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‘We're not worried about the tax situation:’ strategist

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Head of Equity Strategy at Wells Fargo Securities Chris Harvey joins Yahoo Finance to discuss the market's positive reaction to the CPI report and the possible outcome of the tax debate in Washington.

Video Transcript

[MUSIC PLAYING]

BRIAN STOZZI: The market is still acting a bit confused as September rolls along. Does it bite on correction calls by strategist or does it ignore the haters and continue to trend higher into year end? Chris Harvey is the head of Equity Strategy over at Wells Fargo Securities and joins us now. So, Chris, we were just talking about the positive market reception so far to this morning's CPI report. Break this down for us. Because to me, I would think a little bit less hot inflation means an early Fed taper, not good for stocks. What say you?

CHRIS HARVEY: Yeah. I think the market is pretty comfortable with the Fed tapering around November. And I think what we got today-- it was a couple of things. One is, we didn't get a surprise. The equity markets, they really don't like surprises. So it was in line, maybe slightly lower, and that was fine for the equity market. Right?

Now we can focus on the fundamentals, right? We've cut numbers, but as we look forward, COVID is improving, lot of cash on the sidelines, demand is still strong, and we think we have an equity melt up between now and year end.

JULIE HYMAN: Does that-- how much of a threat-- even if, OK, say the tempers Novem-- the-- the-- um, sorry.

CHRIS HARVEY: [LIGHT LAUGH] Taper. Taper.

JULIE HYMAN: My brain is moving too fast from my mouth. Rates might go up before here in year end. They are likely to go up, especially if we see the Fed start to taper. What effect is that going to have on corporate profits and on the market? Is it just so well telegraphed now that it's not a concern?

CHRIS HARVEY: Yeah. Julie, I really don't think it's a concern. And I think we need higher bond yields. One of the things that we've gotten from the fixed income market is this belief that bonds are right and equities are wrong. When rates were going down and the curve was flattening, I got a lot of phone calls, I had a lot of conversations that, the wheels are falling off the cart. Things are bad. If we begin to see rates go higher, we think that's natural. That should occur. That will help the reflation trade reassert itself. And we think it's good for the overall equity market and for relative pricing.

More importantly, rates are still incredibly low. Credit spreads are tight. This is a recipe for more M&A activity, and we think we're going to see a ton of-- excuse me, M&A activity between now and year end.

BRIAN STOZZI: Chris, what did you mean by "an equity market melt up"? What is that?

CHRIS HARVEY: Right.

BRIAN STOZZI: And where would that take-- where would that take the S&P 500 in to year end? Would that take it beyond your-- what-- 48-25 call?

CHRIS HARVEY: So, Brian, our 48-25 call, that's what we call an equity market melt up. You know, between now and year end, we're looking for 7%-- 8% upside. A lot of people are calling for a 5%, 10% correction. Could it go higher than what we expect? Well, when we put out our new price target, we had a really varied response. Some were saying, Chris, we're going to 5,000. Others were saying, Chris, your top ticked it, that's it. And others were saying, Chris, we've been wrong this whole time. We don't know.

But with regard to market melt up, we think 48-25, that constitutes a market melt up. Could it go higher? Certainly could go higher. One of the things we want to tell clients-- one of the things we want to tell investors is, we have history on our side. We look back to 1990, and we looked at periods where the equity market was up double digits in the first eight months of the year. We had nine such instances. In every single one of those periods, the equity market continued to move higher. On average, it was 8%. It was as little as one, it was as high as 13. But on average, 8%. We like those odds. We like those probabilities. And we like that magnitude.

And we think the fundamentals are also on our side. We think EPS numbers go higher, we think that corporations have been very conservative, and we think that, ultimately, price follows earnings.

BRIAN STOZZI: So, Chris, if the market is to-- if it is to melt up, what sectors lead this?

CHRIS HARVEY: So we are talking more about your cyclical sectors. So it's financials, it's the cap good space. We recently upgraded media and entertainment. We want to have more cyclical exposure into this melt up-- or what we believe is this melt up. We want to start moving away from-- we recently downgraded software-- we want to move away from situations where people are hiding and where you don't have the same type of economic sensitivity.

JULIE HYMAN: Chris, I can't believe I'm doing this, but I'm going to ask Brian Stozzi question. His current favorite risk, perhaps, for the markets is taxes-- higher taxes. And of course, we hear the Democrats now bringing up a potential corporate tax rate of 26.5% for companies that earn over $5 million annually. Stozzi's laughing because he knows I don't necessarily think it's a risk.

BRIAN STOZZI: But go ahead. Go ahead. Go ahead.

JULIE HYMAN: Well, listen, even if it gets passed, it's not going to take effect this year, right?

CHRIS HARVEY: Right.

JULIE HYMAN: But, Chris, how are you thinking about the tax issue?

CHRIS HARVEY: Right. We thought we'd be talking a lot more about taxes at this point in time. And what we see is already the Democrats are realizing they can't get the kind of aggressive stance that they wanted to get through. And it's still a very narrow-- it's still going to be a very tough lift. And one of the things we keep talking about, the longer it takes and the slower the process, the less likely it gets done. Because you're going to roll into midterm elections next year. You have to get this done by year end or by first quarter. If you don't get it done by then, we don't think it actually gets done.

Because even if you're going to say, I'm going to tax the rich. Any sort of tax hike I don't think plays really well heading into the midterm elections. So we're not as worried about the tax situation as we were at the beginning of the year. And it's playing out a lot less onerous than we would have thought. And if you don't get it done very shortly, very shortly over the next couple of months, we don't think it gets done or it doesn't get done with any sort of teeth.

BRIAN STOZZI: Chris, let me push back on that. Because it is very likely that, at the bare minimum, the corporate tax rate goes higher. Maybe not to President Biden's 28%, maybe it lands at 26% like the Dems suggested this week. Wouldn't that have an impact on corporate profits? Wouldn't that have an impact then on stock prices? And then wouldn't that have an impact on stock multiples, if that goes through?

CHRIS HARVEY: Yeah. So, Brian, a couple of things there. So we are talking about a market melt up this year, but we're talking about a small pullback next year. So our year end price target for 2022 is 47-15 I said-- yeah, it's 47-15. So about a 2% pullback from our year end target. Part of that is predicated on the belief that the Fed will be tapering, we still have to worry about higher inflation, we have to worry about Fed fund hikes. And you're right, if we do get some sort of tax situation, or some sort of increase in taxes, that is not great risk product, that is not great for earnings, that's not great for multiples.

But again, we think where we're standing and the progression that we're seeing, the teeth-- it's less onerous than we had expected. And as we go forward in time, it's going to be harder and harder-- or what we think is you're going to have to start lowering that rate. And as that rate goes lower, it's less impactful to the equity market. So yes, it will have a negative impact if and when it gets done. But from where we started to where we are now, that impact is less. And ultimately, we think that 2022 is a more difficult year than this year.

BRIAN STOZZI: Chris, the way I just computed that is that I am right and Julie's wrong. Is that what you're suggest-- no.

[LAUGHTER]

We'll leave it there. I don't want to get anyone in trouble. I kno you guys--

[INTERPOSING VOICES]

JULIE HYMAN: That's not fair. That's not fair, Stoz.

BRIAN STOZZI: OK. All right.

CHRIS HARVEY: Julie is never wrong.

BRIAN STOZZI: All right. Fair enough.

JULIE HYMAN: Thank you. All right. The pronouncement.

BRIAN STOZZI: All right. Chris Harvey, Head of Equity Strategy at Wells Fargo Securities, thanks for playing along in this tax debate game. We'll talk to you soon.