Markets higher with stimulus talks, earnings in focus

Alicia Levine, BNY Mellon Chief Strategist, joins Yahoo Finance’s The First Trade with Alexis Christoforous and Brian Sozzi to discuss what's moving the markets around Monday’s opening bell.

Video Transcript

ALEXIS CHRISTOFOROUS: Good morning, Alicia. You know, I thought that this market had already priced in no stimulus ahead of the election. You know, if we get anything, it would sort of be a bonus at this point. So why are stocks rallying?

ALICIA LEVINE: Stocks are rallying for a couple of reasons. Look, I think the headlines on stimulus are kind of dizzying. But ultimately, we work in markets, and you always want to follow the numbers and maybe not what people say. And let's think about the numbers for a second.

Back in June, the House passed a $3.2 trillion stimulus bill that went absolutely nowhere. The White House was at $1 trillion. Then we were-- Pelosi dropped to $2.2 trillion, and the White House came up to $1.4 trillion. And then the White House came up to $1.6 trillion. And now the White House came up to 1.8 trillion.

So now we're only $400 billion away. For me, the numbers are saying one thing-- these sides are actually not that far apart. We're pretty much getting to the midpoint of where those opening salvos were. Think about it, right, that's where they were back in June.

And the numbers are telling us there's a deal to be made here somewhere. And even Mitch McConnell has said is if the White House and the House agree, he'll bring it to the floor. I think, ultimately, the market doesn't believe it won't happen either now or after the election, simply because it really is in everybody's interest to pass this thing.

BRIAN SOZZI: Alicia, I have Black Monday top-of-mind here. It was-- it was today in 1987 when the Dow fell about 508 points, off about 22.6%. Insane. Taking a step back, though, do you think that one big down day, not obviously on the same magnitude as Black Monday, but does that one big down day exist ahead of the election? So many folks I talked to are really-- they're really unsure if it does lay out there.

ALICIA LEVINE: Yeah. No, that's a great question. Look, I speak to portfolio managers and asset managers all day long, personal life, professional like. Nobody quite believes there is not going to be some sort of reaction if there's a Democratic sweep, because the tax changes are actually extraordinary, not just on the corporate side, in a sense it's less extraordinary on the corporate side than it is on the individual side and the taxes on businesses and capital.

And it's hard to believe the market is not going to react in some way. Is that a day? Is that a week? Is it a slow trickle until the end of the year? Because we know if there are tax increases, they will be retroactive to January 1, 2021. It's hard for them to believe this is going to happen without some sort of hiccup. It may not be a big hiccup. It may be that the power of stimulus and the power of a Democratic White House with a Democratic Senate and maybe a $3 to $4 trillion stimulus would overcome taxes.

BRIAN SOZZI: Well, Alicia, that begs the question here. There's so much focus on the blue wave and that's what might be driving this market rally over the past few weeks. Well, what if President Trump wins re-election? Does the market go straight down?

ALICIA LEVINE: That's a great question. I think-- here's what you want to think about. Right now Biden is still out-polling Hillary Clinton in the general, right, by about 3 percentage points. So it looks like the White House probably, at this point, is going to go to Biden.

But those swing states are the places to look. And right now Biden is actually under-polling Hillary in those swing states as of this day versus four years ago. So the swing states are interesting.

And the interesting thing is the Senate and the odds there kind of tightens a little bit, so you could get a Democratic White House, a Senate that remains Republican, and you would not get a huge stimulus in that case. And you also wouldn't get a large tax increase. So is that more stable for markets? Maybe.

ALEXIS CHRISTOFOROUS: Interesting scenario, which we're not hearing a lot of talk about. What's your best educated guess what happens to the market if the Senate stays Republican? I mean, does that just mean there's going to be gridlock in Washington for the next four years and maybe Wall Street actually likes that?

ALICIA LEVINE: So my guess is we'll get some-- maybe a $1 trillion stimulus, if that happens. The market won't like that, but it will breathe an enormous sigh of relief that the existing tax regime would stay the way it is, which is more favorable to capital formation and investment. Because as we know, if there's any law in economics it is if you tax something you get less of it. If you tax capital, you'll get less of it.

So I think there'll be a sigh of relief there, but your stimulus will be much, much less. And that's the countervailing force. You know, you've got these two forces moving against each other. The market likes gridlock. It doesn't like huge changes. It likes rulemaking remaining pretty similar across administrations.

