Fed: 'The market is currently pricing in 3 rate hikes' in 2022, strategist says

Albion Financial Group CIO Jason Ware and Janney Montgomery Scott Chief Investment Strategist Mark Luschini join Yahoo Finance Live to discuss the stock market close on December 8, 2021.

Video transcript

EMILY MCCORMICK: We want to introduce our panel to discuss the markets as we head to the closing bell and beyond. Mark Luschini is Janney Montgomery Scott chief investment strategist, and Jason Ware is Albion Financial Group partner and chief investment officer. But before we check in with you both, let's get one more quick check of the markets with just about a minute to go until the closing bell. We're taking a look here at stocks in the green across the screen, looking like we are going to eke out a third consecutive day of gains on the S&P 500. That index up about 0.3%.

And taking a look at the sector action here, we do have health care, communication services, and real estate outperforming, whereas on the flip side, we do have financials, consumer staples, and utilities in the red. Now taking a look at the Dow here, that index up just under 40 points. We do have the NASDAQ up another about 0.7% after yesterday's more than 3% gain for the NASDAQ composite, which had been that index's best day since March. And then taking a look as well at the small cap Russell 2000, up about 0.8% here heading into the closing bell. And here we have that bell on the New York Stock Exchange.

[BELL]

[APPLAUSE]

ADAM SHAPIRO: All right, there's the closing bell. We have the gavel. The trading session is done, and we're going to close in the green with the Dow up about 34 points. The S&P 500 will settle up a little better than a quarter of a percent, up 14 points, NASDAQ up about 100 points, better than half a percent. And real quick, pay attention to Apple. Apple shares closed up today over 2%. And they are closing in on $3 trillion market cap.

Let's get back to what those of us on Earth, when they have those kinds of sky high valuations-- wow-- are looking at. And that's how our money grows. Let me start with you, Mark, because there was a lot of concern that the flattening yield curve between the 10 and the two-year treasuries was signaling that there is trouble ahead for the US economy. Can investors breathe a sigh of relief, or do you still have to be cautious?

MARK LUSCHINI: No, I think they can breathe a sigh of relief. Surely, the destination for that yield flattening, should it have breached 50 basis points in approaching 0 basis points when, historically speaking, has had very high predictive value relative to preceding a recession that would typically start some six to 18 months following that inversion, we're a long way from today at 70 to 80 basis points.

And so I think what we're more likely to see, as investors realize through a [? recession ?] in some of the inflation readings we've been getting, it's going to allow the Fed to be a little bit more patient than perhaps what markets are anticipating at the moment. And perhaps that two-year yield will back off somewhat, allowing for a resteepening of the yield curve, which should be a setup for investors to breathe that sigh of relief and look at what is really very strong fundamental conditions for the US economy today, let alone providing the inertia for it to continue throughout next year.

EMILY MCCORMICK: Jason, I want to toss it to you on what Mark was just mentioning about the Fed perhaps having an opportunity to be more patient than market participants are expecting right now. What do you think about that, especially in light of some of the inflation prints that we've been getting that are still elevated at this point?

JASON WARE: Yeah, I think that's the question that's on every investor's mind as we go into 2022, is what's the inflation picture, and how is the Fed going to respond. And I think at the end of the day, what we are seeing and what the market is now adjusting to are the Powell comments, what we're calling the Powell pivot, where, you know, they would like the optionality to be able to react to inflation if it does not cool off as we get into the middle of 2022 by accelerating the taper now. So that gives them the ability to get that out of the way and therefore be able to adjust the dials on interest rates to react to inflation.

Our view is that while the Fed has become a lot more hawkish around inflation, the likelihood that this persists up in the 4%, 5%, and 6% range is unlikely for a variety of factors. So I think as inflation does get into more of a disinflationary tenor next year, that will give the Fed some wiggle room to hold off. The market's currently pricing in three Fed rate hikes by December. We think that's probably a bit too hawkish, maybe more like two. But we'll see what Powell and co does as we get into the spring here and as inflation continues to come in, in the first half of next year.

ADAM SHAPIRO: Jason, good to see you. You just talked about those potential lift-off interest rate increases. For those investors who are looking at financials-- and that sector over the last 52 weeks up 35%, not so much today. But what should they take into consideration? Because their decision to go into financials is going to be based upon what they conclude is the next course of action with the Fed, right?

JASON WARE: Right. Yeah, it's great to see you as well. And it's a really good question. And I think there's a lot of nuance that investors need to take when trying to size up the opportunity within the financial sector relative to the direction of interest rates. I think if you have a steepening of the yield curve, and Mark was talking a bit about what that might look like, I think you can own financials, especially those most directly tied to an increase in net interest margins.

If what you have is a continuation of a flattening yield curve and whether that's because the two-year is rising faster than the 10-year, if we don't see an expansion of that net interest margin, then those stocks actually are a little bit more difficult to own, despite an overall rising rate environment. Of course, outside of those banks that are most exposed to net interest margin and as that feeds through the profits, there are a lot of other financial companies that benefit from fees. So I think you just need to be very selective when you're picking the stocks within that context, and make sure you're owning the right ones for the right reason.

