Cooling inflation prints may prove to be the ideal lay-up for the Fed and earnings season this quarter. Baird Investment Strategy Analyst Ross Mayfield and Annandale Capital Founder George Seay share their opinions on the earnings performance of big bank stocks, such as JPMorgan and Wells Fargo, and what it may say about market volatility moving into the second half of 2023. Seay continues to say that the Fed may have even 'engineered a pretty brilliant' soft landing scenario, noting that further interest rate hikes won't immediately handicap markets or consumers.

This post was written by Luke Carberry Mogan.

Video Transcript

SEANA SMITH: Big names like JPMorgan, PepsiCo, and Delta all beating the Street's expectations.

But is that enough for investors and for the market to continue here to the upside?

We want to discuss with Ross Mayfield, Baird Investment strategy analyst, and George Seay, Annandale Capital founder and chairman.

Great to see you both.

Ross, let me start with you.

When it comes to even the results that we saw today, JPMorgan, Wells Fargo, Citi, the trading action on those stocks have been mixed despite the fact that all three beat the Street's expectations.

So beating the Street's expectations, is that not going to be enough once again this quarter?

ROSS MAYFIELD: I think it's going to be enough to keep stocks from really retreating from this rally, but I don't know if it's enough to spark the next leg higher.

We saw, as we did in Q1 and as we see in most quarters, expectations and estimates drop across the quarter until the earnings season is really de-risked, but when you beat those estimates, you're beating kind of a lower estimate than otherwise would be expected.

So I think unless you're seeing big beats, double line beats, maybe it's not enough to spark the next leg higher for a market that's sitting at bull market highs or the highs for this cycle.

So I think it'll take a little bit more than just beating these de-risked estimates to spark a new leg higher.

SEANA SMITH: George, is it more about guidance?

We certainly know that is something that investors take very seriously, what they are focusing on when you're trying to gauge what the company, what the results are going to look like two, three quarters out from now.

Is that going to be really the driving factor here?

GEORGE SEAY: Well, that's the right question, Seana.

You have classic sell the news today, and you're going to have to really outperform what the Street is looking for to continue upward momentum in stocks, and you see that the Fab Seven stocks that have led the markets higher so much this year are starting to stall out a little bit, and the market just looks heavy and looks tired, and we've had such an unbelievable rally the first half of this year.

I don't think it'll be too difficult to have some factors come in that make it a lot harder for the market to press higher, especially the NASDAQ that is up so much more than the rest of the market this year.

It just looks toppy and tired and ready to take a break, and the VIX is showing a lot of complacency.

I think that going into the fall, we may get a little more volatility coming in.

SEANA SMITH: Do you agree with that, Ross?

ROSS MAYFIELD: Yeah.

I mean, look, Q2 was as calm a quarter as we've had in three or four years, really, in the post-pandemic era.

If you look at the VIX making a three-year low, if you look at something like the lack of plus or minus 2% moves for a day, it was a really calm quarter despite some of the headline news and noise, so I do expect volatility to pick up, especially July is usually fine, but getting into August and September are typically seasonally challenging months.

You do have extended valuations, you do have rates spiking a little bit over the last couple of weeks.

And so, do we expect some volatility?

Yes.

But at the same time, we respect the momentum and the resilience of the market from the first half, and if you look at history of first half strength like we saw has really been a bullish signpost for the second half.

We might just have to get towards the end of the year towards Q4 before we really start to reap those results.

SEANA SMITH: And, George, we're also starting to get some commentary on the consumer.

We heard it from a number of the bank CEOs this morning, Citi CEO Jane Fraser saying that we are seeing a more cautious consumer but not necessarily a recessionary one.

What are you expecting to hear this quarter about the health of the consumer?

GEORGE SEAY: I think every aspect of the economy is going to start fading somewhat, Seana.

I do think the Fed has engineered a pretty brilliant soft landing, which I always thought was kind of the most likely outcome because we had so much stimulus in the market they did have to jack rates up that excessively to bring inflation back to bear and bring the economy back to a more gradual steady state growth rate.

But I think that, again, back to exhaustion, I think that these interest rate increases, they don't immediately handicap the economy and the market and the consumer.

It's about a 9 to 18 month lag period in between the time they start jacking up those rates to see the really significant impacts of it, and I think this fall, this winter, and maybe even into the spring, we're going to start to see some real overhang from that and some real pressure on the consumer and the markets and the overall economy.

SEANA SMITH: Ross, let's talk about some of the data that we got out this week, because we got a few readings on inflation, also the consumer, US consumer sentiment rising for the second straight month the highest level that we've seen in almost two years, and this sharp incline largely attributed to the fact that we are seeing inflation ease just a bit, stability in the labor markets.

