Loan growth ‘best indicator’ for a recession: NewEdge Advisors CIO

NewEdge Advisors Cameron Dawson joins Yahoo Finance Live to discuss equities, bank earnings, rising interest rates, investor sentiment, and the outlook for markets.

Video Transcript

- All right, well the upward swing in markets indicating resilience in equities fueled by falling interest rates and strong earnings estimates. But is the optimism sustainable or supported by just a few strong performers? Let's get right to it. Joining us now on set is Cameron Dawson, NewEdge Advisors chief investment officer. Cameron, lovely to have you here in studio. So let's talk about this market action that we're seeing. How much of this is really reflecting this flight to quality?

CAMERON DAWSON: Well, a lot of it we think is because there has been this big inflow into tech, and not just all tech. It's really been those that have this perceived quality and stability in the biggest names in the index. And so we see that the current market is really being held up by just a handful of names. But when you look under the surface, what you see is that only about 40% of the names within the S&P 500 are trading above their 200-day moving average. That means 60% of the names are below their long-term trend. So you're seeing some deterioration in the broader subset of the S&P.

- So then how should investors play this, then, if you just have sort of a few big boats lifting all the tides at the moment?

CAMERON DAWSON: Well, we've certainly seen this at many points during rallies. And what often happens is that it could be an indicator of future volatility to come, just meaning that you have a little bit more of a shaky ground underneath the market. I think the other thing to remember is that we are barreling into earnings season very soon. In just two weeks, we're going to start to hear from the banks.

And the really interesting thing is that, despite all the turmoil that we've seen in markets and uncertainty about what's going to happen, earnings estimates have not been cut over the last three weeks. And so it will be very interesting to see if earnings are well calibrated for what could be the ultimate impact of the banking fallout.

- Because we have seen some of these valuations start to get pressured, then. So what are the expectations there?

CAMERON DAWSON: Well, we do think that there will eventually be an earnings impact from the regional banking fallout. It's just a matter of time. It simply takes time for slower loan growth, which we think will be the first way that slowing banks will impact the economy and earnings. But it may not be this quarter. So we're going to be listening to what companies say, if they're starting to pull back more.

The other thing to remember, a lot of the announced layoffs that we got in the first quarter, big, huge companies announcing layoffs, they-- a lot of them don't hit until the second quarter. So it takes a couple months for you actually to see the increase in unemployment, possibly, or increase in initial jobless claims. So we'll be watching that closely.

- So then what are some of the top three risks that you're seeing that perhaps investors really aren't honing in on enough?

CAMERON DAWSON: Well, we do have a debt ceiling, and I think that that's probably not being priced into markets right now, meaning that we saw what happened in the last debt ceiling debate, where we saw Congress really take us to the brink. And so that was a big source of volatility for markets when we look back to 2011. So we'll be watching that very closely in the coming months.

And then, of course, it is this earnings story. And we're watching loan growth extremely closely because one of the things that we see is that, going into recessions, the best indicator that's a coincident indicator that you're going into a deeper recession is loan growth. And so if we see the SVB and what's happened within regional banks is the spark that causes loan growth to roll over, that's when we think that those earnings estimates may be too high and have to be marked down.

- And I want to look at some of the recession signals here, because obviously a lot of people looking at what's been happening with the two-year yield--


- --and some of the indicators there. What is that telling you, and should we really be basing our predictions on the bond market? It has been a little bit unpredictable.

CAMERON DAWSON: It is a really good point that the two-year plunging is typically a fantastic signal that a recession is soon on the horizon, because what a two-year yield falling rapidly says is that the Fed is going to have to cut interest rates very, very soon. Now, in today's environment, one thing that could be skewing that message is that two-year yield positioning has been extremely short. We've seen record short positioning in what's the CFTC data.

When that has record short positioning, you see a little bit move lower in yields, that causes a big move lower in yields. And so maybe it's amplifying these moves. So maybe the two-year isn't as clear of a signal of oncoming recession as it was, but if we just look at history, it would say two-year yields falling, curve resteepening, that means trouble's on the horizon.

- So then when you do have these sort of disparate signals at the moment, what is the play here going into the second quarter, in terms of sectors that you like?

CAMERON DAWSON: So what we've been seeing is that cyclicals have started to roll over pretty hard. That's consistent with a falling two-year, that recession signal. So what we've been looking at is really wanting to keep a balance between our cyclical and our defensive exposure.

Our defensives have really lagged to begin this year. You look at health care, underperforming the market really significantly and underperforming tech really, really significantly. So we're staying long in health care. We have a little bit of cyclicals within materials. In that event that China reopening works in our favor or you have a much weaker dollar, that would be good for materials. And it's really keeping that balance.

And the last part is keeping an overall overlay of quality. Now is the time where you want to focus on balance sheets. You want companies with really strong balance sheets that don't have to raise debt at high interest rates or generate a lot of strong free cash flow. And so whether you're looking at growth versus value, cyclical versus defensive, quality has to be a central tenet.

- So then for people who are looking for a safe haven-- we've had this discussion as we've sort of been looking at gold prices, looking at bonds-- could tech be the safe haven?

CAMERON DAWSON: I think that that's a little bit dangerous, to think that it's the ultimate safe haven. Prior to the COVID recession, tech was a cyclical sector, or considered a cyclical sector because it had earnings variability. It depended on what was going on with companies' tech spending budgets.

So during recessions, companies would pull back, and so you'd see tech shares underperform. But in COVID, you had a period where tech actually was the only sector that grew earnings during that time. But that's because we were all locked in our houses in pandemic lockdown. So we don't think that tech is going to behave the same way in future recessions that it did in the COVID recession, which may mean that companies-- or investors, sorry-- are underpricing the potential earnings risk of technology in a recession.

- You raise an interesting point because so many of us were relying on that tech, but it's a different game now as we're post-- you know, coming into this post-pandemic phase.

CAMERON DAWSON: It certainly is. It certainly is.

- Definitely good to note. A pleasure having you. Cameron Dawson there, NewEdge Advisors chief investment officer. Thank you for joining me in this morning.