The first half of the year saw equity markets perform better than some had expected. But with central banks poised to continue hiking interest rates, will that trend continue? David Sekera, Chief U.S. Market Strategist at Morningstar Research, outlines key themes he’s watching.
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* First half of the year saw equity markets perform stronger than some had anticipated. But could that trend continue? Central banks, of course, poised to continue raising rates. Joining us now to discuss, David Sekera, Chief US market strategist with Morningstar Research. David, great to see you again. Great to have you back on the show.
* Oh, good afternoon, Greg. Good to see you.
* All right, so let's talk about stocks. Obviously, the first half of the year did perform better than some had anticipated. You recently came out with a note where you raised the question, is it time to batten down the hatches or raise the sails? How should we be reading this market?
* Well, during the second quarter, the market rose 20% from the October lows. And, of course, that's now the technical indicator of what's considered a new bull market. And once that happened, I started hearing a lot of market commentators in two different camps. One was out saying, hey, this is the indication of a new secular bull market. And you should be now putting more money into stocks. The other camp being, hey, this is just a bull trap in a longer-term bear market. And you should be getting out while the getting is good.
* But I think both of these camps really missed the point. And thinking about investing, it's always where you should be putting your money to work where you see the best valuations. So at the beginning of the year, we thought the markets were trading at a pretty significant discount to a composite of the fair values of the stocks that we cover. But now, following this rally, we do continue to see the markets as slightly undervalued, but now trading at much less of a margin of safety.
* So really, now is the time that I think investors should be looking at their portfolios and deciding where they should be making changes. So I think what they need to do is look and say, where has the market overvalued, overextended? Look to take profits in those areas. So for example, the growth stock area and, in particular, the tech sector would be two areas that we think have become overvalued.
* And then reinvest those proceeds in those sectors that have been left behind, those that we think remain undervalued and still see opportunities for investors, such as the value category and a lot of the cyclical sectors.
* So not so much a dire situation, or an off to the races situation, but really tactical kind of thinking about the markets and how you should be allocating funds. Obviously, this market is also very, very dependent on big events, I think, in terms of inflation reports, of which we're getting another one tomorrow morning.
* I do feel, though, that the market, last summer, things got very whippy. You got a print that was either hotter or colder. And markets would roar 2% or 3% to the upside in a matter of one afternoon. Things have seemed to calm a little bit. How should we be viewing these big events now?
* Yeah, probably a little bit lower volatility now. And I do think that people are starting to think more about the long term than necessarily looking at any one individual economic print. Although today, it just does have the feel that it could be the lull before the storm over the next couple of weeks and for earnings season.
* So as you mentioned, we do have CPI coming out tomorrow, PPI later this week. Now, interestingly, yesterday, we did see a big decrease in used car prices. And I think that now the market expectation is that CPI will probably come out lower than what consensus is right now. So the market's still fully expecting the Fed's going to raise another 25 basis points at their meeting later this month. But if the CPI does come out lower than consensus, I think that will take some of the pressure off the Fed from having to raise the federal funds rate any further thereafter.
* Now, we actually project that inflation will continue to keep moderating. And, in fact, our US economics team does forecast that this hike here in July should be the last hike of this monetary policy tightening scenario. So there, we're now looking at earnings season starting at the end of the week. We do have the big mega banks reporting and then some of the regional banks early next week. And then we'll wrap that all up on the 25th and 26th with the Fed meeting and see what Chair Powell has to say at his press conference.
* When it comes to earnings season, the fact that I've been told by other guests on the show, when you think about the reason why we're still seeing central banks hiking rates or threatening to hike rates further, is that the economy has been stronger than expected. And then that could feed through into corporate earnings, because things weren't quite as bad as perhaps they thought they would be. Is that the right mindset to enter this earnings season with?
* Yeah, generally, I think this earnings season is going to look pretty good. And I think about the setup coming into this earnings season, as you mentioned, a lot of people thought the economy was going to be weaker than what it turned out to be. So I think a lot of management teams gave pretty conservative guidance for the second quarter. So I think generally, it's going to be pretty easy to meet or beat those expectations.
* Now, the hard part is what management teams are going to be coming out with their third quarter earnings expectations. So on the one hand, we still do expect the economy will continue to slow. We're looking for a sequentially slower growth rate for the next three quarters until it bottoms out in the first quarter of next year. Then we expect it to re-accelerate thereafter.
