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Fed, labor market concerns showing 'some dents in the armor of the consumer': Strategist

Hennion & Walsh CIO Kevin Mahn joins Yahoo Finance Live to discuss the state of the consumer amid retail earnings, Target Q1 earnings, Walmart earnings preview, Fed rate hikes, inflation, and the impact on consumer spending.

Video transcript

SEANA SMITH: All right, well let's talk a little bit more about these retail earnings and the state of the consumer. For that, we want to bring in Kevin Mahn. He's Hennion & Walsh Chief Investment Officer. It's great to see you here, Kevin.

KEVIN MAHN: Seana.

SEANA SMITH: I guess your big takeaway from the results that we're getting so far, the fact that we are seeing consumers pull back with their discretionary spending-- what that signals for what lies ahead.

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KEVIN MAHN: Yeah. What stood out to me was the forward looking guidance that both Walmart and Target provided, striking a very cautious tone about their outlook for consumer spending in the second, third, and fourth quarter. If the consumer does, in fact, start to curtail their spending, not only will it affect the earnings of retailers, but also the economy as a whole, remembering that 70% of GDP growth comes from consumer spending.

However, there is a silver lining, though. If, in fact, the economy continues to slow due to a slowdown in earnings, the Fed is going to have to stop. I believe they hiked in May and will go away. And in all likelihood, by the end of this year, we'll start talking about cutting rates. And if, in fact, they're cutting rates during an economic slowdown, which could be a recessionary period, well, that creates opportunities for investors.

AKIKO FUJITA: And, Kevin, we'll get some more of your thoughts on the Fed in just a bit. But going back to where retailers are right now, I do wonder what you make of the Street's reaction today. I mean, Target certainly giving a more cautious outlook. We are still seeing that stock up.

I mean, is it at the end of the day about some of these big box names that are still able to offer sort of a diversified experience as opposed to some other retailers that are a lot more focus and could get hit further from a cautious consumer?

KEVIN MAHN: Yeah, absolutely. You have to look at those retailers that don't have as much of their revenue derived from discretionary items, much more in the staples items, the grocery items that you alluded to earlier. We also have to remember that during periods of economic slowdowns leading up to and through recessions, consumer staples stocks generally fare well.

Walmart is an excellent example of a consumer staple based upon their large majority of their revenue that does come from staples related items such as groceries. So we would anticipate consumer staples companies, less so consumer discretionary, faring well, just as we would anticipate health care companies faring well during periods of economic slowdowns leading up to and through recessions. And those two sectors, Akiko, they also tend to fare pretty well during periods of interest rate cuts as well.

So if you're looking to position your portfolio to take advantage of an upcoming interest rate declining cycle in addition to an economic slowdown, look to your consumer staples. Look to health care, and even look to technology companies with strong balance sheets.

SEANA SMITH: Kevin, when it comes to some of the opportunities out there, we have really been stuck in this pretty tight trading range. And a lot of that has to do with the uncertainty that lies ahead. Earnings clearly has not been the catalyst to get us out of that range. What will be?

KEVIN MAHN: I believe once we have confirmation that we've reached the end of this rate hike cycle, which I believe I already heard-- apparently some on Wall Street don't believe they have already heard, with the 25% probability of still yet another rate hike in June-- I believe that provides the catalyst to start looking for opportunities.

And where do you look? Look for some of those names that were really beaten up in 2022 that should rebound and benefit the most from an end to this rate hike cycle. Earnings, we've had the second consecutive quarters now of negative earnings growth. Even according to the Fed's own projections, they believe the economy is only going to grow by 4/10 of 1% this year.

Everything that they wanted to do with this massive and aggressive rate hiking campaign is now coming to fruition. The economy is slowing. Inflation is slowing, but still remaining well above their target. Now, we're going to get to see all the damage that all those rate hikes have actually inflicted on the economy.

AKIKO FUJITA: So, Kevin, a potential pause that you're looking at. I also heard you say positioning yourself for an interest rate declining cycle. I mean, is that what you anticipate, at least in the near term future?

KEVIN MAHN: Not in the near-term future. In fact, at the beginning of this year, I suggested that, in all likelihood, they were going to raise rates by 75 basis points during their first three meetings of 2023. Fortunately, I got that one right. At that point in time, once they hit that terminal rate of around 5% to 5.25%, I believed that they were going to stop, sit back, and reflect upon all the damage that they've done to the economy, and in all likelihood, wouldn't consider starting to cut rates until early 2024.

