Evercore ISI Senior Managing Director Julian Emanuel joins Yahoo Finance Live to discuss the bond market and why investors should turn their attention there if they're turned off by market volatility.
RACHELLE AKUFFO: Well, let's take a look at the broader markets and bring in Evercore ISI senior managing director, Julian Emanuel. Now, obviously, we heard Jay Powell saying, look, these inflation reducing tactics, they're going to come with some pain. How much more pain do you think can the markets expect then?
JULIAN EMANUEL: Well, look, this has been an historic week in many respects because Chairman Powell, in talking about that pain, basically endorsed the idea that the Fed's base case is a recession in 2023. And what you have right now is the market in the midst of increasing the recession probability. So if you look at the average bear market, a non-recession bear market tend to average down around 27.7%. The average recession bear market, that number is closer to 41 and 1/2%.
So we are in the midst of beginning to discount, at least the rising probability of recession. From our point of view, we think there's likely to be a clean break of the June lows across the major indices. And then we'll just have to take from there the market is in an emotional phase, which is why investors have to try not to let their emotions run rampant as well.
SEANA SMITH: Julian, what are the levels that you think we need to fall to before we start seeing a relief rally?
JULIAN EMANUEL: And so, again, in the S&P 500, there's major support at around 3,585. And that is the level, the 200-week moving average, which really only gave way momentarily during the pandemic and where we would expect to see certainly some buying support come in.
But more important to us-- and this is very, very much something that we're focusing on-- in a year where stocks and bonds have correlated as positively as they have in this very risk-off environment, what we're really looking for is starting to see a bid to longer dated bonds because if you think about it, inflation expectations being subdued, the Fed telling you that there's a greater probability of a recession should draw buyers into bonds at these yields. And if that's the case, that's the beginning of where stocks stabilize.
DAVE BRIGGS: Julian, how high do you expect bond yields to go with the two and the 10 both to 10-year highs?
JULIAN EMANUEL: So the two and the 10 are two distinctly separate concepts right now. And frankly, the fact that the curve isn't inverting to an even greater degree is somewhat surprising to us. We'll have to see how that evolves over the next week because the market still assigns a very high probability of the Fed hiking by 75 basis points in November. And to us, that is likely going to be, let's say, under review as the data evolves and as the markets remain in this emotional and agitated state. So I wouldn't expect a lot more upside to yields in the near term.
RACHELLE AKUFFO: And we're obviously seeing global central banks moving at different speeds, trying to get inflation under control, really trying to spur growth. How much is that going to weigh on what the Fed is trying to accomplish here in the US?
JULIAN EMANUEL: Well, and that-- this is really one of the peculiarities of 2022, is that the rest of the world almost feels as if the market is intentionally ignoring the stresses overseas. And look, the Fed's mandate is really to deal with price stability and full employment in the US. But effectively, we all know that the Fed does tend to act as the world's central banker.
And at some point, this-- all of these stresses that are manifesting themselves in the stronger dollar, and particularly this week, in surging higher gilt yields in the UK and much wider credit spreads in Europe as stresses intensify there, are going to become an issue. And to us, it's probably less a matter of exactly what the price catalyst is and more along the lines of whether there's a potential news catalyst in terms of event risk over the next week or so.
SEANA SMITH: Julian, if you're an investor out there, you have cash on the sideline right now. What should you be doing?
JULIAN EMANUEL: So this is, again, where you really have to re-examine your long-term investing goals. And I would say that if you have cash, you certainly want to start dipping into fixed income here. We do think that's attractive. And then, look, what you have to think about in terms of your equity allocation is, we're right at the lows. Think about how you felt as an investor when we broke-- made those lows back in June.
If you can't see yourself buying into new lows-- and when I talk about new lows, I mean, call it down 10% increments after these new lows. If you can't see yourself being a buyer there, where you should be a buyer there because buying the dips has worked for literally decades and we do believe that's going to continue, then you just want to hang tight or, frankly, perhaps shift a little bit out of stocks and into bonds because as I said, we do think bonds are very attractive here for the first time in over three years.
DAVE BRIGGS: Julian, any concern that the Fed's going too fast here?
JULIAN EMANUEL: Lots of concerns that the Fed is going too fast here. Look, the thing is, is that if you think about it, in a lot of ways, the Fed has been really focused on not making the mistakes that were attributed to the 1970s. There was a Fed chair in the mid 1970s that cut rates in the middle of exceptionally high inflation to stave off what was then an accumulating recession. That had the effect of prolonging inflation for the rest of the decade.
The Fed is cognizant of-- but actually maybe reinforcing the potential for it to happen by being so aggressive to fight inflation without seeing whether there's enough sort of tightening in the system already to show that inflation could, and we believe, is starting to slow, so that you put so much tightening in the system that you're actually forced to cut the mistake that it doesn't want to make before, conclusively, you have this turndown in inflation. We are very concerned that the Fed has gone too far too fast.
DAVE BRIGGS: Medicine takes time to kick in, doesn't it? Julian Emanuel, Evercore ISI, appreciate you, sir. Have a good weekend.