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Stock market ‘in dangerous territory here,’ economist says

MKM Partners Chief Economist & Macro Strategist Michael Darda joins Yahoo Finance Live to discuss market uncertainty, a recession, the expectations for the FOMC meeting, investor sentiment, and the outlook for the economy.

Video Transcript


BRAD SMITH: Also, the headlines versus the bottom line, stronger than expected GDP figures might be disguising a lack of spending among consumers. But recession may not necessarily be the base case for economists. Joining us with more, we've got Michael Darda, MKM Partners Macro Strategist and Chief Economist here. So what is the base case from your perspective, Michael?

MICHAEL DARDA: Thanks for having me on. I actually think the base case is for a recession. And the reason that I say that is if you look back at historical Fed rate-hiking periods, the ones that end up with inverted yield curves that are sustained and chronic weakness in every measure of monetary growth-- really, we're in record territory on that score, those are periods that precede recessions without any exceptions.

And so I think if one is in the camp that we're going to soft land, you're really making the argument that it's different this time. And as they say, those are the most dangerous four words in economic forecasting.

JULIE HYMAN: And are we going to get a reminder of some of this from the Fed? I mean, obviously the Fed is not going to tell us that we're not having a soft landing, Mike. But are we going to hear from the Fed that maybe they're not going to be as benign as the market is also assuming here?

MICHAEL DARDA: I think so. They don't really have reaction function that would pave the way for a soft landing. So we're listening to what they're saying. They're telling us the intent is to take policy into a restrictive stance and then to hold there for an extended period of time. That means rates above the neutral level. And then, they hold them there. So the economy goes to below-trend growth, the unemployment rate starts to rise. I mean, that's essentially a recession.

They're also telling us that they want to lean against so-called financial conditions, which is just a coded way of saying the stock market and maybe credit spreads. So the recent rise in equity markets, if the Fed believes that is cutting against their policy intent, they'll simply respond by tightening more than they otherwise would. So I think if you add it all up, we're going to be in a pretty volatile situation this year for risk assets and recession risk remains quite high in our view.

BRIAN SOZZI: Michael, do you think the Fed this week will try to jawbone the market a little bit lower just given how fast the market has come out of the gate this year?

MICHAEL DARDA: Yeah, I think so. I think based on everything they've said and done, I think they're going to be really reluctant to sound, quote-unquote, dovish in an environment where the equity market is held up well. And we do have weakness in a lot of data. But they're focused mostly on the labor market. And the job gains, while decelerating, have still been pretty resilient. And the unemployment rate hasn't budged yet. We're sitting here as a triple bottom at 3.5%, basically a 50-year low.

So unless those things change, I think the Fed is just going to just stay the course here. It'll be 25 most likely for the rate hike, not 50. But they're going to continue to press unless things more visibly start to fall apart.

BRAD SMITH: For investors that have abided by the adage "Don't fight the Fed," how can they at least position their portfolio to anticipate the Fed?

MICHAEL DARDA: Yeah, I think you want to lean against the wind a little bit here. So the stock market has gone all in on the soft landing story. I mean, we're sitting here at 18 times forward estimates. Even the soft landers, I think, acknowledged that the forward estimates are probably too high. So I would be pretty cautious in here. If the market eventually takes a nosedive, we know with recessions markets don't bottom out before the recession even starts, usually it's 2/3 to 1/2 to 2/3 of the way through a recession. So if we make new lows at some point this year, closer to 3,200, 3,300 on the S&P, then I think you can start to add to risk-asset positions. But I would not be chasing this market here. I think that's essentially a fool's errand.

JULIE HYMAN: Do you think, then, we are going to make new lows this year? And if so, without putting you down to be too precise, which, as we know, is very difficult, when do you think it's going to happen, first half, second half?

MICHAEL DARDA: Yeah, I do think we'll make new lows if there's a recession this year. And we do believe there will be. It's interesting thinking about consensus expectations. Obviously, the perception is that the recession is a consensus view. The other two consensus views are that any recession would be short and shallow. But we don't really know that.

And number two, that the market would be down and then up this year. Well, maybe it's up and then down. Right? So I would just be hesitant to be too bullish on equities here. Unless we're actually making new lows down in the low 3,000s. Then, I think you can start to get a bit more bullish on the equity market. But I think we're in dangerous territory here. So people are really getting intoxicated with this China reopening and Europe soft-landing story.

And that's really pushed a lot of risk assets up at a dangerous time for the business cycle with the inverted yield curve and the negative money supply growth. So if you respect business cycle history and leading indicators, then I think you want to be a bit more cautious here.

BRIAN SOZZI: Michael Darda, MKM Partners Macro Strategist and Chief Economist, always good to see you. We'll talk to you soon.

MICHAEL DARDA: Likewise. Thank you.