Stock market: ‘Fundamentals start to reappear’ when liquidity conditions change, strategist says

Head of CIO portfolio strategy for Merrill and Bank of America Private Bank Niladri Mukherjee joins Yahoo Finance Live to give an outlook on the market for this week.

Video transcript

KARINA MITCHELL: We are going to stay on the markets and bring in our guest Niladri Mukherjee, head of CIO portfolio strategy for Merrill and Bank of America Private Bank. Nil, thanks so much for stopping by with us today. I want to just get your sense of what you're seeing in the markets and all the volatility. Today, it looks like equities are shaking up the bond market, which is a reversal of what we've seen in the last three weeks. So is that a temporary pause in what we're seeing happening in bonds and equities? And then do you think we've seen the worst of the selloff?

NILADRI MUKHERJEE: Well, I think what you're seeing is, across the board-- and this has been playing out for the last few months, which is companies with less profitability, companies with questionable business models, companies with a high PE, high valuation, et cetera, more speculative companies, more concept-oriented stocks, they have been weakening since, really, February of last year. And that weakening has accelerated.

Meanwhile, the market is rotating into value-oriented investments. And even some defensives are doing better. So I think the market is now pricing in what is going to be an environment which is going to be pretty difficult from a liquidity standpoint. So the Fed is obviously going to start hiking interest rates starting in March, most probably. So you won't have that tailwind going forward.

And I think some of this volatility is to be expected. We had a great year in the stock markets last year. And we had, over the last three years, something like 100% return in the S&P 500 and 5%-like returns actually happened three times a year.

So this volatility, in my mind, is welcome. It is to be expected. And I do think it creates an opportunity for long-term investors to pick up some high-quality names on the cheap going forward.

ALEXIS CHRISTOFOUROS: And Nil, speaking of to be expected, what about these stay-at-home trades, right? Zoom, Netflix, Peloton saw incredible growth both in the stock market but also their bottom lines early on in the pandemic. And investors seem to have soured on these stocks. Do you think the selloff we've seen in that trade has been a little bit overblown? Because at the end of the day, we all knew that torrid pace of demand would have to end sometime.

NILADRI MUKHERJEE: You're absolutely right. And some of these names, if you think about it, came out of nowhere and became household names within a few months of having the pandemic beginning and everybody using it across the board globally. So it wasn't a surprise. Perhaps it was to some people. But as the pandemic raged on throughout 2020 and into 2021, these stocks just kept doing well and kept going up.

And their earnings estimates went up. Their case for profitability became even more stronger. But funny things happen when liquidity conditions change in the stock market. That's when fundamentals start to reappear. And I think that's what investors are doing.

Now that the Fed liquidity bonanza is behind us, and it looks like they will hike interest rates and potentially shrink the size of their balance sheet, I think these names could continue to struggle. And if you think about where we are in terms of the pandemic with vaccinations, with omicron raging through the entire population in very quick fashion, I think some of these names are also discounting the fact that we could be getting, slowly but surely, to the other side of the pandemic.

In fact, many research reports are pointing to that. And experts are saying that, especially as vaccination rates are improving. So I think investors are going back to the names that they had ignored for a long time.

Once we get to the other side of the pandemic, I think it's less likely that people will be sitting at home and watching Netflix. I think more likely, they're going to be getting on a plane and going for their beach vacation or wherever they go for a vacation.

So you see that rotation. You see that flow play out in the stock market as well.

KARINA MITCHELL: And then what do you see as far as the international story? Do you see opportunities in, let's say, Japan, in China as opposed to the US now?

NILADRI MUKHERJEE: Yeah, it's interesting. International has gotten off to a slightly better start compared to the US. Keep in mind that the US has handily beaten international over the last seven to 10 years. And every time international starts to gain some traction, it looks like the markets pivot back to the US as the outperformer.

I do think that international developed markets, like you mentioned, Europe, Japan, they have the potential to keep up with the US. Valuations are reasonable there. When we go to the other side of the pandemic, countries like France, Italy, Spain will benefit from a recovery in tourism.

If you look at the European Central Bank and the Bank of Japan, they are less hawkish than the Fed is. So that's a relative win in terms of the stock market for those regions.

But if you look at emerging markets, they've started the year off a little bit better. But they have a lot of fundamental challenges. If the dollar stays strong, I think that hurts emerging markets. If China continues to slow down, even though they have started to induce monetary policy back into the economy-- but they're expected to slow down quite dramatically this year. I think that takes away from emerging market fundamentals.

And if they continue to be on this path of regulatory oversight of technology, real estate, education, et cetera, I think that is another negative for emerging markets as well. So I would say on a risk-adjusted basis, it's still a good time to be favoring the US because the outcomes around our base case with respect to inflation, pandemic, and Fed liquidity are very wide.

So from a risk perspective, I think US is still the best market to invest in. And I think international developed could potentially keep up with the US. But I still find fundamentals in emerging markets extremely challenging.

ALEXIS CHRISTOFOUROS: And Nil, finally in the 30 seconds we have left, we know that volatility is going to be the name of the game, at least in the short term, especially for tech. Do you think it's anywhere near finding its floor yet?

NILADRI MUKHERJEE: I think we're almost there. Keep in mind, tech has majorly outperformed US indexes over the last 10 years. So the market is trying to find a floor here. I think we're getting to that point. I do think there's more downside for some of the high PE and speculative names.

But I think in the next couple of weeks, it will be time for investors to come in and step in to those high quality, old technology, free cash flow, secular names which are levered to things like the digitization of the global economy. So I think we're getting close on that front.

KARINA MITCHELL: Definitely, there is a lot of value in free cash flow at this moment. All right, we will have to leave it there. Niladri Mukherjee, head of CIO portfolio strategy for Merrill Lynch and Bank of America Private Bank, thanks so much for stopping by today.