* So management teams may not necessarily want to get out over their skis and give too strong of earnings guidance. But at the same point in time, with the economy holding up better than expected, they can't really cut their guidance too much. I think that if anyone comes out and they really disappoint the market with lower than expected guidance, I do think those stocks will be at risk of having some pretty severe sell-offs in the short term.
* I feel like when we've been hearing from corporations and through their earnings for the last bit of the cycle, a lot of warns about storm clouds on the horizon, recession fears. We're worried about the consumer. We're worried about that-- sort of the recession that never shows up. How do we feel-- you talked about a slowdown in the economy. But that's different than an actual recession. How do we actually feel about the prospects for the economy?
* Well our US economics team has really held the view all year that they didn't see a recession. I mean, it was a relatively high probability compared to the past. We're looking at potentially a 30% probability of a recession. But our base case was never that we were going to be in a recession.
* Now, we do think that the rate of economic growth will slow the next couple of quarters. But we're not looking for any type of contraction this year or next. So I do think that the economy should kind of almost get to this not too hot, not too cold area. And I do think that that will take a lot of the pressure off the inflationary rate. In fact, on a year-over-year basis, we expect inflation will end this year at 2%. And on average, inflation in the US actually will, according to our projections anyways, be slightly under 2% in 2024.
* So we do have a Fed rate decision, as you noted, later this month. Then you don't get another decision until we head into the fall. But we do have Jackson Hole. I only think about Jackson Hole in the sense that it used to feel sort of sleepy. We made a big deal out of it, and then nothing really happened. Of course, last year at Jackson Hole, Jerome Powell decides to lay it down and use that as his forum. So between that rate decision and then another Jackson Hole event, what are you listening for? What are you watching for out of the Fed?
* Yeah, I think it's a much different setup this year for Jackson Hole than it was last year. And I think about what inflation was doing last year. It was ramping up much higher than I think the Fed had expected, much higher than what the markets had been pricing in. It peaked and only just started coming down early fall last year. So I think that was much more top of mind for everybody.
* Now, inflation, granted, it hasn't come down as fast as I think the Fed would prefer. But it is still on that downward trend. We are still seeing a lot of indications of some of those things that really caused inflation to ramp up last year continuing to moderate. So I don't think we have that same kind of set up where we could potentially have Chair Powell coming out, really, with any new changes to his outlook for monetary policy.
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* First half of the year saw equity markets perform stronger than some had anticipated. But could that trend continue? Central banks, of course, poised to continue raising rates. Joining us now to discuss, David Sekera, Chief US market strategist with Morningstar Research. David, great to see you again. Great to have you back on the show.
* Oh, good afternoon, Greg. Good to see you.
* All right, so let's talk about stocks. Obviously, the first half of the year did perform better than some had anticipated. You recently came out with a note where you raised the question, is it time to batten down the hatches or raise the sails? How should we be reading this market?
* Well, during the second quarter, the market rose 20% from the October lows. And, of course, that's now the technical indicator of what's considered a new bull market. And once that happened, I started hearing a lot of market commentators in two different camps. One was out saying, hey, this is the indication of a new secular bull market. And you should be now putting more money into stocks. The other camp being, hey, this is just a bull trap in a longer-term bear market. And you should be getting out while the getting is good.
* But I think both of these camps really missed the point. And thinking about investing, it's always where you should be putting your money to work where you see the best valuations. So at the beginning of the year, we thought the markets were trading at a pretty significant discount to a composite of the fair values of the stocks that we cover. But now, following this rally, we do continue to see the markets as slightly undervalued, but now trading at much less of a margin of safety.
* So really, now is the time that I think investors should be looking at their portfolios and deciding where they should be making changes. So I think what they need to do is look and say, where has the market overvalued, overextended? Look to take profits in those areas. So for example, the growth stock area and, in particular, the tech sector would be two areas that we think have become overvalued.
* And then reinvest those proceeds in those sectors that have been left behind, those that we think remain undervalued and still see opportunities for investors, such as the value category and a lot of the cyclical sectors.
* So not so much a dire situation, or an off to the races situation, but really tactical kind of thinking about the markets and how you should be allocating funds. Obviously, this market is also very, very dependent on big events, I think, in terms of inflation reports, of which we're getting another one tomorrow morning.
* I do feel, though, that the market, last summer, things got very whippy. You got a print that was either hotter or colder. And markets would roar 2% or 3% to the upside in a matter of one afternoon. Things have seemed to calm a little bit. How should we be viewing these big events now?
