Market ‘is all about the Fed,’ not geopolitics: Heritage Capital president

Heritage Capital President Paul Schatz joins Yahoo Finance Live to discuss attributing market lows to the Fed's monetary policy schedule over the Russia-Ukraine conflict, inflation, interest rate hikes, the energy sector, and focusing on the biotech industry.

Video Transcript

BRAD SMITH: Joining us now for more on today's market activity, we've got Paul Schatz, who's the Heritage Capital president. Paul, you heard from Jared there with regard to today's move, but broadly, in context of this week as well. And particularly, you say that this bottom is hard to call. Of course, we want to be perfect and always call the perfect bottom. But this one more difficult even if we did move off of that 34,000 level, which was kind of a key support line for the Dow Jones Industrial average. When you think about what makes this more difficult to call or this bottom more difficult to call, what is at play?

PAUL SCHATZ: Sure, and thanks again for having me. Since the Christmas bottom of 2018, the various pullbacks and corrections have looked like a V. Market came down, very spiky. Market went right-- literally right back up. There was no pause. Prior to the fourth quarter of 2018, most bottoms were more diffuse, meaning price-- bottoms were on points in time. Bottoms were like a mattress top, where you sunk into, you came out of it, you sunk into it. Price had-- like water. Price had to find its own level.


So this market right now looks similar to other Fed-induced declines. To me, this is 90% driven by what the Fed is going to do this decline. If you look back at the first quarter of 2018, you had a decline in January and then a more diffuse bottom over three months. If you look back at 2015, '16, you had, really, six months of the market trying to find its equilibrium. And all the way back in 1994, when I was in the business for six years already, and you guys may not even been born, the market took an entire year after the Fed surprised the market with a rate hike and many rate hikes before it found its footing.

This is another one of those situations where people should be-- my three key words for the year were patience-- you got to be patient this year because it wasn't going to be a great year-- frustration-- bulls and bears both get frustrated, I think we've seen that already-- and quality, which we can get to another time.

BRAD SMITH: I appreciate the extra youth. I'm not that young, though, unfortunately. However, when we think about what is at play right now and particularly what you mentioned with the Fed, what does this put them in the position of? Do you think they have to frontload, or now, because of the international conflict, do they need to push out some of that tightening and perhaps put that on the backend of their strategy?

PAUL SCHATZ: I, as I normally do, I have very anti-consensus, contrarian opinions. First of all, the Fed is not going to backload this. The Fed is geared up, reared up. They're wrong. They should have been doing this starting in the middle of 2020. So-- and I've said that for 18 months now. The Fed is going to go full steam ahead in, what, four-- I'm looking at the calendar-- four weeks or so. And they're going to raise rates, and they're going to raise rates again and again at least two or three times.

I do think, ultimately, the Fed is going to blink. And I think they're going to blink later this year. And that's going to be the impetus for the next leg higher in the market in 2023. But no, the Fed is not going to backload this. They don't have much credibility now anyway. If they did not follow through on what they've all been saying publicly with multiple rate hikes and then the balance sheet reduction, balance sheet sale, that they would have a negative credibility. So they're going to go full steam ahead.

And it's kind of where I see this bottom ultimately forming. Today, the action today is pretty good. If you're a short-term nimble trader, you can try to time this and play this, and you just get out if, frankly, we close below today's lows. But I really see this bottom wrapping up somewhere plus or minus a week around the Fed meeting in March.

EMILY MCCORMICK: Paul, you mentioned the Fed is really what the market is responding to right now, but there still has been volatility in response to Russia-Ukraine. Now FactSet noted today that the combined revenue exposure of the S&P 500 to Russia and Ukraine is only about 1%. Now given that, how much of a direct impact would US companies see from a potential Russian military invasion into Ukraine?

