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Midterm elections 'may actually be a catalyst' for corporate earnings: Strategist

Barrett Asset Management CIO Amy Kong joins Yahoo Finance Live to explain potential catalysts for markets.

Video Transcript

[AUDIO LOGO]

DAVID BRIGGS: Let's bring in Amy Kong, Barrett Asset Management Chief Investment Officer. Nice to see you. So we came into today 8% off the S&P's August highs, and we continue along those lines. What's driving the markets even lower?

AMY KONG: Yeah, I think, you know, you are seeing the remnants of a pretty tough week last week continuing into this shortened holiday week. We had a pretty good earnings season, better than expected to an extent. And obviously, the Jackson Hole comments are refocusing investors back to the point that the Fed is not quite done with monetary policy. And I think that's being digested as we see some of these more weakened days in the market.

SEANA SMITH: Amy, Goldman was out with a note this morning saying, "we have argued that the US economy can achieve a soft landing even though the path is narrow." What's your view just on the Fed being able to navigate a soft landing at this point?

AMY KONG: Yeah, I think the odds are probably one in three chances at this point, and that's in sync with what Goldman has been saying. Given the ISM Service data being stronger than expected, the jobs numbers from last week also better than expected, there is a buffer for the Fed to continue to raise interest rates without quite yet knocking the economy back into a recession. So I think at this point, the odds at about one to three is reasonable. Certainly as we get more data points, that number can certainly move quite a bit.

RACHELLE AKUFFO: And Amy, as you talk about that buffer there, how does the housing and rental sector play into that?

AMY KONG: It's a great question. I think as the affordability index for the real estate market continues to decline lower given that mortgage rates have shot higher quite a bit, I think the rental market is something we're going to watch quite closely. You're seeing that on a month-over-month basis, it's been increasing maybe half a percentage point. But that may continue to be a factor of why CPI numbers can stay elevated because, again, those leases are going to start to roll over into higher numbers as the real estate market continues to become less and less affordable.

DAVID BRIGGS: Much more on the rental market across the country later in the show. What can be the next catalyst to move these markets back in the other direction?

AMY KONG: Yeah, I think going into the next couple of weeks and months, there are a couple of things that I'm watching. Certainly, we just finished the second quarter earnings season. The third quarter earnings season is something that I'm going to put a lot more weight on.

A lot of companies may begin to give us a little bit of clues in terms of what 2023 may look like from an earnings standpoint and obviously can go either way. But what we've seen from the second quarter is that profit margins have held on, which is a plus. That's something I'm watching quite closely as we head into the next season.

And then, of course, the Labor Day holiday, if you would, is really the official start to the election season, and the midterm elections could be the next catalyst or the next headline, if you would. Typically, stocks do well going into midterm elections. Obviously today, there's some inflation data that may be an offset. But I think ultimately, when the elections happen, that actually may be a catalyst because it's over, and certainly investment-- investors-- excuse me-- tend to like the fact that things are settled and done, and they tend to move forward.

SEANA SMITH: Amy, if we do see that rally into the midterm elections like you're talking about, what do you expect to lead us there? What do you expect to be the outperformers then over the next 60 days or so?

AMY KONG: Sure. I think going into the midterm elections, if it becomes a split government again, meaning the Republicans take over the House, you may see a little bit of a rally into perhaps the health care sector. Certainly, the fact that it is an all-Democratic government at this point has been a headwind for the sector. And so perhaps that can perhaps change the sentiment going into November if it becomes true that the Republicans can take over the House again.

RACHELLE AKUFFO: And Amy, we know that a lot of times voters tend to vote with their wallets. When you look at the state of the consumer, how would you characterize where they are now, especially as we've seen gas prices off some of their highs?

AMY KONG: Yeah, I think the consumer continues to hold up well. It's interesting that you ask that. Americans tend to shop when they're happy, and Americans tend to shop when they're not happy. And given that gasoline prices have retreated a bit, I certainly think that is a head-- that is a tailwind-- excuse me. But of course, as I've mentioned, the rent component to it is-- could be a headwind, and so that could be something that could potentially be a wash.

When you look at wage growth, certainly from last week's data point, it's still pretty good at 5%, 5 and 1/2%. And so I think, ultimately, if inflation does come back, you are seeing that the consumer is likely to hold up because of the wage aspect, but also they're still ripping off savings from the pandemic. There's still about $3 and 1/2, $4 trillion of excess savings on household and corporate balance sheets. That's a pretty significant number.

DAVID BRIGGS: Indeed. And the market's pricing in a 75-point hike. What, if anything, could shake their resolve?

AMY KONG: Well, perhaps there is one more CPI data number that's likely to perhaps change the results if it comes down significant, which we doubt. But if that does happen, I think the Fed may reconsider. But at this point, given the fact that the ISM numbers, as I've mentioned, the jobs numbers continue to be strong, that buffer is quite there from the standpoint of the Fed to probably go towards the 75 basis point rate hike.

SEANA SMITH: Amy, you mention earnings here for the third quarter and then, of course, looking out to 2023. Morgan Stanley's Mike Wilson, he was out with a note saying that "in 2023, he expects profits to fall 3% even in the absence of an economic recession." I guess, how big of a drop do you think we could potentially see?

AMY KONG: You know, at this point, given the Q2 earnings season, the market is still expecting an 8% growth rate for S&P 500 earnings. I think that is likely to move lower as we head into the Q3 earnings season and, of course, into the new year when companies can report full year as well as 2023 guidance. And so I think at this point, 8% growth is still pretty high. I would expect something maybe low single digits to be probably the base case from what we're seeing given some of the management commentaries we've heard.