EMILY MCCORMICK: Mark, you mentioned in a note to us earlier that you thought the volatility induced by the discovery of the omicron variant was an overreaction. I'm wondering, based on the latest developments and the developments we may continue to get in the coming weeks and months, how do you expect the market to respond to some of these new updates, as we continue to get these probably well into 2022?

MARK LUSCHINI: Sure, and, you know, we identified this as a risk for, among other things, for investors that could undermine our otherwise rather sanguine view of macroeconomic conditions. That being, of course, a vaccine evading variant that should come about, and not only spread widely, but also have a more severe outcome than what we've known here in some of the previous iterations of the coronavirus.

I mean, so far, obviously, not to make judgments yet because there's still a lot of evaluation being done by epidemiologists all around the world with regarding the omicron variant, it is encouraging that it seems as though conditions are mild. In many cases, those that contract it are seeing asymptomatic conditions. And so I think investors, if they know this is the known unknown, which is to say, we knew we were going to get other variants because we haven't seen full vaccinations applied completely uniformly around the world as of yet, likely, we're going to see mutations that are going to result in outcomes that investors are going to have to react to.

But in each case that we've seen a new variant here so far off the initial reaction of the pandemic announcement, back in February, March of 2020, is that the reaction seems less severe. Markets have digested rather quickly and then begin to embrace the prospects that perhaps through vaccinations and the therapeutics have already been introduced along, those that can be quickly developed and launched, there's a way to work around this and allow for the management of this coronavirus outbreak without having to resort to the mitigation protocols and severe lockdowns, which nobody has an appetite for again to be reinstituted.

And so I think that's helping to calm investors' fears as quickly as we've seen so far and allow this market to restart on a path that I think is likely to advance well into next year, albeit not without some divots along the way.

ADAM SHAPIRO: Mark, I wanted to ask you real quick as we head to hearings in Washington today on cryptoassets, what kind of pressure are you getting from clients to start including crypto assets in any way? I mean, right now, it's limited when it's through a firm like yours. But is there pressure? And what kind of pressure are you getting from clients who are saying, we want to get in on this?

MARK LUSCHINI: Well, I don't know that I've seen so much pressure as a need to get in, but a desire to know more and more about it. I speak at a lot of client events in which I'm in front of groups of individuals. And in the Q&A session, it used to be the only question that I ever heard consistently in every single event was, what do I think about the amount of debt that the United States has? And what does it mean for not only interest rates, but the consequences for the US dollar and so on, and all kinds of nuances associated with it.

Today, what has usurped that question is, what do I think about crypto, whether its application, its skepticism around it, should it be investable, whether it's been Bitcoin or one of the other cryptocurrencies or assets. And so I think there's a very strong interest that is sort of emanating throughout sort of mainstream, as this is becoming more widely utilized, advertised, and even embraced, to some degree, by retail investors and even some institutional investors.

And I don't think it's going away. It's just going to be a function of getting it regulated to the point where companies like ours, Janney, is able to think about it in terms of how to apply it and, obviously, how to drape it in the right caveats as to what it means for an investor, should they decide to make that leap of faith and have it be a position in their portfolio, where, academically, it's been demonstrated it can have some value. But obviously, it's still somewhat embryonic instrument. And so there's a lot of concern about the volatility associated with it and truly, its broader application as a currency, as opposed to how I tend to interpret it as not so much just as a currency at this point, but rather, as an actual asset class.

EMILY MCCORMICK: Jason, I'm wondering, as we head into 2022, where are you seeing some of the biggest investable opportunities, whether in US equities by sector or even if we take a look at some of these emerging markets and international stocks?

JASON WARE: Yeah, it's an interesting question. I think the reality is at Albion, we are not calendar-based investors. You know, we take a much longer term view. So, you know, the companies that we own today we think you should continue to own into 2022. Otherwise, we would have already sold them on fundamental merit. But trying to be a little more specific than that, to answer your question, you know, I think there's a lot of opportunity within the large cap technology space. We're still very overweight large cap growth.

And I think if you look at a stock like Amazon, for example, it's basically been consolidating for about 18 months. Yet the fundamentals of that business continue to compound on themselves. We saw a really strong AWS last quarter. That should continue in earnest as far as the eye can see. So I think there are areas within technology and secular growth that might look attractive on a relative basis in 2022, as the economy normalizes-- that is 3% real GDP versus 6%-- and as inflation cools, which, again, is our base case as we get into 2022. And oh, by the way, if the Fed isn't going to hike three or more times, if it's more like one or two times, then I think owning secular growth in an environment where growth is slowing is a place investors can look to.

EMILY MCCORMICK: All right, Jason Ware is Albion Financial Group partner and chief investment officer. And Mark Luschini is Janney Montgomery Scott chief investment strategist. And we thank you both for joining us.