Equity markets may ‘go back up’ to all-time highs over the next few months: Strategist

Mike Gibbs, Raymond James Director of Portfolio & Technical Strategy, and Kevin Nicholson, RiverFront Investment Group Global Fixed Income CIO, join Yahoo Finance Live to discuss equity and fixed income markets, inflation, and the Fed's interest rate hike cycle.

Video Transcript

[MUSIC PLAYING AND STOCK EXCHANGE BELL RINGING]

- And there you have it, your closing bell for April 7, 2022.

All right. Let's take a look at how the market settled after starting mostly in the red this afternoon, as we see all three major indices ending in the green. The Dow up a quarter of a percent, at 87 points. The S&P 500 also up about just under half a percent, 0.43% there. And of course, the NASDAQ there just edging into positive territory, at 0.06, ending the day up just about 8 and 1/2 points.

Well, Dave, Brad, and myself are going to be bringing in our market panel now to digest all the market news of the day. Kevin Nicholson joins us, RiverFront Investment Group's global fixed incomes co-CIO. And Mike Gibbs, the Raymond James Director of Portfolio and Technical Strategy

So Mike, as we saw in these last minutes as we headed into the afternoon, markets heading into positive territory. What do you make of what we saw, especially, though, the NASDAQ lagging but still edging into the green?

MIKE GIBBS: Yeah, I wouldn't call today overly impressive. You know, we've been in a little bit of a 4% drawdown here in the last couple days. And if you think, all right, health care led us today, broke out to a new high. Consumer staples led us today, broke out to a new high. Those are very defensive sectors, and those were doing well to begin with.

And if you look at the market internals, we had more decliners than advancers on the NYSE. We had more decliners than advancers on NASDAQ. So you know, one day never sets a trend. But to me, it looked like it was an oversold bounce. And some of the areas that had been hit pretty hard, transports are down 13% seven days, semiconductors down 13% seven days, tech down 8%, consumer discretionary down 13%. So they had all been hit pretty hard. So it was sort of a bounce.

But when you have the defensive sectors of health care and staples leading you, I don't think that you go ahead and put today's trading into the positive ledger just yet. You need better action than that. So let's see what happens tomorrow.

- And Kevin, it had been a couple of rocky days for the NASDAQ. Some bounce back there. Your big picture takeaway from today's action.

KEVIN NICHOLSON: Well, the way that I look at today is that, you know, the market actually had to digest a lot of information, a lot of hawkish information from the Fed over the last couple of days. And so we had been in a sell-off mode. And I think today we finally got a chance to take a breather and realize that the equity markets, especially, have some actual positive things that are going on.

We still expect the earnings season to be better than expectations. You know, expectations are very low. And what we've been seeing is we've been seeing S&P operating earnings estimates come up. We also think that, you know, you have support with a strong labor market. The economy is in great shape from that perspective. So we expect that equity markets will rebound, and we actually are looking for them to go back up towards their old highs of 4,800 over the next few months, especially as they get more clarity from the Fed.

As we all know, equity markets do not like uncertainty. And as we get more and more information coming from the Fed, I think that we'll gradually break out of this range.

- Mike, do you expect the choppiness to continue? Investors, how patient do you expect them to be? And what would you say is a good opportunity that they should take advantage of, if they do see?

MIKE GIBBS: Well, I think a little different than his opinion. I do agree that we are positive on the market. And we have a year-end price target of 4,700, you know, bull case of 4,800.

But I do think in the coming weeks and months, there's just too much uncertainty around inflation. You know, it's going to take a while for us to determine what's happening with the supply chain, the labor market participation coming back, et cetera, et cetera, all factors that we think will have moderating inflation as the year progresses. But I think in the coming months that we're just not going to get that data yet.

So I think that the uncertainty will be there. You have the geopolitical uncertainty. And I think you're in a market that right now has gone from a period of time to where we had this enormous amount of liquidity thrown at it, and that raises asset prices. Now it's adjusting to the fact that that liquidity is going to be pulled back. It's not dire. We're not looking for a market collapse. I just think that you get more back and forth trading, maybe similar to what we saw in early 2018. We sold off hard in January of that year, and we sort of chopped until we really got our legs under us late in the summer and started progressing higher from that point.

So I think we get the choppiness, just because the simple uncertainty and how dramatic the uncertainty is. If inflation proves too sticky and the Fed has to get too aggressive, you know, the market just can't stand the valuation where it is right now, especially on the growthy side of the market. I don't think that happens. We have a more positive outlook for the market. I just think you be patient.

And I think investors, the way you approach this is, you look at how much you're investing now and you look at the success you've had with your portfolio and look at the marginal cash that you have to invest, and when you have the drawdown s-- and I remind you, this year you've already seen a 12% to 14% drawdown on an intraday basis-- use those as opportunity to fill in the points of your portfolio you need to fill in when you get those inevitable rallies. And we've had 9% rallies and 14% rallies this year.

Don't chase, at that point. And just take your time, let this game plan play out. Let's see what happens with inflation. Let's see what the Fed has to do. We think it moderates. We think the Fed may not have to go as far as people are expecting and we can have a market that 12 months from now is higher than today. But take your time in the coming months.

