Stocks drift below record levels as earnings continue

Gibson Smith, Smith Capital Investors Founder and Chief Investment Officer joins the Yahoo Finance Live panel to discuss the latest market action.

Video transcript

ZACK GUZMAN: I want to turn to what it all means for markets here though, of course, as we are seeing the Dow give back a bit of the gains here off of what has been a historically hot start to earnings season. As we covered yesterday, the S&P 500 seeing its best reaction to the early earnings season in the last two years.

And for more on whether or not that enthusiasm is expected to continue as earnings season rolls on, I want to bring on Gibson Smith. Smith Capital Investors founder and chief investment officer joins us now. And, Gibson, I mean, when we look at the numbers, they have been pretty strong, and we continue to see some of those reports trickle in that are impressing and even in terms of expectations for full-year outlooks. But how do you see maybe how investors are going to be reacting to those if they continue to hold up?

GIBSON SMITH: Well, I think, you know, validation that the recovery is underway. We're seeing it in the economic data. This is to be expected. And the further along the path of recovery that we get, the greater the validation and probably the stronger the capital markets will be.

There's a nice support system in the equity market and the credit markets right now because of the recovery. It's playing out very traditionally in many ways, albeit a little bit slower than many in the marketplace would have liked.

AKIKO FUJITA: Having said that, Gibson, it feels like we've gotten some key warnings from a lot of these companies that have reported so far, one being higher fuel costs, obviously the supply-chain disruptions as well. How do you think that's going to weigh on that recovery you just pointed to moving forward?

GIBSON SMITH: Yeah and also a lot of references-- when you look at the Beige Book yesterday, I think there were 72 or 73 references to wage pressures and the cost of labor. And again, these are all elements of an economy that is in recovery. And ultimately some of those costs will find their way into the system and will hurt margins, but let's not forget, we're coming off of very high margins, so there is room for a little compression there.

What we're seeing in the early earnings releases, which I think is maybe the reason for the equity market hitting new highs, is that the operating leverage inside of companies right now is so significant. Think of top-line growth in the 18% arena where you see bottom-line growth in the 50%, 60%, 70%. These are all positives for corporate America and I think will actually be the fuel to launch equity prices to higher levels.

ZACK GUZMAN: You know, we're talking about maybe potential things, right? I mean, it's been a year for black-swan events. You know, when we talk about things that could knock people off course or at least investors off course, one of the things that's recently been chatted about-- and I know you put it in your note here-- was the idea of Jay Powell maybe not getting renominated to the Fed in his position. We've heard a lot of chatter here. Lael Brainard's odds have risen quite dramatically since the drama there in terms of insider trading or trading when they shouldn't have been trading at the Fed.

I mean, how would that maybe rattle through markets if Jerome Powell-- you know, given through all the ups and downs that we've seen, he's been a steady hand. What might that do?

GIBSON SMITH: Yeah, the optics around the trading at the Fed in the equity market or other securities is definitely not good, and that definitely weighs or is-- I think markets are holding Powell accountable for that. We're going to find out more in the next two or three weeks, but I do think that the odds of him being reappointed by the Biden administration are, in many ways, declining by the day.

Markets don't seem set up for that. They seem somewhat complacent that Powell will be re-elected to another term. And I think if there is a surprise, that could bring more volatility into the markets.

The other element of this that we have to watch closely, it's not just Powell. When we look at the seats that are coming due, there's going to be some realignments away from Republicans and towards Democrats with, you know, Biden in the White House and a Democratic-led Congress, so that's something else to watch out for.

I think the market has-- is of the belief that if we see more Democrats elected to the Federal Reserve or appointed to the Federal Reserve that there will be a more dovish stance or more accommodative on the monetary policy front. So those are a couple of things to watch closely. It's really hard to handicap the appointment of Powell, but based on everything we're seeing, we think that is one event that could trigger some significant volatility in markets.

AKIKO FUJITA: And one more risk, Gibson, that you've highlighted here is the recovery out of China. Of course, we got those GDP numbers earlier this week at 4.9%. We saw a pullback in the sessions even in the US on this fear that potentially growth can be slowing in China. How do you view that risk? Is it a short-term risk coming from what's happening with the real-estate sector, with the power issues and factories having to shut down, or is it something much longer, much more long term just given the headlines we have seen about the way in which Xi Jinping wants to potentially manage the economy moving forward?

GIBSON SMITH: You just hit the key phrase, a managed economy, and it really comes down to how much liquidity is pumped into that economy. And when we look at the global growth rates, the consensus right now sees us moving higher in growth and then tailing off in late 2022 into 2023 and normalizing in 2004.

When we look at China, the estimates are between 5 and 1/2% and 6 and 1/2% and, you know, India in the 6 and 1/2% to 7 and 1/2%. When we think about the second-largest economy in the globe being China, if those numbers fall short and don't come at the 6 and 1/2% or 5 and 1/2% or even 4 and 1/2%, somewhere else around the globe is going to have to make up for that.

I think that the US is on track for better growth than the consensus. All the foundations are in place. But it is a risk factor, and we have to watch that closely. We're going to watch the actions out of China more closely than the commentary and kind of keep an eye on all the economic indicators that we can track real time and see if that is following through.

I think probably the scarier scenario for markets-- and we're concerned about, obviously, China not growing as fast. But the scariest scenario is that China comes with a flood of liquidity into the system at some point over the next six months at a time when the US is starting to take hold, and you actually could see an acceleration in global growth much different than the consensus.

AKIKO FUJITA: We'll have to have you back on to see if that plays out. Gibson Smith, Smith Capital Investors founder and chief investment officer, good to have you on today.