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Market sell-off ‘quite extreme’ but not surprising, strategist says

Charles Schwab Chief Investment Strategist Liz Ann Sonders joins Yahoo Finance Live to discuss the August CPI report, market swings, rate hike expectations, ongoing volatility, and the outlook for the Fed’s upcoming FOMC meeting.

Video Transcript

[AUDIO LOGO]

- Well, we've got much more conversation on this. Let's dive more into this market action with Liz Ann Sonders who is the Charles Schwab Chief Investment Strategist. Liz Ann, always good to speak with you. First, can we get some sense of your expectation with more of the conversation that's kind of been coming forward around a potential 100 basis point hike based off of yesterday's CPI prints, that really jettisoning the probability of a 100 basis point hike higher by about 20%. Do you think that's in the cards?

- Um, maybe in the cards, but further down in the deck I think than a lot of the chatter around that with the meeting so close up until yesterday's CPI report, a firm expectation of 75 basis points. I'm not sure the Fed at this point and with this narrow a window of time between the next FOMC meeting would want to do shock-and-awe kind of policy.

So their MO has been to move somewhat consistent with market expectations, even sometimes juicing market expectations via, maybe, well-planted whispers in certain reporters' ears. So I think 75 is more likely. I think what really was the implication of yesterday's hotter-than-expected CPI report was not so much the size of the hike coming next week, but the fact that we have to push into November and December, not just hikes, but maybe more significant hikes. Not an easing back to 25 to 50.

- Yeah. I mean, who needs shock-and-awe from the Fed when you're going to get it from BLS when it comes out with these inflation statistics, right? The economy is providing its own shock-and-awe, I guess, to the markets right now. Where do we go from here after the sell-off that we saw yesterday? As we talked about, the bounce that we're seeing this morning does not feel assured.

- So yesterday, although it was quite extreme conceptually, wasn't a terrible surprise. What's been more surprising to me are the days where the market-- and not just days, but days and weeks where the market seems to want to forcefully fight the Fed. Julie, as you know, I grew up in this business working for the late great Marty Zweig, and he coined the phrase, "Don't fight the Fed." So I'm steeped in the background of that and how important that is, especially in the type of cycle that we're in right now combating a 40-year high in inflation.

I thought the notion of a pivot made no sense at all. The only background conditions for a green light to the Fed to start cutting interest rates so soon after an aggressive tightening policy would be much more significant deterioration in the labor market from here, and/or in the economy from here.

So the fact that it was sort of a bullish wrapper around that narrative, I didn't think made a lot of sense. And I think the Fed continues to have to push that rates will continue to go up fairly aggressively. And once they get wherever they get to where the Fed can say, OK, maybe we can pull our foot off the brake a little bit, they're going to stay there for a while. And I'm not sure that the equity market has yet fully reflected that in its behavior. So yesterday was less of a surprise. Some of the rally days in the face of news that shouldn't suggest it, I think, has been more of a surprise.

- And so in terms of the strategy that people should be thinking through, whether they're trading desks or whether they're individual investors, when they think about how companies may have to also adjust some of their own outlooks in the guidance that we've seen thus far and where that might be actually coming down, what would your expectations be there?

- All right. So I do think we're only at the beginning of the reversal in terms of earnings estimates and the move down for the latter two quarters of this year and the first couple of quarters of next year. You still have consensus for dollar earnings for 2022 at about 225, that's versus 208 for 2021. So still a decent growth rate.

I think those estimates have to come down. It certainly wouldn't surprise me to see us end up at the end of 2022 with an earnings number South of where we were in 2021, meaning a negative year-over-year change. And I think that has obvious implications for the market because you've got now this deteriorating E in the forward PE, which is putting upward pressure on multiples while inflation, which hasn't been tackled yet, puts downward pressure on multiples. So it's a bit of a push and pull right now.

But there are factors that tend to do well consistently in declining estimates, declining earnings environments, and it's factors like return on equity, stronger free cash flow, positive earnings revisions, lower volatility. And those don't necessarily work when you get these pops higher, these counter trend moves on the upside. But I think those are the types of characteristics you want to look for in this ongoing period of volatility, but especially because of this deteriorating earnings outlook.

- Yeah. And these are factors that you've been talking about for a little while now as we've been in this current period, Liz Ann. Are they particularly concentrated in any sectors or is it sort of spread out across different sectors? I mean, we were showing a chart that you tweeted this morning about the NASDAQ 100. And the theme you were just talking about that we have seen PE multiples actually expand, even though the earnings outlook has not been great.

- Right. So no, there isn't really a heavy concentration in any one sector to, maybe, marginally you find a lot of those more in the health care sector than other sectors. But one of the benefits and points of factor-base analysis is you don't have to make that one step up call sort of at the sector level first and then move to the factor level, you can apply factor-based screening across the spectrum of sectors because there are opportunities throughout the market.

And I think the sector call is particularly difficult this time because we're so macro-driven right now and you're seeing this pretty rampant sector volatility. Even energy, which has been the best performing sector over the past year, has spent as many months where it was the worst performing sector as it has months where it was the best performing sector.

So that kind of activity, I think it's going to drive shorter term investors crazy trying to figure out that sector call where there's been more consistency at the factor level. But, yes, if I was going to point to one sector that maybe has those incorporated in a little bit more than others, it would be health care.

- Liz Ann, just really quickly. For lack of a better term, were people you were talking to freaked out yesterday by what was going on?

- I did six virtual events and there was concern, but I wouldn't say freaking out because a lot of the concern about inflation has been there. It's always a shocking day to go through that. But if you're disciplined, you can ride through tough periods like that, individual days or weeks or even months.

- I guess for some levity at this moment, who was the musician that's on the wall behind you? I just need to know.

- It's a whole bunch of them. So I should turn this.

- Oh my goodness. This is far more expensive than we thought it was.

- I got it at a charity auction. I'm a I'm a total rock chick. And it's every amazing guitarist ever. It's Jimmy Paige and Jimmy Hendrix and Eddie Van Halen and Jeff Beck and Clapton. And so that's what sits over my shoulder giving me good advice.

- That is the conversation we need to have next time, just go down the top 10 list of guitarists.

- That's way more fun.

- That is. That is. Liz Ann Sonders, Charles Schwab Chief Investment Strategist. Thanks so much for joining us this morning.

-Bye, you guys.