That may have to take place at the end of 2023 at this point, depending upon how much the economy does slow and how much the consumer starts to rein in spending. Of course, on the other side, if inflation stays rampant or actually goes in the opposite direction and doesn't continue to moderate, well, the Fed may need to step back in. I do not believe that they will. I don't believe they're going to cut anytime soon. But by the end of this year, I believe that in all likelihood, they're going to start considering rate cuts.

SEANA SMITH: Kevin, what about when it comes to rate hikes versus the pause here? The other side of the argument would be that a lot of the economic data has remained extremely strong, even what we've gotten out so far this week when it comes to housing, when it comes to yesterday's retail sales number-- that coming in better than expected. Do you think that, though, is going to give the Fed a little bit of pause just in terms of the headway that they have made on inflation?

KEVIN MAHN: The Fed has been driven 100% to curtail inflation since March of last year, essentially telling investors that they were going to continue to raise rates, cut the size of their balance sheet until something broke. Well, now, something has broken-- certainly in the regional banking system.

We've seen it impact the housing market. And now, it's trickling through to earnings. So what's really holding up this particular economy right now is the strength of the labor market. But, now we're starting to see some dents in the armor of the consumer.

Just yesterday, we learned that we've hit an all time record in terms of consumer debt-- $17 trillion. Consumers are now dipping more into their personal savings, putting more on their credit cards to help keep up with these inflated prices. How much longer can that last?

AKIKO FUJITA: So let's talk about some of the opportunities that you see in the market. Two names that stand out to me, both big pharma. What do you see there?

KEVIN MAHN: Well, historically, based upon the research we've done at Smart Trust, the three sectors that perform best during periods of economic slowdowns accompanied by declining interest rates are health care, number one, consumer staples, and information technology. But there's two ways to play health care, right?

One is through your traditional large cap pharmaceutical companies that are generally more defensive in nature. One name that we hold and happen to like is Merck-- pays an attractive dividend of over 2%, forward looking PE of just 17, and continues to be innovative in terms of the types of health care treatments they provide. Another way to play the health care sector is through smaller cap biotech companies. From an M&A perspective, one name that we hold at smart trust is Rocket Pharmaceuticals-- about a $1.4 billion smaller cap biotech company that's using genetic therapies, such as gene editing, gene splicing, to cure rare and chronic diseases-- really at the cutting edge of health care innovation in our country right now.

That's a little bit more growth oriented. Obviously, the larger cap pharmaceuticals are a little bit more defensive oriented. But the combination of those two should fare well over the next two years.

SEANA SMITH: Kevin, you mentioned M&A there. And the FTC blocking Amgen's deal to buy--

KEVIN MAHN: Very aggressive.

SEANA SMITH: --to buy Horizon Therapeutics. How do you look at a move like that as an investor given the fact that the Biden administration has been very critical of M&A activity and what exactly that would mean here for competition?

KEVIN MAHN: It reminds me you have to be a lot more targeted in identifying potential M&A opportunities in the biotech space. What they seem to be focusing on are these larger names-- $30 billion and plus type of acquisitions. I just mentioned Rocket Pharmaceuticals-- about a $1.4 billion smaller cap biotech company.

I believe you need to look for those smaller cap names that will stay out of the regulatory crosshairs and also have at least one drug in FDA level 2 or FDA level 3 approval status, because that's where the acquisition appeal comes in. And if, in fact, they have a revolutionary and innovative health care treatment, whether it's CRISPR, CAR-T, antibody treatments, these gene editing and gene splicing type of technologies-- well, large cap pharma is going to look to use their excess cash on their balance sheet to acquire those companies.

AKIKO FUJITA: So, Kevin, let's go in the opposite direction. You gave us your three picks. What are sectors that you think investors should be a little more cautious on, stay away from right now?

KEVIN MAHN: Well, obviously, very volatile sector always is energy. A large part of that, obviously, is driven by mandates coming out of Washington and also supply demand characteristics that are somewhat outside of our control with respect to OPEC. Other areas to be very leery of as we head into an economic slowdown, which we'll, all likelihood, enter a recessionary period as well is high yield. Any areas where you have companies with high debt on their balance sheet-- you want companies with strong balance sheets, a history of growing their earnings, dividend paying, and also an entrenched and committed management team on the stock side.

On the bond side, look at investment grade municipal bonds or municipal bond closed end funds. We think there's a lot of upside potential based upon the difficult year they had last year and also the supply demand imbalances that exists for municipal bonds today.

SEANA SMITH: It's great advice right there. Kevin Mahn, we got to leave it there. Thanks so much for hopping on and joining us here on set.