Fed's worst case scenario has not played out for markets: Strategist

Strategists are adjusting and raising their market price targets ahead of the Fed's June FOMC meeting. BMO Capital Markets Chief Investment Strategist Brian Belski highlights the likelihood of the Fed's next rate hike and the resiliency of AI drivers across tech stocks.

Video transcript

AKIKO FUJITA: As the labor market continues to trend in the right direction and stocks remain resilient, our first guest is raising his S&P 500 year-end price target. Let's bring in Brian Belski, BMO Capital Markets Chief Investment Strategist, joining us here in studio.

BRIAN BELSKI: Oh, Akiko! Oh, Yahoo!

AKIKO FUJITA: Good to have you here in studio. Let's start with that target. We're raising your target from 4,300 to 4,550.

BRIAN BELSKI: Yep. So, we had three scenarios coming into this year, OK, a base case, a bull case, and a bear case, and so our base case was 4,300, our bull case was 4,800, and our bear case was 3,600. So we raised our price targets by 250 points across the board, because the cost of equity is down, and equity risk premium, down, inflation, down. So we believe the worst-case scenario, in terms of the Fed and inflation, has not played out, so, therefore, we have to adjust accordingly. That's number one.

Number two, we're not changing anything in our earnings number, because we think most investors are looking to 2024 anyway, and nobody really knows what 2024 earnings are going to be like, but we've seen a massive-- you used the term "resilience" before-- we've seen massive amounts of resilience in corporate earnings so far this year, so we think we're our 220 number is pretty good, but we do actually see earnings accelerating in the fourth quarter, and then into next year, but we'll get to that while we get to that.

Now, the next question you're going to ask is, so, well, at 4,550 and 220, that's a 20 multiple, Brian? Isn't that expensive? Well, if you go back and look at history, and it's something that we warn people, coming out of a bear market, the average multiple increase for 12 months following a bear market is multiple points, six multiple points, so multiples go up, OK, because earnings are low, multiples and stocks lead earnings, which lead the economy, and that's exactly what we're seeing.

And so we still believe that we're in a big, giant, 20-to-25-year bull market. We're not being stubborn. We've been accused of that, because you can have negative and flat years, like we had a negative year last year, and we were wrong, and, humbly, we lost people money. But we've been right nine out of the last 10 years, and, remember, seven out of 10 years, markets are positive, so we'll take that math.

But I do believe that the worst is behind us. The Fed, maybe, has one more interest rate increase between now and the end of the year, and that's OK, but I think most of that has been already priced into the market.

SEANA SMITH: Brian, where does the Fed stand in its fight against inflation right now, because you make a point in your note that, inflation, we are seeing some positive momentum in terms of it easing right now, but we're still at pretty high levels, compared to where the Fed would like it to be.

BRIAN BELSKI: Well, BMO has learned that we're going to have higher interest rates for longer. Anything is higher than zero. That's number one, OK? Number two, in terms of the 2% target that the Fed is targeting with respect to inflation, we still have some work to get there, and Canada rose interest rates yesterday by 25 basis points, because we've seen some higher food inflation there. So are we going to have a little bit higher inflation this time around next week, when we see CPIPPI? I don't know.

I do think the Fed probably has one more 25 basis point. For us, the way we look at things, it would almost be better, Seana and Akiko, if they raise interest rates by 25 basis points one more time, because I think it would be a lot worse for the market to pause, and then, later this year, all of a sudden, they come back and go, uh-oh, inflation is coming back, because then you have the rhetoric with respect to, oh, this is the '70s again, and the Fed is wrong, and then I think that would really cause a stir in the market.

AKIKO FUJITA: So get the hike out of the way next week?

BRIAN BELSKI: I think so. I think so. And I do think that the bond market is kind of telling you that I think. I think the high is in for the 10-year Treasury, which is good news, because that'll be good for mortgage rates. But I think people are missing that the homebuilding stocks have been outperforming, and homebuilding stocks have been outperforming, and that's a leading indicator for the stickier part of inflation, which is the services side, meaning rentals, and housing, and things like that. So, if we had more supply on that, I think that's going to be really good.

SEANA SMITH: What about the odds of a recession, the odds of a soft landing at this point, and it sounds like maybe that is still in the cards?

BRIAN BELSKI: Soft landing, no landing, obsession, recession. We're obsessed with it.

SEANA SMITH: Going through all the hits with you.

BRIAN BELSKI: We're going through all the hits, you are an obsession, if you like the '80s music. You know, listen, the stock market was down 27% peak to trough, right, and so the stock market, when it's down more than 20%, that portends to a recession down the road. So it almost doesn't matter. I don't know if you know this or not, but you don't invest in the economy, you invest in the stock market.

