For this week’s Big Interview, I sat down with Jim Pearce, chief investment strategist of our flagship publication Personal Finance.

I’ve known Jim Pearce for years. Jim [pictured] began his career as a stockbroker in 1983 and over the decades has managed client investment portfolios for major banks, brokerage firms and investment advisors.

Jim has a BA in Business Management from The College of William & Mary, and a CFP from the College for Financial Planning.

Jim’s also a cigar aficionado with an impressive humidor in his Virginia home. The only thing he likes more than a good cigar is making money for readers. I asked him to light up and answer a few questions about the markets.

The analyst consensus is for second-quarter corporate earnings to post negative growth, after falling in the first quarter. Two consecutive negative quarters constitute an “earnings recession.” And yet so far, earnings for the most part have been better than expected. What’s your view as to how it all shakes out in the end?

I think many investors have forgotten that a share of stock represents equity in a business. Ultimately, the value of that equity is a function of profitability since that is what determines what that business is worth. If profits are falling, then the value of that equity should fall along with it. Any other explanation is a rationalization to keep equity prices high.

Although earnings are coming in better than expected, they are still negative. As of last week, 16% of the companies that comprise the S&P 500 Index reported a blended earnings growth rate of negative 1.9%. Of those companies that also provided earnings guidance for Q3, more than half issued negative expectations. No matter how you slice it, those two data points cannot be construed as good news for the stock market.

Stocks are overvalued and yet the major U.S. stock market indices continue to hit new highs. Both Goldman Sachs and Morgan Stanley predict a correction of at least 10% in the third quarter. Does this sound accurate or unduly pessimistic?

I don’t see how we’ll get through the remainder of the year without a stock market correction of some sort. The stock market has already fully recovered from last year’s correction, and then some. However, much of that gain has been the result of expanding earnings multiples, and not from a gain in earnings.

The forward P/E ratio for the S&P 500 is currently sitting at 18, which is about 10% above its five-year average multiple, so a drop of that magnitude would not surprise me.

For the stock market to drop a lot more, there would have to be a significant macroeconomic or geopolitical event that is not currently factored into the financial models. I doubt the White House will initiate any activities heading into the next election cycle that might drive the economy into a recession before then.

What’s your informed hunch as to what the Federal Reserve decides at its meeting next week? Will the central bank significantly cut rates, slightly cut them, or stand pat? If the Fed doesn’t cut rates, how do you think the stock market will respond?

Fed Chair Jerome Powell is walking the proverbial tightrope. He wants to appease the White House, which would like to see him cut rates by a half-point now, but at the same time, he needs to leave enough room for rate cuts later on if the economy starts to stall out.

For those reasons, I think the Fed will cut rates by a quarter of a point, along with language making clear its willingness to cut again if economic conditions warrant additional stimulus. Not cutting at all would send a shock wave through the stock and bond markets, and cutting by a half-point might send the wrong signal to the market that the economy is a lot weaker than feared.

Name a couple of underrated sectors right now that are poised to take off and explain why they will enjoy tailwinds.

It is difficult for any sector to take off when the overall stock market is stagnant. That said, my IDEAL Stock Rating System indicates that energy, financial and consumer staple stocks are currently undervalued and likely to outperform the overall stock market over the next 6–12 months.

The one big positive for the U.S. economy is the very low unemployment rate, which in turn drives consumer spending. That also increases demand for credit, which is one of the major engines of the financial sector. A strong economy also increases demand for all forms of energy.

Just this week, we saw proof of that in the Q2 results released by credit card issuer Discover Financial Services (NYSE: DFS), which reported a 12.5% increase in EPS. As a result, its share price spiked 9% in a single day. Shares of electronics retailer Best Buy (NYSE: BBY) are up 15% during the past month on no news at all, just the expectation of strong performance when it releases its next set of quarterly results a month from now.

Stable energy prices are good for “midstream” master limited partnerships, such as Genesis Energy (NYSE: GEL), which get paid a fee to transport and store oil and gas. GEL is up 25% so far this year, and pays an annualized distribution rate of 9.3% to its unitholders. That’s better performance than the SPDR S&P 500 ETF (NYSE: SPY), which is up 22% thus far in 2019 and pays a 1.9% dividend yield.

The bond market is largely driven by expectations for future economic growth. What is the bond market telling us right now?

The 10-year Treasury note is currently yielding 2%, which pretty much tells you everything you need to know about what type of economic growth the bond market is expecting. That number happens to coincide with the most recent GDP forecast by the Fed, which projects a GDP growth rate of 2% in 2020 and 1.9% in 2021.

From a longer term perspective, the bond market will have to reconcile the implications of the rapidly expanding federal deficit, which could send interest rates soaring in a few years if nothing is done to bring federal spending under control.

The White House recently signaled its willingness to consider revising its recently submitted $4.7 trillion budget proposal for next year, but it will be difficult for such a deal to be consummated during the heat of campaign season.

Moreover, if some of the promises being made by several of the high-profile Democratic presidential candidates are to be believed, the federal deficit would expand dramatically to pay for universal health care, free college tuition, and the elimination of fossil fuels. Of course, most campaign promises are never kept, but there will be political pressure to increase spending in those areas.

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