Fed may be in ‘a pause mode’ in the latter half of 2023: Strategist

Verdence Capital Advisors CIO Megan Horneman and Arbor Financial Group President Jeff Small join Yahoo Finance Live to discuss market and Fed outlooks for 2023, projections for the S&P 500, and favored international stocks and markets.

Video Transcript

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SEANA SMITH: We’re going to get to the closing bell on Wall Street.

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DAVID BRIGGS: All right, there’s your closing bell on Wall Street for this hump day as the markets and, quite frankly, all of us await tomorrow’s pivotal CPI data. And it’s been a pretty solid start to this trading year. Look at the Dow, up 268 points. The S&P gains almost 1.3%. And again, it’s the interest rate-sensitive NASDAQ that continues to lead the way, up more than 1.75%, 189 points, continually showing a great start, surprising, to this early year.

Let’s talk about the day in trading. Megan Horneman, Verdence Capital Advisors Chief Investment Officer, Jeff Small, Arbor Financial Group President. Nice to see you both. Jeff, let’s start with you. What do you make of this action today and the last couple of days? Are we optimistic about the CPI data?

JEFF SMALL: Well, I think the market certainly looks like it’s optimistic. But we’ve been in this range of bear market rallies where the 10-year note starts to fall, yields start to fall organically before any kind of great news, and the market rallies. And then the CPI report comes out and inflation data is not good, unemployment data is not good, and the rates rise organically before the Fed does anything and the market falls.

And so we’ve been on this yin and yang for a while. So I really think we haven’t seen the new lows that we’re going to see because the market’s never bottomed before recession has started. Unfortunately, that’s where we are today.

SEANA SMITH: Megan, what do you think? Do you agree?

MEGAN HORNEMAN: Somewhat. I do think we’ve been stuck in this range, and I agree completely with the rationale why. It’s really on the interest rate movements and the expectation for the Federal Reserve. Also keep in mind that January does tend to be a bit of a good seasonal month as well for equities as we get past any tax loss harvesting and we move into the new year. But I am cautiously optimistic. I still think that we will retest and get down to some volatility, some more pullbacks in the market before we can say we’re all clear.

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DAVID BRIGGS: And, Jeff, you’re optimistic about the first half of this year. Why not the second half? And do you think we’ll retest those lows?

JEFF SMALL: Well, I definitely think we will retest those lows. And it sounded like my companion there on the panel here agreed with everything that I said. She just said it in her own way. I’m just giving you a hard time, Wendy. I apologize for that. But no, seriously, for investors, though, the first six months of the year are great opportunity for folks to get involved in some of the best stocks that are beat up the most and have the greatest growth potential. And that’s kind of really what we have to do to modernize our money and kind of gear up for where we are today.

And so from that perspective, I think we’ve got six months to do that before we really see the recession start to get a firm grip on the numbers. And that means we should take our time and not go all-in at once. And so the next six months presents some unique opportunities.

The second half of the year, it depends on if we have a soft landing or not. Is it going to be a moderate recession? Is it going to be a softer landing? Is the Fed going to look at lowering rates early, which the possibility of that is always there if they were going to lower rates before the end of this year or, let’s say, maybe even starting in the third quarter if the data look bad.

But I don’t see the Fed doing anything until we see the unemployment rate get over 4.8% to 5%. And that’s really– it all depends on what layoffs are going to look like this year and what earnings are going to look like this year to dictate what happens in the second half of next– of this year, actually.

SEANA SMITH: Megan, when it comes to earnings, certainly the outlook here has been pretty pessimistic. We’re expecting a pretty substantial drop on a year-over-year basis. Do you think that’s a little bit too pessimistic or maybe do some of those revisions, are they going to be revised to the downside even further?

MEGAN HORNEMAN: I think that for the full calendar year, there still is room for the revisions to come downward for the S&P 500. Just from taking season by season, naturally, typically, we beat earnings expectations by a few percent, so we may say it’s a little bit pessimistic for this particular earnings season. But I do think 2023 needs to come down.

And where I disagree with my counterpart just a little bit is that I think the first half of the year is going to be the most challenging part of the year for the equity market and for the economy. I think the second half is where we can say we might– the Fed’s going to be at a pause mode, not a cutting mode, at a pause mode, and that’s where the market can then really start to look at the next phase of what will be a bull market.

I think inflation will have peaked and have come down substantially. But I think this first half, we’re going to have to pay back some of that pent-up demand from a consumer standpoint. We’ll see a softer consumer. And as we know, the consumer is the biggest part of GDP. So when the consumer softens, that’s when you tend to see that weakness in GDP. And I think we’re going to get that in the first half of this year.

DAVID BRIGGS: Jeff, why do you see it differently in the second half? And if you could tag on that, give me a name that you like in ’23?

JEFF SMALL: Well, there’s lots of great names up there. But one of the ones I like the most right now is Baba. You can almost buy them at a 2014 IPO price or just a little bit higher than that today. Their revenues are up over 800%. Their cash flow’s up over 500% since then.

And I think that’s one of the most beaten up tech plays that are out there that really is a generational move that we can make some serious money on going forward in the future as long as the virus becomes something that goes at bay and it doesn’t become a problem going into the future with China or the rest of the global economy.

SEANA SMITH: So, Megan, what are you– what are you advising clients? What do you think investors should be doing at this point?

MEGAN HORNEMAN: So coming into the year, we were raising a bit of cash to have that dry powder. I think right now the key to success for 2023 will to be– to have that flexibility, some dry powder to put to work because I think the opportunities will be there. What we’re looking at is from a contrarian standpoint, what’s already been priced in, what’s priced in that peak pessimism or priced in the expectation of the economic weakness that we see.

Small and mid-cap stocks are one of the areas of the market that we think are so beaten down from a valuation perspective and just price perspective that they offer opportunity. And then don’t forget internationally as well. International equities, they actually outperformed US equities for the first time in many years last year. I think this might be a chance where we can see that turn because the one part– the one thing the US has against it right now, especially this year, is it’s tech-heavy. That’s not necessarily the case internationally. And I think tech still has some room to decline further.

SEANA SMITH: All right, Megan Horneman, Jeff Small, thanks so much for joining us here this afternoon.