Citigroup Managing Director Scott Chronert joins Yahoo Finance Live to discuss peak bearishness, rising rates, recessionary risks, and the outlook for equity markets.
Video Transcript
BRAD SMITH: Welcome back to Yahoo Finance Live, everyone. As recession concerns remain high and market volatility remain a constant, our first guest this morning says that equity markets may have reached a peak bearishness related to Fed expectations and recession risk. For more, let's bring in Scott Chronert, who is the Citigroup managing director. So, Scott, peak bearishness, I mean, when you listen to some of the calls that have been made on Wall Street, even this morning, it sounds like that there's still some decline that could potentially be ahead.
SCOTT CHRONERT: Right, so let's frame the discussion a little bit here. So our view is that when you look at a variety of positioning sentiment and related indicators, the perspective is that in terms of a market response to concerns regarding recession and recession risk, we feel like we priced in something approaching to this peak bearishness construct a couple of weeks back when the S&P was closing just around the 3,800 level.
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JULIE HYMAN: Hey, Scott, it's Julie here. I'm curious what-- if you're looking at where we are in terms of peak bearishness or not. What are the sort of threats to that? In other words, what could potentially not be priced into the market here?
SCOTT CHRONERT: OK, so our view has been that the rising rate influence, first as we moved from negative real rates to positive real rates, which started back in January and continued over the past couple of months, has created a valuation response that has essentially corrected the multiples, particularly on the growth side of the market, less so on the value side.
But the implication, in our view, is that the rising rate influence on the market has mostly run its course. Most of what we're looking at in terms of Fed hawkishness is pretty well identified at this point. The issue from here becomes the move away from a valuation focus to more of an earnings expectation focus. And here, we're of the view that we're probably still looking at some downward revision risk to the second half of '22, but more importantly, recession risk would really be a '23 earnings event, in our view.
So the takeaway here is that you have to begin to consider the recession risk, which we, at Citi, are putting at 50-50 for 2023, and the market response literally a year ahead of that. And so the way we've been framing this is our base case for the S&P 500 is 4,700 by year end. That's essentially a soft landing scenario. We've also put out a recession scenario at 3,650.
So when you look at where the market was trading a couple of weeks back and hear that 3,800 level, as we were arguing that rising rates were mostly priced in and that this peak bearishness construct around positioning was baked in, what you're left with is a toggle between soft landing and a recession scenario, and the issue here being increasingly on or the earnings progression.
BRIAN SOZZI: Scott, the 50-50 chance of a recession next year, what tips us into a recession?
SCOTT CHRONERT: Well, I think we to see the persistency of inflation, right? So we're starting to see some signs of economic activity beginning to plateau or roll over. And I think for, like, last week, for example, was sort of a trigger for some of the market response. So what you begin watching for here is the Fed path. And we, at Citi, have been using over the next-- well, four 50 basis point hikes between most recent and into September.
At the same time, you have to marry that with what's happening in terms of economic activity and conditions and some of the leading indicators. And so, to the degree that the Fed is consistently viewed as a bit behind the curve and more emphatic about addressing the inflation issue, you end up running the risk of an overshoot. But I think it's premature to judge that, which brings us back to the point in case, where we're looking at sort of a 50-50 recession scenario. So, essentially, incremental Fed hawkishness on top of economic activity showing some signs of rolling already is the formula that we need to sort of bench against.
BRAD SMITH: At what point do you believe that a recession will show up in the economic data?
SCOTT CHRONERT: So this is the trick, right? So when you look at, historically, you look at some of your indicators, whether it's industrial production or some of the leading indicators, they'll tend to approach that 0 growth level just ahead of recessions. And at this point, we're, again, just coming off of peak levels. So you have to presume that a traditional recession is still many months off, if you will. And so, trying to navigate this between where we are currently and where you might actually get to that condition is the trick.
Now, we've been arguing that given the data availability in assessing inflation, Fed actions, and projected Fed actions, the market is able to discount much more quickly now perhaps than in the past how it positions ahead of that recession risk.
JULIE HYMAN: And so, if all of that is the case, and you say the trick is getting from here to there, as an investor, how do you do that? How do you position yourself to be nimble enough, right, for this sort of quick discounting mechanism that the market has become?
SCOTT CHRONERT: Right, so the way we've approached this is that, to your point, there are still a lot of uncertainty ahead that remains to play out here. And given the positioning commentary, we want to be careful about being too negative around the market circumstance. So what we've been arguing is for more of a focus on quality attributes as a means of positioning.
Essentially, when you think of quality, you think of more persistency of earnings or cash flow, lower debt ratios, higher profitability as a means of navigating this uncertainty in the months ahead. And that does a couple of things. We expect that at some level, it protects some of your downside in ongoing sort of macro deterioration-led circumstance. At the same time, it gives you an opportunity and a means of participating, should the market decide to rally from here, again, more lined with a soft landing perspective.