that earnings guidance. It's picked up a bit recently. It's moved up to about 20% of the companies are providing positive guidance, which is actually the long run average. So from that point of view, it's a quite normal earnings season.

But we had gotten used to positive guidance of 50%, 60%, 70%. And so from that point of view, it's disappointing. And if you add that coming on top of this anticipation of tighter monetary policy from the Fed, that's really been a double negative whammy for the markets.

ALEXIS CHRISTOFOROUS: When you think about what the Fed may be planning to do, rolling off the balance sheet really at the same time it's looking to hike interest rates, are you concerned that that combination could force the economy into a recession later this year or into '23?

DANIEL MORRIS: Well, that's probably quite low on our list of worries that we have right now. And I think what's different this time about this hiking cycle versus previous ones, where you have seen that phenomenon where the central banks act too late, they then have to hike more, and you end up going into a recession in order to get inflation down, is, we're starting from a point where growth is significantly above trend.

So even if we do get more slowing and economic growth than we anticipate, you're probably still going to be above that long rate trend of growth, whereas, previously, if you were starting from a point that you were near trend, you don't have so far to go to get to a recession. But at this point, to get from what we're going to have for the next few quarters to actually negative growth, we think that's going to be way too much. And we don't really have significant worries about that.

ALEXIS CHRISTOFOROUS: I want to get back to the market action for a minute and specifically take a look at the NASDAQ because we know that tech stocks have had a really rocky start to 2022. But when you look at valuations for a lot of those mega tech stocks, they are still above pre-pandemic levels. So are we at a point where you would feel comfortable being a major buyer of some of those large cap tech stocks at this point?

DANIEL MORRIS: We haven't made that change to our allocations yet. We're currently underweight the US, kind of implicitly underweight those mega-cap tech stocks. Our overweights currently are TEM to Japan and to Europe. When you mentioned the valuation, so we've fallen from over 30 times when you had a peak last summer to 28 or so times forward earnings on the NASDAQ currently, so that's quite a bit lower. And we've seen that in the price declines.

But before we had the pandemic and the most recent round of quantitative easing, multiples were around 22 times, which even then, actually, was quite high. So depending on where you think the Fed's balance sheet ends up, how quickly it gets there, there's at least a reasonable chance that those valuations need to revert back to that 22 times.

You've got to remember, though, we are going to have earnings growth. So from a total return point of view, potentially compression and valuations offset by earnings growth. And it's the net effect of those two that essentially tells you what your total return is going to be over the next two years.

ALEXIS CHRISTOFOROUS: So if you are underweight US equities at the moment, and you're concentrating on places like Europe and Japan, how do you view the potential conflict between Russia and Ukraine right now?

DANIEL MORRIS: Well, that's probably the key risk for European equities. Currently, there's a lot of reasons to be optimistic about Europe. Generally speaking, we're looking towards value markets to do well. And Europe is certainly more value oriented than the US is.

But in the short-term, without question, you have the risk of some increase in tensions between Ukraine and Russia, that leading to a rally in government bonds and potentially a sell-off in European equities, as at a minimum, you'd anticipate higher energy costs, which has already been a drag for several months. So that's a near-term risk. We don't anticipate it being a medium-term concern. And if it actually did materialize, if anything, we might look at that as a buying opportunity.

ALEXIS CHRISTOFOROUS: All right, lots of question marks hanging over investors' heads. Daniel Morris of BNP Paribas Asset Management, thanks so much.