Economic slowdowns will 'primarily be led by the consumer' through reduced spending: Strategist

Chris Zaccarelli, Independent Advisor Alliance CIO Christ Zaccarelli and Verdence Capital Advisors CIO Megan Horneman join Yahoo Finance Live to discuss the market outlook against the Fed's interest rate hikes and how economic slowdowns are tied to inflation and consumer sentiments.

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- All right. Let's check again on the markets on this Tuesday, how they closed. The Dow falling more than 400 points. Not a lot of action on the S&P and the Nasdaq. The S&P falling 27 points, 0.67%. And the Nasdaq down marginally. Joining us now to talk about all this, Chris Zaccarelli, Independent Advisor Alliance CIO, and Megan Horneman, Verdence Capital Advisors chief investment officer. Nice to see you both. Chris, let's start with you. Best July we've seen, best month since 2020. And August really starting out with a whimper. What are markets reacting to?

CHRIS ZACCARELLI: I think markets are really looking at valuations. I mean, clearly, with all the headwinds we have in front of us in terms of inflation and rising prices and now the federal reserve reacting to that, stocks at the end of June were trading around 15.4 times earnings, which were a lot more attractive than where they were at the end of July, which is closer to over 17 times earnings. So I think as we head into August, we're really seeing more of the same. It's been a really tough year with the exception of July. And I think we may have a lot more volatility ahead. So I think this is more par for the course. July was really the exception to the rule.

- So Megan, what view should we be taking? Given where we were pre-pandemic and some of the extraordinary measures that had to be taken by the Fed, what lens should we be viewing this current market action?

MEGAN HORNEMAN: So I think today, you know, I think the reaction we got today was primarily because the market got ahead of itself expecting what the Federal Reserve was going to do. So remember, we got that negative print on GDP. So the expectation is that we are in a recession. The market got ahead of itself thinking the Fed was going to back off. And what we're seeing is we haven't really gotten ahead of the inflation fight. So the Fed is going to have to continue to be aggressive. Bond yields are backing up. I do agree that July was, you know, you get a lot of bear market rallies when you when you're trying to find a bottom of a bear market. But we are heading into a very challenging seasonal period in August and September as well.

- Megan, you mentioned the fact that the Fed is going to have to stay aggressive. I guess how aggressive are you expecting the central bank to be in the fall?

MEGAN HORNEMAN: So I think definitely 50 basis points will be on the table for September, possibly 75. But we get a lot of economic data between now and then to get a little bit more clarity about that. And also, don't forget we'll get the Jackson Hole Symposium at the end of August, which tends to really be a market moving market moving event.

- Yeah. And Chris, what are your expectations in that regard, specifically after San Francisco President Mary Daly said our work on inflation is far from over, telling you what?

CHRIS ZACCARELLI: Yeah, absolutely. I mean, next Wednesday when we get the new CPI numbers out, we'll see if they're below 9% this time or if they're above 9% again like they were the previous month. Really, inflation is the name of the game. The Fed is going to be focused very much on inflation. I agree that Jackson Hole is an opportunity for them to communicate a little bit more before they head into the September meeting, which they're going to have to look at the data.

But, ultimately, the Fed is going to be somewhat data dependent. I really do agree that 50 basis points at least, possibly 75. And it's all going to be depending on what happens with the inflation data. That's really what's driving the Fed's actions. And, ultimately, that's why we were in a bear market and we may still be depending on whether or not this turns out to be a bear market rally.

- And Megan, looking at some of the other indicators, primarily the consumer, obviously this is a consumer-led economy, as well as what we're seeing with the housing market, what is that signaling to you about how the investment strategy might need to change at this point?

MEGAN HORNEMAN: So the economy is going to continue to slow. And it's primarily, in our opinion, going to be led by the consumer. The consumer has been resilient for the past few months. But if you look at savings, the extra savings they had during the pandemic has been completely wiped away. While balance sheets still remain pretty strong in a historical context, consumers are getting squeezed by high energy, high food, by inflation. That's going to continue. And it's going to continue to weigh on spending in the second half of this year.

But as we tell our investors, it's important to look at what's priced in the worst case scenario. So there are some areas of the market that we still would look to invest in even though we aren't sure that we're at the bottom of this bear market. Look from a valuation perspective. What's priced in the worst case scenario? Small, mid-cap stocks. And in some instances, even international stocks have priced in that pessimism. As we get through this, which we will, you're going to see those areas of the market that have beaten down the most rally the most. Take a look at July, for example, where you saw small caps that have had really no bid this entire year, they led that rally in July.

- Chris, I want to stay with the consumer with some numbers out from the New York Fed. Household debt reaches $16 trillion for the first time ever. Credit card balances up 13%. That's the biggest gain in 20 years. What's your read of the consumer in this moment?

CHRIS ZACCARELLI: I mean, I think the consumer is really mixed. You had a very strong consumer heading into this year with balance sheets really high flush with cash. And as inflation is really taking a bite out of that consumer, we're really going to see that bifurcation. I think you're going to see-- just looking at earnings today, you look at Starbucks, which is still currying favor with that higher end consumer and still able to pass along those prices and keep pace with inflation. I think you're seeing mixed results from other retailers, looking at things like Walmart earnings, for example.

So, really, it's going to be a case by case basis. I think the consumer can't be painted with a broad brush. You're going to have upper income consumers and then lower income consumers. And unfortunately, there's going to be a differentiation in how the spending goes into the rest of this year. And therefore, I think companies, depending on who their target audience is, are going to find different results going forward as well. There really is going to be a lot more diversification-- a lot more spread between those winners and losers within the market.

- We do thank you for joining us. Our market panel there, Chris Zaccarelli and Megan Horneman, thank you both.