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Why the market lacks a 'negative catalyst' for a pullback

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Randy Frederick, Charles Schwab Managing Director of Trading and Derivatives, joins Yahoo Finance to discuss the latest trends in the markets including if a stock market pullback may be on the horizon.

Video Transcript

ADAM SHAPIRO: Let's talk about Chevron up 2% because the energy sector, as we talked about, is up 3.5%. Crude oil inventory is not quite what the analysts had expected. We're watching WTI futures trade higher over $72.50 a barrel. But we're going to talk about all of this, and what you need to be aware of regarding your money, with Randy Frederick, Charles Schwab managing director of trading and derivatives.

And Randy, thank you for joining us. A lot of--

RANDY FREDERICK: Hi, Adam.

ADAM SHAPIRO: --investors want to jump into, you know, what do we do? But I just have to ask you real quick-- we had a discussion in the last half hour about the fight that's coming out of Congress regarding the debt ceiling. If they don't do something, is this going to have a real impact on how we-- we invest? Are we going to see a lot of volatility?

RANDY FREDERICK: Well, if we go back in history, the answer would probably be yes. And we know history is not always a perfect guide, but it oftentimes gives us a pretty good indication. 2011, 2013 were two periods-- and, to a lesser extent, 2015-- where the government pushed this issue of the debt ceiling right down to the limit. And the market got very uncomfortable, and volatility got very high.

I don't think any of us really think the government's ever going to let us default on the debt. I mean, that would be a catastrophic thing that would take probably decades and decades, if not longer, to recover from, if ever. So I don't think that's going to happen. But when they have pushed this issue to the limit-- and they'll often use it as leverage in negotiating other bills-- the markets don't like that.

So I would have to think that we're going to see a pickup in volatility if that continues. Janet Yellen says that deadline is floating, but it's sometime around mid October. So we're getting pretty close.

SEANA SMITH: Randy, we're looking at some buying action today. But over the last several days, we have seen the market under a bit of pressure. We've been hearing calls that this could be the start of a significant pullback. Do you think we're due for one? And, I guess, how do you think investors should be positioned if so?

RANDY FREDERICK: Well, we're due from the sense that statistically it's been a long time since we've had one. This year, we've had-- we had, like, a 4% pullback, I think, in May. But almost every other one we've had has been, like, 2% or so which is just about where we're at now, 2.5% or so before the dip buyers sort of stepped in.

So statistically, yes, we are overdue. But you know how statistics work. You might-- something that happens once a year might not happen for 18 months, and then you get two right in a row. And that could happen, and we have seen that in the past. So I don't think statistics or just how long it's been is a good reason. Generally, you need some sort of a negative catalyst.

What we have right now is not negative catalysts so much as a lack of positive catalysts. As you know, we're about two weeks before the end of the quarter. The beginning of the next earnings season doesn't start until about two weeks into that quarter. So we've got about three to four weeks before we start getting earnings reports, which, frankly, I think will probably be fairly positive. We've also had the market, just a week and a half ago, at an all-time high. So it gets to be a little uncomfortable.

I think what has caused some of this more recent volatility is that we had a number of Wall Street firms that downgraded both GDP estimates and corporate earnings estimates. Those are just forecasts. They may turn out not to be right. Certainly in the last two quarters, the earnings results have substantially outperformed the expectations, even though the expectations bar was quite high. So being due for one, and actually getting one, are two entirely different things.

ADAM SHAPIRO: And I'm cheating as I talk to you because I'm looking right at the Schwab note where you talk about year to date performance 2021 for the different sectors. And no surprise here, real estate up 30%, communication services 28.8%, financials 27.9%. As we go forward, do you expect us to pull back dramatically to more realistic and normal gains in those sectors, or is real estate going to continue to go on a tear?