But, Ross, how do you think the Fed is looking at the data that we've gotten out over the last several days and what that tells them just about their fight against inflation and how much higher they need to go with rates?

ROSS MAYFIELD: You know, to me it would say we could look at a pause or maybe one last rate hike, but what the Fed is saying is they still want to do two more hikes, if not more down the road, if they view inflation as not properly anchored.

And they might look at the CPI data, the PPI data and be encouraged.

They might also look at core CPI still around 5%, or in the consumer confidence report this morning inflation expectations still kind of anchored above 3%, and see reason to keep hiking.

If I were the Fed, I would definitely be pausing here.

I think the disinflationary trend is obvious.

I think you can engineer a soft landing if you don't go too far here.

But what the Fed wants to do has been made clear.

They want to do two more hikes this year, and they want to keep the optionality to go higher if inflation isn't where they want it at 2%.

They want to be higher for longer, and I think they feel like they can do that.

SEANA SMITH: George, if we do see-- another rate hike is pretty much a sure thing, although you never say that, but largely in terms of what traders are betting on, they think that it's a sure thing later this month.

If we do see though two more rate hikes before the end of the year, what does that mean for the labor market and what that's going to look like by year end?

GEORGE SEAY: Well, as we've seen so far, it hasn't meant much.

The labor market is still incredibly strong and we've seen a lot more rate hikes than just another 25 to 50 basis points.

I think the Fed's got one to three hikes left in it, but I don't really like the slow and steady gradual drip methodology they've been using.

I was calling six months ago for them to do a 75 basis point hike early this year and say, we're done, and we may be done for good, but we're done for at least six to eight months, give the market some certainty, and this slow drip, drip, drip may not matter for now, but eventually it may matter for the market if short term interest rates get up around 6%.

All of a sudden people look at the multiples they're paying for NVIDIA and Microsoft and some of the other more speculative stocks and go, whoa, with 6% short term rates, we've got to discount these earnings more.

So I wish they'd get it over with and hit a pause and then assess how the economy reacts.

And I agree, I think that's going to happen pretty soon.

I hope it's sooner rather than later.

SEANA SMITH: Ross, let's talk about how to play all of this here.

Bank of America strategists, they were out with a suggestion today saying to short stocks as global equity funds see inflows of nearly $70 billion in the past seven weeks, and I think this massive run-up that we've seen since the start of the year, a lot of strategists are saying, hey, maybe now is the time for a pause.

Do you think it's time, Ross, for some caution from investors?

ROSS MAYFIELD: So I think-- I think, sure, a sign for some caution, maybe expectations of volatility and some sideways trading for a bit, but I don't think it's time to get bearish or short stocks.

As I mentioned, if your first half is 10% or greater, your second half has a higher percent chance of being strong.

So the momentum in the market is really something to be respected.

You know, maybe a rotation into some of the more cyclical value stocks economic.

Momentum is pretty strong, economic surprise indices are at multi-year highs, you're starting to see just a little bit of percolation from something like energy, industrials have been the story of the market if not for tech, so I think there's still opportunity out there within the equity market to maybe rotate into something that looks a little bit more-- a little bit cheaper on a valuation basis, but without trimming your exposure to stocks, which are really responding to a stronger economy and have been resilient in the face of a lot of headwinds this year.

So we're not getting bearish yet.

SEANA SMITH: George, where do you see the most opportunity today?

GEORGE SEAY: Well, I agree that trying to time the market I think is a fool's game and I don't advocate.

We at Annandale Capital don't advocate that for anybody.

But I think you ought to look hard at your allocation and make sure that whether it's 40% or 60% or 70%, you've got the right allocation to stocks, and if you've had a big move in your technology and other kind of high tech related growth areas of the market, you ought to look at trimming those or potentially riding some call options against them and look at sectors of the market that are much more attractive because they've been left behind this year.

And as mentioned previously, that's energy, I would say that's also healthcare, and I would say financials too.

We think regional banks are very attractive because they got thrown out so hard earlier this year, and there's going to be some consolidation in that space for sure, because they just can't compete with the big money center banks.

And I think exposure to the best of class money center banks like JPMorgan is a great idea too.

There was a sell the news today movement going on among the Street, but if you own the best of class firms in that area too, that's a good idea.

So I would look at it less as trying to time the market or make a draconian reduction in your stock exposure, more to rotate to areas of the market where future upside is more attractive than it is in some of the stuff that's rallied so hard this year.

SEANA SMITH: All right.

George Seay and Ross Mayfield, great to get your perspectives here on the market.

Thanks so much for joining.

Have a good weekend.