Two positive signals in the economy as recession odds rise: Strategist

Evercore ISI Senior MD Julian Emanuel joins Yahoo Finance Live to discuss the state of the economy, inflation, gas prices, yields, volatility, and the outlook for a recession.

Video transcript

- Welcome back, everyone. As we wrap up the first half of 2022, there is no question that rising inflation and a concern for global recession has been on the mind of investors over the last few months, causing the markets to experience some of its roughest stretches in years. Joining us in studio now to discuss, hopefully, a better second half of the year, we've got Julian Emanuel, Evercore ISI senior managing director. Do you think it's going to get better in the second half?

JULIAN EMANUEL: Well, probability dictates that after a down 20-something first half that the odds are it's going to be better in the second half. And in a week or two that has been full of downbeat news, we can step back and we can say that in terms of inflation, one thing that we're focusing on, gasoline prices, have started to decline. That's a positive. The other positive is that yields have started to decline. And in a year where a lot of this volatility is being caused by the fact that stocks and bonds for the first time in 25 years are consistently moving together, yields declining is a positive.

- So, yesterday, we heard from Chair Powell speaking in that European roundtable. And he's been hammered as of late. Are you going to cause a recession? Are you going to cause a recession? Are you going to cause recession? And he's sort of now saying, well, not on purpose. It's a higher risk now. And he's sort of acknowledging something that the market has been acknowledging for quite some time. So does that also help sort of mark the bottom, that he's acknowledging the difficulty that the Fed's going to have in a more dramatic way?

JULIAN EMANUEL: So in raising my to now college-aged sons, I've always said that when you use the phrase not on purpose, which was clearly what the body language was yesterday, it really doesn't matter because the thing happened anyway, and perhaps you need to take ownership of that. Again, the market's narrative has shifted. We're not saying that inflation is defeated by any stretch of the imagination. Whatever the glide path is is that-- Evercore ISI's forecast is 4% on core PCE next year. That's still too high.

But when you look at it, inflation breakevens-- I don't think there's any way to sugarcoat the word-- have collapsed in the last few weeks. And that tells you that the recession odds are rising. And in our client conversations, whereas a couple of weeks ago perhaps half of our clients thought that there was going to be a recession likely starting in the next 12 to 18 months, I would say that number is closer to 85%. And of that 85%, I'd say half of them believe we have started one already.

- Yeah, Julian. Let's pick on that because we've been highlighting, really, all week some weakness in retail results. You had RH another warning last night. Bed Bath & Beyond yesterday. Very bad results. Target a couple of weeks ago. To your point, do you think we're in a recession right now?

JULIAN EMANUEL: So, technically, if you look at it, obviously, first quarter GDP printed negative. You look at Atlanta Fed GDP. It's literally on the flat line. So we don't say this very much in the business. But it really is, for the most part, a flip of a coin whether in fact it is. And I would suggest that if you talk to most people, the feeling is is that if we're not in one, we are edging very close to one. And if you think about it, what's different this week than prior weeks is the Conference Board survey fell because the labor market conditions are now being judged as deteriorating certainly more rapidly than we had thought just a few weeks ago.

- I mean, we're not at the point where we're getting negative headlines on jobs, right?

JULIAN EMANUEL: No. No, no, no, no. We're still away from that. And frankly, we have to remember that when you go back to the pre-pandemic era, monthly jobs growth of 100,000 to 150,000 or so was perfectly acceptable for a GDP in the neighborhood of 2%. That's still applies. But, again, the potential for a sudden shift is what really the markets are focused on.

- And so in the event that people are looking to set a position for the long term given the pullbacks that we have seen in some equity names, pretty much broad based here, where would you start picking out if you would?

JULIAN EMANUEL: So several themes here. The first is is that the way you're going to make money the next several years is not the way you made money the last 15. We stayed close to the index. That drove us into growth. That drove us into FAANG. Those stocks are still relative to the rest of the market have a relatively high valuation. What we want to focus on is this concept-- a lot of people say, OK, we've got lots of inflation, so cash is not really valuable.

Well, we argue that cash is actually more valuable when there's inflation because the volatility of assets picks up. And we love companies that throw off cash. They come across all industries. There's just a ton of them. And, frankly, what it does is that-- and for the most part, concentrated toward the value sectors. Financials. Health care especially. But there are some in consumer names, which, again, is a very beaten down area. If you throw off cash, you've got a margin of safety. You can return to shareholders. And you can manage your business better.

- One quick final question. You're also a market plumbing guy. You look at derivatives and all of that stuff as well. There were such huge increase in options trading during the pandemic and shortly thereafter. Has all of that been washed out? And what effect is that going to have on in the next six months?

JULIAN EMANUEL: So it hasn't been completely washed out because if you look at it-- and, again, this was driven by the public largely. Because margin debt is still very high, and that is mostly the public trading on margin, that needs to continue to moderate. But interestingly enough, we have seen the option volumes decline simply because when you look at positioning, professional investors are relatively hedged. They've seen this storm coming. They don't know how it's going to unfold. But they aren't using options for protection as much because their positions have already been degrossed, which means you have the potential for a bear market rally literally at any time.

- Great insight as always. And good to see you in studio. Thanks for coming down.

JULIAN EMANUEL: Same here. Great to be with you all again.

- I know you've been doing these things via Zoom. But thanks for coming hanging out with us. Appreciate it. Julian Emanuel, Evercore ISI senior managing director.