Transcript:
Writing
Caroline Woods: Joining me to wrap up the week is Ben Emons, CEO of Fed Watch Advisors. Ben, welcome back to the desk.
Ben Emons: Thank you Caroline. It’s great to be here.
Caroline Woods: All right. So stocks on pace for a mostly higher week. The Russell is the only laggard so far this week. But I want to kick things off by talking about treasury yields because we’ve of course been keeping a close eye on the ten year yield. And you actually say investors may be underestimating how high they can go. I see 6 to 7%.
Caroline Woods: And your notes how realistic is that.
Ben Emons: It’s realistic because one the economy is strong and doesn’t seem to be weakening, even though we’re going high energy prices and rising interest rates. And then secondly, we do have inflation that’s building. You know, you can tell from the energy markets that there’s disruption that may be coming through more going into the winter season when things already get tied in terms of gas supplies and that sort of thing.
Ben Emons: Inflation probably is going to go up a bit more and the fed will respond to that with higher rates. So that’s I think the the reason why yields are going higher. But it’s a good scenario. Yes Lewis. We’re getting an orderly rate rise and even rate rise based on a strong economy. Then even though there’s inflation stock market could go higher which you know stocks are good.
Ben Emons: That’s true.
Caroline Woods: Of it is 6 to 7% yields a good situation.
Ben Emons: While is good in terms of fat. It’s reflecting where the economy is right now which is a strong economy. That’s not how it should be. You know, we should have yields to sort of 5% where the nominal GDP the economy is. If it were much higher the way the economy is, that would cause a lot of pressure. So that’s the good news.
Ben Emons: Inflation is a different story. You know it’s hard to see how high it will go, but that depends on how the fed will react to it. That’s a part of it where yields going higher may not be as positive as these for markets. But as I said stocks are the best hedge for inflation. I particularly think if you want to invest in the markets, think of oil stocks, think of companies are involved in the energy play.
Ben Emons: That’s probably your best bet that yeah.
Caroline Woods: No, I was taking a look at your notes and you say that the next big winners are oil refiners could actually outpace the gains that we’re seeing from eye stocks. So oil refiners are the next big winners to focus on here.
Ben Emons: I think so because if you think like a Phillips 66, Valero or Marathon Oil, these are far smaller companies. There’s a market cap than a micron or Nvidia or any of those. But they could expand towards that level because refining is now such a important thing to control the energy prices in our in our economy. I don’t know if we can refine it to get a lot of higher gas prices.
Ben Emons: So they’re getting a lot of margin from this oil price increase to the profits are ballooning. So I think it’s a it’s a it’s a grain of truth. And if you look at where refiners are trading towards AI names or tech names, the difference between the two is so enormous already. And I think the mark is discounting that refines will get more premium.
Ben Emons: Take on more leadership on this one question.
Caroline Woods: What level does oil have to be to continue your bullishness in the refining space though?
Ben Emons: So it definitely has to stay where we are now, albeit higher.
Caroline Woods: 90 or higher.
Ben Emons: 90 or higher. Now if we go back to 60 then sure. And you know the picture could change. That doesn’t seem likely. We’re going to go back to 60 because we just don’t have enough capacity to meet all this demand.
Caroline Woods: Would you take money out of eye stocks right now and put it into energy, or do both trades work?
Ben Emons: Both trades work? I think if you want to take money out of something, I would say take it out of balance and put it into the energy stocks. I think that’s a better hedge against inflation then then low maturity bonds that are, you know, you want to sell. Right. So but in those shows about I think of the cyclical part of the markets, I think bullish on consumer discretionary because if the fed us to job phrase and guess that inflation and control over time consumers will benefit.
Ben Emons: But in the interim we’re dealing with the situation as we are now. So I think taking money out of, say, staples, taking money out of healthcare and putting it into energy, probably a good play.
Caroline Woods: You know, you tried to explain this to me the last time you were on how higher rates translates into a stronger consumer, and I still can’t really wrap my head around it because I would look at higher borrowing costs is a bad thing for the consumer. Higher oil prices as a headwind for the consumer make the case. Why are higher rates good for the consumer?
