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Earnings season typically drives the stock market higher: Binky Chadha

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Deutsche Bank Chief Global Strategist Binky Chadha joins Yahoo Finance to discuss how markets are faring amid the pandemic and how the COVID Delta variant can affect U.S. recovery efforts.

Video Transcript

MYLES UDLAND: Let's stay on the markets, talk a little bit more about the setup here as we look to wrap up this first real full week of earnings season let's call it. We're joined now by Chief Global Strategist over at Deutsche Bank, Binky Chadha. Binky, great to have you back on the program. Thanks so much for jumping on.

I want to start with a note that your team put out, which I wrote about a couple weeks ago. This idea of how fast the cycle is moving and the sectors of GDP that are now above their pre-crisis trend. And I'm just curious how you guys are thinking about what the future of this recovery looks like for markets given the breadth of the recovery that we've seen across industry so far?

BINKY CHADHA: Yeah, I think you know, the key message that one wants to take away is that if you look at very sort of broad aggregate measures of economic activity and you look at, for example, GDP, which is probably the most popular measure of aggregate activity, you know, you've got to conclude that in Q1 we were still about 1% short of sort of pre-COVID levels and especially, if you look relative to the trend in GDP because of course, GDP grows over time, you know, there's still a four percentage point gap, and that suggests that you know, the recovery phase back up to trend has a ways to go.

And of course, you know, the cycle doesn't end there, we go the other side of trend and all of that suggests you know, the recovery has much, much further to go. But what is very, very unusual this time around, and it's a function of really the speed and the composition of the recovery, you know, something that doesn't happen one, two, three, even three years into a recovery, is that various components of GDP, especially on the goods side and part of the investment side, are way the other side of trend.

And so what does this have to do with the equity markets? If you map the same kind of way of thinking about things of where we are relative to trend, into 53 industries in the S&P 500, you know, the somewhat surprising and rather loud conclusion is that about 2/3 of the S&P 500 by market cap is well, well above trend. And about half of that 2/3 or about 1/3 of the S&P 500 is actually in terms of activity levels is about five standard deviations above the trend level.

Now, this doesn't mean that we're definitely going to roll over. It definitely does mean though that growth and earnings growth and activity level are likely to-- activity levels are likely to slow.

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And you know, what I would say looking both bottom-up and top-down, you know, the way that the market's priced currently is sort of that we are very much in the early stages of recovery. I mean, if you look at the multiple on the S&P 500 we're trading at sort of 24 times. It's normal for multiples to be high in the early stages of the recovery but you know, a deeper look at the industry level of the S&P 500 suggests that the bulk of it is actually much later and multiples and valuations should be a lot lower.

You can see that some parts of the S&P, especially the parts that are below trend, those that are basically sort of at trend you know, are discounting as the market normally does. And as you go above trend, the market puts a lower multiple on them. But for the market as a whole, I would argue earnings are already elevated and the market's trading at elevated multiples on elevated earnings. So it's not a good combination going forward.

BRIAN SOZZI: And there you saw the opening bell on this Friday morning on Wall Street. Xponential Fitness ringing the bell, the owners of Pure Barre, Rumble, and a whole lot of other fitness studios. Some of the top trending tickers on Yahoo Finance right now, Snap, really a blowout quarter, Facebook benefiting from the strong quarters from Snap and Twitter. Twitter third trending ticker on Yahoo Finance. DiDi's still under pressure given potential regulatory concerns, Intel, of course too, top-trending ticker on the site right now post-earnings. Binky, why-- we came into the week the market sold off aggressively. We've seen stocks rally back, why do you think the market has come back as quick as it has?

BINKY CHADHA: So you know, we've argued for some time that you should basically look for a you know, significant and bigger pullback as basically macro indicators of growth peak. It's what's happened basically in every recovery about a year in. And if you look at things like the ISMs, they have peaked but you know, what we've really seen is sort of the pullback on or the reassessment of growth or where we are in the cycle, we see the pullback happen basically across asset classes.

And really, the S&P 500 and the NASDAQ have been the exceptions. And here I would argue that basically, you know, the US 10-year yield arguably basically overshot to the downside and as it did that, you know, it sort of impacted you know, tech which was basically, you know, pretty beat up. So that combination has sort of you know, seen us basically move back up.

But I would argue we are in the middle of earnings. Earnings you know, generally see basically the market go up by about 2%, and there's never really-- you know, we could go up by less, we can go up by more but we don't really, have never really seen a big pullback during earnings season, you know, unless there's a clear sort of outside exogenous catalyst like we had some time ago with Chinese devaluation and the like. But barring that, I mean, it's clearly earnings have been very, very supportive of the market. And we are in the thick of earnings season and so it is currently still supportive basically.

JULIE HYMAN: And Binky, how are you thinking about the Delta variant right now and its effect or lack thereof on your growth forecast? I mean, it seems the data that we're getting is that vaccinated folks, they may get it, but they're not likely to be hospitalized or become severely ill but we are, of course, seeing places that are pulling back on reopening. Is that going to have any effect on growth?

BINKY CHADHA: So you know, it's another version of kind of what we've seen where basically we've had this split between the goods side and the services side. And you know, we are awaiting basically for the services side to you know, get further along, basically the reopening and recovery process. So you know, that might slow some but I would say you know, as far as the goods side is concerned I mean, every lockdown has seen, you know, sort of a more modest negative impact. And so from a market point of view, I think that the market's going to continue basically to look through things.

You know, on the economic activity side, our economists basically see the risks right now to the outlook as pretty balanced but remember that for the last several months the main issue was really upside risk to the recovery, which as you know, as we talked about earlier, been happening much faster basically than most people expected. And so you know, some slowing in the cyclical trade you know, some pullback like we've seen 10-year yields, many commodities. So I think it has an impact on the composition rather than a bigger impact on activity of the markets.

MYLES UDLAND: All right, we'll leave it there. Binky Chadha, Chief Global Strategist and head of asset allocation over at Deutsche Bank. Binky, always appreciate the time. Have a great rest of your summer. I know we'll talk soon.