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Inflation: Consumer confidence 'has been destroyed,' strategist says

The Leuthold Group Chief Investment Strategist Jim Paulsen joins Yahoo Finance Live to discuss today's market gains in the greater context of the ongoing Fed rate hikes and economic environment for consumers.

Video transcript

DAVE BRIGGS: All right, let's take a broader look at the markets and the action today with Jim Paulsen, the Leuthold Group chief investment strategist. Jim, good to see you. Let's-- we want to get to this massive market rally on a Monday. But first, your thoughts on that warning from the UN. Should the Fed consider developing economies around the world when lifting rates?

JIM PAULSEN: Well, I think that I agree that the Fed should pause, or should get ready to pause. I think that the rate movements on the upside are getting way out of bounds, David, compared to a number of things. We've got the-- until today, we've had the 10-year Treasury yield going straight north, while commodity prices are collapsing, while inflation surprise index is falling overall, while the ISM surveys for service pricing or manufacturing pricing is collapsing.

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It's just getting increasingly out of bounds. Yields now in relation to inflation expectations, breakeven points in the bond market are all way, way high relative to their storied norms. They're in contractionary areas, certainly. So the UN has a case. I'm not sure the Fed should have such a broad mandate that it considers all these different groups.

I'm more of an old school. It has two mandates-- sort of employment rate and inflation. And probably inflation is number one and employment two. And if they start entertaining too many mandates, I think it gets them in trouble. They're really not built for that.

SEANA SMITH: Jim, what do you make of today's rally? Because, yes, it is a rally, off the lows, the lowest levels that we have seen in a couple of years. Yet, the Dow still up 877 points, S&P up nearly 3%, as well as the NASDAQ. Do you think that this is just a brief bear market rally? Or is there any reason to think that today's gains have some legs?

JIM PAULSEN: Well, we're very oversold. There's no doubt about that. We had a lot of extreme pessimism at the end of the last week. So are we due for a bounce, a rally, and a pause in the bear? Certainly. And that could be part of what is happening today.

But I'm fairly bullish here, Rachel. I think that things have gotten too extreme on the rate front, too extreme on the currency front. I think policy officials around the globe are going to have to switch gears to stopping tightening here soon. I think the valuation of equity markets are pretty compelling. We've got a 17 trailing PE multiple in the S&P 500 before today, which was lower than 70% of the time since 1990.

Pessimism has been extremely high on almost any sentiment measure you look at. Typically, historically, when you look back over the post-war era, peak inflationary periods are great buying opportunities for the stock market if you look forward one year. And I think we're in that realm.

So I don't know if this is the bottom, and this is it. I mean, it certainly wouldn't surprise me if it's just kind of a dead cat bounce. But I'm not too worried about it. I think investors shouldn't worry about what's going to happen over the next few weeks or even the rest of this year. Think about where this thing could be in a year. And I think you could draw a big circle down here. In your buying today, 12 months out, you're going to be happy to do it.

SEANA SMITH: Jim, I know you just said, don't worry about the next few weeks or what's happening from here until the end of the year, but I'm going to ask you about that because so many investors are closely watching what the Fed is doing. I know you said that you think the Fed should pause its rate-- should pause its rate hikes. When do you expect, though, the Fed to pivot?

JIM PAULSEN: Well, I wouldn't be surprised if at the November meeting they do a rate hike. that's far less than the 75 they've been doing. They could do maybe 25 and 50. And I think they might take a pause after that. I mean, to me, we're at the point to where we've had to be sufficient tightening, Rachel, in the pipeline since March of 2021.

We've had a tremendous drop in the money supply growth rate from 27%, down to basically 4% year on year. Fiscal juice was 18.5% of GDP back in March of 2021. It's now down to 3%. The dollar has gone up 25%. Bond yields across the curve have been-- some of them have been rising, really, since 2020. So there's-- regardless of what the Fed is going to do, there's enough in the pipeline already with about a one-year lag that's going to keep inflation going down.

I think the war on inflation has already been won. We just don't know yet. And so I think the Fed is getting irresponsibly tightening now into the taking too much risk of aborting this recovery when they really don't have to. And I think that's going to become clearer and clearer. This morning, we got information that Credit Suisse isn't in peril a bit.

That's weighing on the positive bid for the Treasury market today. We also got ISM reports on manufacturing that showed more weakness than perceived. There's just going to be building more and more data that's suggesting that real growth is slowing, and inflation is slowing. And the Fed has probably have to pause. And if the market picks up that they're going to pause, this market could rip.

RACHELLE AKUFFO: And Jim, we know that, obviously, the Fed got caught on the back foot, sort of being late to the game when it came to trying to tamp down inflation. And you're saying that the war has already been won on inflation. But because of this lag in the data, we're still waiting for it to catch up. So then when you look at things like the strength of the dollar and what we've consistently seen with consumer sentiment, how do you expect that to play out for the rest of the year?

JIM PAULSEN: Well, if you look back historically, Rachel, consumer sentiment in the United States everywhere, really, not only consumer sentiment, but small business sentiment, CEO sentiment, they are strongly, closely correlated in an inverse fashion with the annual rate of inflation. What destroys confidence more than anything is rising inflation rates. This has been going on all the way back to World War II.

For example, some of the big major bottoms in incompetence was 1970, 1974, and 1980, which coincided with the peaks and the big inflationary burst of the 1970s. This is no different. Confidence has been destroyed in the last 15 months or so, as inflation has accelerated. In fact, the University of Michigan measure went to its all-time lowest recorded reading.

But here's the deal. In the last 20 months, consumer confidence now has risen three months in a row off those lows. Small business confidence has risen in recent months. CEO confidence has risen in recent months. Why? Because inflation peaked and is starting to come down. And that's resurrecting confidence. So one of the things that could-- a resurrection of confidence has two implications.

Typically, without a massive inflation, the thing that really makes a recession much worse is that you go into it with generally sky high confidence, and then you destroy confidence on Main Street, which lengthens and deepens the recession. We won't do that here because confidence has already been destroyed. We're heading into a slowdown with confidence starting to revive, which will buffer us against a contraction overall.

The other thing is, if animal spirits start to revive here, that's going to run right through Main Street economy and also help the stock market revive as well. So confidence is playing a big role. The destruction of it is hurt in the last year, but now that inflation is peaking, I expect confidence to be continuing to rise now as we look forward.

RACHELLE AKUFFO: We'll certainly be keeping an eye on it. A big thank you there, Jim Paulsen, Leuthold Group chief investment strategist. Thank you so much for joining us this afternoon.