Ben Emons: So one thing we can already tell us that consumers have continued to spend, even though we’ve got high gas prices and even though we got higher rates, and that’s I think because consumers are not deterred by deaths itself. No, they discount that costs and have maybe made changes in their budget to continue to spend all everything they want to spend on despite all the rising costs.
Ben Emons: But higher interest rates are a really good tool to get inflation down over time. When that happens, the consumer will only benefit their their income, adjusted for inflation, will only go up. That’s that’s the reason.
Caroline Woods: Why will there be short term pain before though. And how would that play out.
Ben Emons: I think the pain right now is just the gas prices. I mean, that is I think, a bite out of every consumer’s budgets. Currently there’s interest rates. Depends, right? If you have your mortgage locked in from a few years ago, it doesn’t actually matter. Your credit card interest is not linked to necessarily is what happens to Treasury yields.
Ben Emons: So I think the interest rate part of it is probably not so much of a negative, but the pain is from gas prices.
Caroline Woods: Why aren’t we seeing consumer discretionary stocks do well right now.
Ben Emons: Them true I can I think that I am maybe in the majority in the minority. But I think people looking at that, the earnings growth of these companies has been limited by these higher costs that are out there, including the the the retailers and the consumer discretionary companies themselves. The face these higher cost of transports in terms of like warehousing and that sort of thing.
Ben Emons: But ultimately the consumer drives their margins. So I find it interesting that consumers haven’t stopped spending at all. You know, in fact, it’s only seems to be increasing inflation, by the way, to an extent does help that too, because, you know, you have to spend more when there’s inflation.
Caroline Woods: The way to play that is through an ETF though, versus stock picking that consumer discretionary sector.
Ben Emons: You could do it through ETFs. You can pick the stocks I think either will work. The ETF gives you the broad suite of of of retail consumer discretionary stocks, which is a good idea in terms of you don’t want to be in stock picking. But if you were to be able to pick stocks, I mean, think of like, anything that’s related to consumer spending, apparel, retail, you know, high end retail.
Ben Emons: There’s three separate stocks I would think of is.
Caroline Woods: Our financial stocks and opportunity or trap ahead of earnings next week. Because if you’re saying the consumer strong you know by consumer discretionary stocks financial stocks should benefit too right.
Ben Emons: They should as I’m being bullish on that sector to be in a bit of a bit of a move down a lot of these stocks, there’s somewhat different story going on. Let’s see what’s happening in France. And there’s a bit of a pressure on French banks that have somewhat spilled over to our market. And if people have looked at these rising yields that that actually affects the bank, maybe someone negative in terms of interest margin.
Ben Emons: But that’s I think, all at the margin. What’s really driving bank earnings is that there’s plenty of lending opportunities out there that the capital markets remain open, even though some IPO may have or not happened, but it remains open. The trading of markets like volumes have been very helpful. And then I think, as you say, the consumers are borrowing, they are spending.
Ben Emons: The deposit growth is good. So I think it’s all a really good story for both regional banks and investment banks today, reporting a lot of them next week. There’s a lot of value placed there. I always like Citi. It’s been a continuously recovering story from the financial crisis, and Goldman has always been the superior. And does the investment match.
Caroline Woods: Is there any reason to buy small caps here with yields this elevated? I mean it’s hard because you’re bullish on the economy and small caps should benefit if the economy is strong.
Ben Emons: In general this year. But be mindful of small caps itself. There’s a lot of companies there that are really small and unknown. Large companies are borrowed a lot of money to that level of small caps, much higher to what’s the big cap stocks are. And just because that’s shady the ETF which you can track right. Is that maybe the best way to play that I think what but.
Caroline Woods: You talking about the Russell.
Ben Emons: Yeah. The Russell 2000 ETF may not may be a way to do it. But it’s sensitive to what happens to interest rates. There’s a sentiment issue there. So keep that in mind. You know when once that’s kind of gets over and yields are higher and stabilize I think then the smoker platform makes sense.
