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The market rally could be 'just enthusiasm' as inflation continues hitting consumers: Strategist

Julie Biel, Kayne Anderson Rudnick Portfolio Manager and Senior Research Analyst, and Kevin Nicholson, RiverFront Investment Group Global Fixed Income CIO, sit down with Yahoo Finance Live to talk about inflation's impact on consumers, market rally trends, the outlook of the travel industry, and defensive sectors.

Video Transcript

- And there you have it, the closing bell for this Friday, August 12. It's been a positive week all around, especially with the economic data that we've gotten on the inflation front certainly helping investor sentiment. Let's try to break down today's market action here. We've got Julie Biel, Kane Anderson Rudnick Portfolio Manager and Senior Research Analyst. We've also got Kevin Nicholson, RiverFront Investment Group Global Fixed Income CIO.

So Julie, let's start with you. I mean, I guess you look at where we are today. We've got what three straight days rallying on the back of economic data that came down. What do you make of the moves here. And is this, same question I asked the guest earlier, is this a bear market rally or are we seeing more of a meaningful turn happen now?

JULIE BIEL: I think it's hard to say. What's clear to me is that there is a lot of enthusiasm about this Fed pivot based on softer inflation reports. And I think what's important, though, is to look at what's driving that softness in inflation. It's gas prices and those are quite volatile, right? More volatile than my college roommate by far.

So what I would say is when you look at how sticky something like rent is and you see the increase in food prices, it makes you really wonder how much the consumer is going to be able to handle going forward. If food prices remain persistently high, that's going to take a real bite out of weekly earnings. And we know that rents aren't going down any time soon.

It's going to take a pretty meaningful change in supply for that to change. So I'm less optimistic about the strength of the consumer. And I don't think that this rally really has the fundamentals behind it. I think it's just enthusiasm.

- And, Kevin, there was a lot of data that investors were riding high on. You had Fridays, last Friday's jobs report, PPI, CPI consumer data coming in. Is there too much enthusiasm built into the markets right now?

KEVIN NICHOLSON: I think that when you think about where the market has gone there has been a lot of enthusiasm. And when you look at the S&P 500, for instance, we just broke through a significant resistance level of 4230. And so that was really going to break that downtrend that we have been seeing. So I think that when you think about where we are right now, markets are euphoric.

And so you have to proceed with a little bit of caution. Because you could very well be getting a head fake and getting a pullback. But what I do know right now is that inflation is going to be persistent. The Fed is going to continue to raise rates.

And the equity markets are looking past all of that and they're looking out into the future to see exactly where we are going to end up. And one thing is for sure. Right now when you have multiples earnings, you have multiples that are trading about 17 and 1/2 next year's earnings, there's not going to be any room for multiple expansions. So they're going to definitely have to grow earnings if this is going to be sustained.

- So it doesn't sound like you think this is the time to take on more risk, Kevin.

KEVIN NICHOLSON: Well what I would say is I will take on more risk. But you have to do it in a measured sense. And a lot of folks have been short the market. And so they may be going back in and reducing a lot of their underweights. But I don't feel comfortable at this juncture in going overweight the market.

And so what I would be doing is I would just be closing some of the underweights that I have in the portfolio. And I've been focusing more on megacap tech. Because that is exactly where what has been rallying, because that's what has been beaten up.

- And, Kevin, you mentioned a head fake. And Julie, in your notes, you talk about travel earnings season for the third quarter potentially being a head fake. What are you watching there?

JULIE BIEL: Well, I think anyone who's experienced finally getting out of the house to travel is seen that airplanes are completely full. It's very hard to get reservations. And so it really feels like there's wonderful, strong, healthy demand. And I think even business travel has been much stronger. Because people are just really eager to get back out, see their clients, et cetera.

But I think that longer term kind of past this summer holiday, you're going to see business travel start to peel back. And it's just because Zoom has done a really great job in being able to eliminate some of that travel. We're just not going to need to be doing it quite as much. We don't need to have these mega conferences quite so often.

And so I think that that's going to lead to weakness in overall business travel earnings, particularly for the airlines. And that's important because the people sitting in the front of the plane really drive the profitability for those businesses. And they're just adding capacity. So I think we could see a real decline in airline prices in the back half of the year.

- I mean, we've already seen some drops when you go past Labor Day, which is sort of typically when we start to see a pullback in airline prices. I mean, you're talking specifically about business travel. But I wonder what you see in leisure travel. Because everything we have heard, whether it is Airbnb or Marriott, it's that people are still booking into Q4. And they aren't seeing cancellations, despite some headwinds and these cost increases that a lot of consumers are still facing.

JULIE BIEL: Yeah I think for sure if you're coming off of the weakness that we saw in 2021, the numbers are going to look better. But at the end of the day, unless you're specifically geared towards leisure travel, it's very hard to make your hotel or your Airbnb work unless you're filling out the middle of the week.

So it's great that people are doing holiday travel or going to New York, for example, for to see the Christmas lights. But they need to fill those hotel rooms in the middle of the week or those flights in the middle of the week. And that's much harder without very robust business travel.

- So Kevin, as we look further down the line to the second half of the year then, what are you looking at in terms of rotating in or out of to really match some of these economic conditions we're facing?

KEVIN NICHOLSON: Well one of the big things that I've been rotating out of you start thinking about rotating out some of these more defensive sectors such as Staples and health care, utilities, and you know, telecom type communication services. And you're going to be rotating back into the more growth year names. Because those, through this last earnings season, they seem like they are the ones that are being able to maintain and grow earnings.

And so I think that it'll be important to look at those sectors. And then when you think about fixed income, one of the things that we would be doing is, we're going to continue to focus on the front end of the curve because we know that rates are going to go higher. And that is going to give us basically the highest yield per unit of duration, knowing that you want to lock in a lot of that income as much as possible so that you're not sitting with too much cash on the side as the Fed continues to do their rate hiking.

- And, Julie, unlike your volatile college roommate what do you see as perhaps the safer bets for the second half of the year? You know I think we look at a lot at switching costs as being a good indication of the durability of your earnings. So for example, if you provide software that's mission critical, I would think of like a Bentley Systems that offer software for infrastructure. It's mission critical software. You're not going to be ripping it out.

Those are the types of businesses that are exposed to less cyclical end markets and that themselves have high levels of recurring revenue. They can plan their expenses accurately. Those are the types of businesses that we're looking at. They're never going to be cheap. They're high quality businesses. So you're never going to get them on the cheap. But they're cheaper than they have been. And so I think that's a good place to be looking.

- A big thank you to our market panel there, Julie Biel and Kevin Nicholson. Thank you for joining us this afternoon.