Debt ceiling: 'More noise means more volatility' in markets, strategist says

U.S. Bank Asset Management Group CIO Eric Freedman joins the Yahoo Finance Live show to discuss the Fed's decision to keep inflation at 2%, the market's reaction, consumer spending trends, and the outlook on the Japanese stock market as Nikkei hits a 33-year high.

Video transcript

SEANA SMITH: Let's talk a little bit more about this the fight to get inflation back to 2%. For more reaction on Powell's comments today, I want to bring in Eric Freedman, US Bank Asset Management Group chief investment officer. It's great to see you here. So at least from the start, it looks like the markets were encouraged by what they heard from Powell, and the markets go right back down to the downside after GOP negotiators walked out that debt ceiling deal. But when it comes to Powell's comments here, Eric, how do you read that? Do you think that it is likely that we could see a pause?

ERIC FREEDMAN: I think it is very likely that we'll see a pause. And I think that the bar is actually very high for the Fed to come off of this, this sort of wait and see mode that they've signaled. I mean, there's only a 16% chance priced as of this second in Treasury markets that we actually could see a June hike, and so it's, again, not off the table completely.

But I think the Fed is recognizing that you have a confluence of a couple of things happening. I think you certainly have concerns about the lending industry. You have concerns about the cumulative impact of hikes already made, but then also two variables that probably aren't getting enough attention. One is the potential for China to actually draw back on liquidity injections. That's something that, really, we don't think is enough talked about in the capital market lexicon right now.

And the second variable would be what happens if and when the debt ceiling talks do ultimately find some resolution. What's going to happen is the Treasury is going to come back to the market and issue debt. They're going to sell securities. Capital's going to come out of the system and pay for those securities. And that really leads to just less capital sloshing around the system, so to speak. So I think the Fed understands that you have this confluence of events that, again, suggests that they should probably wait and see what the cumulative impact has had versus forcing perhaps even more liquidity to drain out of the system relative to where we are right now.

AKIKO FUJITA: On that point, Eric, it was interesting to see the market reactions today. On the one hand, you've got the Fed Chair sort of implying that potentially there could be a pause on the table here. And yet, it really was the headlines coming out of DC and that pause in discussions around the debt ceiling that seemed to drive the market to the downside. I mean, does that suggest where the risk or at least where investors see the risk right now? Because all indications are that, at least, on both sides, what we have heard from Republicans and the White House is that they're not going to go right up to the X date. They don't expect a default.

ERIC FREEDMAN: Yeah, Akiko, I think that's very well put. I mean, there's the risk that both sides really have concerns about the perception of either Democrats or Republicans being basically associated with a hangup here. And I think that the risks are too great on either side for this to be prolonged. I think the fact that you had some discussion that there were aides getting together over the weekend and that there may be a bill on the floor on Monday or Tuesday, that that suggests in terms of the commentary from Washington today that that actually may, in fact, not happen.

So I think this is one of those things that as a professional investor, one of the things that we think about is, where do we have an edge? And the comings and goings of what may be happening in Washington are really not what we consider to be a high edge environment, even though we have people on the street in DC and we, of course, have a great connectivity there.

You have to be really mindful and respectful of the amount of variability that could happen between now and a resolution. So, again, more noise means more potential volatility. We do think a deal will be met. And again, both sides are worried about being the proverbial scapegoat on this that's being pushed beyond or even up to the X date, as you mentioned.

SEANA SMITH: Eric, what do you make of the market's performance, not only here in the US, but really, what we have seen globally? And taking a look at the reaction today, yes, markets are in the red before the year. We're certainly up pretty significantly. The S&P just briefly trading above 4,200. What do you make of the current valuations, especially the runup that we've seen in tech names?

ERIC FREEDMAN: Yeah, it's been a really interesting runup, particularly in the international developed side. That has been, again, what we do. Part of what we do is we manage tactically asset allocated portfolios. And so, being really underweight Europe had been a significant source of alpha for us for a long time. And we took that view off earlier in the year. The reason for that is because we just felt that the story was getting a little bit better.

Not saying that things in Europe are going gangbusters strong, if you will, but there was a real negative scenario coming out of the unfortunate Russian and Ukrainian conflict, where Europe was going to be in a tough position with respect to energy and energy prices. It was a cooler-- I should say, it was a warmer winter, and that actually helped things out. And you're seeing some consumer activity, both in Europe, as well as Japan.

So I think that the international story has been probably less focused on. Again, the DAX flirted with an all-time high earlier today in Germany. So there's been some really strong momentum there. I would say that the knock that everyone has about this market is that it is a very narrow leadership market. You've had tech and, in particular, a couple of stocks that have done quite well. Valuation is actually not a tailwind for domestic equity markets. We are actually smack in the middle of a 20, 25-year either on a trailing basis or a forward-looking basis. You don't have a lot of valuation support with respect to saying this market is exceedingly cheap.

