The Fed can face a ‘credibility issue’ in the coming months: Expert

Tom Essaye, Founder and President of Sevens Report Research, joins Yahoo Finance’s Kristin Myers and Alexis Christoforous to discuss market outlook, bank earnings, and the latest economic data.

Video transcript

ALEXIS CHRISTOFOROUS: Let's stay with the markets now and bring in Tom Essaye, founder and president of Sevens Report Research. Hey, Tom, good to see you again. So talk to me about earnings season. What do you like so far? Any big surprises for you to the upside or the downside so far?

TOM ESSAYE: Hi, Alexis. Thank you very much for having me back on. I think that it's been a very strong start to earnings season, right? I mean, we really haven't had any blowups yet. The numbers have been very solid. I'm surprised that-- to a point, that the banks aren't being met with a bit more enthusiasm. Some of the numbers are very high. There are some issues with Reserve releases, but as I look at the banks, I think they're set up really for a couple great quarters, if the economy recovers. So I'm a bit surprised they're not being bought more on these earnings. But overall, it's a great start.

KRISTIN MYERS: So, Tom, speaking about that, as you mentioned, financials not doing as well. It had been in the red just yesterday. We'd seen a nice pop in tech. Tech right now, of course, is in the red, down about a tenth of a percentage point. Given that, that you think the financials, there should be more enthusiasm, especially around some of those bank stocks, where do you sit on this growth versus value debate? How should investors really be looking at those two-- at these different sectors and their portfolios?

TOM ESSAYE: So I'm on team value here as far as a full year outperformance. I think that if what everybody is saying and what the market is saying, that we're going to have a big economic recovery, that we're going to have rising inflation, that we're going to have improved labor market, then value, small caps, and cyclicals should continue to outperform. Now, I fully acknowledge over the past three weeks, we've actually seen growth and tech outperform. But I think that's more due to the past six months of value and cyclicals just massively outperforming. And now we're seeing a little bit of a reversion to the mean. But for a full year basis, I still think value is the place to be.

ALEXIS CHRISTOFOROUS: You know, Tom, I'd love your take on what we're seeing happening in the bond market right now with the 10-year Treasury yield. Because you remember it was rising at such a speed. It got a lot of stock investors nervous. A lot of folks were unloading those large tech stocks as we saw the yields starting to rise. But now they're falling back a little bit. I know the 10-year Treasury yield is down from 1.64% that we saw last week. Why do you think that is? I mean, are investors now finally buying into what the Fed has been saying all along, that they're not going to be bumping up interest rates any time soon to rein in inflation?

TOM ESSAYE: I think that's part of it. I think a lot of us have been surprised by sort of how dismissive to a point the Fed has been about incredible data. I mean, in normal times, the numbers we saw yesterday on Thursday from Philly Fed Empire in retail sales, they'd have sent the 10-year yield up 10 basis points. Instead, it went down 10 basis points. Now part of that had to do with short covering from people who were short treasuries.

But the bottom line is the Fed is giving a drumbeat that regardless of how strong the economy is, it seems they are not going to talk about tapering QE any time soon. Now that works great right now, but down the line, if the data continues to get better, then the Fed is going to, frankly, face a credibility issue. I mean, if we're talking about 9%, 10% GDP, and the Fed is saying we're still going to buy $120 billion of bonds every month, people are going to start looking around and saying, what's going on here? So I think for now, the Fed's message is being delivered. But as I look out a month, two months, three months down the line, it could cause some volatility.

ALEXIS CHRISTOFOROUS: Do you think that these falling yields call into question aspects of the reflation trade? Should people start rethinking that reflation trade?

TOM ESSAYE: No, I don't think so. I think that this is part of a market that, frankly, is awash in liquidity. And this market tends to be-- it's like we're on a boat, right? And we just have one crowd running from one side and running to the other. In March, it was everybody was running out of bonds, out of treasuries and yields. You know, yields went from, what, 120 to 170 in a couple of weeks? I mean, that's not a sustainable move higher. Just like yields falling 10 basis points on the day when we had blowout economic data, I mean, that's not going to be sustainable either.

So I think part of this volatility is just a function of all the liquidity that the government and the Fed has put into the market. And we're just sort of like a herd running from one end to the other. And I think we just have to get used to that. Longer trend, though, the reflation trade is still good. COVID, thankfully, is going away and hopefully will be really gone, to all intents and purposes, in the next couple of months. And I think the reflation trade will re-engage in a big way.

ALEXIS CHRISTOFOROUS: All right, Tom Essaye of the Sevens Report Research, thanks so much. Have a good weekend.