Caroline Woods: Okay I want to go back to this ten year potentially hitting 6 to 7% call. How likely is that.
Ben Emons: So I come down to it from from several points. One. So we have a Federal Reserve that just started raising rates as a projection out that it will be small steps from here. But because of the energy situation being so uncertain and because fed members have and now looks at the energy situation as a reason to raise rates, there could be a lot more rate hikes coming to try and control for inflation.
Ben Emons: That’s one way. The second way used as the economy has not been off the track in any sort of way. We just started investing with EI in the economy. This year has been a few on the billion that are lined up of trillions more to come. If that were to happen. So that that’ll drive yields higher bond because there’s a lot of borrowing involved too, because the economy gets stronger from investments.
Ben Emons: And then finally there is a real, real reallocation happening away from bouncy treasuries to other types of bonds or better, to stocks, because people are recognized that bonds are just not really delivering. But they used to deliver because, yes, inflation is too high in the fed has react to it. And then the economy is very different than before the pandemic.
Ben Emons: So much stronger and much more investment and things are happening. So that leads you to this 6% level as in the broken, also through technical levels. That is not a reason. I guess the final point is that people are worried about the deficit. Yes, we have a lot of treasuries supply, a lot of issuance of bonds. That doesn’t seem to be changing.
Ben Emons: And that’s I think, another reason. So you could see 6% historically you could move to that based on all the charts. But the real number, the long term average is 7%. That would be really different dynamic.
Caroline Woods: And what happens to stocks if we see that? Would it be a correction because the market is spooked. But ultimately that can head higher because the foundation is good. Or would that be the end of the bull market?
Ben Emons: So let’s say 1999 is the comparison. When we have to attack investment in momentum in the markets and yields were at 6% or somewhat higher. That worked for a while until the fed went on with rate hikes and pushed it, I think, too far. And that made the 6 or 6.5% yields that you had at that time to way too restrictive what they call for the economy, meaning it really starts affecting economic activity and slows everything down too fast.
Ben Emons: So that could happen at 6%. But that does depend on how far the fed was willing to go. So say that they go to 4.5% five and we reach 6% of the ten year yields. I think the market will and the economy would be okay. But if you push it too far, yeah, then the 6% yield becomes or higher becomes problematic.
Caroline Woods: Okay. And your expectation for the fed moving forward is that this is just the beginning of the rate hikes. How many more can we see. When do we see them. And I should note that last time you were on, you said there was a 70% chance that the fed would hike rates. It seemed crazy because at the time the CME fed watch tool was pricing in something like 30 or 40%.
Caroline Woods: Your models were right. They were just ahead of the times, if you will. So tell us now, what are your models showing in terms of additional fed hikes.
Ben Emons: Two things that 1st October probability on my models is close to 30%, and the mark is more like below 20%. So there’s a little gap there. And that I think has to do with that. This is a live meeting. And I think they they do not want the midterm elections or anything else interfere if they have to make a decision to raise rates again.
Ben Emons: So that could happen. Secondly, the model is also indicating that from the speeches and the minutes that that shows exactly now of people thinking that they should move rates higher over time and that we have currently priced three hikes in the markets. But that directory shows more like five hikes.
Caroline Woods: Next year.
Ben Emons: Into next year. So I think that is important to watch because it’s the fed that does. The fed makes the decisions to raise rates not to market. They could price in one direction or the other to the fed will take notice of that. But they will make that decision. It tends to be historically the market prices in more than what the fed ultimately does.
Ben Emons: But we could be in a different situation this time because I think really, Caroline, that if you think back 21, 22, when they were really behind, they don’t want to be in that situation again. They don’t want to be in a situation where they have to slam the brakes, have to come out and raise rates by a loss.
Ben Emons: They’d rather be more diligent and say, we have to give the right dose to the economy to control the situation that we’re in. And I think this is why the problem is your my model indicating more hikes from anywhere in the market.
