U.S. stocks closed Monday near session lows to start the week, with the Nasdaq dropping by over 2%.  Investors continue to monitor inflation as it prepares for a slew of earnings reports this week, along with inflation data from the Consumer Price Index.  Jeff Schulze, Investment Strategist at ClearBridge Investments, joins Cheddar News' Closing Bell to discuss.

Closing Bell

U.S. Stocks Close Near Session Lows to Start Week

well let's turn back to the major indexes joining me now is Jeff shells the investment strategist at the Global Equity Manager. Clear bridge investments, thanks so much for coming on the show. What's your reaction to the downbeat market that we had today? Well, first of all thank you for having me on the show and I think that what you're seeing in the market is some profit taking after a nice counter rally over the last three weeks because we're heading into the middle of this week where we're going to get the C. P. I. Print and C. P. I. And the payrolls data, the two biggest prints that are going to drive that policy and ultimately the path of the economy. And with payrolls coming in at a very healthy 372,000 on friday. If you get a C. P. I. Print that surprises to the upside that could bring about an even more hawkish fed than what's currently being priced. So I really think it's some jitters ahead of this big release that we're going to get later in the week. Okay so C. P. I. Of course earnings in the backdrop as well, Jeff. Um What is the state of the consumer? Can you gauge the state of the consumer based on the stock market action? Well, I think the consumer is in the best shape that we've seen over the last three or four decades. Um if you look at household leverage, it's at levels last seen in the early 1970s. Um Household net worth is up 32 a half trillion dollars since the end of 2019 average hourly earnings are up 5% on a year over year basis. So the consumer is in a pretty healthy environment at the moment. But again, if you look at any of the consumer sentiment, surveys, higher inflation is starting to weigh on the consumer and there's this unanswered question right now and whether or not the consumer is starting to crack now, I personally believe that the consumer is going to be more resilient and what if a lot of people are anticipating, but we're going to get a good glimpse of that as we move through the back half of the year and see if consumption can remain robust. What are the key signals that we'll get from this earnings season, Jeff obviously inflation is always in focus and no particular company. No, two companies are the same. They play in different sectors. But what are some of the important clues that investors should be on the lookout for as reporting season begins later this week? Well, I think most importantly, if you think about this, bear market usually bear markets happen in two stages where at first it's multiple contraction and then the second part of it is earnings expectations coming down and believe it or not earnings expectations have just started to come down over the last couple of weeks. So this is going to be a critical earning season to see whether or not forward guidance can hold up and whether or not expectations for 2022 and more importantly in the 2023 are going to remain at these levels. Um one of the things I'm gonna be watching is whether or not the company management is optimistic about continuing to be able to pass through higher costs to consumers. Um And also, you know obviously what that's gonna do to margins and top line revenues. But ultimately our view is that expectations right now for the broader industries are too optimistic and need to come down from here, which I think is going to start to be reflected as we get into earnings later this week, interesting. So how much more of a pullback Jeff do you think we could see in these major indexes knowing that we are Already technically in a bear market down 20% from recent highs. Well, if you look at all the major bear markets, um you usually see bear market last 16 months in the average decline is around 35%. Um so with this being six months and about 24% overall history would suggest more downside for equities. Um So that is our base case because earnings expectations are just starting to come in. Um but again, we're not certain on whether or not we're going to have a soft landing or a recession at this point with our views of a recession, about 50, 50 over the next 18 months. So I think we're gonna get some important clues on this earnings season about the durability of the consumer and earnings, but nonetheless we are expecting some lower lows as we move through the back half of this year until visibility can be restored. When looking at that historical data, Jeff, is this time different at all? Are there any additional risks would seem like there are we're still in a covid world. Russia is invading Ukraine without any signs of backing down at least immediately. What risks are associated with this bear market? That might mean it could play out differently than what history would tell us. Well, it's always uh, you know, you never want to say this time is different. Those are famous last words of anybody who's an investor. But I think one thing that I'm really keying in on is the path of Fed tightening right now. In the first year of this Fed tightening cycle, markets are anticipating 3.5% of tightening. If this was to come to fruition, this would be the second fastest start of the Fed tightening cycle Since 1955 only trailing 1980 when Volcker had to break the back of inflation. And because monetary policy acts with a drag on economic activity, there's a very strong possibility that the Fed is going to create a policy error and tighten too much and inadvertently end up causing a recession next year. So I think that is the most important consideration for the health of the economy and the path of markets. But as you alluded to um the situation with the war in the Ukraine and whether or not Russia decides to cut off natural gas supplies to europe is going to be a really important black swan event to to watch. And again we're going to get some visibility on whether or not the pipeline reopens up in a couple of weeks and whether this is going to come to fruition, What's the expectation as to how long inflation will remain elevated, Jeff? We get this consumer price index points later this week. Consumer prices of 8.6% in May from the same time a year ago. We'll get them this week for June, how long do you expect? These prices will say hi well I think this is going to be another high print again, consensus is expecting close to 9% for C. P. I. But I think this will be the peak of inflation. Um Looking at commodities, all of them are down quite a bit over the last month. Um retailers are overstocked with goods at the moment. They're gonna start to see some discounting take place in that area. And you could see a softer consumer because of the higher interest rate environment that we're currently dealing with. So um I think we are at peak inflation, I wouldn't be surprised if inflation moves down to 5%, maybe even 4% by the end of the year, but the degree of which inflation comes down is really gonna dictate again the path of the Fed and whether or not we can create a soft landing for the economy. So what does that mean for the path forward for the stock market, Jeff? I know you started by saying usually what happens in a bear market is there's multiple contraction and then downward earnings revisions. But if inflation is coming down and the Fed doesn't tighten too much, I can not create some space for the stock market to actually rise. It can, it can, if the Fed can pivot um or not continue to tighten further than what's being priced at the moment. Um you have the possibility of a soft landing and in those types of environments, non recessionary types of environments. You usually earnings expectations come in around 5% over the last three recessions, earnings have come down about 15% on average. Um So there's a very big differential on what happens in a recession in a non recessionary type of environment. But if we Have that soft landing, maybe earnings expectations can remain positive over the next 12 and 18 months. Um and that means that a lot of this negativity is already priced into markets, but again, unfortunately because the data, the path of inflation is uncertain. The that the Fed is data independent at the moment and I don't think visibility is going to be restored before the next 3 to 6 months. Alright, Jeff shells the investment strategist at clear Bridge investments. Jeff thanks so much for coming on the show.