RANDY FREDERICK: Well, generally, the-- whatever leads and has been outperforming everything else will tend to moderate at some point. Real estate, of course, has been driven by exceedingly low interest rates. Because we had a soft inflation number, yesterday interest rates have come down a little further. We might see a second wave of refis or buys and things like that if the mortgage rates come down in conjunction with the 10 year, but it's had a pretty darn good run.

Generally, the last leaders aren't the next leaders, and it's one of the reasons why we always sort of talk to people-- and I do this regularly-- about the annual rotation among the sectors. One of the reasons I post, as you noted, not just the year to date performance on those sectors, but also, how did they do last year?

So technology is a good example. Technology was an outperformer. Technology has been an outperformer in the past, like, something like the top performer in four out of the last 10 years. But that doesn't mean you should by technology. It means that, hey, at the end of each year, maybe you should take a little bit off the table because you're probably a little over concentrated and you should pick up one of the underperformers.

What was an underperformer then? Energy. Energy then shoots right to the top of the list. Now, this doesn't always work quite that perfectly. But if you look at a period of 10, 15, 20 years, you'll see that remarkably, as the calendar changes over, the top two or three sectors of the previous year will tend to move towards the bottom and vice versa.

So again, real estate has a very good run going this year so it's only a little bit over a quarter left to go. Odds are pretty good it'll finish out the year maybe not in the number one position, but in the top two or three almost certainly. But that wouldn't necessarily be a catalyst to buy it for the following year, that might be a time to take a little bit off the table.

You know, what's really nice about this market, and one of the reasons I don't have huge fears of a big correction or downturn, is that we haven't really had a broad based bubble, as some people have talked about. What we've had instead is bubbles in certain areas. And when those areas get a little bit overpriced, we see people taking a few profits off the table and buying some of the underperformers.

So we've had rotations of bubbles throughout a few different areas. You could slice that up by market sectors. You could slice that up by growth versus value. You can even add commodities and you can throw cryptos in there, whatever you like. But you've seen different areas where things have outperformed, but it hasn't all been just one direction. So there's a lot of breadth in this market, and I think it's one of the reasons why we, even today, are still only a couple percent off an all time high.

SEANA SMITH: Randy, I think a lot of investors' ears perk up when they hear the word "bubble." You mentioned maybe some of the bubbles that could be forming here in this market. What are some of the ones that you are closely watching, or that are on your radar at this point?

RANDY FREDERICK: Well, we've seen a lot of them. Certainly-- I mean, housing is probably one that I would be most concerned about. That has been going on for quite a while. That doesn't mean, again, that it has to be a crash. A lot of the bubbles we have seen throughout this year-- and we can just go back to the springtime, we saw cryptos just going, like, crazy-- they came down fairly quickly.

But we also had a big huge spike in energy prices, which then moderated and are now moving back up. We had an enormous spike in lumber, which has been come way back down. There have been a number of different ones. Housing is one that has sustained longer than most, but housing cycles historically have tended to be quite long.

In fact, the current housing bull market, if you will, began in about 2012. So that was a few years after the financial crisis ended. It took a while before housing really got its footing again. So we've been going up for pretty close to 10 years right now. It doesn't mean, we're at an end, but that is definitely something that we see that-- that will likely continue, but again, probably see some moderation.

OK, used cars, there's another one, right? That's a fascinating one. It's also one of the things that's been driving some of the inflation metrics. We know what's caused it though, right, an unusual thing. Because of COVID, we have a lack of new cars because of a shortage of semiconductors, which has driven up the price of used cars. We also see data that's indicating that that has now leveled off. And, in fact, this month, we just got a little bit of a dip in that area as well.

So the good thing is, most of the bubbles we have seen have not popped. Most of them-- not all, but most of them-- have sort of slowly deflated. And then people, again, have not been afraid to move those assets into other categories of the market. And again, that creates this nice breadth that we see.

ADAM SHAPIRO: Randy, it's always good to see you. Randy Frederick is Charles Schwab managing director of trading and derivatives, and we appreciate your insight.

When we--