22V Research Founder Dennis DeBusschere joins Yahoo Finance Live to discuss economic growth, inflation, pricing power, volatility, and the outlook for stocks amid market swings.

Video Transcript

JULIE HYMAN: Thing three is the markets and what we have to focus on there. And our next guest says you might have to brace yourself in these markets. The recent rallies brought the S&P 500 back from its low, of course, on March 8. We've got the Fed to contend with, the growth outlook that is still unclear. 22V Research founder Dennis DeBusschere says returns will be violently flat.

How's that for an oxymoron for you? Until you have more clarity. Dennis is with us now. Dennis, good morning. Explain to us what you mean when you talk about this violently flat backdrop.

DENNIS DEBUSSCHERE: Yeah, good question. So we'll start with the upside. It seems pretty clear to us that the Fed needs to ratchet down demand growth. Demand growth can slow on its own, maybe, because of demand destruction as it relates to commodity prices. But either way, economic growth is likely to slow over the next six to nine months. Inflation needs to come down.

One of the consequences of inflation coming down is pricing power being weaker. I mean, the way you have pricing power is because companies have higher margins. So that will start to reverse because the Fed is going to demand it. Could happen naturally. But again, the way they demand it is through tighter financial conditions.

So being along the market for breakouts when you know that the Fed is going to be working against that because stocks are a large part of financial conditions is difficult, unless you can make a very hard supply constraint, a supply improvement argument. On the other side, you have to be pretty confident in a recession, and a significant detrending of earnings-- trend is really an important point here-- to get real negative on the market, we're about around 40 to 100.

And the reason is, you still have these monopolies in the US that return boatloads of cash to shareholders. So if growth is slowing, inflation's lower, you're obviously going to be capped on rates to a certain extent. And if you're capped on rates, then your cash return yields in the market do look pretty attractive. Again, assuming no severe recession down in the 4200 level. So that is how we get to a violently flat kind of call.

BRIAN SOZZI: Dennis, I know you watch the markets very closely day-to-day. Now, we're coming up against first-quarter earnings season. Inflation very hot. How do you think that impacted company's earnings in the first quarter, and do you expect a market correction when these numbers start to hit?

DENNIS DEBUSSCHERE: I do expect a market correction later on this year related to numbers hitting. For now-- keep this in mind, I think this is not something that's fully internalized by investors-- if we have a lot of inflation in 1Q, that's good for earnings. That means companies are passing things along, right? The problem is when wages stay sticky high and inflation at a top-line level starts to slow. That's where you get your margin squeeze.

So I don't think 1Q is the negative catalyst for the overall market. It might be for certain internals, like your riskier stocks-- sort of you overweight quality through 1Q. But for the overall market, remember, inflation just means profit margins.

JULIE HYMAN: I mean, at the same time, Dennis, if we do see wage growth remaining sticky while top-line inflation comes down, isn't that better for consumption, for spending power on the part of individual consumers?

DENNIS DEBUSSCHERE: It is. It's just a matter of how much growth needs too slow for that inflation to come down. So that's kind of your two-step. Ultimately, it's a good thing. Certainly, on a longer term basis. But as it happens, the reason why inflation comes down is really important. And that's kind of the underlying of your question-- why is inflation coming down. And this will be the market call.

So we'll look really stupid if inflation can come down without the Fed having a slow demand growth. But if demand growth has to slow, i.e. consumption slowing to lower inflation, then that's the process you're going to have to go through over the next six to nine months, which will be negative for earnings.

BRIAN SOZZI: Dennis, your mention of a market correction later this year, is that the byproduct of what could be five or six rate hikes from the Fed starting to hurt corporate America?

DENNIS DEBUSSCHERE: Yes. And I would believe if it's going to happen, it's going to happen in the next three to four months, because there's pretty high odds that we're going to go 50, 50, and 50 from the Fed. So bang, bang, bang. And then, from there, it probably get a little easier because you might step down back to 25. So the issue is going to be the next three meetings.

That'll take it through the end of July. And I think it's going to be a pretty decent tightening of financial conditions, because that's what the Fed wants. Once we get through that, we'll see where the growth outlook is settling down and we'll see where the inflation outlook is likely to settle down. And from there, I think it'll get probably a lot more positively inclined.

But there's just so much uncertainty between now and then. It's just difficult to say, hey, just chase stocks along from here.

JULIE HYMAN: Dennis, I don't know if your new firm here, you're doing sector work, but I am curious where you think there are places to maybe ride all of this out while it's unfolding.

DENNIS DEBUSSCHERE: Yeah. Large-cap tech, for sure. So that's going to be your monopolistic tech companies that I already mentioned. So the Microsofts of the world, just to give viewers an example. Defensives will be more interesting. So that's your health care names, pharma in particular. Utilities to maybe a little lesser extent, staples.

From a factor point of view, it's basically companies that have very high profitability, very high earnings quality. Large sizes is something that you want to be more inclined to. And the deeper cyclicals-- and this might be a little controversial relative to what people are saying-- I think come under pressure. It's really hard for us to believe that energy will keep on outperforming if demand growth is going to slow.

I get the supply arguments, and certainly, there's a ton of uncertainty as it relates to Russia, but commodity prices in general are going to come down if demand growth is slowing around the world, and particularly in the US.

BRIAN SOZZI: So Dennis, where do you fall in this debate right now that a recession might take hold later this year or early next year?

DENNIS DEBUSSCHERE: I think the odds of that are extremely low. So where I fall in the debate is I think that it's way overblown. And you see it in market pricing. The short curves. So like, your three-month bill through 18 months is at a record steepness. So yeah, the long curves are flat or slightly negative, but near-term recession risk, whether you see that in credit or other measures like I just mentioned, is extraordinarily low.

So I don't see the-- I think it's very hard for the Fed to raise rates enough to cause a recession. It would have to happen, you know, based on some shock that, you know, I'm not-- none of us could really call for. So just very low odds. I think next year and maybe the latter part of next year is when recession risk is probably above where consensus is.

JULIE HYMAN: Let's hope that that shock doesn't happen. Dennis, thank you so much for being here. It's good to see you. Dennis DeBusschere, 22V Research founder.