Amid rising uncertainty, Brandywine Global Portfolio Manager John McClain joins Yahoo Finance Live to weigh in on the markets following the hot CPI print.
McClain says "the market narrative has gotten ahead of itself" in pricing in six rate cuts and slowing quantitative tightening by mid-year. He argues that outlook takes the possibility of a "soft landing off the table."
With the Fed delivering "constantly muddled" communications, McClain expects markets will cool on dovish pivot hopes as further data rolls in. In his view, cuts coming as early as March seem highly improbable.
Given lofty valuations, McClain think the market is priced for a "Goldilocks narrative," but given the potential for "conflicting data" to prop up the CPI print, he doesn't think "we're going to be declaring victory" before the presidential election.
For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.
Editor's note: This article was written by Angel Smith
Video Transcript
RACHELLE AKUFFO: Well, as we noted, CPI came in even hotter than expected in December and we can see the major averages reacting mixed on this news. Joining me now is John McClain, Brandywine Global portfolio manager. Good to see you, John. So give us some context here because you're saying that this doesn't really move the needle in terms of the market narrative. Why is that?
JOHN MCCLAIN: Well, the market wants to go higher. And I think we got a slightly stronger CPI today. And we're seeing a bit of a pullback, but not anything meaningful right now.
And you know, I think the three biggest things to take away from the CPI report, one being the shelter component up half a percent and that's in line with recent trend. But we think housing is going to be strong in 2024. And because it's the biggest component of CPI, that's going to be a real challenge to see us moving from kind of this mid 3s, high 3s type of number down to the Fed's target of 2%.
And then other components that have been pretty volatile, things like airfare and used cars were only up a percent and 1/2%, so they're not as volatile anymore. So we're not going to see as much noise, I think. And then the last piece really is the medical care component being up 6/10 of a percent for the second month. I think that's going to lead to the potential for some higher prints in 2024.
So the market narrative has gotten ahead of itself. It's saying six cuts. It's saying balance sheet runoff is going to slow down here. We think that if that were to be correct, then the soft landing is off the table here. You're not going to see six cuts plus a slowdown of QT with the economy doing fine.
RACHELLE AKUFFO: And so then as we look at some of the messaging here, I know markets looking for some clarity on the Fed. Fed kind of hedging their bets, so that markets aren't really sure-- really sure, which is why they're running with whatever narrative makes sense for them. But you compare the Fed and the market relationship to an old married couple. How does this relationship end up going from this point, given this data?
JOHN MCCLAIN: Well, you know, again, the Fed's message is constantly muddled here. We had Logan saying balance sheet runoff is going to slow down. We had Williams contradict that. And the market just says, hey, risk on and let's keep going and pushing stocks higher and bond yields lower.
I think at a certain point in time, the data is going to support more of where the Fed is saying rates are going to be by the end of 2024, which is a couple of rate hikes and it's not happening in March. And the market's gotten, again, way ahead of itself here. And I think we'll continue to get more data and the market will coalesce to where the Fed is this time around.
RACHELLE AKUFFO: And so then when you look at some of the fundamentals in the market, obviously, we saw the narrow rally with the tech stocks and then we saw that start to broaden out. But what are you looking at in terms of valuations at the moment?
JOHN MCCLAIN: Oh, yeah, fundamentals are really strong. And we've got a number of conferences going on right now, the JP Morgan Health conference, the ICR conference, CES. And kind of the information that we're getting out from companies here is that things are pretty reasonably-- pretty reasonably strong in the marketplace. And we think we will see some nice top line growth and potential margin expansion from companies in 2024.
The problem with this is that valuations are very high. You look at the S&P 500 trading at 22 times PE. That's an elevated level, particularly the Fed funds north of 5%. You look at investment grade credit spreads trading around 100, that's a pretty tight level. And same thing with high yield at about 350 spread.
We're kind of priced for the soft landing for the Goldilocks narrative and it's going to be hard. And we think, as we mentioned a little bit earlier, there's going to be some conflicting data which leads to the potential for CPI to stay elevated in 2024. I don't think we're going to be declaring victory before we have the presidential election.
