How ‘pent up demand from the consumer side’ will drive up economic growth

Truist Wealth Co-CIO Keith Lerner joins Yahoo Finance to discuss the gains taking place within the market ahead of the Fed decision, Evergrande’s continued effect on the market, and prospects of economic growth in the coming year.

Video transcript

- Our next guest is on the prowl for market gut checks. Keith Lerner is the Co-CIO and Chief Market Strategist at Truist Advisory Services and joins us now. Keith, always good to see you here.

Bizarre market action this week, to say the very least. Big down day on Monday. We saw that reversal yesterday. Do you think the selling in the market is done for this week?

KEITH LERNER: Well, first, Brian, always great to be with you. Yeah, it was definitely a hectic way to start the week, and we've seen that reversal. You know, going forward I do expect that we're going to continue to have somewhat of choppy waters. But the overall-- the primary trend in our view is positive.

As we came into September, you know, first of all, we all know we had difficult seasonals to deal with, but we also thought we would have choppy waters just because there was so much political wrangling. But we said by the end of the year, we'd at least see one more gut check and likely from something outside of what it was front and center, and that happened to be Evergrande on-- on Monday.

- And, Keith, speaking of Evergrande, that continues to be something that investors are closely watching here. We've had strategists over the past couple of days really contest this notion of it being the next Lehman, contest the notion that this is going to spark a global contagion. What's your view on where we go from here on that front?

KEITH LERNER: Yeah. I think that's right. The first thing with Evergrande, even though it became front and center on Monday, this has been an ongoing issue for several months. In fact, the stock itself was down over 90% from its high.

If you look at the bond market yields on their debt, it was over 60%. So what was that telling you? That investors were already braced for a significant haircut. And, you know, I think it's just too important for the Chinese government not to help manage this, you know, default, which we think they have the wherewithal to do.

But don't forget, they have over $3 trillion of reserves. But there are some deflationary impacts of that as a whole. But again, from a US standpoint, we're relatively closed economy. This doesn't change the consumer position, and we still think that the economy is on solid footing.

- Keith, is-- the Fed meeting today, is that another potential gut cut? Let's be real, if they come out here and they raise a couple more dots go into the Fame dot plot, suggesting that rate hikes might happen next year, that can't be good for the markets.

KEITH LERNER: I would think that the market would take that, you know, somewhat negatively but, you know, they've telegraphed this tapering so well for so long. And we look back at 2014 during that tapering period, which came after a really strong market year, by the way, and stocks were still up about 10%. But there were definitely gut checks along the way.

And we see some of these gut checks, Brian, as really the admission price to being in the market. There's always an ongoing carousel of concerns. But if you think about the big picture, is what's happening now going to change the overall trajectory of the economy? We-- we think now-- we think we still are past peak growth, but we think economic growth will likely be well above trend into next year.

There's still a lot of pent up demand from the consumer side. And let's be honest, there's just not a lot of great relative opportunities outside of the equity market today.

- So it seems like right now heading into this Fed meeting, market participants pretty much agree that this is going to be a setting the stage for an eventual, perhaps by the end of this year, announcement and then implementation of tapering. But I'm wondering, as we have another stream of economic data due out in the next month or so and earnings results, what do you think on the margin here could potentially sway the Fed when we think about their forthcoming decisions at those November and December meetings?

KEITH LERNER: I think the most important number is going to be the upcoming employment report, actually, after the one last month, which was still healthy but disappointing relative to expectations. You know, one other point I'll bring up is, even though they'll be tapering, they'll still be adding to their balance sheet in the tune of $300 to $400 billion by next year, even if they start, you know, in November. So that's just something else to keep in mind.

And going back to the economy, you know, one positive-- and I think this will be helpful for the markets as we move past this kind of sloppy period in September and October-- is expectations have been reset. The economic surprise index shows that the economy has been missing estimates, but we're at a point historically where we are set up for positive surprises. And also, as we have to rebuild these really depleted inventories, I think that's going to help keep this economy moving forward.

- Keith, I'm staying negative today. That FedEx quarter last night, that earnings call, everything-- everything about the quarter in the earnings call really bothered me. And why won't we see more quarters like that from big companies when they report? The cost of doing business is not only going up, it's going up significantly at the same time growth is slowing down. That's not a good-- just not a good backdrop for corporate earnings.

KEITH LERNER: Yeah. No, Brian, listen, I think there's-- I mean, not everything is rosy out there. There's some challenges. But we also have to think about what's baked into the market.

And as I mentioned, we've seen GDP estimates this quarter come down significantly. That economic surprise index has been cut significantly. And then also from a market perspective, you know, the transports have underperformed by about 15% since May as a whole. And then you've just seen pure liquidation out of the cyclical areas of the market.

In fact, our work shows we've seen the most outflows out of the cyclical areas the last three months than we've seen at any other time over the last five years. So I would just say that bar has been set lower. If-- if our thesis at that peak growth is a weak growth is right, then-- then I think what's about the surprise to the upside later this year. And again, some of these factors are going to stay with us, but it doesn't change that the economy still overall on good footing in our view.

- Keith, I want to stay on that topic of these cyclical sectors seeing these massive outflows, because that's one of the charts that really struck me in your recent note. And I'm wondering, as we think about just this drawdown we've had in these sectors, do you now expect them to lead the market for the rest of the year just on a sort of percent basis, given the fact that they have come down so far and perhaps are in oversold territory?

KEITH LERNER: Yeah. And just going back to one point about those flows, in March, it was a total opposite. Everyone was really positive because all the news today was positive. And that was not the best time to be buying these cyclicals because a lot of good news was priced in. So we're saying today a lot of bad news is being priced in already, and you're set up for a better fourth quarter on this side.

We do think that this market broadens somewhat encouraged here over the last few weeks is that, you know, you have to look at the cyclicals and say, OK, where is that relative opportunity? The financials have held up relatively well. We haven't seen yields come back down that much, even with some of the bad news we've seen.

Energy is also holding up well, with less favorable on the industrials and some of the materials, which have more exposure to the global economy and some of the things that's happening in China today.

- Keith, you didn't reveal your S&P 500 2022 target for us. I have someone coming on a later hour looking for-- for 5,000. Where are you?

KEITH LERNER: Yeah. You know, Brian, I'm not a big advocate of trying to guess where the market's going to be on a certain day 12 months ahead. We really look at relative opportunity and where-- you know, what the way of the evidence says, and we look at statistics of the market. And based on where we are today and looking at the equity risk premium, we're at a point where the market tends to outperform fixed income by about 10%. But I won't-- I don't really have a great clue of whether that will happen in September 13 or December 31 of next year, just to be candid.

- Hopefully, we'll both be above ground. Keith Lerner, always good to see you. Stay safe, have a great rest of the week.

KEITH LERNER: Great to be with you. Thank you.