September sell-offs: ‘Worst week in the worst month of the year,’ strategist says
Great Hill Capital Chairman and Managing Member Thomas Hayes joins Yahoo Finance Live to discuss the market outlook in the last week of September, the Fed's interest rate hike strategy, and how investors should respond to the inflation-fighting tactics.
Video Transcript
[AUDIO LOGO]
SEANA SMITH: Once again, today, we're back in the red, the S&P hitting a new low for the year. What's ahead?
THOMAS HAYES: Well, you know, first off, we're in a period of seasonal weakness. So September is the worst month of the year, and this happens to be the worst week of the worst month of the year. So there's max pessimism. It does remind me a bit of June when we were coming into earnings season. There was max pessimism, estimates were-- expectations were extremely low.
We have a very similar situation right now. Earnings growth is expected to be just 3.2% for Q3. Prices have doubled more than that. So you're effectively looking at negative earnings growth, and the economy just doesn't look like it's going to go that way. So it sets up for a positive surprise into year-end.
We're also going into the election. And the likelihood based on the data is that there's going to be gridlock after November 8. That, too, can be bullish for the stock market. It means no new taxes. It means no new regulation. And the market likes that. Regardless of who's in the executive branch, it's good to have gridlock. The less that gets done, the more Wall Street likes it.
DAVID BRIGGS: Looking like the Republicans take the House and Democrats hang on to the Senate, all this pessimism going around, do you share it?
THOMAS HAYES: I don't. I look at the way managers are positioned. We've got the highest cash levels since the pandemic lows, since March of 2009, since the tech wreck. Usually when things get to this level of extremes, it's a market turning point, and we just don't know what that catalyst is going to be.
What I have seen is central banks around the world blinking. So the ECB, they came out with that facility to buy Italian bonds on the periphery. You saw Bank of England have to buy gilts. And the question is, when is the Fed going to be next? And the key thing here we have to keep in mind, Chair Powell has this idea that he wants to be Paul Volcker. The difference between Paul Volcker and today is when Paul Volcker was raising rates, the debt-to-GDP was at 30%. Today, we're at 122%.
So for every 1% he increases the Fed funds rate, that adds $285 billion to the deficit, so it becomes unsustainable. And sooner or later, like all politicians, they get disciplined by the credit markets. And when municipalities and companies have to refinance and the government has to refinance and the interest costs become unsustainable, they'll have to back off.
We've just come off of three emergency hikes of 75 basis points. In the last-- since 1983, you've had about 88 hikes. 75 of them were below 50 basis points. So what we've done is pretty material, and we have to kind of just take a pause and see how that works.
RACHELLE AKUFFO: And as we sort of wait for some of the things-- these things to work their way through the real economy, Tom, what looks attractive to you right now? A lot of people are wondering if the Fed risks overtightening.
THOMAS HAYES: There's no question they risk overtightening, that's for sure. One of the groups that we like that's kind of less sensitive to the interest rates, although people think it is sensitive, is biotech. In the last tightening cycle we had, in anticipation of it, the biotech group dropped about 50% from 2015 to early 2016. Over the next two years while the Fed was increasing the Fed funds rate from basically 0 to 250, you saw that group recover about 130% off the lows.
We're seeing the two key catalysts start to work out. That is major deal activity we've seen since May-- it cooled off a little bit in the fall with rates-- and major drug activity, yesterday being the biggest with Biogen. That's huge for Alzheimer's.
And we're going to see more investment and more excitement come into the sector that has been really left for dead and very few people are focused on right now. Despite the 56% move off the May lows, we're now consolidating. I think, as you look out over the next one to two years, Rachelle, there's opportunity there.
SEANA SMITH: Tom, what do you make of what's been happening in the tech sector and the selling that we're seeing there? Once again, we're seeing a lot of these larger-cap tech names lead to the downside today. Apple, Amazon, Meta, Google among the worst performers in today's market. What's it going to take to stop some of the bleeding there?
THOMAS HAYES: Yeah, it really is a function of rates, and it really is going to be a question of when the Fed blinks. And what we need to see is some better inflation data. We need to see employment cooling. This morning didn't help, but we'll see the jobs report coming up real soon.
And once you see some stabilization in rates and the dollar-- one of the key things that I look at, Seana and Dave, is the weekly Commitments of Traders report. And I look at the commercial hedgers because they're always right and they're always early. And what we're seeing is the commercial hedgers are the most short the dollar that they've been in a long time.
They're most long the 10-year Treasury than they've been in a long time. And they're long S&P futures. They've been right. And if you look at the last five peaks and troughs for those instruments, it's always preceded major market turns. So I don't know if it's in the next two days or the next two weeks, but I think within the next two months is realistic.
And I would say if you're going into the end of the year excessively pessimistic, there's really no one left to sell. The National Association of Active Investment Managers today came in at 12.86% equity exposure. They were at 11% at the pandemic lows when we didn't know if we'd have a vaccine for four years.
So I look at things, active investment-- the Association of Individual Investors at 20% bullish, that's consistent with pandemic lows, great financial crisis lows. And I really don't think we're in a situation like the pandemic where the uncertainty was that high or like the Great Financial Crisis where banks were in a bad shape. Banks are in very good shape right now.
DAVID BRIGGS: The action in the 10-year, we mentioned it earlier. What's it telling you is around the corner?
THOMAS HAYES: Well, you know, it's pricing in that the Fed is going to keep going on autopilot. And the last time we heard autopilot was December of 2018 when Powell came in and made his first mistake of three major mistakes and crashed the market 16 and 1/2% within a couple of weeks. Right before Christmas, Mnuchin had to call up six banks and get a liquidity line.
Five days later, a Chair Powell backtrack. He walked back his language on that autopilot. Within three months, we were at new market highs. Last year when inflation was at 4%, GDP estimates were at 3.8% for this year, they thought 10 basis points made a lot of sense and inflation was transitory. Now that GDP is at 0.2%, collapsing, inflation is coming down, they think 4.6% makes a lot of sense.
It's like a dog chasing its tail. They're working-- they're forgetting about the lagged effect of monetary policy. And I think the credit markets will let them know very, very quickly. Just like Bank of England, they will walk back or they will pause, and that will be very, very bullish for equities, including tech.
RACHELLE AKUFFO: And, Tom, as you look at some of the stickier parts of inflation, when do you expect those to start subsiding?
THOMAS HAYES: Yeah, that's going to take some time. If you look at-- post World War II was the last time we had debt-to-GDP this high, over 120%. And what they basically did was they talked hawkish and they act dovish, very similar to what they're doing today. And they did run inflation above trend about 3% to 5% over the five years following World War II. And what you saw was debt-to-GDP drop from 120% down to 63% in just a handful of years by running inflation above trend.
The key thing about the Fed where they've been right is that hawkish talk has brought down five-year inflation break evens from 359 in March to 237 yesterday. So they're anchoring those long-term expectations. They are succeeding with the language. Now they just need to ease up a little bit on the action. They've gone a little bit too much the last three hikes is you might kill the patient with too much medicine.
DAVID BRIGGS: Let that medicine work--
THOMAS HAYES: Exactly.
DAVID BRIGGS: --right, man?
THOMAS HAYES: I'm with you, Dave.
DAVID BRIGGS: Keep beating that drum, Tom. Hey, it's good to have you here in the studio.
THOMAS HAYES: Thanks.
DAVID BRIGGS: Thank you, sir.
