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Markets have 'reacted in wrong direction' following Fed’s rate hike comments: Strategist

RiverFront Investment Group Global Fixed Income CIO Kevin Nicholson and CAPTRUST Director of Investments Christian Ledoux join Yahoo Finance Live to discuss recent comments made by Fed officials about interest rate hikes and the resilience of the American consumer.

Video transcript

[BELL RINGING]

DAVE BRIGGS: And there is your closing bell on Wall Street. Let's check out how the markets finished on this Thursday. The Dow down about 190 points. The S&P 500 just about even, but, you know, sneaking into the red there by 3 points. The NASDAQ the only in the green, up just narrowly-- 14 points.

Let's talk about all of this with Kevin Nicholson, RiverFront Investment Group Global Fixed Income Chief Investment Officer and Christian Ledoux, Director of the Investments at CAPTRUST. Good to see you both. Christian, we'll start with you. Your read of really the last two days, as Jared just did there, kind of got a lot of them in giving that massive reaction to the Fed words.

CHRISTIAN LEDOUX: Oh, gosh. I, and a lot of people out there, are tired of the Fed. We've got Fed fatigue. Yeah, we're always trying to predict what they're meaning with their words in their releases, and then on the press when they talk. And it's getting very complicated.

But I think we're getting closer to the point where we can stop thinking about the Fed. They're finally acknowledging that they're close to the top, if not there real soon. And then we can start talking about corporate earnings, which is what's going to really matter next year.

SEANA SMITH: Kevin, what do you think? Do you agree?

KEVIN NICHOLSON: I think that-- well, I think that the Fed is not done hiking. I think that the market actually has overreacted in the last day, especially the bond market. The bond market is pricing in more of a recession, while credit markets are basically telling you just the opposite that you're going in a growth cycle.

And I think that the Fed is-- from yesterday, the Fed and Powell said that we may get rates higher than we expected for the terminal rate. So I think that the market has reacted a little in the wrong direction, in my opinion.

DAVE BRIGGS: Christian, Kevin makes a good point, though, about the bond market. What is it telling you?

CHRISTIAN LEDOUX: Well, what I look at in the 10-year treasury, which is really where that inversion is the most steep, is that's where the market believes the interest rate should be. We're seeing the big fat part of the short end, which is where the Fed is indicating it's going, at least in the short run, and that's being forced there by the Fed.

If we do, indeed, see inflation continue to roll down, which we're already seeing that in the current data, the Fed is going to react at some point in the next year or two-- I don't know how long they're going to keep rates up-- but then they'll start trending down towards that 10-year rate and you'll see a much flatter curve.

SEANA SMITH: Kevin, we heard Christian quickly mention earnings, that they were going to be the focus here moving forward. In terms of your expectations, Kevin, we had JP Morgan cutting its 2023 S&P earnings forecast by 9%. Are you revising your forecast lower?

KEVIN NICHOLSON: At this point, we have not revised it lower. I mean, we think that next year we'll see roughly about $227 worth of earnings, which is pretty much in line with consensus at the moment. I think that you're going to have-- expectations have been lowered. And I think that there may be some surprises.

I think the big thing that we're going to have to watch going into next year is going to be profit margins. Will profit margins continue to stay high or will they come down? And how many firms will have pricing power? I think that's the big thing that's going to drive earnings in 2023.

DAVE BRIGGS: And, Christian, I know you wanted to weigh in there. You said that is what truly matters. In addition to the JPM trimming by 9%, they also said we could retest the S&P lows of 3,491. So your thoughts on earnings and Q123, where we could see the S&P headed.

CHRISTIAN LEDOUX: Yeah, I don't think we go to new lows. I would certainly agree that we've gone a long way in the short run, maybe a little too far too fast. What I would think is going to play out is a lot of the companies that have what's going to likely be much lower earnings next year have already come down a lot in price. I'm thinking about industries like homebuilders and a company that we own in our portfolios, HP Inc, which is already doing some layoffs to offset the downturn that they're likely going to see.

And it's already baked into the stock prices. So it's the industries that are going to get through this with, as Kevin said, pricing power. That will hold up earnings on that end. And then the ones that are seeing the earnings declines that are likely going to happen that has been very well foreseen, the stock's already down to reflect that.

SEANA SMITH: Kevin, we've heard from a number of retailers. We're waiting for Ulta to come out here any minute. Dollar General was out before the bell. We've had a number of other companies here report-- Gap, Urban Outfitters-- over the last week or two. When you try to gauge the consumer, the strength that we're seeing there, are you confident that we'll see the consumer remain resilient here as we head into the new year?

KEVIN NICHOLSON: The consumer has the ability to remain resilient for a little while longer. And the reason for that is because during the pandemic, they were able to fix their balance sheets. And even if the savings has come down as we've seen, they have the a clearer balance sheet to be able to have access to credit.

So you will probably see credit card balances go up. But as long as the consumer can meet those payments, I think that you will see the consumer hang in there for a while longer.

DAVE BRIGGS: Yeah, credit balances rising faster than we've seen in 20 years. You mentioned HP-- you have a couple other names for us, Christian, starting with Lowe's. Why?

CHRISTIAN LEDOUX: Well, Lowe's has a number of things going for it. When people can't buy the house that they would like to upgrade into because mortgage rates have gone up so much, what do they do? They upgrade their existing house. So that makes the home improvement group a little bit more recession resistant.

And we like Lowe's versus Home Depot for a couple of reasons. It's, first of all, trading at four PE turns cheaper than Home Depot. And second, Lowe's has made a concerted effort to attract the pro consumer by having some membership and recurring messaging with their professional customers. And that's starting to gain a little bit of share in Home Depot's very profitable segments.

SEANA SMITH: Kevin, when you try to gauge just the biggest risk to the market right now, to the investor out there, you mentioned the fact that you thought it was a bit of an overreaction-- the reaction that we did see investors give the Fed and Jay Powell yesterday. What do you-- I guess what's your assessment just in terms of where you're seeing the biggest risk potentially for the coming months?

KEVIN NICHOLSON: The biggest risk is that if you think about what the Fed needs to do, the Fed's goal right now is to tighten financial conditions. And financial conditions have actually been easing over the last month. And so I think the biggest risk that the markets and investors face right now is a bit of a whipsaw.

Because if the Fed continues to see financial conditions loosen, then they're going to actually end up tightening monetary policy more. And that may mean further rate hikes. And that could be the potential risk that hasn't been factored in to the markets at this point.

SEANA SMITH: Certainly something important to keep in mind. Kevin Nicholson, Christian Ledoux, thanks so much for joining us.