PAUL SCHATZ: So since this geopolitical event began, I said the decline is 90% Fed and 10% everything else. Look, this is not Iraq and baiting Kuwait, part 2. We don't have a national interest in Kuwait-- in Kuwait-- in Ukraine. What could happen would be a tragedy with insane loss of human life. But it's not going to impact GDP growth, which is slowing. It's not going to impact earnings growth, which is slowing. It very mildly impacts the energy markets, which probably roll over or go sideways, anyway.

So for me, I think investors are way too focused on Russia and Ukraine. Their eye is off the ball. The ball is the Fed. Look at what leads and lags rallies and declines. It's not a geopolitically led market. This is all about the Fed. If people don't wake up to that, their portfolios certainly are going to take it on the chin.

This market-- I said this in October, November, December, January. It's a sell the rally and selectively buy the dip until we get through at least July 4th. Because I think the Fed, again-- Fed is going to blink second half of this year. They're not going to do six, seven, eight rate hikes. They're going to blink, markets are going to applaud. We're back on our merry way in 2023, later in 2022 for sure.

EMILY MCCORMICK: So where are those areas of the market, then, where you would be selectively buying the dip, like the ones that we've been seeing recently?

PAUL SCHATZ: So I think it depends on what kind of investor you are. If you're a nimble, short-term trader, frankly, you buy what's been beaten down the most and you sell the first rip. That's what a very nimble, short-term person does. If you have a little more length, if you have a longer time horizon, in the weakness for now, you want to buy some stuff that will do OK, because GDP growth and earnings growth are slowing. I like things boring, stodgy, not sexy and exciting, like staples and utilities. People will yawn and say, oh, some old guy's talking about stuff that doesn't really do anything. But this is the kind of stuff which should do well in an environment where growth slows down.

And the other one is biotech, which you're going to look at me and say, it's been decimated, and you're right. Biotech is to the point where it's so bad, it's becoming good. It's the hold your nose. It's aggressive. Close your eyes. Let it run six to 12 months, and I think you'll be OK. And let me say this. Cathie Wood has been beaten mercilessly in the media-- and maybe with good reason because of her bravado over the last couple of years.

But even something like, you know, her ARK ETF, for the nimble trader or someone who puts a small amount of money into it, when it bounces, whether it's here or 10% lower, you're going to get something, like, a 20% to 50% bounce pretty quickly. Her companies all aren't going out of business. They're not going to-- I mean, the ETF may go down further, but sentiment is so negative, it probably bounces first.

RACHELLE AKUFFO: And picking up on your optimism on biotech, we did see that it did become cyclical during COVID-19, which obviously isn't usual. And with COVID-19 starting to abate, at least in the US, we do expect that to change. It's still very undervalued, but we're also seeing a lot of limited M&A activity in this space. What is the biggest appeal for biotechs for you right now? And what could potentially change that?

PAUL SCHATZ: A lot to unpack there, but I'll try. To me, the biggest, appealing factor of biotech is that it has been decimated. They threw the baby out and the bath water out and the bath tub out. Any time that happens in any sector, when sentiment is literally scraping the bottom, you can't find a bull. And who is left to sell? Because they've thrown out the real gems. You get why a Moderna has been thrown out, right? The pandemic is kind of cresting, and we're moving on to the next phase, and so on and so forth.

But you've got real companies with earnings. You know, you've got Amgen, and you've got Biogen. You've got a whole stream of biotech companies that have nothing to do with the pandemic. And they've just been thrown to the wolves. I mean, some of these stocks are down 60%, 70%, 80%. So unless you believe this is a new paradigm, and biotech is going to be some kind of dog for the next three to five years, again, you close your eyes, you hold your nose.

Because the catalyst to me is not apparent yet. Right now, the two catalysts are it's been decimated, and sentiment is awful. And that's usually what turns a sector. The kind of upside catalysts where it really gets going, you find out down the road when you look back and go, wow, you didn't see that one coming.

RACHELLE AKUFFO: Well, it was certainly great having you on. Great energy there. To Paul Schatz there, Heritage Capital's president, thank you so much.