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Why it’s difficult to get a read on the economy now

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Paul Hickey, Bespoke Investment Group co-founder, joins Yahoo Finance to discuss the strength of the economy and outlook on the market.

Video Transcript

MYLES UDLAND: Let's stay on the markets here and bring in Paul Hickey. He's the co-founder over at Bespoke Investment Group. Paul, great to talk with you this morning. Let's start--

PAUL HICKEY: Hi, Myles.

MYLES UDLAND: --with something that's kind of come across my radar as the new consensus, which is that market here trading at a record high, been a great run. With the economy ripping, though, we've seen a lot of folks say, well, maybe the market takes a pause here. Maybe we see that 5% or 7% correction with PMIs. You know, it's 64 across the board here. How are you thinking about the setup today for markets, given-- given that backdrop? Does that kind of logic, is that compelling to you?

PAUL HICKEY: Well, so, I mean, yes. So I mean, there's a couple of things that we can discuss in this. As far as the economic data is concerned, we've seen some very strong data. February was a poor month for the US economy, and I think it was twofold.

We had, you know, COVID cases on the rise again. But we also had that major storm in the Texas and surrounding areas, which really crimped activity. If you look at economic data from February, we saw much slower momentum. So far in March, we're starting to see an uptick starting with Friday's jobs report. And then we've seen two ISM reports, as you were just talking about, in the manufacturing and the services sector, which were very strong.

So I mean, yeah, so looking at that, you could think to yourself, OK, is this-- is the economy going to overheat and is the Fed going to come in? But what you have to do is you have to listen to what the market's telling us here. And despite these historic readings in ISM, very strong jobs report, the 10-year yield is down this month. So, you know, the market seems to not be overly concerned about this.

And we've seen a number of statistics regarding the strong ISM manufacturing when it goes above 60 that forward market returns have been weak. And that's true. But just about all of those occurrences were in the 1950s, '60s, and early '70s, where you saw these big swings in the ISM.

And it was a much more volatile index then, and the economy was much more volatile back then. You tended to see shorter business cycles and a much more manufacturing-centric economy, whereas nowadays, you have a much more services-oriented economy and a much more stable business cycle than you used to have. So I wouldn't read too much into the high ISM readings at this point.

BRIAN SOZZI: Paul, you guys-- you guys crunch a lot of data at Bespoke, a ton of data. Where are you-- what are some of the most overbought stocks in the market? And then secondarily, what are some of the most overbought sectors right now?

PAUL HICKEY: Yeah, so if you're focusing on just about-- I mean, on the individual sector basis, you have a lot of, you know, sectors that are at overbought levels right now, depends on your time frame. But when you just look at the-- we've started to see the market as a whole as what we call extreme overbought levels. It was-- I believe it's the most overbought in about four years.

And what that means in the short term is you tend to see maybe some minor weakness, but it's not a-- it's not a major warning signal. I think what you have to take away from this is that not necessarily be a-- expect a market decline, but you could see a pause in the consolidation and the rally. As far as sectors are concerned, we've seen energy-- energy and financials have, you know, real strength in the last quarter and the quarter before that. So they've reached somewhat extreme levels and expectations for the sectors coming into this earnings season are on the high level.

Now when we've looked back at prior periods where you've had high expectations in these sectors, what we found is that for energy and financials, it's two different paths. Energy, when you have high expectations coming into earnings season in prior quarters, we've tended to see the sector struggle during earnings season. Whereas in financials, when you have the high expectations, they tend to do-- perform better than average and see gain. So we've seen-- when you've seen this level of earnings revisions to the upsides for the financial sector, it's tended to be about an average to median gain of 3% for the sector during the earnings season.

JULIE HYMAN: That's really interesting. Maybe the financial companies just tend to be better at managing those expectations better, who knows, on balance. As Brian mentioned, Paul, you guys crunch a lot of different numbers, and you look a lot at history, right.

You look at various indicators and say, well, when we saw a parallel like this, this is what happened with stocks. I know you were looking at consumer confidence as one of those measures. But when you look at the sort of ensemble of all the different historical indicators you're looking at, what does it tell you about the likely returns on US stocks this year?

PAUL HICKEY: Yeah, so I think, I mean, touching on consumer confidence, that was one of the last indicators, you know, throughout this recovery off the COVID lows. We've seen economic indicators show consistent rebounds in activity. Consumer confidence is one that hasn't had a big bounce until last month. It was stuck near its lows up until last month, and it had a big surge.

And when we've seen-- we've seen similar type surges of that level back in the early '90s and in 2003, both coming out of recessionary levels. In '03, recession had been over for some time, but it was right at the start of the second Gulf War. So those periods were-- tended to see strong gains for the market. Overall when you see a big surge in consumer confidence, it tends to see-- you know, it's not necessarily a contrarian or a positive indicator. You tend to see average returns going forward, so you can't read too much into it.

I think it's really hard to get a read on the economy now because-- and look at a historical parallel, because we haven't seen this type of extreme decline followed by this type of rebound. So there's not much in the way of a parallel. And so I think, you know, one of the things we're looking at, though, is that there's this expectation that this strength is going to-- strength is going to beget strength and going to beget strength, and we're going to see this ongoing boom for years to come.

You know, I necessarily wouldn't bank on that view, so to speak. I think we're going to see strong growth. We've put a lot of stimulus into the economy here. But once we work back to an equilibrium level, what's going to be the driver of growth? And I think that's a question to think about and is one reason why you may not see interest rates go up as much as some people are expecting.

MYLES UDLAND: All right, Paul Hickey, co-founder of Bespoke Investment Group. Paul, thanks so much for jumping on this morning. Always great to get your thoughts. I know we'll be in touch.

PAUL HICKEY: Thank you. Take care.