Massive market selling suggests that investors believe the Fed is ‘behind the curve’: Strategist

Brian Levitt, Invesco’s global market strategist, joins Yahoo Finance Live to discuss the latest statements from the Federal Reserve regarding interest rate hikes, volatility, shifting consumer demand throughout the pandemic, and the outlook for markets and technology stocks.

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Dave Briggs: For a closer look at market selling, let’s bring in Brian Levitt, Invesco’s global market strategist. Good to see you man. Happy Friday except for the markets. Let me re-read what Janet Yellen said. I don’t expect a recession. She added that the reflection of the underlying economy is not the stock market. Let’s hope that isn’t the case. But what does this day indicate?

Brian Levitt: Oh, it indicates that the market still thinks the Fed is behind the curve. Thus any time inflation rises in place, it speeds up the economic cycle. And any time you see the Fed behind the curve or continued policy uncertainty, it really does lead to volatility in the markets.

And in the past days we’ve had very hawkish comments recently from Fed Chairman Jay Powell, yet inflation expectations have risen. Thus, the market is indicating that the Fed is behind the curve, now three 50 basis point hikes are priced over the next three meetings, and the fed funds rate to 3% by early 2023. Thus, investors are grappling with the possibility that the Fed will have to The screws are tightened considerably here.

Brad Smith: Brian, in addition to the Fed being behind the curve, is part of that as well, which is what we’ve actually seen in this year’s tape, which represents some of the dearest about pandemics and pandemic events, they see some of that undoing the growth of that slowdown in growth. How much is also intertwined in these movements that we see less?

Brian Levitt: Yes, you had a lot of those names that traded with very high ratings amid expectations that the environment we were living in would continue. And in the end, what we’ve seen shift is some reopening as the Omicron variant dissipates. Of course, we’re still dealing with other pressures, but we’re also dealing with rich interest rate hikes.

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And so, for many of the names that the market deemed perhaps more speculative or needed a really perfect environment to do a good job, once interest rates started going up, the markets took away those names that were more speculative or what were seen as longer-term assets. Since then the focus has been on focusing more on high-quality, cash-flow-generating stocks, contrary to what some might consider more speculative.

Dave Briggs: Brian, the markets, you say, are pricing this up 50 basis points, which we haven’t seen since 2000. But you said three consecutive meetings of 50 basis points. What indication do you have that this will happen?

Brian Levitt: This is the market price. So if you look at Fed fund futures prices, you’re looking at 50 basis points in the next three meetings. You’re looking at 3% of the feds money by early 2023. Now, investors can look at that and look at where the two years have gone and say, well, the bond market has priced a lot of this. The challenge we are dealing with continues to rise inflation expectations.

And that indicates, you know, that you have a 10-year break-even point in the TIPS market of more than 3%. This is above the Fed’s comfort zone. She suggests that the Fed should act. And as you know, we are seeing stock markets adjust to what is now an expectation of further tightening. I mean, remember, December last year, the market was priced in two price hikes this year. We’re now looking at 3% by early 2023. Ratings have been raised, and are adjusting accordingly.

Brad Smith: Brian, when we think about how strong a consumer has to be right now to beat the Fed, what they’re navigating, and the journey toward this tightening policy that relies so much on maintaining employment and increasing the participation rate, even at the highest wages, as well, For now, the price stability metrics the Fed is looking to implement.

Brian Levitt: Yes, so the Fed feels comfortable when it reaches full employment. They are not comfortable with price stability, which is why they are moving. You know, it’s almost a paradox. Consumers have been very strong in the shadow of the pandemic and in the months immediately following the initial hit of the pandemic when companies were cutting workers and when companies were cutting inventory. And so you ended up being where we are today, which was an environment where there was a lot of money chasing very few merchandise.

So the way this was likely to be implemented this year, what we were all hoping for was consumer demand starting to decline. I’ve already seen American consumers, when surveyed, saying, the prices were way too high. They were holding back on big purchases. This would have enabled companies to rebuild inventory. This is how this story was supposed to unfold this year.

And then, of course, the Russian relocation to Ukraine, which shocked the prices of energy, agriculture and other commodities and also continued to disrupt supply chains. You’re putting on top of China’s policy of no coronavirus spread, supply chain challenges persist, and inflationary pressures persist. So the Fed’s job now is to tighten financial conditions. They will slow demand by tightening financial conditions. Markets are adapting accordingly.

Dave Briggs: Yes, there is not enough interest, given the lockdowns in China due to the coronavirus. They’ve gotten out of hand, and the few reports you see, they’ve been devastating shutdowns, taking over skyscrapers. Now, Brian, there are two things that Jared Blaker said, I want to point out and get your reaction. He said Friday incidents like this are usually followed by a similar incident on Monday. Do you expect it? It also showed that all large-cap stocks have been declining in the past 12 months, down between 20% and 50%. Do you expect this trend to continue throughout the quarter?

Brian Levitt: So in terms of whether Monday comes after Friday, I mean, I don’t necessarily stick to those kinds of patterns. You know, I think the market is probably going down – it’s going to be in more volatility, as long as the policy uncertainty continues. Now, with the huge caps, what we’ve seen is a higher price move and an adjustment in valuations. Those in which investors question models, whether it’s Netflix or Facebook, have been hit even more.

You know, I expect companies like Apple or companies like Amazon or even Microsoft, you know, more of the cloud computing business, I don’t think so — I think we’ve seen very big successes for those parts of the market, valuation adjustments with a price move. But when you consider slowing economic activity amid tighter policy, investors tend to fall back in favor of high-quality, cash-generating companies.

Brad Smith: Brian Levitt, Invesco’s global market analyst, we’re going to continue to see all of these topics, not just at close, but especially going to the next Federal Reserve meeting as well. We appreciate the time and ideas here today.