So I do think that what bulls have to get excited about is, again, that run to 4,200. A fail at 4,200 on a closing basis would be an issue that the bulls really have to be focused on, of course, focused on. But I would say that the other side of that, of course, is if you look at the breadth of sectors, it has been very narrow so far this year. So bottom line is that we still think that, again, having some emphasis on income with respect to sector allocations-- again, energy has been a weak point. Utilities have been a weak point.

We think those are interesting. Those are things that you can really get paid as you wait, if you will, to see if we have a pronounced breakout above 4,200 with broader sector representation. If we don't have that broad sector representation, we'd be more skeptical about this rally higher.

AKIKO FUJITA: Eric, you're talking about your international exposure. What's your exposure to Japan right now? To your point, we saw the Nikkei hit a 33-year high. There's a number of factors that we have seen there play out. It's corporate governance reform. It's the Bank of Japan still being an outlier with ultra low rates. What makes this market attractive for you right now?

ERIC FREEDMAN: Yeah, I think there's a couple of things. One is, as you highlighted, you have a little bit of corporate governance reform. And again, the knock against Japanese equities has been that you still have those conglomerate type of entities that are difficult at times to invest in because there's just layers and layers of potential revenue growth. But there's also layers and layers of expense that are hard to tie back to.

So I think that a little bit of a shakeup there is a positive. You certainly have some turnover at the central bank office, which, again, I think you have a very solid academic who is both a practitioner, as well as an academic and a chair, right now recognizing that monetary policy is not the cure-all for what's happening in Japan. And again, the demographic situation is continually challenging for Japan. I think that the country recognizes that. And so potentially being creative on immigration or on labor mobility, those are things that are positive.

So, again, I think that you're seeing a little bit more flexibility with capital, which is a good thing. We don't think the Japanese demographic story will be solved overnight. But it is a place that we think offers a decent risk-reward, which is something we really couldn't say a couple of years ago.

SEANA SMITH: Eric, bringing it back here to the US, some of the retail trends that we have been seeing, certainly a massive story this week as we heard from Target, Walmart, TJX, just to name a few. We got a mixed bag when it comes to guidance, but there does certainly seem to be a trend that's developing. And that's that consumer is a bit more cautious, and they are trading down. What do you think this signals about the economy and, really, market implications here now?

ERIC FREEDMAN: Yeah, it's a great observation. If you throw another log into the fire, you're looking at what's happening with luxury goods retailers, which are just, again, have been outstanding performers. So the consumer has been a very, very difficult animal to track, if you will, over the past couple of quarters, and you're seeing that with, again, big box retailers, as well as some of the retailers. And the trends that we're seeing are more of an emphasis on experiences, so travel, leisure, hospitality, less on accumulating stuff. That's true not just domestically, but also with China in particular.

So what do we think that means? We think that, again, the consumer has still got some capital saved up from stimulus savings. The consumer, though, is now starting to put more things on credit. And I think the Fed understands that if they keep rates high or if they keep increasing rates, that we could see a consumer that faces a really challenging environment as we get deeper into this year.

So again, our viewpoint is that we're really more market weights with respect to the discretionary side right now. But we're likely to become a bit more bearish as the year goes on because we think the confluence of higher interest rates, lower liquidity, and again, that trend that you cite, that tradedown, if you will, does suggest that the consumer is in a little tougher position than they are or maybe than they were three, six months ago.

AKIKO FUJITA: So what does that mean for you in terms of positioning? We're coming on the back of a week where we heard from all the big box retailers. What we're learning is that there's a similar narrative, and then we're also seeing the differentiation between a Walmart, for example, that leans more towards groceries, and then a Target. I mean, how do you look at all of that? Is it more about the very highly focused groups like travel in that area? Or is it about going for those retailers that are a little more diversified?

ERIC FREEDMAN: We don't really have a strong view at the-- I call it at the [INAUDIBLE] allocation level about retail domestically per se. We're really more market weight at this particular juncture. I would say that the things that we are very focused on would be the potential for travel to kick in and pick up.

So one of the things that we think is often ignored in terms of people's investment psyche is infrastructure. Just think about ports, not just airports, but also toll roads. These are, again, they do well when people get out more. They actually have some inflation adjustments embedded in their pricing. So those are areas that we think are often underloved in capital markets, and they also spit off a bunch of current income and yields.

So that's an area that in terms of travel and consumer changes, if you will, that's probably the area that we have the most conviction on. And certainly, from an absolute performance standpoint, we think there is some valuation support at current level. So probably a stronger view about infrastructure and hospitality than in retailing per se right now.

SEANA SMITH: It makes a lot of sense given the current environment. All right, Eric Freeman, US Bank Asset Management Group chief investment officer, thanks so much. Have a good weekend.