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Equities: 'Difficult to imagine durable rebound' without stable dollar, strategist says

Charles Schwab Chief Global Investment Strategist Jeffrey Kleintop joins Yahoo Finance Live to discuss the dollar, U.S. labor market, and earnings season hopes against recession worries.

Video transcript

- Well, now let's take a closer look at the broader market with Charles Schwab chief global investment strategist Jeffrey Kleintop. So, Jeffrey, as you're taking a look at what markets are reacting to right now, and you're really saying the currency story is the one to keep an eye on, what are the currency markets telling you right now?

JEFFREY KLEINTOP: I think that's true. Stocks have completed this round-trip voyage and at their new all-time lows for the year. They rose over the summer but then have come all the way back. And European stocks are now entered into a bear market. As equities rallied from mid-June to mid-August this year, the currency market was skeptical. The dollar continued to rise as the safe haven trade continued in the markets.

It's difficult for me to imagine a durable rebound in global equities without the dollar at least stabilized. And clearly, there's no signs of that today.

- Jeffrey, taking a look at the declines once again today, coming off what was a brutal week for the markets last week, at the levels that we're looking at today, do you think we're near the bottom?

JEFFREY KLEINTOP: Well, that's hard to say. I think one of the concerns is, are we going to get a mild recession or a deep one? I think a mild recession is probably more than priced in at this point. The question is, how much deeper is that going to go?

Of course, that's very dependent upon central banks. Do they continue to push higher and higher, wanting to be the Paul Volckers of their era, until they get policy rates into real positive-- policy rates into real positive territory? Right now, you know, monetary policy, interest rates have moved up. But they're still very negative on an inflation-adjusted basis.

Big moves would be required to get them into positive territory, as Paul Volcker did back in the early '80s. So if they do that, that's an ugly economic scenario. I'm more hopeful that housing begins to come down, rents begin to come down, and inflation begins to abate later this year in a weaker labor market. But that's yet to be seen.

So there are several different paths to the economy can take from here. I think the outlook for a deeper recession would certainly suggest stocks could come down on a much deeper decline in earnings. Remember, it's just been the price-to-earnings ratio that has accounted for the losses so far.

- And so how will when you think that the Fed is really near its peak hawkishness?

JEFFREY KLEINTOP: Well, there's a few things that we can watch. For one thing, we can look at other central banks around the world who may be leading the Fed. About a year ago, we saw rate hikes by the central bank of Brazil for emerging markets and central bank of Norway among developed markets, a big G10 central bank. They have now indicated that they're probably done.

The Bank of Brazil did not hike rates in September after hiking in August, saying they were finished. And the Bank of Norway did hike by 50 basis points but said they are probably at or very close to the end. They led the Fed by about six months. So if that's the case, maybe somewhere in the first quarter of next year, we might begin to see that the Fed can begin to put on the brakes, or at least pause for a while and see what's gonna happen.

But so much is dependent upon rent. It's 40% of inflation, and rent prices are going up even as housing prices come down. Until we see that break, probably due to a weakening labor market, we'll continue to see the Fed pushing down much harder on that brake pedal.

- Jeffrey, earnings are going to be in focus here over the next several weeks. They've now kind of been joining inflation, joining the Fed moves. That's really one of the big concerns here for investors as we start to get those third-quarter results. Do you think we're going to see more downward revisions when it comes to earnings, and what are your expectations?

JEFFREY KLEINTOP: I do. And, you know, I just put a chart on my Twitter feed related to this. So we have not seen the normal downward revisions we'd see going-- two or three or four weeks before the earnings season starts, you usually start to see some downward revisions to earnings estimates. And we're not this time. Looking at a global basis, they're relatively stable.

That tells me expectations are probably a little bit too high going into this earnings season. Not only have there been unexpected developments take place that could have caught business leaders off-guard, but I think their guidance out to Q4 and Q1 of next year, where we're likely in a global recession, probably need to come down as well.

So, again, I think that earnings, which have been a support to the market here, expecting to rise a few percentage points this year, maybe 5% next year for the S&P 500, the STOXX 600 in Europe, the Nikkei 225, I think those are a little high. I think those numbers are gonna come down, and we may be hearing about it in the next few weeks.

- So then, Jeffrey, how is that informing your strategy for right now for investing?

JEFFREY KLEINTOP: I think investors want to focus on quality stocks across sectors, not just try and pick out a sector or two that might be outperforming. One of the ways we've defined quality this year are what we call short-duration stocks, companies that get more of their cash flows in the near-term than out over the next several years. So that's a lower price-to-cash-flow ratio.

Those stocks have been outperforming since interest rates began to rise back in August of 2020. They've outperformed all this year and even in the month of September. So focusing on that is important.

Second, I think high dividend payers-- a very similar theme. Companies paying a high dividend generally have good cash flow and strong balance sheets. Those stocks have been doing very well this year-- not avoided losses, but really have only experienced about half the losses of the overall market. So that's another theme investors want to keep in mind.

High dividend payers in every sector are outperforming. You don't just have to go to those classic high dividend payers in, say, utilities or telecom. You can find them even in the tech sector. The highest dividend payers are the outperformers.

- Jeffrey, if you have some cash on the sidelines right now, like some of our viewers likely do, are you putting money to work? Or should investors wait, maybe, for some of this volatility to calm down?

JEFFREY KLEINTOP: Well, I think you can use volatility as your friend. If you've got a long time horizon and you've got some cash, I think dollar costs averaging into this type of a volatile market does make long-term sense. I think trying to pick a bottom is very hard. You know, increasingly, we're seeing more value even in the bond market despite the selloff there.

With high-yield bonds now yielding over 9%, we've got-- you know, dividend yields in the US are now higher than they've been in quite some time. So I think you have the opportunity to buy in and wait and pocket that yield even as you wait for prices to recover.

- And, Jeffrey, what are you steering clear of in this environment?

JEFFREY KLEINTOP: Well, you know, I still think there are some stocks that really benefited from the liquidity wave of recent years in the tech sector and in other areas that-- long-duration stocks, those companies with very lofty growth prospects in the future. As liquidity continues to be drained and financial conditions tighten, those may fare the worst. So those are the highest price-to-cash-flow stocks. What we call long-duration stocks, you can find more of those in the growth sectors of the US stock market.

- Jeffrey Kleintop, always great to get your perspective. Thanks so much for joining us.