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What could cause an 'immaculate correction' of rates, inflation

Mon, Feb 12, 2024, 1:25 PM

The latest reading of the Consumer Price Index (CPI) will be released on Tuesday, giving further insight into how inflation is faring and potentially affect the Federal Reserve's future interest rate policy decisions. Many investors have been preparing for multiple interest rate cuts from the Fed as it seems likely the Fed will hit its target goal for inflation of 2%.

GenTrust Principal Matt Kishlansky joins Yahoo Finance to discuss everything around inflation and the Federal Reserve and how the market is pricing in potential cuts.

Kishlansky explains how market participants have been overly eager and discounting a lot of the risks associated with the economy and what they should want instead: "I think we want to see some amount of rate cuts to justify the multiples for which we are to see the cost of capital start to come down, but too many rate cuts once we get going on that path, too many rate cuts portend a world where the Fed is worried about growth and starting to artificially prop us up. So the market is kind of signaling that they believe in what I'm going to call the immaculate correction of rate levels and inflation levels without any impact on growth. And to the extent we do actually experience that, I think they're going to really reward equities, I think they're going to push prices up even if that means pushing multiples up further from here."

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Nicholas Jacobino

Video Transcript

- We have obviously seen a big migration in the estimates for how many rate cuts we're going to get this year. And what's been interesting is that even with that change, stocks have continued to rally. Do we get confirmation still of all of this from the CPI tomorrow?

MATT KISHLANSKY: Well, first of all, thanks for having me back. I think there's a lot of information, that's already come to us. And things are really coming into view, I think for 2024. A pretty quickly. We're pretty far along now in earnings season. With more than 60% of the S&P having reported and representing probably more than 75% of the market cap.

And at this point, we believe with what's priced into to the S&P, that market participants are giving us a pretty strong sense of the world they expect to inhabit by the end of 2024. And I have to say, based on what it looks like, that looks like a pretty spectacular place to be. They expect to see earnings growth of between 10% and 11%.

They expect six rate cuts and they expect inflation to have come all the way down to 2% and really anchored there. And so it's pretty beautiful at the other end of the rainbow. I think unfortunately, there's a big mountain of economic data, inflation data that you just alluded to geopolitical risk, noisy election year here in the US and a lot of Fed decisions between here and there.

And so instead of pricing the market to go slowly and carefully around that mountain, we've bid prices up and multiples up particularly for the S&P to go straight up the mountain and directly across it. And I think the market is somewhat discounting how treacherous a path that is. We need disinflation to continue across 2024 to get down at least below 2.5% in order to give the Fed the room to start making those cuts.

But we can't really see it go too far down below 2% for fear of cutting into the aforementioned growth that's priced in for earnings, for the rest of the year. And similarly with the rate cuts, I think we want to see some amount of rate cuts to justify the multiples, which we are, to see the cost of capital start to come down.

But once we get going on that path, too many rate cuts portend a world where the Fed is worried about growth and is starting to artificially prop us up. And so the market is signaling that they believe in what I'm going to call the immaculate correction of rates, levels and inflation levels without any impact on growth.

And to the extent, we do actually experience that, I think they're going to really reward equities. And I think they're going to push prices up, even if that means pushing multiples up further. From here we're already at 20 times forward earnings. On the S&P versus what the rest of the world is probably closer to about 13 on average.

And I think we'll even see the multiples push higher if we do achieve that, what I call immaculate correction and then obviously, there's a lot of ways for us to be disappointed along that path.

- And so Matt, given that outlook, you obviously see plenty of reasons for caution here, some red flags. Given that outlook Matt, when you look at the US stock market, where do you see value right here in terms of sectors?

MATT KISHLANSKY: We tend to be more purely tethered to the index. I think within the various sectors, obviously, technology is the one everybody's been watching and it seems pretty bid up. But again, that's where all the growth is expected. I think more broadly we're looking at US small and mid cap, excuse me and seeing a little bit more value there versus the rest of the US large cap.

But again, the game is in the growth and the growth is really priced at the top of the market right now.

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What could cause an 'immaculate correction' of rates, inflation

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