Markets are ‘deceptively inexpensive’ right now: Strategist

US SPDR Business at State Street Global Advisors Chief Investment Strategist Michael Arone joins Yahoo Finance Live to discuss market volatility, recessionary risks, rate hikes, and the outlook for investors.

Video transcript

BRAD SMITH: Welcome back to Yahoo Finance Live, everyone. It's been a dismal first half of the year for stocks, with the major averages logging steep declines as inflation and recession concerns weigh on investor sentiment. However, despite the challenges, all is not lost for investors.

Joining us now for more clarity on potential strategies for the second half of the year is Michael Arone, who is the State Street Global Advisors US SPDR business chief investment strategist. OK, all maybe not lost, depending upon what you've invested in here. But when we think about where we can kind of look through the first half and get the setup for the second half, what most broadly would you be looking for?

MICHAEL ARONE: Brad, I still think that investors need to emphasize quality and value in the core of their equity portfolio. And so, what does that mean? Quality and value is in the eye of the beholder. For us, it means that companies, sectors, industries that exhibit very healthy balance sheets, very stable earnings, low debt to equity, lots of cash flow, and that are either paying their dividends or increasing dividends, we think those will be leadership in the second half of this year.

JULIE HYMAN: Michael, it's obviously useful to find where people can make money right now. But it seems like it's going to be a pretty tough, challenging environment right now. The conversation that we keep having over and over again is, how do we know when we have bottomed in stocks? And I'm curious what signs you're looking for.

MICHAEL ARONE: I think calling a bottom is one of the most difficult things us strategists have to do. From my perspective, I think that if we look historically at bear markets, a typical bear market falls about 33% or so. And again, this is on average over most kind of bear market over the last 100 years or so. And so we know that the S&P kind of reached about 24% in terms of decline from its peak more recently.

So Julie, I still think there's a little bit ways to go here. Not very much. I think we're getting near the bottom. But I do think that there's some risk due to the downside. I think Dan Ives just did a great job. I think one of the big things that I'm looking for is that those analyst estimates finally need to be cut. So right now, S&P forecast, analysts are forecasting earnings per share growth and revenue growth, both north of 10%. And that's as of the end of June. Those numbers typically, during a recession or during the bear market, get cut by about 30%.

So, right now, for all those investors who feel like the market's inexpensive because multiples have come down, I think it's deceptively inexpensive. And so I would wait for those earnings to be cut further before I started to get kind of comfortable that we're at a bottom.

BRIAN SOZZI: Michael, does a bad earnings season coming up for the second quarter-- and I'll quantify bad as lots of earnings misses and guide downs for the third quarter-- is that the type of backdrop that could send the market down another double digits in the current quarter?

MICHAEL ARONE: I think it might. Now, we have started to price in a fair amount of bad news, right? We're all talking about this has been the worst first half for stocks and even bonds in 50 years. And so there's been very little places to hide. So I do think that in some ways, risk assets reflect higher inflation, rising rates, tightening monetary policy, a cut in earnings and a potential recession. So once we kind of wash out here, I do think it could create somewhat of a durable bottom for us to rally.

But Brian, to your point, I don't think we're there yet. And I do think some of the kind of misses on the earnings front, as well as the warnings in terms of the future expectations, could continue to put some downside pressure on stocks throughout the summer.

BRAD SMITH: So it seems like the markets have been trying to price in to the best of their ability a mild recession. To what extent do you believe it will actually be mild versus-- and I bring this up because of the data that we'd seen from the Atlanta Fed this morning and their projections for what the second quarter will look like-- and if we see that protracted out even longer, what that will start to look like priced into the markets as well.

MICHAEL ARONE: So, Brad, I think it's an interesting dynamic that's happening right now. So I don't think it'll be like the 2000 to 2002 period where the technology, media, telecom bubble burst, 9/11 geopolitical risk. That was a bit longer. But I certainly don't think it will be like the brief recession we had as a result of the pandemic. So I've been suggesting it's probably going to be your garden variety, your typical recession from that standpoint.

And I do think that in some ways, we may already be there. And the very good news here is that all the soft-ish landing hopefuls that are holding on to that narrative tightly, they do have some good points in terms of the consumer is in good shape. Businesses are spending. Corporate profitability has been good. Labor market's tight.

And so far, manufacturing and services data suggests we're still in expansion. So the point here is that at least headed into this recession, we're in reasonably good shape compared to past recessions. And I think that will result in a more typical recession over a few quarters.

Now the concern is that the Fed is raising rates at a time when the economy is already slowing. And that's going to have some lagged effects in future quarters. So that does make me a little bit nervous on this idea of a double dip recession perhaps later in 2023. But we're not there yet in terms of that concern. We just need to keep an eye on.