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Market strategist on recession risk: 'Fear starts to feed on itself'

RBC Capital Markets Head of U.S. Equity Strategy Lori Calvasina joins Yahoo Finance Live to discuss stock futures, May consumer price index (CPI) data, inflation, recessionary risks, and the outlook for the stock market.

Video Transcript

BRAD SMITH: Here to dive more into that market reaction with us, we've got RBC Capital Markets head of US equity strategy, Lori Calvasina. And Lori, I mean, this kind of jives directly with what some of your anticipations were, especially for the S&P 500. But even going forward from here, you know, where does the inflation start to ease in order for the markets to finally have something to perhaps see a turning or a turning of the corner around?

LORI CALVASINA: Well, thanks for having me on, as always. It's obviously an interesting day in the market with today's CPI print. Look, I will tell you that as we talk to investors this week, there was a lot of concern about this print that was coming up. And, you know, I've heard institutional investors, some at our energy conference, some I met with privately, have been saying things to me, like, how can we possibly avoid a recession with the Fed being as aggressive as it is, with gas prices being as high as they are, with inflation being as high as it is.

So I think that we've all been sort of looking for capitulation in the market. I do feel like just the exasperation and the frustration with this inflation backdrop has really seeped into the investor community this week. And look, we still do think that equities are going to be higher by year end. Our economics team has been optimistic that by year end, we will get some moderation, particularly in core CPI. We obviously didn't get that today. But I do think that just the fears that I have seen, I don't think that this was a total shocker for the investment community or the equity community today.

JULIE HYMAN: Perhaps not a total shocker. Hi, Lori. Perhaps, but--

LORI CALVASINA: Hi.

JULIE HYMAN: --an unpleasant surprise, let's call it, then, if not a total shocker, right? The fact that it was a little bit higher than estimated. And so, walk me through this path here, from here to the end of the year and still seeing some kind of gains from here in equities, especially if-- OK, so even if it's not 8.6%, what if it's still 7%? What if it's still 5%? I mean, these are not happy numbers any way you slice it.

LORI CALVASINA: Well, look, I think if we did get some sort of moderation, right, from an 8 plus percent number down to a 5% ish type number, you know, I think you do have-- that would be more on the headline side. You do have to look at core. And that is what the Fed has said they're going to be more focused on. But look, I think the path is pretty simple, Julie. It really does come down to whether or not the Fed is going to pull off this landing. And I don't like the term soft landing. I think it could be a bumpy landing, and the market could still be OK.

But I do think it has to avoid sort of the crash and burn scenario. And we've told people that our economists is not making the call for a recession, rather a return to sort of sub trend conditions in GDP later this year into next year. If that continues to be the case, I think the markets will breathe a big sigh of relief. But I do tell people my conviction level that we'll avoid the recession, I think it's about 60%. Like, it's definitely the way I tilt. It's better than 50-50. I do understand why people are concerned.

I think the market needs clear and convincing evidence that a recession is coming before it's willing to price one in, simply because if you look back the past few years, whether it was the trade war, whether it was the pandemic, there have been so many instances where the consumer was doubted, where corporate America's resilience was doubted.

Investors panicked over it, and frankly, things ended up being more resilient than previously expected. So I do think that the market really does need to see signs that the Fed is going to tighten us into a recession and be pretty convinced of that before he'll take another leg lower below that May 19th low of 3,900 that we already had.

BRIAN SOZZI: Lori, do you see this inflation print as being the worst case scenario for investors this summer? You have inflation that just accelerated, and you have a Fed that is about to put its foot on the gas.

LORI CALVASINA: Look, I think it's all about the Fed messaging. And I think after sort of the last round of commentary that we got, I think investors took some comfort on the equity side, at least, in the idea that the Fed was pulling forward some of the hikes and being aggressive with hikes in sort of a front-loaded fashion so that they could be flexible later on. That, in my mind, contrasts very much with what we heard back in 2018, when the Fed essentially said that it was on autopilot. And investors, I think, got a very different message. So we do need to see what the messaging is going to be going forward.

JULIE HYMAN: Lori, I'm also curious, as market psychology is, obviously, important here, even though most of the trading in markets is institutional, so an institution, I guess, is less vulnerable to psychology. But everybody's paying higher prices, right? Everyone is watching the markets. And so you get the so-called wealth effect of people feeling like they have less as stocks go down. Are we in danger at all of seeing sort of a circularity, if you will, to that psychology, where people are less willing to put money to work?

LORI CALVASINA: I think that's a great term, circularity. You know, I've sort of thought about the phrase a lot. The biggest thing to fear is fear itself right now. I don't think that necessarily, we have to have a recession. But I do sort of think about what keeps me up at night. And a client asked me this yesterday. Actually, it is just that idea that the fear starts to feed on itself. I've heard institutional investors fretting about the high sort of airfares that they're looking at for their family summer vacation. So this is not just a low income consumer problem where the inflation is starting to take a bite and cause some consternation.

But I will tell you, if you go back and you look at the numbers over time, when sentiment is as washed out as it has been on the AAII Net Bull-Bear Survey, and if you look at the CFTC data on institutional equity, futures positioning, they're both basically sort of circling the drain. They're about as low as they tend to get. And prior to this week, at least, we had started to see some signs of a positive inflection. And so that is something that continues to tell me that even sort of this pain that a lot of investors are starting to feel personally in their own lives, a lot of that has already been reflected in markets. Perhaps not all of it, but I do think a lot of it is there.

BRAD SMITH: Of course, reading into the inflation print this morning, also looking into some of the companies that have announced that they are going to be either hiring or freezing some of their hiring-- excuse me-- or cutting some of their workforce as well, on the path that the Fed is on right now, do some of their own goals with regard to employment, full employment, and then even price stability, do you see that breaking down even as they are on the way towards that continued tightening?

LORI CALVASINA: Look, I think that I've heard a lot about sort of the labor market from investors. The housing market is something that comes up. If you talk to my homebuilding analyst, he'll tell you it seems like the Fed is on a mission to really cool the housing sector, and that can't be good for his stocks. I do think that these are things that have to happen, right? The Fed is trying to cool things off. The question is simply going to be whether they cool them off too much.

And again, I don't think that history book has been written yet, but I do think what we know is that the Fed has demonstrated in some of the recent commentary a sensitivity to the broad part of their mandate. I'm not a Fed watcher. I'm not a Fed prognosticator. But I will tell you as an equity market generalist, that is what I heard in some of the recent commentary. And we do need to see if they continue to sort of toe that line or if they take the messaging in a different direction.

BRIAN SOZZI: RBC Capital Markets head of US equity strategy, Lori Calvasina, always good to see you. Have a great weekend.