- And Kevin, for the fixed income market, what are some of these signals indicating as to how people should be positioning their investments there?

KEVIN NICHOLSON: Well, in the fixed income market, I think that the big thing that everyone should remember right now is that we're in a rate hiking cycle. So because of that, we want to move towards the front end of the curve. You're not getting paid to take that long duration risk. And so we've been focused in on short-term corporates. We've also been adding senior loans to the portfolio, because they're floating rates. And so that's kind of where we are focused right now.

And I think that when you look at the yield curve, you know, 2s to 10s, a lot of people have focused on that curve for a while now, and that they were afraid that it was going to invert. But as you saw that as the Fed has talked about quantitative tightening, that curve has started to steepen. And we really focus on that, just that curve, only to see whether or not the market is saying that the Fed is going to make a policy mistake.

We really focus on the three-month to 10-year curve, because that is what tends to signal whether or not there's going to be a recession. And as you have seen over the last couple of days, that curve has actually steepened further. And so as we have more quantitative tightening, as the Fed gets that underway, we expect that 2- to 10-year curve to steepen further.

Also, when you look at corporate bond spreads, they have started to come in. Credit spreads broadly have come in, both in the high yield market as well as the corporate bond market. You have corporate bonds yielding close to 4% now and you have high yield that is yielding a little north of 6%.

So you know, there are attractive opportunities. I think that a few months ago, people were not looking at fixed income at all. And I think that now you're getting closer to levels where people are going to start caring again, because the dividend yield on the S&P 500 is now 1.38. And just a few months ago, they were yielding about the same. And now we have a 10-year Treasury up at $2.65.

- Mike, you said prior, you don't think the Fed will go as far as some people expect. And some do expect 50 basis points at the next two, maybe even three meetings. What do you, then, expect?

MIKE GIBBS: No. Maybe I misspoke there. I don't really-- I'm not making a projection of where they go. I'm saying that there are catalysts, as the year progresses, that they may not have to go as far as even they think or the market thinks. You've got to remember that they're not great forecasters. The market's really not a great forecaster. And some things can change. We need to see what happens.

We've got 1.6 million people out of work now that were working before the pandemic. And we got 1.8 million open jobs, you know. And the majority of those people that aren't working are leisure, hospitality, education, and health care, all very low paying jobs. So there's some natural things going on in the economy that as they come back, you could get, you know, some take this pressure off wages, which may give the Fed-- I'm not saying it will, I'm just saying it could-- give them the potential to maybe not go quite as far as the market thinks.

Now the market has a tendency to knee jerk reaction to things. And I just think we've got to wait and see how this plays out as the year advances before we really take it to the bank.

- Kevin, to that point, I'm always fascinated to get an answer or some type of perspective on how far out the markets are looking. How far out do you believe the markets are looking, considering all of the different factors that are on the table right now, whether that be the continued recovery from the pandemic, even as we've got a spike in cases now that it's impacting the White House and other political realms, you've still got an international conflict, you've got a midterm election, all of these factors considered, how far out do you think that the markets are looking at this point?

KEVIN NICHOLSON: I mean, I really think that the markets are focused until the end of the year. That's really as far as I think that they can really project out at this point, because there's just too much uncertainty that is out ahead of us. And so when you look at Fed funds futures, the focus has been until the end of the year. And I think that that is basically as far as the market is telegraphing at this juncture.

- And so Mike, as we look at what you're seeing in terms of perhaps your downside case, looking at some of your notes, you said this path remains the most unknown regarding economic growth, inflation, and the Fed. Break down what your thoughts are in terms of the potential downside and how prepared you think the markets might be for it.

MIKE GIBBS: Was that question for me?

- Yes.

MIKE GIBBS: Oh, sorry about that. Well, the downside, you know, we're looking at, of course, looking at technical charts and looking at fundamentals, we think around the 4,000, 4100 level would be the level. If we're wrong, and if the market starts to get anxious that the Fed might have to go a little more rapidly, that inflation looks a little more sticky, you know, we could see a market down around 3,600. That would be a normal non-recessionary type bear market move.

And you know, I don't think that's what we think will happen. But if inflation proves too sticky, I'm not sure that investors are going to be willing to let the market trade at the valuation that it's trading today. Even though the valuation's come down a lot this year, it's down in line with the five-year average, but it's still at a premium to its long-term average. And it's typically, expectations for inflation interest rates you go into that premium valuation.

So it's really just going to depend on where we go with inflation. And even though I think inflation stays higher this year than anyone would think we'll get to eventually, if we get it moderating and the market can see the light at the end of the tunnel that we are seeing some moderation there, I think that we can maintain some premium valuation to the market and we don't have to go back down and retest those levels. But you know, first look, 4,000, 4,100, if it's worse than we think, then you could slip into the 3,600 range.

- Great to have both of you here with us today to round out today's markets activity. Kevin Nicholson, RiverFront Investment Group, Global Fixed Income co-CIO, as well as Mike Gibbs, who's the Raymond James Director of Portfolio and Technical Strategy. Thank you to you both.