Two mantras are working- one is don’t fight the Fed and the other is the market is always 4 months ahead of GDP: Strategist

Stifel Head of Institutional Equity Strategy Barry Bannister joins Yahoo Finance’s On The Move to address the Federal Reserve’s response to the coronavirus pandemic.

Video Transcript

JULIE HYMAN: Barry, it's good to talk to you. So, you know, we've kind of been trading more in a sideways fashion over the past couple of weeks. What do you think could change that trajectory going forward?

BARRY BANNIESTER: Well, if I look at the move that we had, what happened was back in March-- on the 19th of March we made a fairly aggressive call at two days before the market bottom, March 23, that the market would rise to 2,750 and the S&P up 15% and do it by April 30. We raised that to 2,950 a couple weeks later, and we got that price on the 29th of April intraday, 2,950. So we cut our rating on the market and went to neutral at that day.

As far as what's going to happen now, what's happening in the market is that it's the mantra-- two mantras, really, working. One is don't fight the Fed, and the other is the market's always four months ahead of GDP. So in a sense, it's reflecting an inflection upward in GDP sometime later this summer. Call it August.

If neither of those happen, if the Fed pulls back or if the economy can't inflect, then the market's going to go down. Otherwise, it's just going to trade sideways here and to just digest its recent gains.

ADAM SHAPIRO: Barry, hey. It's Adam Shapiro. Good to have you here. Are you worried that there's a shock coming that's going to drive equities down steeply?

BARRY BANNIESTER: No. We have a 2,925 plus or minus 5% view through the end of second quarter. We are watching all of the major variables that we need to watch as far as risk. I actually think deflation near term is a greater risk than inflation. Deflation tends to be disruptive to credit, and that would really, you know, start to affect the market and call the Fed out. The Fed is buying bonds, but there's just no way they're buying enough to offset a sharp rise in bankruptcies and defaults.

So deflation remains a risk, and we know what to watch for there. It's mainly currency- and commodity-based indicators and the yield curve as well.

The other thing that we watch for is political risk. I mean, more government involvement in business is not a positive for equity prices or wealth.

Second, you know, we have to consider that more unnecessary shutdowns or politicization of shutdowns which is occurring is a very negative thing for the market. And the third thing is the stimulus bills. You know, they're a lot of fiscal, but they're getting to the point of being wasteful now, and they're not addressing near-term concerns, so they don't help GDP now. They're just filling holes in state budgets that are long term like pensions, and that's not going to help the near-term economy. So that's just spending without benefit. Not going to be a good thing.

So all these things are things to watch, but right now they haven't been a major issue. So we're at 2,925 plus or minus 5% through the end of June.

RICK NEWMAN: Barry, hey, Rick Newman here. Back to the Fed. The Fed does not really like to be seen as propping up stock prices even when it is propping up stock prices. So do you see any likelihood the Fed could sort of step to the side and let-- you know, however that might happen and allow equities to deflate, like, 10% or something like that?

BARRY BANNIESTER: Yeah. The analogy I've been using for quite a while is it's what comes first, the chicken or the egg? the old riddle. So the issue is does the economy have to lay an egg and the market have to lay an egg and then the Fed will turn chicken? I mean, that's essentially the problem is the Fed only reacts. It doesn't proact. The Fed tends to react to events.

So the best strategy is using another analogy is to be like the roadrunner. Step out of the way and let the anvil hit Wiley Coyote, the economy. And then after that the Fed will act, and then you can move on if you're the investor.

So we're dealing with a real problem here in that the Fed's reaction and function is going to lag, and right now they're not doing incrementally more, which means that whatever they've done is already reflected in the price. And that was one of the reasons for our downgrade to neutral is we had upgraded before the big Fed actions, just as they were starting to rumor them. And then after they did them, there was just no reason to still be positive. The market reflected all that good news.

ADAM SHAPIRO: Barry, I remember those old Roadrunner cartoons with the coyote. And then, you know, you mentioned the Fed, and you also mentioned, in the short term, their fear of some kind of deflationary-- I don't want to say spiral, but aspects of deflation. Yet they don't buy stock, but demand has been killed. We've seen demand destroyed, and how is it going to come back when, even as we open up this economy, we're going to be restricted at capacity? So isn't the Fed going to find its hands tied as companies are failing and they can't get the debt financing they might need?

BARRY BANNIESTER: There's so many crosscurrents. I mean, you said restricted supply with demand coming back. That sounds like stagflation to me, you know, when there's a demand but not enough supply. But it's still a weak level of demand, and you get stagflation.

On the other hand, you know, the deflation associated with defaults-- I mean, you can't stop the motor of the world the way we just did and not expect a large surge in defaults very soon, particularly with the states that are talking insanely about waiting until June or later to really reopen.

It took about three months after they reopened for China to start to see the consumer come back. I mean, production came back quickly, but consumers are starting to come back. Commuters are starting to come back. China-- we all know the issues related to China in terms of obscuring the origins of the virus and not playing up the risk, but they were about almost two months ahead of us.

And so we can use them as a template to know what's going to happen to the US next, and what happened to China is things like manufacturing and production and inventory came back. Inventory restocking came back, but there wasn't a lot of consumer demand, particularly in face to face, person to person. That took longer, but it's just now starting to come back.

So figure that is, again, August, which is about what the market expects and inflects. If we get the recovery of the consumer by August, then what will happen is the market rising now was justified, but it still has to consolidate in the near-term until we have more visibility post August.

JULIE HYMAN: So buckle up is the theme then. Barry Bannister, thank you so much for joining us. He's the Stifel head of institutional equity strategy. Appreciate it.