Welcome to my latest video interview. Today, I’m questioning Jim Pearce, chief investment strategist of Mayhem Trader and our flagship publication, Personal Finance. The article below is a condensed version of our discussion; my questions are in bold.

Jim, an increasing number of analysts are calling for a correction to occur by the end of this year. The potential triggers for a sell-off include a big spike in inflation, rising interest rates, slowing global growth, an international crisis (for instance, the collapse of Afghanistan), and of course a worsening pandemic. What’s your view?

Stocks are priced for perfection even though conditions are far from perfect. In addition to the factors you just mentioned, there’s also the growing reality that next year’s numbers won’t compare as favorably to this year’s numbers.

Last year was anomalous due to the pandemic, so a lot of companies reported a big jump in earnings. The estimates for next year are for a total per-share earnings increase for the S&P Index of maybe 5% over this year. And yet, nearly all of the major U.S. stock market indices are at or near record highs.

Most of the pain from rising rates probably won’t be felt until after the 2022 mid-term elections. Between now and then, I’m not expecting a stock market crash but a decline of at least 10% could easily happen.

When I started out as a stockbroker nearly 40 years ago, a decline of 10% was a big deal. But the market has become more volatile, and it has learned to live with that volatility, so we could easily have a decline of between 10% and 18%, and as we saw last year, the market could recover from that within weeks or months.

One of the big macroeconomic debates right now is whether the rise of inflation is transitory or whether it will prove “stickier.” What’s your outlook?

My outlook is some of both. The extreme double-digit price hikes we saw earlier this year, such as in lumber and used cars, will be transitory but the overall cost of living is going up so it would be misleading to categorize all of it as being temporary.

A lot of money has been injected into the economy to avoid a collapse, and the Fed will not be able to recover enough of it via quantitative tightening to prevent a long-term increase in inflation. I’m talking several years down the road.

Inflation should gather steam in 2023 once the Fed increases the rate at which it is tapering bond purchases or discontinuing them altogether. At that point, any inflation that occurs can no longer be considered transitory.

Bond yields have been retreating in recent days. What is the bond market trying to tell us?

Normally, declining bond yields suggest that slower economic growth is on the way. However, in this case the decline in bond yields coincides with the rapidly escalating rise in new cases of COVID-19 due to the Delta variant.

The economy won’t need to shut down again like it did last year, since half the nation is fully vaccinated. If this fall social distancing restrictions are put back in place, there won’t be nearly as much friction in the economy in terms of everyone being able to carry on as close as possible to business as usual.

Which sectors look particularly appealing?

I like basic materials. That’s the stuff used in building the products that you and I buy. The cost of sourcing the commodities to create those basic materials is relatively fixed, but the price at which they are sold to manufacturers is variable. I expect basic materials prices to continue rising. It’s a job seeker’s market, which means salaries will be going up which means prices will be going up.

I also think semiconductor chip manufacturers, especially those that own their own foundries, will enjoy growing demand for years to come thanks to 5G and the Internet of Things.

Which sectors look particularly dangerous?

In the near term, it’s too soon to bottom fish and start buying up travel and tourism stocks until the Delta variant is brought under control.

Some of these companies are already in precarious financial condition. A lot of them have had to restructure their balance sheets, such as issuing more debt and equity. They have some tolerance for a little more pain but not for a lot more financial damage if that occurs.

Retail stocks also are at risk of falling. They appear fully valued, so it will be hard for them to continue outperforming. A new survey from the University of Michigan showed its consumer sentiment index sharply dropping during the first two weeks of this month.

What are some of the risks that you think investors are underestimating?

Many of the risks that we’ve talked about are frequently discussed. Frankly, when one of them goes away, something else pops up. The stock market climbs a wall of worry, as the old saying goes. But what people really underestimate is the extent to which the stock market has become overvalued.

Notably, I look at the so-called “Buffett Indicator,” which is a ratio that compares total U.S. stock market value as measured by the Wilshire 5000 value to the gross domestic product of the United States. The ratio currently is higher than it has ever been.

Name an industry that stands out, in your mind, as a superb investment opportunity right now.

I don’t normally use anecdotal events as the basis for an investment recommendation but in this case the opportunity is too compelling to ignore. This is based on my own personal experience with chronic arthritis. I’ve tried everything, but nothing really worked until I applied for medical marijuana certification in Virginia.

I don’t like the idea of constantly taking painkillers, so my physical therapist convinced me to try medical marijuana. Since then, I have felt considerably less pain in my knees and back. Marijuana is the first product that has done that for me.

Marijuana isn’t just a trendy thing. I know it works, and I know how big the numbers are when you start thinking about how much money is being spent on treatments and medications that don’t work that well. I’m really excited about the marijuana sector, and I feel it is a huge growth opportunity a lot of people are overlooking.

Thanks for your time, Jim.

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John Persinos is the editorial director of Investing Daily. Send your questions or comments to mailbag@investingdaily.com.

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