Kevin Nicholson RiverFront Investment Group Global Fixed Income CIO, and Heritage Capital President Paul Schatz assess market losses, outlook for market bottoms, earnings forecasts, and the impact of the Fed's interest rate hikes against inflation.
- Paul, let me start with you. Just in terms of the losses that we've seen play out over the last couple of weeks, losses today in the S&P and the NASDAQ, what's your big takeaway from the recent action that we've been seeing?
PAUL SCHATZ: Well, look, if you open up any newspaper, turn on even just regular network television news, you can't escape the bad news. It's literally a barrage day after day after day after day. So it's really weighing on and beating up investors' psyche. Nonetheless, this is, one, it's a midterm election year. When there's a decline in the midterm election year, you typically see a bottom in Q4, most specifically in October.
Bottoms don't form with good news. Bottoms form when no one wants to own stocks. So if you look at midterm election years like 2018, it was December. And then you saw in 1998, 1990, 1994, 2002, the bear market low. This is what happens. I don't want to say the bottom is today on the point. But now the narrative is stocks can't make a low until the Fed pivots.
And I'll argue vociferously that stocks are absolutely going to make a low before the Fed pivots. There's no doubt in my mind. The key is you need to see some relief with the two-year Note. The two-year Note's got to pull back. You've got to get some relief from the dollar before stocks can make a durable low.
- Kevin, given the language out of the Fed, are we anywhere near a pivot? And is cash king?
KEVIN NICHOLSON: No, I don't think that we're anywhere near pivot at this juncture. I think the Fed is going to continue to hike until they feel comfortable that they have actually stomped out inflation. The other thing too is that we're going to see the Fed-- the only way that the Fed pivots is if it actually breaks something, or more importantly, that there is a financial crisis. I think that would be when you would see the Fed pivot if they haven't finished with stomping out inflation.
Cash is a bit of a king right now. In our portfolios, we have an elevated amount of cash. But unlike in years past, holding cash, you're actually losing some purchasing power just given the fact that the dollar is so strong at this time.
- So then, Paul, as we look ahead to earnings season then, as we get ready to get into the thick of it then, what are the expectations there? Paul, that's for you.
PAUL SCHATZ: Oh, I lost audio for a minute. I'm sorry.
- No problem. I was asking you about your expectations for earnings season.
PAUL SCHATZ: Oh. Again, just like the fundamental backdrop, it's really hard to believe earnings season is going to have a lot of upside surprises. But remember, to me, it's not exactly what the news is. It's how stocks react. What you want to see is you want to see stocks go up in the face of bad news. That's a clear sign-- just like we saw in March of 2009 and April of 2009-- stocks are washed out.
It's really hard to have good expectations coming into this earnings season. Clearly, we're going to hear what companies have to say. But I want to see the reactions. I want to see stocks go up in the face of bad news. I want to see companies use the dollar as an excuse and then the Fed has an excuse. And let's not forget the last four Fed chairs have all made monumental errors that caused, as Kevin said, something to break.
And we're at that point right now. I mean, they're making another monumental error. So here we are again. I think you've got to watch for that final breaking point. And then volatility should begin to calm down. I think we're at the beginning of the end, not the end of the beginning.
- Kevin, the earnings season expected to be very volatile here. We certainly have seen estimates revised to the downside. The strong dollar, the uncertainty in terms of the economic backdrop here all challenges here for the companies that are about to report. What do you think just in terms of I guess your expectations for the season and the likelihood that we could see even further downside revisions?
KEVIN NICHOLSON: I have very low expectations for this earnings season. If we go back to June 30 and until now, we've almost seen earnings revision for 2022 come down almost $16. And into 2023, they've come down about $11. And, really, what it's really showing us is that most of that change-- and when we look at 12 months forward, it's a little over $5 that they have come down.
So what we're really looking at is Q3 and Q4 that have been revised down heavily. And so unless we get some type of upside surprise here in Q3 and Q4, we're going to see pressure on equities continue. And so I really am not holding out a whole lot of hope for going into the end of the year because when you think about the equity risk premium, it has come down this year largely because Treasury yields have gone up and earnings yields really haven't moved a ton. But it would argue for the fact that you would have a stable low inflation environment if the equity risk premium has come down. And that's not the environment that we have right now.
- Man, oh, man, the bad news just piling on here. Let's see if we can find something, Paul. Could the catalyst be a good inflation print later this week?
PAUL SCHATZ: I mean, sure. The catalyst is going to probably come from where no one expects it. So everyone's so focused on inflation. Everyone's focused on the Fed pivot. It's going to come from somewhere else because it always does. How many people can you drag on right now that are going to pound the bullish case other than the ones that start on January 1 and pound the bullish case? And the answer is almost none. There are very few because it's so dark.
But remember-- and I'm not saying you should go all in and lever up your portfolio now. I think you need to be tactical or surgical or opportunistic, whatever adjective you want to use. But, clearly, there are-- there's always opportunity in markets, especially ones that have come down so much. And look, the S&P is down roughly 25% this year. It's not like the S&P hasn't priced in at least a mild recession for Q1 and Q2 of next year. We didn't go down 25% because things are rainbows and unicorns. So I would argue perhaps part of, most of, much of what's coming in Q1 and Q2 has already been priced in. We're going to see shortly how much that's reality.
- So a tough road ahead. But as you mentioned there, opportunities still to be had. A big thank you to our market panel, Kevin Nicholson and Paul Schatz. Thank you for joining us this afternoon.