Market ‘is beginning to price in the end’ of the Fed’s rate hikes: Strategist

Wells Fargo Securities Head of Equity Strategy Chris Harvey joins Yahoo Finance Live to discuss the state of the economy, market conditions, the probability of a recession, Walmart slashing its profit forecast, and the expectations for the upcoming FOMC meeting.

Video Transcript

BRAD SMITH: Welcome back to Yahoo Finance Live, everyone. In the latest note from Wells Fargo Securities Head of Equity Strategy, Chris Harvey, clients were told to be aware of soul-crushing sell-offs coming this summer. Chris joins us now.

Chris, great to have you here with us today. Help us break this down a little bit further. Despite any interim bear market rally, what would the catalyst be for such a sell-off to the downside from your perspective?

CHRIS HARVEY: Yeah. So one thing we also had said is that you should expect some face-ripping rallies, which is what we're seeing right now. Where we may get that sell-off is once we get through the FOMC and once we get through earnings, the macro is going to take over. And as you pointed out earlier on your show, the macro is not so great at this point in time.

The other thing that occurs is liquidity starts to come out of the system. And we could see some sort of sell-off in August or September, basically because people start worrying about the recession, people start worrying about financial conditions, and we don't have a lot of idiosyncratic information or stock specific information because we got all that during earnings season.

BRIAN SOZZI: Chris, do you think what we heard from Walmart last night, very worrying tell on the state of the economy, then you have that Federal Reserve meeting tomorrow-- do you think those are the two trigger points that trigger that soul-crushing plunge in the markets headed into August?

CHRIS HARVEY: So one thing I would say about Walmart-- you have to be careful, because it looks like Walmart, Target, and Amazon, one thing that they did-- and this is going back a few months-- is they were in a bit of an arms race to get inventory, to get workers, to get warehouse space. And they just misjudged the market. They built up too much inventory.

And now what happened is they have this inventory that no one wants, and they have to discount it. We are of the opinion that we're going to go into recession, it's going to be a consumer-driven recession, but it's going to take a while.

Part of that is because we're seeing the negative wealth effect. Stock prices are down. Housing market's not as strong as it used to be, and people are beginning to be stretched. So you can't just say it's just Walmart. There's a lot of issues that we have to deal with and look at.

But at the end of the day, the economy is slowing down and you have to be careful about things versus experiences. People had a lot of, quote unquote, "things" at this point in time. They don't need more. And you're right-- they have to spend more on your day-to-day consumables. They are still spending on your higher end. But the things in the middle is what people are sacrificing at this point in time, and that's where you don't want to be.

JULIE HYMAN: And we'll start to see if services start to rollover as well. The PMI-- the last S&P Global PMIs, Chris, did not look very good on that front, sort of surprisingly. OK, so if we're going into a consumer-led recession, I'll ask you what we've been asking so many folks, which is, where is the bottom? Where is that priced into the market?

CHRIS HARVEY: Yeah. So we think the bottom on the S&P is somewhere around 3,700. That's close to where we touched before. I think we got to 36 and change, so maybe we get close to retesting the lows. But at the end of the day, I think-- and you also hit on it before-- we're getting toward-- or I think we're getting toward the end of the Fed tightening cycle.

The market is now beginning to price in the end. The market is believing the Fed won't be as aggressive as it initially thought. And that's a real positive. We think that the market can begin to firm once it believes the Fed is going to toggle down expectations or once they believe that the Fed is done or close to being done. And you're not going to get that tomorrow.

But I do think you get a pretty good probability of that occurring in September. And so what we think is you potentially see a pretty good fourth quarter rally. And we do think you probably see some downside from here, so some value being uncovered in the next one, two months.

BRAD SMITH: All right, so Santa Claus is perking up a little bit on that, if we were to see something towards December and the fourth quarter. But at the end of the day, too, with it coming down to the Fed and what they're going to announce, what, most notably, could the markets hang its hat on tomorrow, even if 75 basis points comes out and then, additionally, the Fed gives some type of insight into the next rate hike that could take place later on?

CHRIS HARVEY: Yeah. So we debate this internally. And one of the things that we look at is that's a little bit boxed in, because CPI was a big print. And so they can't say inflation based on CPI or what they call survey measures is beginning to weaken.

What they can say is those market-based measures of inflation are beginning to come down. Not to get too wonky, but breakevens have come down significantly. And that's an indication the market believes that inflation has peaked, at least for now-- what you're seeing. And to your point about Walmart and the consumer, we are seeing the consumer-- last year at this point in time, the consumer was price unconscious.

If you raised prices, 5%, 10%, 20%, they'll say, I'll take two, I'll take three. Now as you raise prices, the consumer is changing his or her behavior. And that's important. And then the last thing is you're seeing commodity prices come down and you're also seeing that negative wealth effect.

So the Fed does have some things to work with. And if the Fed does start to say, things are beginning to work, I think that's a positive. They just don't have a ton of ways to communicate that.

So I think they'll be a little bit more conservative. And I think it's more in their favor to be more conservative at this juncture.

BRIAN SOZZI: Chris Harvey, Wells Fargo Securities Head of Equity Strategy, always good to get some time with you. We'll talk to you soon.