So the stock market's already said, hey, we're going to have some sort of a recession. My bet is this. I bet, within the next 12 to 18 months, the ECRI, or all those smart people in the economic world, will come out and say, hey, by the way, we had a recession, and it was in the third and fourth quarter of 2022.

AKIKO FUJITA: Is this an impersonation?

BRIAN BELSKI: This is just really, like, serious. No, I'm sorry. I don't mean to be flippant about it. But I think we're worried about the end game versus living our life, right? So stocks lead earnings, which lead the economy. The earnings have held in a lot better than everybody thinks. The economy is still strong. I mean, you think about, go back to weekends ago, Disney had its fifth-highest opening ever on a weekend, right, for "Little Mermaid." We're still going to the movie theater. We're still spending money. I'm jumping on a plane this afternoon. There's no seats. There's no hotel rooms, not just in New York City, but it's everywhere. So people are still spending money. They may be not spending $150 at Lulu, but they're still spending $100, and that's a good thing.

AKIKO FUJITA: Let's talk about your investment thesis and what you're liking right now, the tech sector, clearly, seeing some of the big gains here, up more than 30% on the year. You are overweight on the sector. Is it all about AI?

BRIAN BELSKI: No, it's not, and thanks for bringing that up, and by the way, it's the first time we've been overweight since 2019, and that's a big call for us, because, at that point, heading into the end of 2019 to 2020, tech was about 30% of the market, and I don't like when a sector is 30% of the market. That's why our rating is 29. That's number one.

Number two, we've had three different tech markets so far this year. January was the January effect rally, meaning the worst-performing stocks in 2022 were the best-performing stocks in January. January and February, we had more of a value move. Then we had the bank, quote, unquote, "debacle." I'm not going to call it a crisis, because it wasn't a crisis, OK? And you had investors sell their financials and buy tech. That's tech move number two.

Tech move number three, I think, is the real move, and that is AI. I think AI is here to stay. It's built in efficiency. I think you need to look at AI like you would any other emerging technology in another sector. For instance, in health care, you want to buy the big health care companies, because they'll end up buying, or finding the drug, or the biotech that's actually going to work, right? Or, in energy, you want to buy alternative energy, you want you want focus on alternative energy, buy Chevron and Exxon, because they're going to be the ones that are going to invest the most in alternative energy. It always works that way.

So what does that mean for tech? I think it's Apple, Microsoft, the Google machine, Netflix, those types of names. But, also, we've owned core positions in Nvidia and AMD, because they're the best companies in that space anyway. So I think you want to barbell semiconductors. On this idea, you have Nvidia and AMD, and then, on this side, you have Broadcom and Qualcomm, and you kind of value, you kind of balance out the higher multiple with the lower multiple.

SEANA SMITH: That's putting rest to some of the fears out there that maybe this rally that we have seen in AI is overdone at this point. Brian, what about health care, because you also changed your positioning there, your outlook for that sector, downgrading it to market, right?

BRIAN BELSKI: Yeah, thanks for bringing it up. There's been a bit of a COVID hangover, I'll call it. And we always like health care. We buy companies that keep us alive, and that's kind of our thesis, aside from UnitedHealthcare. It's true.

SEANA SMITH: I like that.

BRIAN BELSKI: UnitedHealth care is an amazing company, throwing off lots of cash and great dividends. It's been one of our core positions for 11 years that we've been managing money at BMO. But I think some of these health care stocks get in above their skis a little bit, and they've had a little bit of problems with growth, and so we like the biotech sector for cash, actually, and value. There's some really great value there.

And some of the drug companies, and a company like Thermo Fisher, which is just a juggernaut in terms of instrumentation, so we've just tightened up our positions there a little bit. Remember, people forget that health care is the second-largest sector in the United States, second-largest. So you have to be really careful in there. I think you have to be much more stock picking.

I think the other big thing that people are missing in the market shot, if I have a second, is small cap, small mid-cap. I think we've had a generational opportunity to buy small cap, thanks to the banking debacle. I think they threw the baby out with the bathwater with respect to small caps, and they've created this great and amazing buying opportunity. As the market broadens out, small caps, with respect to cash flow, balance sheets, and earnings discernibly, are the best I've seen in 30 years. And I think that's very, very good for the United States market.

AKIKO FUJITA: So get in now?

BRIAN BELSKI: Get in now.

AKIKO FUJITA: OK, Brian Belski, BMO Capital Markets Chief Investment Strategist. Have a safe flight back.

BRIAN BELSKI: Thank you.

AKIKO FUJITA: I hope it's not too crowded.

BRIAN BELSKI: It will be, but that's OK.

SEANA SMITH: Gotta come back and visit us soon there, Brian.