US SPDR Business at State Street Global Advisors Chief Investment Strategist Michael Arone joins Yahoo Finance Live to discuss the U.S. banking crisis, investor sentiment, a recession, and the outlook for the Federal Reserve as inflation remains sticky.

Video Transcript

BRAD SMITH: Also, with uncertainty continuing to unravel in the banking industry, investors are also looking ahead to that Fed decision on Wednesday. The Federal Reserve is largely expected to hike rates by 25 basis points, as the central bank moves forward in its inflation fight. We'll discuss what this all means for the Fed with Chief Economist from S&P Global Ratings later on in the show.

[AUDIO LOGO]

JULIE HYMAN: Well, writing in today's "Morning Brief," Yahoo Finance's Brian Sozzi focuses on the wider banking sector, saying the crisis creates two key questions for investors. First, is the action to shore up the global financial system an opportunity to take on risk? And secondly, what does it do for banking stocks?

Our next guest says, despite the best efforts of government officials and central banks, investors do remain on edge regarding the future prospects of the banking industry. Joining us now, Michael Arone, Chief Investment Strategist for the US SPDR at State Street Global Advisors. Thanks for being here, Michael. It's always good to get your perspective.

It does feel like there's a little bit of tentative risk taking starting to creep back into the market. But as we know, man, that can change on a dime, can't it? So how are you thinking about your risk appetite this morning?

MICHAEL ARONE: So I think what's interesting is outside of the financial sector, things seem to be OK, in terms of the economy continues to muddle along. So the Atlanta GDPNow figure, just from last week, suggests that in the first quarter, the economy is gonna grow by a little more than 3%.

| think Brad was doing a good job of kind of highlighting some of the areas that could kind of continue to perform well. So one of the areas that we highlighted it back in November was, in fact, semiconductors. This is-- they were kind of their worst performance year since 2012. They were in the bottom 20 percentile of their valuation, highly profitable companies. And our view was that with the CHIPS Act and demand for kind of technology just generally, that this was an opportunity in something that had beat-- had been beaten down pretty aggressively.

So I think the key message here, Julie, is that selection is going to be key. And one of the things that we are really highlighting is dividend payers and growers and folks that can expand or grow their margins because that's also been an area that's been challenged of late.

BRAD SMITH: Michael, I welcome that vote of confidence in my commentary a moment ago. And that'll buy me at least two more days showing up to the desk here. I appreciate it. You know, just when we think about how investors can really shape their playbook right now during a banking turmoil that we've seen ensue and play out here, what does that playbook look like?

MICHAEL ARONE: I think you start with parts of the market that are trading at a less expensive, in terms of a price-to-earnings multiple. I also think that you want to look for good shareholder yield. So folks that are returning capital through either dividends, or buybacks, or both. And I also think, again, that kind of either high margins or expanding margins.

So getting to kind of brass tacks here, what does that mean? We still like energy as a sector. We still like industrials. 87% of energy companies are going to increase their profit margins. Now, I know the price of oil is falling and year-over-year earnings comparisons will be difficult in energy. And of course, folks are somewhat nervous that with a potential recession, demand will contract.

But energy companies only trade at eight or nine times multiples. Their margins are very attractive. And they returning capital to shareholders. Industrials is going to expand their profit margins by more than 25% year-over-year. So like here, again, we think that that's an attractive proposition for investors.

JULIE HYMAN: Michael, I don't think I've heard you say banks or financials in there anywhere. Do any-- do any of the financials, at this point, meet those criteria you were just talking about? Or is that just a sector you just want to avoid right now?

MICHAEL ARONE: I think what's interesting is that the bigger banks could be the winners here. So I continue to hear anecdotally around folks fleeing some of the regional banks and headed towards some of the bigger, super banks, like The Bank of America.

Now, Julie, you know I'm not a stock picker, per se, but it just it does seem to be a transition from some of the fears regarding the regional banks to maybe the net winners are going to be the large kind of bulge-bracket banks and that may be a shift. So maybe larger, money center banks, like the Bank of America, JPMorgan, for example, may benefit if, in fact, now all of the banks are going to have to play on the same kind of level playing field from a regulatory perspective.

And depositors who are concerned about their assets, they seem to be heading to larger banks. And I do think that those could be beneficiaries. And they do meet some of the criteria outlined. They are cheaper. They have good profit margins and they're returning capital to shareholders.

BRAD SMITH: Even as some of those larger banks consider what's taking place with regional banks and where they are either sputtering or perhaps failing in some instances, does that mean that we need to re-evaluate how we think about their own expansion efforts? Even if they decide, hey, we're not gonna go out and try and buy this regional bank or save a regional bank, but we might decide to play in the same space where we may not have already. Does that change the calculus around how some of the bigger banks may operate in the future?

MICHAEL ARONE: I don't think so, Brad. I think that those banks are already operating in some of those areas and they'd be happy to kind of continue to increase scale. And so I do think that, you know, some of these bigger, bulge-bracket banks would be interested in the opportunity to kind of move down market, if you will, and provide kind of a full service to the regional bank depositor.

I think for them because of the scale, they don't have to increase their costs so much to do that. They're happy to come along and attract those depositors and those banking clients. And I think that is what is happening now. So again, anecdotally, I continue to hear from clients that, you know, people are moving their assets from those regional banks and most of them are going to places like Bank of America.

I do think that that's a natural kind of transition. And the bigger banks could be natural beneficiaries. There's a perceived safety around moving those assets. Now, whether it's real or not, I think we'll find out. But I do think that there is this perceived safety of moving up in terms of those larger bank and deposits to those larger banks.

JULIE HYMAN: You know, Michael, you sound pretty calm here this morning. I just kind of wanted to note that because I do think there is this concern-- you know, you see the headline, European banking crisis, right? And that can definitely cause alarm for investors, create echoes back to 2008.

Are you calm? Like, do you think that this is going to end up being a bigger deal? Not just for the banking sector, but for markets more broadly, for the Fed, et cetera. Or do you think that people are getting a little too worked up about it?

MICHAEL ARONE: I'm reasonably calm. I think that it's clear that government officials, central banks, and even the banking sector is doing everything they can to contain the-- I even hesitate to call it a crisis-- the challenges within the regional bank sector. And Julie, just a moment ago, you were pointing out, even today, we look at those regional banks, a number of them are up so far this morning.

And so it seems like First Republic is continuing to struggle, but many of the other regional banks are starting to kind of rebound. And so to me, that's a good sign that some of the measures that are being taken are at least calming some of the concerns. So I'm reasonably calm at this point. I would need more information to get a little bit more frazzled. And I just don't think we're there yet.

I think, for me, the big key this week is going to be-- now for the very first time the Federal Reserve, in a meaningful way, will have to balance its finance-- its kind of inflation-fighting credibility with financial stability. They haven't had to do that yet in this tightening cycle. And this week, I think, is gonna be key.

So for example, I think it was Brad that just mentioned, 41% expect maybe that the Fed wouldn't increase interest rates. If they don't, to me, that sends a bigger signal that maybe they're a little bit more concerned, and then I would start to get a little bit more anxious. I expect them to raise rates by 25 basis points this week.

JULIE HYMAN: All right, well, we'll see what they-- we don't have to wait too much longer. The suspense only lasts another couple of days. Michael Arone, great to catch up with you this morning. Thanks so much. State Street Global Advisors US SPDR Business Chief Investment Strategist Michael Arone, thank you.