Declining stocks signal corporate earnings are starting 'to deteriorate': Strategist

Macro Intelligence 2 Partners (MI2) Co-Founder and President Julian Brigden and Morgan Stanley Managing Director Kathy Entwistle examine the market outlook amid Fed rate hikes, sell-off concerns, inflation, and the labor market.

Video Transcript

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SEANA SMITH: All right, for a closer look here at the broader markets, let's bring in Julian Brigden, Macro Intelligence 2 Partners Co-Founder and President, and Kathy Entwistle, Morgan Stanley Managing Director. Julian, let me start with you. Selling here, once again today, coming off a very, very rough week for the market, S&P just notching a new closing low here for the year. What's ahead? Should we expect more selling?

JULIAN BRIGDEN: I think so. I think so, I'm afraid. I mean, look, short term, the markets are extraordinarily oversold. We could get a little bounce. But I'm extremely concerned that we've seen-- while the pros have been pretty heavily hedged, and a lot of downside options positions-- that we see the individual investors still remain highly committed to the markets.

If you look at things like the American Institution of Individual Investor Survey, you can see equity holdings remain very, very high, historically. I think we're going to start to see capitulation, which will push us back down to sort of pre-COVID levels, so 3,000 on the S&P, and probably 8,000 on the NASDAQ 100.

RACHELLE AKUFFO: So, Kathy, when you have a policy-driven bear market, what are some of the markers here that distinguish it from other bear markets?

KATHY ENTWISTLE: Well, basically, we're looking at the earnings of companies at this point versus what's going on in the economy and the inflation issue. We've been calling for this for quite a while that we would see earnings of companies start to deteriorate, and we are seeing that now. That's why those stock prices are going lower, and it's more of a pain point in the clients' portfolios.

SEANA SMITH: Kathy, what do you think of what Julian just said, 3,000 for the S&P, 8,000 for the NASDAQ? Here we are today and taking a look at where we close, NASDAQ 3,655-- or excuse me-- S&P at 3,655, NASDAQ at 10,802.

KATHY ENTWISTLE: It's not unheard of that this could be a possibility. In terms of the markets, the way things are going and the way that the Fed and Powell is-- they're talking about continuing to raise rates-- and they've acknowledged there's going to be pain-- that would certainly be a lot of pain. So it's possible.

Hopefully, that doesn't happen. We're looking at opportunities for clients when the markets do have a little bit of a bear market rally. We're going in and trying to rotate out of things we don't want to hold in the portfolio anymore. And when they go down, we're going to start looking for opportunities to buy.

RACHELLE AKUFFO: And, obviously, keeping a close eye on the labor market, Julian, and you're saying that the Fed doesn't want to come out and say that they're focused on slowing down the labor market. But, essentially, that's what's happening, yes?

JULIAN BRIGDEN: Correct. You know, I think if you look at, say, Andrew Bailey from the Bank of England who came out and sort of said, well, you're just about to experience the worst recession in your lifetime, there's just no way you could imagine Jay Powell saying anything similar at all. And given the twin mandate, which is very, very obvious, with the employment mandate that many other central banks don't have, he cannot be as explicit. But the fundamental problem for the Fed is-- beside the headline inflation is the strength of the labor market because until you really crack that, you will not deal with the underlying inflation metric.

You cannot have wages rising at these sorts of levels. We still have nominal GDP growing at around 9% per annum. And that's a function of the strength of the labor market. I mean, you've got very, very high levels of labor demand, very high levels of wages.

And when you aggregate that all together across the whole economy for the number of people working, you've got, effectively, pre-tax take-home pay running at 10%, which is double anything that we've seen in the last decade. So I'm afraid the Fed has to crack the labor market. And cracking the labor market, given what we refer to as hyper-financialization, so this very strong correlation between equity prices and the labor market, really means cracking the equity market.

SEANA SMITH: Kathy, what do you make of the labor market? We certainly have not seen a deterioration there. Some economists are saying we will see significant slowing. What do you make of the fact that it has been so resilient? And do we need to see it substantially slow in order to get inflation under control?

KATHY ENTWISTLE: Well, it is an issue of supply and demand, right. We have more people that want to hire people than those that want to work. So that's part of the issue with the inflation in wages. What I would say is we are hearing about some layoffs coming up with some companies, not all companies, but some.

And those are the individuals that really have to be cautious and make sure that they've got an emergency fund, a lot of cash on the sidelines, to help make up for potential lost wages. So it is a little bit of a balance of two cities, in a sense. But we'll see what happens. That's basically what we're looking at for our clients. We're telling them to be cautious, to be thoughtful, and almost to be a little boring with where they're putting their money right now.

RACHELLE AKUFFO: But boring can be good when you have this much volatility in the markets. Julian, another sticky part that we're seeing, obviously, is what we're seeing with housing inflation. How key is that, though, to bringing-- to getting the Fed down to where it wants to be with the 2% target?

JULIAN BRIGDEN: Well, look, owner equivalent rent clearly is the big buck of that bear there, and I think that remains a problem. We are starting to see-- our model's suggesting a flatlining of owner equivalent rent, but at really pretty sticky prices, so around 6%. I think elsewhere, to be honest, I'm actually extraordinary bearish on the construction sector.

I think we are going to see a true bust in US housing construction, just simply because of what mortgage rates have done. If you look at the amount of houses that are coming onto the marketplace that are in construction currently versus sales, we're looking at downturns that we haven't really seen since the early '90s, worse actually-- not while it won't have the credit implications, worse actually than we saw in the GFC.

SEANA SMITH: Kathy, you said that you're telling investors that maybe now's the time to stay boring. What is boring? What do you like?

KATHY ENTWISTLE: Yeah, boring is like the new sexy, right? So boring is cash. It's-- municipal bonds have looked a little bit more attractive than they have in years. We're looking at the typical defensive dividend-paying stocks. We're looking at real assets.

And really, just being patient. Your investment money should be money for the long term, and we shouldn't be looking at the short term for the cash that we need for everyday living. So invest for the long term, and make sure you have money on the sidelines for the short term.

RACHELLE AKUFFO: All right, we'll have to leave it there. A big thank you to our market panel, Julian Brigden and Kathy Entwistle. Thank you both for joining us this afternoon.