BRIAN SOZZI: Is there somewhere you could hide out?

ALICIA LEVINE: Yes. So what have we seen so far? So the tech sector is now 40% of the S&P, outpacing the 37% of 1999, which was the old high. Some people see this as a mania, and there's definitely concentration risk. The truth of the matter is these are the companies that are actually growing from 2019 earnings levels versus other companies in the S&P.

So it's not really a mania. We do think there is some stimulus passed. We do think the economy is recovering fairly well with risk to the labor force, but still fairly well. We think the cyclicals work here. And we think you have to have an allocation to tech as well.

ALEXIS CHRISTOFOROUS: All right, we're got to talk earnings. Expectations are high. The bar has been raised. These valuations are high. And it's early on in the earnings season, but so far 86% of companies in the S&P 500 have beat by a very healthy 23%.

ALICIA LEVINE: That's right.

ALEXIS CHRISTOFOROUS: Is this market setting itself up, though, for failure because these companies are not going to be able to at least even meet this highered bar?

ALICIA LEVINE: So look, most of the earnings are being driven by health care and tech, cloud, software, all that. So the earnings probably will come in better than expected, as you pointed out, Alexis. You know, only 13% of the S&P has already reported and already the earnings loss just went from minus 21% to minus 18% just with the 13%, which is actually extraordinary.

So look, the trough in earnings is in-- I think the interesting quarter is the fourth quarter, the quarter we're in, because this is the quarter where stimulus kind of rolled off. And so that's-- I think third quarter will beat. It will be stabilizing to markets.

If there is a Democratic sweep, you have to subtract 10% off of corporate earnings next year in 2021 when you start thinking about growth rates. But I think the fourth quarter is the interesting quarter if there's no stimulus. That's where you could see a hiccup.

BRIAN SOZZI: Alicia, COVID-19 infections and deaths continue to rise. We still have no stimulus. In terms of fourth quarter GDP, what's the risk we go back and we, in fact, do have that double-dip recession?

ALICIA LEVINE: Yeah, so the fourth quarter is like, as we said on the earnings front, same on the GDP front. We do need stimulus, because the COVID hole is longer for many people than what the government thought back in March when it passed stimulus. And we definitely need it there.

The third quarter's coming in. The Atlanta GDP is at 35% growth. It was at 10% growth a few months ago. So clearly, the third quarter outperformed. The fourth quarter is the risk, really, if there is no stimulus.

That labor force, you could have 8 to 10 million people permanently unemployed in the service sector because the demand in that sector has just dried up. So you really need stimulus here, and you need it now, because waiting three or four months is really the risk. Rent doesn't get paid, right. When rent doesn't get paid, it starts rippling through the mortgage-backed security market on the commercial and the residential side.

ALEXIS CHRISTOFOROUS: I want to get back to something you said a moment ago, if I heard you correctly, that if there's a blue wave in DC, you can immediately shave 10% off earnings what is-- what is the first quarter of next year? Or when would you be looking at earnings taking such a haircut?

ALICIA LEVINE: So analytically, this is how you want to think about it, right. Right now S&P earning estimates for 2021 are about $168 per share for 2021 with the existing tax regime. If I take the Biden tax plan at its word, OK, and everything else being equal and not everything is equal, but let's take it and isolate the variable, what does that increase in the corporate tax rate from 21% to 28% mean?

And what it means is, everything else being equal, you shave 10% off of 2021 earnings since we've been told the tax increases will be retroactive to January 1, 2021. So if you're at $168 today for next year and you take 10% off, you're really looking from $168 to about $150 per share, just isolating the impact of the higher corporate tax rate. Now, there could be different offsets, but that's how you need to think about it.

BRIAN SOZZI: But Alicia, certainly I understand the math, but if we do, in fact, get that stimulus, doesn't that prop up earnings growth? So wouldn't earnings, let's say, go up by 10% and just completely wipe out the tax hikes?

ALICIA LEVINE: So yes and no, right. So that's-- when you want to isolate the effect of something, you need to hold everything else equal, which is what I just did. The other thing that could happen is that the administration could roll back all those tariffs that we talked about, you know, 18 months and two years ago on this program.

So if you roll back the tariffs, you actually add back about $7 a share back to earnings. So it is a push-pull, and that's how you might want to think about what happens. I mean, I'll say this that the higher tax companies, and it's really in retail, right, so retail pays the full statutory rate, for the most part, those are the companies that will be hit harder than, for instance, tech companies.