Stock market: ‘The jury’s still out’ on how sustainable the rally is, strategist says

Chris Konstantinos, chief investment strategist at RiverFront Investment Group, and Geetu Sharma, investment manager and founder of AlphasFuture, join Yahoo Finance Live to discuss the market rally and what the Fed's rate hikes mean going forward.

Video Transcript

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- And that's a look at the closing bell on the floor of the New York Stock Exchange, or up at the podium there, ProShares ending out this week's trading activity at the NYSE. And taking a look at the major averages here as we close out a week that had a lot of gains in it, the Dow Jones Industrial Average closes higher on this Friday by about 8/10 of a percent. We'll round that off to 268 points higher. The S&P 500-- that saw gains today of more than 1%, 1.2%. We'll be generous and round that off, too. The NASDAQ composite tech-heavy average moved higher by a little more than 2%, 279 points to the upside.

So for more on this week's activity, and especially how we rounded out this five-day period, today we've got Chris Konstantinos, who is the RiverFront Investment Group chief investment strategist, as well as Geetu Sharma, who is the AlphasFuture founder and investment manager. And Geetu, I want to-- I'm going to start with you particularly because when you think about the Fed activity and, really, what type of uncertainty that may have removed going forward from here as they started to, at least even more, so signal what the intentions are for the rest of this rising rate year, how much of that uncertainty was removed just with this singular decision?

GEETU SHARMA: Hi. Yeah. Thank you. I think the Fed did a great job in removing uncertainty around the rate hike plan. They-- firstly, they raised rates by 25 bips, which is what they had already kind of indicated in January. So there was no change to that. And then they clearly laid out a plan for one rate hike every meeting. And that took away a lot of uncertainty because in-- I think given the market reaction last few days, clearly, the market was expecting more, or maybe the market was expecting more front-loading of the rate hikes, whereas the Fed has kind of just pushed it all towards the back end and really continued the liquidity environment-- is in a way, continuing. They've also delayed the balance sheet tightening to May. So it looks like The fed did not take the punch bowl away.

- So then, Chris, how sustainable is this rally, given how we've seen markets reacting, but obviously, with the existing headwinds coming off of things like Russia and Ukraine, oil prices, and still not really knowing how aggressive the Fed is going to be going forward?

CHRIS KONSTANTINOS: Yeah. Great question. And thank you for having me.

I think the jury's still out here on how sustainable this rally is. If you think about the pullback we've had, it crossed the 200-day moving average. Actually, the S&P 500 had what's called a death cross just last week, I believe, which is, historically speaking, not a terribly reliable sign, but often a pretty tradable signal.

The rally we've seen has, basically, gotten us back to around-- somewhere around a little bit under that 200-day moving average. We want to see the market make more headwind-- more headway, excuse me, here before we got a little bit more excited technically.

And fundamentally, I think you bring up all the right points. I certainly agree with Geetu's point here that I think Jay Powell and the Fed did a really nice job of sort of walking that tightrope. But at the end of the day, keep in mind back in October, November of last year, we were talking about two or three rate hikes. Today, as it stands we're debating whether it's seven or eight. That is a dramatic difference in terms of tightening of financial conditions that we've witnessed over just the past few months.

The inflation situation is clearly still a serious headwind for markets. And the general thesis in our part-- on our-- in our thinking is if there is a recession sometime in the next six to nine months, this pullback has just gotten started. If the US economy can stay out of recession over the next six to nine months, then we're probably somewhere close to a tradable low. But again, that uncertainty is still out there. We think the probability of recession went from somewhere like close to 0% three months ago to something more approaching 20% to 30%.

- Chris, I want to stay with you for a hot second because you bring up the R word in recession. And of course, Fed Chair Jerome Powell was asked about this very directly and said that the probability of a recession within the next year-- he tried to downplay that. Do you think the markets latched onto that, ultimately?

CHRIS KONSTANTINOS: Yes. I totally agree with your point that that is one of the things the markets really keyed off of and probably one of the triggers for this powerful rally over the last couple of days. But of course, also, what's Jay Powell going to say? I think he's going to try to set a steady tone at the helm because markets care a lot about his tone and the words he uses.

And I would agree with him that. I think the probability is not greater than 50%. But I think it's undeniably risen significantly since just a few months ago. And obviously, the war in Ukraine has complicated the picture pretty significantly for the Fed.

So a couple of the indicators that we like to look at when we're trying to gauge recession risk-- one of them is the yield curve. And the classic one to look at is the three-month-- the 10-year curve. And right now, that's still relatively steep. In fact, it's actually steepened since the Fed talked, which we view as a good sign. But it has flattened meaningfully over the last few quarters. And if you look at the other 10ers, like the 2-to-10, for instance, is quite flat, actually-- so those have been heading in the wrong direction.

When we look at things like consumer confidence, there's some cracks in the plaster there. And of course, implied inflation expectations that we've imputed out of bond market signals and out of the swaps market also suggests that inflation expectations have risen a fair amount. All of those are-- I wouldn't call them red flags yet. They haven't reached those levels. But we do see those as a few yellow flags in terms of recession risk.

- Just to follow up on top of that because I was actually looking to my left here at my notes at exactly what Fed Chair Jerome Powell said-- he said the probability of a recession within the next year is not particularly elevated, believing that the economy is very strong and able to withstand tighter monetary policy, and cited the labor environment. So Geetu, when you think about the labor environment that we find ourselves in right now, there was also discussion about how higher inflation pressure would actually push more people back into the labor market. Do you believe that to be true? And where and when would that begin to show up in the data?

GEETU SHARMA: I think we have to see that right now, we are in the best labor environment, 3 and 1/2% unemployment rate, which is the best in decades. And the Fed is forecasting that to remain stable as-- over the next two years, as they continue with the monetary tightening.

So we will have to see how this-- the rate-- the increase in inflation actually affects the unemployment rate. As of now, the companies are hiring at a faster pace. So it's not showing in the data yet.

- And Geetu, you talked about in your notes talking about seeing the yield curve flatten, something that we also just heard there. And you said that we're seeing that while equities have been rallying. Talk about what the bond market is telling us then about inflation and how people should position their portfolios accordingly.

GEETU SHARMA: Yeah. So the bond market is saying that the long-term inflation is not going to increase much with the-- like Chris mentioned, that 3-and-10 is flattening a bit. 2-and-10 has also flattened to about 20 bips. So we are looking at about inflation staying in the 2% to 3% range, which is what the Fed is also forecasting.

But I think a lot depends on how this war in Eastern Europe plays out because that has a huge impact on commodity prices, on energy, on grains, and other metals. And the longer this war continues, not only it has a huge impact on Russians and Ukraines, but also on the global economy because then we start to see the effects of sanctions and supply disruptions plays out.

So it looks like the Fed is right now assuming that the war will de-escalate and there'll be a resolution. And they are forecasting inflation to come down. That is also, I think, the market's base case because, clearly, the market is not pricing in any significant fallout from this ongoing conflict. But if it continues for longer, then I think we will have huge impact on inflation of-- rather, we would have further inflation spike. And that can have a big effect on economic momentum. And that's where the recession risk also increases.

- Geetu Sharma, who is the AlphasFuture founder and investment manager, as well as Chris Konstantinos, RiverFront Investment Group chief investment strategist, joining us here this afternoon for the breakdown on this week's activity that we've seen in the markets. Chris and Geetu, thank you so much for the time here.