Fed ‘in the driver’s seat’ in this bear market, strategist says

Citi Global Wealth Investments Head Kristen Bitterly joins Yahoo Finance Live to discuss the probability of a recession, market uncertainty, volatility, ADP employment, ISM data, inflation, and the outlook for the Fed.

Video transcript

BRAD SMITH: For more on the markets, let's get to Citi Global Wealth's head of investments for North America, Kristen Bitterly. Kristen, great to speak with you here this morning here. As we continue to kind of put in context the move that we're seeing today with what we saw to kick off the fourth quarter, what does this really set up for the probability of everything from a actual bounce that is sustained to a Santa Claus rally that some might be looking for come December?

KRISTEN BITTERLY: I think-- unfortunately, I think these markets require patience, discipline, and a bit of defense. We expect that we're going to see volatility and choppy markets from here through the rest of the year. And I think what we saw over the past two days-- and look, I'm not one to criticize any market rally. But it really was a function of what we saw back in June as well, some very oversold conditions, peak bearishness. We know sentiment is at all-time lows.

And so the market just having a little bit of a relief rally. I think we have to keep in mind, though, that in bear markets, these types of rallies are actually quite common. In 8 out of the past 10 bear markets, we saw rallies off the lows of more than 10%. And they didn't happen just once. They happened several times. So these tactical bounces are to be expected. But it doesn't mean that we're out of the woods yet.

BRIAN SOZZI: So, Kristen, the market a couple of days ago cheered weaker than expected ISM data. Today, we're seeing the market not like some hotter than expected reads on ADP employment and then on ISM services just moments ago. Should bulls be rooting for bad news on the economy?

KRISTEN BITTERLY: I think it really just points to the fact that the Fed is in the driver's seat. And we say don't fight the Fed in bull markets. We should also say the same when we're dealing with bear markets. And so the Fed has been very resolute and very clear on their positioning in terms of the fact that inflation, their ultimate target is 2%. And we're not anywhere close to that. And also with inflation, the Fed is not just data dependent. They're trend dependent. They're not going to look at just one number. They're going to look at the overall trend. And we need to see that come down.

The second part is employment. Unless we see a material decline in employment, or a rise in unemployment, I should say, that's not going to change their trajectory. So I think the market-- this bad news is good news, good news is bad news is everyone hoping for a Fed pivot, and we don't see that.

BRAD SMITH: So what we are seeing, though, is some of the banks at least calling for what could be a soft landing, or at least, giving the Fed a little bit more credence to say, yeah, we've got more confidence than we had in the past, or on the other side of that, you have some economists saying you know what? It's not going to be as bad of a recession as we thought it might be. Which of the narratives, really, do you believe has the most credence here?

KRISTEN BITTERLY: I think you have to prepare yourself for the probability of a recession. We recently increased our probability to about 70% in 2023. And the reason for that is, again, looking back at these two data points, which are, really, the overall inflation number, as well as employment, unless we see any trend really change, we don't expect the Fed to pivot. And so all of the tightening that they've already done in terms of rate hikes being the fastest and steepest in history, combined with quantitative tightening, this has not flowed through to earnings.

So this is something that those tight-- that tightening of financial conditions can take anywhere from 6 to upwards of 12 or more months to really flow through to the economy, which is why we think the earnings outlook, when you look at consensus earnings growth for next year, at around 8%, we think that's way, way too rosy. And we're actually expecting, if we're continuing on this trajectory, that we would see an earnings contraction next year.

BRIAN SOZZI: If that's the case, Kristen, that 70% chance of recession does come to fruition with an actual recession, should investors be holding cash? Is cash no longer trash?

KRISTEN BITTERLY: So here's the thing. In terms of our portfolios and how we're positioning, we are preparing for this environment. And so I think it actually depends upon your definition of cash. And one of the things that I do think, if we have any bright spots in the market right now, is the fact that if we look just over two years ago, 40% of the world's government debt was negative yielding. Now we have six-month T-bills that are close to 4%. We have a two-year Treasury that's north of 4%.

And so what we've been doing is adding some of this fixed income exposure. Very high quality because of this concern of a recession, but very high quality in terms of US government debt, looking at investment grade corporates, municipal bonds, and even some value in bank preferreds as well. So there's ways of getting marginally higher yields and getting marginally better outcomes, but still being pretty defensively positioned.

BRAD SMITH: With where stocks are right now and where some of the valuations have dipped lower to, for those who have a long-term time horizon, is this a safe time to get back into the markets? Or is there still kind of a leg lower that you would be tracking against?

KRISTEN BITTERLY: So market timing, I think, is a very, very challenging thing. As you mentioned earlier, we do see Santa Claus rallies sometimes. And 80% of the observations in Q4 tend to be positive.

And so one of the things that I think if you do have a medium to long-term time horizon, when we look at situations where the S&P 500 has declined by 25% or more, looking forward out three years, there's never been a negative return. In fact, the average total return over that time period is close to 40%. Out five years, the average total return is around 85%. And so in terms of putting capital to work and looking at opportunities now, there certainly are opportunities if time is on your side.

BRIAN SOZZI: Hopefully, it is. We'll leave it there. Citi Global Wealth Investment's head of North America, Kristen Bitterly, always good to see you. We'll talk to you soon.

KRISTEN BITTERLY: Good to see you.