Caroline Woods: So the area of the market you would most want to be in if the fed is going to hike five times is what I wanted.
Ben Emons: I still think that financials and energy are your best play there because it plays into that dynamic of rates. I think emerging markets are interesting. A lot of people have looked at this as a diversification, you know, whether it’s Brazil as Mexico, whether it’s in South Africa or whether it’s even some Asian countries, is an interesting play this time around, because yes, the Treasury market will continue to stay on the pressure.
Ben Emons: So you got to look at foreign bonds. And finally, I think it’s more about the broader market overall. If you’re not really worried about the economy so much and you’re not too much in the stock picking, you should just stay long. The markets, you know, like, you know, you should not really get out of it. So being an index funds S&P Nasdaq is a pay off okay.
Caroline Woods: And if we see yields at 6% and the fed hiking five times does recession start entering the conversation again.
Ben Emons: Well that depends on how the difference between yields ends up. You know if we’re getting two year yield far above the ten year yields that tends to be the signal. But like I said it depends on how how much is needed to get inflation where they wanted to be, where yields and end of it’s a bit of a dynamic is hard to predict at precisely.
Ben Emons: You know, because I would think that 6% with a few hikes priced in or being delivered and the economy tracked and there’s no issue, you know, a lot of high end. And there sure enough it will become a primary.
Caroline Woods: You’ll have to keep us posted. Let us know what the models say. We’re going to pivot to a rapid fire round of this or that. You know how to play. Quick questions quick answers. Yeah. No hedging. Are you ready Ben I’m ready. Next 10% move in. Stocks up or down. Up S&P 8000 by year end. Too bullish or too conservative?
Ben Emons: Too conservative.
Caroline Woods: What should it be? What will it be.
Ben Emons: As bullish I think it will be 8000.
Caroline Woods: Okay. Market correction before year end. Likely or unlikely. Unlikely. Ten year yield by year end. Higher or lower than 5.3% higher. How high?
Ben Emons: Five and a half five three quarters.
Caroline Woods: Fed’s next move, hike or hold.
Ben Emons: Hike.
Caroline Woods: Even with only 30% chances and.
Ben Emons: 30%.
Caroline Woods: Inflation by year end. Higher or lower than today.
Ben Emons: Higher than today.
Caroline Woods: Bigger risk to the bull market. Higher yields or higher oil. Higher oil stocks or bonds for the next 12 months. Stocks, energy stocks or AI stocks for the next 12 months.
Ben Emons: Energy stocks.
Caroline Woods: Gold or Bitcoin.
Ben Emons: Bitcoin.
Caroline Woods: Fed in 2027. Cutting rates are still hiking.
Ben Emons: Still hiking.
Caroline Woods: Bull market in 2027 intact or running out of steam.
Ben Emons: Into.
Caroline Woods: Recession next year. Real risk or not losing sleep?
Ben Emons: Not going to happen.
Caroline Woods: Which happens first oil at 120 or the ten year yield at 7%.
Ben Emons: Both.
Caroline Woods: Okay, finish the sentence. The biggest market risk investors are underestimating is wow.
Ben Emons: A ten year yield at 7%.
Caroline Woods: Yields will hit 7% when.
Ben Emons: Late 2027.
Caroline Woods: And if what happens.
Ben Emons: If inflation oil goes a lot higher from it.
Caroline Woods: What level.
Ben Emons: So oil at least 120 or higher inflation at least A45 percent range.
Caroline Woods: I would become bearish on stocks when.
Ben Emons: When we do reach these inflation levels.
Caroline Woods: One word to describe how your feeling about the market right now.
Ben Emons: Optimistic bullish good environment.
Caroline Woods: Ben Emons always appreciate joining us. Thank you so much for playing by the rules as well. That’s been Evans you CIO of Fed Watch Advisors. If you enjoy this free talk check out our full interview with Art Hogan. He lays out the case for S&P 8000 by year end and the stocks that get us there.
