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Fed should 'keep the door open for chance they overshoot' in tightening: Strategist

Truist Chief Market Strategist Keith Lerner and Chris Konstantinos, RiverFront Investment Group chief investment strategist, join Yahoo Finance Live to discuss Fed policy and how Chairman Powell might tackle inflation going forward.

Video Transcript

JARED BLIKRE: Here's your closing bell on Wall Street.



DAVE BRIGGS: All right, there's your closing bell on Wall Street. Markets-- well, you got to like what you see on the board. The Dow up 337 points, on track for its best month since 2020. Go figure, up 337 points in the day. And the S&P has been strong for the last, what, seven days now, 62 points up, 1.6%. The NASDAQ ahead of Snap-- excuse me, Alphabet and Microsoft earnings, surging 2.2%, 246 points. We will bring you those earnings as they come in.

But first, let's bring in Keith Lerner, Truist co-chief investment officer, and Chris Konstantinos, RiverFront Investment Group chief investment officer. Nice to see you both. Keith, let's start with you. What do you make of this continued rally?

KEITH LERNER: Of course, it's great to be with you, as always. Our view is heading into October, this market was the most oversold since the June lows. And we've been looking for relief. So I think what we're seeing here is some relief from an oversold condition. Position is light as you head into a seasonal period. Now think about it, Dave. If you-- we've had a really tough year. And if you're a money manager going into the end of the year and you miss out on a fourth quarter rally, that's not acceptable. So I think there's some anxiety.

But our picture-- our big picture view hasn't really changed. Even though we've been expecting some type of rally here, we think the next 6 to 12 months are still more challenging. And as we move up to, say, 4,000, 4,100 on the S&P, for those investors that are overweight risk, we would use that as an opportunity to become more defensive.

SEANA SMITH: Chris, what do you think? Do you agree?

DAVE BRIGGS: Chris, can you hear us?

CHRIS KONSTANTINOS: I lost you guys there for a second, but you're back now. I'm sorry.

SEANA SMITH: Yeah, I was just-- I was asking you, just, what you make of the rally that we've seen over the last three days, the gains really that we've seen over the last month or so. Does that, do you think, have staying power?

CHRIS KONSTANTINOS: Hmm, yeah. And also, thanks for having me. I have to say, I agree with Keith here that one of the histories of bear markets, if you study them going back 30, 40, 50 years, is, generally, in a prolonged bear market, you have pretty dramatic bear market rallies, and they can be pretty frequent. And I think we experienced one from mid-June to August, and we're probably getting another one now. It doesn't mean it isn't going to have staying power. It doesn't mean it can't persist for some time.

But color me a little bit skeptical that the overall complexion of this market has changed meaningfully because at the end of the day, the Fed put is pretty much gone, in our opinion. And the Federal Reserve has to prioritize getting inflation under control over pretty much everything else, including protecting the wealth effect.

DAVE BRIGGS: Chris, what is your expectation at the next two Fed meetings?

CHRIS KONSTANTINOS: I think they have to continue to walk the tightrope that they've been walking, right? I think it's-- they have to talk really tough on inflation because at the end of the day, I don't think that Chairman Powell wants to go down in history as the Fed chairman that allowed the inflation genie out of the bottle 1970s style. So you have history working against him there in order-- so I think he has to stay pretty aggressive, pretty hawkish tone.

But you want to-- if I'm a Fed chairman, you also want to keep the door open for the chance you might overshoot and that financial conditions might tighten too much, and you have to back off the fierce rhetoric. So they're going to have to walk that tightrope. But I expect-- I mean, 75 basis points, I think, are in the bag. And I think you have to expect between 50 and 75, the next one after that. At the end of the day, that is nothing even approximating an easy monetary policy. And I think we have to keep that in mind.

SEANA SMITH: Keith, what's your assessment just of how much headway the Fed has made up until this point?

KEITH LERNER: Well, they've had the most aggressive tightening policy in about 40 years. The issue is, they started ultra loose. So they've been playing catchup the whole time. So I think they've come a long way. But if you think about it, our point of view is similar insofar as that we think the Fed has scar tissue now because of this inflation that's happened in the last year. So they're likely-- the best we can hope for is that they move rates up 75 basis points, maybe 50 or 75, and then hold them there.

And the other thing I want to point out is part of this rally is energized by what happened on Friday, some [INAUDIBLE] that maybe the Fed is going to become less aggressive. Our view is that would spark a rally. But if you go back to 2000 and 2007-- again, we're not saying this is the same environment. Just because the Fed's cutting rates doesn't mean that the market rally will be sustainable.

A big point of view has to come down to whether we see recession or not. We still think recession risk in 2023 is relatively high, especially when you look at the inverted yield curve, leading economic indicators down for the six months. Housing is the business cycle. Housing is softening quite a bit. And even if we sidestep a recession, we just think at 16 times earnings today on earnings that likely have downside pressure, that the upside is likely capped around the 17 multiple. So maybe 5% or 10% upside from here is likely the cap.

So at best, even if we have a kind of a soft landing, which is not a base case, we think the upside for the market is somewhat capped. So you just have to be more tactical in this environment in our view. And that's what we've been doing this year.

DAVE BRIGGS: Chris, can we avoid a recession? And your thoughts on Jamie Dimon over at the Davos in the desert in Saudi Arabia, saying he's less concerned about a potential recession than he is about geopolitical events, most notably the Russia-Ukraine War, and of course, US-China relations?

CHRIS KONSTANTINOS: Sure. So whether we can avoid a recession or not, the thing I'm really mostly focused on is corporate earnings. And if you look at the 1970s, what was kind of fascinating about the '70s is you had three or four recessions between the early '70s and the early '80s. But corporate earnings pullbacks during those recessions in nominal terms actually wasn't-- they weren't that dramatic. Nothing approximating the kind of earnings collapse we had in 2008, or even the brief one we had in 2020.

So what we may end up with is some sort of mild recession where corporate earnings stay a little bit more resilient than we're used to in the recessions of the past 20 years. And that's probably the most optimistic way you could see the market shaping up and how you might guess that somewhere between here and 10 percentage points lower than here is probably a pretty big, longer term buying opportunity for the market. And that's about as optimistic as I can sound right now. We are-- as Keith mentioned, we're in a very similar position in that we've been very tactical this year. We are in risk management mode. We are underweight equities.

But that is the way that I could see this shaping up without having to go through a prolonged 40% plus down two-year type of bear market like we saw in '08. To your question on geopolitics, I think geopolitics are filtering into the story around recession, the story around corporate earnings, right? For me, the two geopolitical hotspots here, we have a hot war in Europe, which is contributing to the inflationary pressures the Fed is trying to fight. And that's not good for the market.

And then the second piece of this is the Cold War we have between the China and the US, which, in my eyes, is only intensifying with the rhetoric coming out of China that we saw from the Communist Party Congress earlier this week. So those two pieces together have real market implications. And neither one of those is potentially a really great setup for the market.

SEANA SMITH: All right, we have to leave it there. Chris Konstantinos and Keith Lerner, thanks so much.