How Fed, AI regulation could derail the market rally

The market melt-up continues its run a week before the Fed's next rate hike decision. Envestnet Co-CIO Dana D'Auria joins the Live show to break down the impact the June FOMC meeting could have on markets.

Video transcript

- Well, the market melt-up turns on. Even a sharp rise in Treasury yields isn't derailing it yet. The S&P 500, now in a bull market, has returned around 12% year to date. The tech-heavy NASDAQ jumping more than 30% in that period. Our next guest says that concentration of stock market gains has reached a truly unprecedented level.

Joining us is Dana D'Auria, who is Envestnet Co-CIO. Dana, thanks for being here. So there has been a lot of discussion about the consternation over this narrow leadership, but it hasn't mattered yet. What's going to make it a problem? Or what will be the catalyst for it becoming more of a problem?

DANA D'AURIA: Sometimes you feel like-- I feel like I've been talking about this for a while. And you're absolutely right. It's like, well, the market doesn't care, right. We plow on. I'll tell you one-- and I mean-- this is can't predict. But obviously, there's some concern around some of what I think is driving this, which is, of course, artificial intelligence and kind of money being plowed into that.

And we've seen, interestingly, these AI CEOs come out and talk about the fact that they think the government should be regulating this more. So I think that maybe not just AI but regulation, in general, finally coming to bear on some of this and taking some of the sheen off.

I also think if you're expecting a pivot on interest rates from the Fed, there's some evidence to suggest that that's not necessarily going to happen in the second half of the year. We've had a couple of central banks actually raise rates. Australia and Canada 25 basis points somewhat unexpected.

And so the Fed, along with a lot of these central banks, is a bit more concerned still about sticky inflation than they are about the fact that we may be headed for a recession. So those are a couple of things, right. Because obviously, rising interest rates not great for growth stocks.

- So let's break some of that down because you mentioned the Fed there. How are you positioned for a pause and a pivot versus a pause and a skip with a potential hike coming up later in the year?

DANA D'AURIA: Yeah, I mean, I think to the extent that the odds are priced in, right, for what that's going to be. And we're kind of incremental here, right. This is not what happened last year, where you have abrupt and very steep increases in rates. We're talking now we're in the realm of 25 basis points here and there.

I think, actually, when you think about just the fact that this monetary policy acts with a lag, probably what you should be thinking about is the Junction of that with the fact that the Treasury General Account does have to be reloaded. And that's going to happen now that the debt ceiling debacle has finally gotten-- we've gotten past that.

So there's reason to think that liquidity will be sucked out of the market. That the monetary policy, interest rate increases that we've already seen are going to hit the economy with a lag. I think even if we did get a pivot, which is not really my base case, I'm not sure that it counteracts these other-- what we're going to see in the economy related to these other effects.

- What is your base case, then?

DANA D'AURIA: I would say that we probably get a pause in June. I think that's the consensus. And I think we probably stay steady for a while. Just based on what we see now, I'm not anticipating that we should expect a pivot from the Fed in spite of the fact that I think there's evidence that we do potentially enter recession in the second half of the year. I'm starting actually to see economists come out and say, of course, that maybe we're in recession already. Of course, I know, notwithstanding that we just got out of the bear market, right.

So a little-- definitely a bifurcation in what the market sees and the average investor, right. There in the index. So for them, they're not really seeing what's going on beneath the surface that we're all talking about, which is that what's driving all of those gains that they're seeing is, in fact, these seven call it maybe eight if you want to throw Netflix and stocks.

- Yeah, so-- OK, so that's exactly what I was going to ask you. Is there a way to play even if we do see a pause from the Fed for near term? is there a way to play that in your portfolio? Is there a playbook that investors can look to right now?

DANA D'AURIA: Yeah, well-- so if you think pause, of course, you're not as worried about what happens to growth stocks. But that's just one input. I mean, generally speaking, I would say, look, if you're an investor and you're in the market cap-weighted index, you're stuck with a heavy loading of these stocks whether you like it or not.

But to the extent that you want to hedge a little bit, tilting away tilting towards a value-- so in other words, if you think about an economy where some of the liquidity is getting sucked out, that should favor value stocks. Tilting just kind of moving a little bit away from the index toward something that accounts for the fact that value stocks, for example, that pay attention to price, that accounts for the fact that maybe these stocks will struggle a little bit going forward if we do move into recession and if the Fed doesn't pivot.

- OK, we'll see what ends up happening. Dana D'Auria, Envestnet Co-CIO. Thanks. Have a great weekend.