Omicron and Fed making for 'very confusing market action,' strategist says

RBC Capital Markets Head of U.S. Capital Markets Lori Calvasina speaks on Yahoo Finance Live about how investors are viewing the COVID-19 Omicron variant concerns.

Video transcript

JULIE HYMAN: What does all of this mean for the markets? When we talk about the movement in vaccine stocks, of course the Omicron effect seems to have largely dissipated when it comes to stocks. So how should we be thinking about things more big picture? Lori Calvasina is with us right now, RBC Capital Markets head of US Equity Strategy.

Lori, it's great to see you here this morning. I think maybe I called the top a couple of days ago when I said it really felt like sentiment had shifted. Now it feels like it's shifted again, back in the bullish direction. And part of, as I mentioned, what we're seeing is large-cap tech is really helping fuel this latest rally. How do you-- I'm having trouble covering it, sort of surfing all of this and figuring out what the underlying sentiment is. What are your thoughts on it?

LORI CALVASINA: Look, look, I also want to pull my hair out. I mean, it is just twists and turns that we're seeing between the Omicron narrative and the Fed narrative are actually cross-currents, cross-tailwinds-- I don't know exactly the right terminology, but they're butting heads with one another, and it's resulting in some very confusing market action.

And I'll take you back, Julie, the last Monday afternoon. My team and I came back from the Thanksgiving holidays. We're scratching our heads, saying, how the heck can we be useful to people? So we just did a survey. And we got 95 people in the course of a couple hours on Monday afternoon to answer a couple of questions for us.

And what we found in that survey was that about half of the investors who responded-- now, this was back on Monday-- were not worried about the new variant. And they said that they were not doing anything with their portfolios yet in regards to it. But we also found that very few expected any kind of change in the Fed's tapering path. And in fact, we found about a quarter thought that the Fed was going to delay tapering or slow it down because of the variant. And that, of course, didn't happen on Tuesday. We got a big negative pivot.

So I do think a lot of the more recent action has been, one, I think that the variant concerns have been calmed even more because the news flow has been pretty decent at the margin. It's still a lot of uncertainty. There's still a lot of more information we need to get. But by and large, little drips we're getting have been positive on top of an investor base that wasn't that worried to begin with.

Now, the Fed was more of a startling surprise. And I think the other thing we noticed is that if you look at the CFTC data on NASDAQ futures positioning and asset managers, on Tuesday evening, so after Powell's comments, NASDAQ positioning was basically back to 2013, 2014 highs and late 2020 highs. It's about the most crowded we've ever seen NASDAQ positioning.

And so we just needed to see some of that tech money unwind, some of that growth money unwind, because expensive stocks, frankly, just don't do well when the Fed is hiking rates. So the valuation concerns have been pricked. But then we have on top of that a bunch of people who want to come in and buy the dip. Because Omicron is making people feel pretty calm about the longer-term story for the economy and the market.

It's a very confusing market narrative. But you know, I would not read too much into yesterday's price action. One thing our trading desk told me this morning, including our tech traders, is that they were, by a very large margin, better to sell. So they were not seeing a lot of conviction in yesterday's move.

BRIAN SOZZI: Lori, now I'm a little bit even more confused. No, to your point, it's been a wild ride the past 2 and 1/2 weeks. But doesn't this investor complacency that you're-- I think you're trying to talk about here, isn't it-- doesn't this argue that the rally could stop dead in its tracks this week? When we get a CPI in the headline, there might be 7%, and then follow it up by a Fed meeting next week. That might be hawkish. Like we all really were reminded of, of it likely happening a couple of weeks ago.

LORI CALVASINA: Well, one of the things our rate strategy team talked about-- they put out their forecast on Friday, and they talked about how one of the big things they see, not just this week, not just this month, but in the year ahead, is they think the market is too sanguine in regards to the Fed hiking path over the longer term. And they actually don't disagree with market participants on the number of hikes in 2022, but they think people are underestimating the number of hikes in 2023 and how high the Fed could ultimately go.

So what that tells me as a strategist is that even if we get a little bit of relief in some of these tech numbers-- you know, we see other good days like yesterday, where people are buying the tech trade back. But over the course of at least a few more months, markets are going to have to come to terms with a Fed that's tightening a little bit more aggressive than what they had been positioned for.

So I don't think that pressure on the tech trade is necessarily going away in the short term. I think ultimately what we want to do over the next, say, six months or so, is be in value stocks. But it's a little bit hard to pound the table there right now, because we do need more information on Omicron.

BRIAN CHEUNG: Hey, Lori, Brian Cheung here. Let's expand a little bit on that. Because what was interesting was that the big story with the reflation trade at the beginning of this year was indeed value. And value appeared to outperform growth through the first half of this year. No one said the word reflation since we've been-- basically after Labor Day. Is the story going to be value or growth in 2022?

LORI CALVASINA: I think it's going to be a tale of two halves. So I think the first half of the year, it's going to be the value trade that's going to do well for a couple of reasons. One, value cyclical small caps all tend to do well when the economy is running above average. Right now, consensus numbers are still at 3.9% on real GDP. The long-term average is 2 and 1/2%.

Also, typically all those trades tend to outperform in advance of the first Fed rate hike. And that's because the Fed usually does start to move when the economy is hot, ISM is really strong, and we've got a really strong cyclical tailwind at our backs. And I think also for now, those parts of the market are all still very cheap.

But I do expect by mid-year we're going to lose some of that valuation appeal. There are lower quality parts of the market. Investors are nervous enough to start wanting to go back towards higher quality. And the problem is that in 2023, GDP is expected to cool back down to average type levels of about 2 and 1/2% if you look at the consensus numbers on the street.

So I think in the second half of the year, after the value trade has had a nice run, you're not going to see that same valuation appeal. People are going to have digested the fact that the Fed is starting to hike, and they're going to pay more attention to the fact that the economy is going to cool off because of it. And then they're going to pivot back to growth. So I think first half is value, second half is growth.

JULIE HYMAN: And so your-- as we were talking in the break before the show, your target for the end of next year is still 50-50, which still implies some level of upside but obviously much more tepid. So what's the biggest downside risk to that forecast? Is it the Fed?

LORI CALVASINA: So look, I think that, you know, COVID is always something we have to have on our list. And shame on all the strategists. We weren't talking about it enough in our year-ahead outlooks before Omicron came out. I would actually say second is probably supply-chain improvement. And most investors we've seen through our survey work, some of the company transcript scraping we've done, are looking for midyear improvement in supply chains.

You have to remember that COVID cases tend to lead supply chains, if you look at freight rates, by about one to two months. So if we do get a worsening on COVID, it could actually cause some more hiccups on the supply chain side. So I think that's something investors wouldn't be prepared for if it happens.

But also the Fed-- remember that secular growth is about 51% of the market cap in the S&P. So a tighter Fed that causes people to sell out of more expensive stocks, which is what the secular growth trade is, will be an anchor on the S&P. We're right now viewing it as a speed bump. But the worst case scenario is that it drags the market down more than we anticipate.

JULIE HYMAN: We will keep an eye out for that, most definitely. Lori, good to catch up with you. Happy holidays if we don't talk again before then. Lori Calvasina, RBC Capital Markets, head of US Equity Strategy. Thanks, Lori.