* Yeah, probably a little bit lower volatility now. And I do think that people are starting to think more about the long term than necessarily looking at any one individual economic print. Although today, it just does have the feel that it could be the lull before the storm over the next couple of weeks and for earnings season.
* So as you mentioned, we do have CPI coming out tomorrow, PPI later this week. Now, interestingly, yesterday, we did see a big decrease in used car prices. And I think that now the market expectation is that CPI will probably come out lower than what consensus is right now. So the market's still fully expecting the Fed's going to raise another 25 basis points at their meeting later this month. But if the CPI does come out lower than consensus, I think that will take some of the pressure off the Fed from having to raise the federal funds rate any further thereafter.
* Now, we actually project that inflation will continue to keep moderating. And, in fact, our US economics team does forecast that this hike here in July should be the last hike of this monetary policy tightening scenario. So there, we're now looking at earnings season starting at the end of the week. We do have the big mega banks reporting and then some of the regional banks early next week. And then we'll wrap that all up on the 25th and 26th with the Fed meeting and see what Chair Powell has to say at his press conference.
* When it comes to earnings season, the fact that I've been told by other guests on the show, when you think about the reason why we're still seeing central banks hiking rates or threatening to hike rates further, is that the economy has been stronger than expected. And then that could feed through into corporate earnings, because things weren't quite as bad as perhaps they thought they would be. Is that the right mindset to enter this earnings season with?
* Yeah, generally, I think this earnings season is going to look pretty good. And I think about the setup coming into this earnings season, as you mentioned, a lot of people thought the economy was going to be weaker than what it turned out to be. So I think a lot of management teams gave pretty conservative guidance for the second quarter. So I think generally, it's going to be pretty easy to meet or beat those expectations.
* Now, the hard part is what management teams are going to be coming out with their third quarter earnings expectations. So on the one hand, we still do expect the economy will continue to slow. We're looking for a sequentially slower growth rate for the next three quarters until it bottoms out in the first quarter of next year. Then we expect it to re-accelerate thereafter.
* So management teams may not necessarily want to get out over their skis and give too strong of earnings guidance. But at the same point in time, with the economy holding up better than expected, they can't really cut their guidance too much. I think that if anyone comes out and they really disappoint the market with lower than expected guidance, I do think those stocks will be at risk of having some pretty severe sell-offs in the short term.
* I feel like when we've been hearing from corporations and through their earnings for the last bit of the cycle, a lot of warns about storm clouds on the horizon, recession fears. We're worried about the consumer. We're worried about that-- sort of the recession that never shows up. How do we feel-- you talked about a slowdown in the economy. But that's different than an actual recession. How do we actually feel about the prospects for the economy?
* Well our US economics team has really held the view all year that they didn't see a recession. I mean, it was a relatively high probability compared to the past. We're looking at potentially a 30% probability of a recession. But our base case was never that we were going to be in a recession.
* Now, we do think that the rate of economic growth will slow the next couple of quarters. But we're not looking for any type of contraction this year or next. So I do think that the economy should kind of almost get to this not too hot, not too cold area. And I do think that that will take a lot of the pressure off the inflationary rate. In fact, on a year-over-year basis, we expect inflation will end this year at 2%. And on average, inflation in the US actually will, according to our projections anyways, be slightly under 2% in 2024.
* So we do have a Fed rate decision, as you noted, later this month. Then you don't get another decision until we head into the fall. But we do have Jackson Hole. I only think about Jackson Hole in the sense that it used to feel sort of sleepy. We made a big deal out of it, and then nothing really happened. Of course, last year at Jackson Hole, Jerome Powell decides to lay it down and use that as his forum. So between that rate decision and then another Jackson Hole event, what are you listening for? What are you watching for out of the Fed?
* Yeah, I think it's a much different setup this year for Jackson Hole than it was last year. And I think about what inflation was doing last year. It was ramping up much higher than I think the Fed had expected, much higher than what the markets had been pricing in. It peaked and only just started coming down early fall last year. So I think that was much more top of mind for everybody.
* Now, inflation, granted, it hasn't come down as fast as I think the Fed would prefer. But it is still on that downward trend. We are still seeing a lot of indications of some of those things that really caused inflation to ramp up last year continuing to moderate. So I don't think we have that same kind of set up where we could potentially have Chair Powell coming out, really, with any new changes to his outlook for monetary policy.
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