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We’re in ‘an equity friendly investing environment’: BNY Mellon Wealth Management CIO

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Leo Grohowski, BNY Mellon Wealth Management CIO, joins Yahoo Finance Live to discuss the outlook on earnings season, the bond market, and inflation.

Video Transcript

ALEXIS CHRISTOFOROUS: All right, want to stick with the markets now and bring in Leo Grohowski, CIO at BNY Mellon Wealth Management. Leo, good to have you here. I know that you are pretty bullish on equities right now. In fact, you're overweight equities, and you are tilting toward those large cap stocks. Make the case for those.

LEO GROHOWSKI: Yeah, we're continuing to believe that we're in what we're calling an equity friendly investing environment. And we're right in the middle of earnings, right? We're about 20% of the way through, actually, earnings season. And two key drivers to the market always, right? Earnings and interest rates. Earnings adjustments coming into this quarter, right? Coming into the third quarter, we had a lot of warnings. In fact, we had the third highest warning of any quarter in the last 10 years.

So I think expectations were more measured. And so far, with about 20% of the companies in, we're running 80% better than expected. So earnings, we believe, will continue to move forward at a nice clip. And the key is interest rates, right? As mentioned earlier, we're carefully watching this 10-year.

Our thought has been the 10-year doesn't get higher than 175, maybe 2% by the end of the year. That supports market multiples at around the 23 level. So a 23 multiple on a 200 to 205 earnings for this year S&P gets us to a market forecast of 4,600 to 4,700 this year. So we're continuing to be constructive on the equity market, based on the earnings and interest rate outlook.

KARINA MITCHELL: As you say, you know, most of the earnings that have come in so far pretty productive. They've beat on the Street. However, is this season starting to prove that the winners are the ones who have pricing power and pass on higher costs to the consumer?

LEO GROHOWSKI: Yeah, that's a really, really good point. And the market, a lot of those warnings were about supply chain issues. And our analysts are laser focused on margin pressure. So the short answer is yes. And we're seeing that even within sectors, right, differences in some of the consumer companies that are reporting, those that have more pricing power than others.

So that is going to be critical. Our sector decisions, right, are overweighting right now technology. Some of technology, particularly software, not as impacted by some of the supply and labor issues. Semis, though, a good example of an economically sensitive area that does, however, have pricing power. We're most cautious, though, on the consumer stocks. And so as those earnings roll in, I think that's where you're going to see more of the have nots with respect to the ability to passing through some of the pricing pressures that we're seeing due to supply chain and labor.

ALEXIS CHRISTOFOROUS: I know you have a target on the S&P 500 of 4,600. We are nearly there. What do you think is going to get us to your 2022 target of 4,950? What are the sectors that you think are going to be leading us there?

LEO GROHOWSKI: Yeah, it's, you know, we're really emphasizing a diversified approach sectorally and stylistically, right? I've been at this for 40 years plus now. And it's amazing how we get into the daily value versus growth. For investors with a 12 to 18-month time horizon or longer, it's going to be really important to be sectorally diversified, right? Right now, we continue to believe that the economically sensitive sectors, right, the industrials, technology, make a lot of sense.

To answer your question, though, about the target for next year, right, it's really a 23 multiple. And that's the key on an earnings estimate of around $215 for the S&P 500, which, right now, is actually feeling pretty conservative. The key will be that market multiple. And that 23 multiple, right, is a pretty demanding multiple and can only, right, be allowed by the market if inflation does, indeed, get a bit more tempered than where we are today, right?

So our inflation forecast for next year is around 3%. We think the market can handle a 3% inflation rate and still allow a PE multiple of around 23 times. And that's how we'll get to our 4,700 and change. Actually, we have a target next year much higher, 4,900 target for next year. But for this year, our target's 4,600 to 4,715 from here.

KARINA MITCHELL: And let's bring it back to right now and what we see this season. How do you expect earnings to pan out this season? And looking to Q4, as yields creep higher, how do you reposition going into the next quarter?

LEO GROHOWSKI: Yeah, it's a really good point. You know, so inflation protection in portfolios continues to make sense, right? So we do think investors should look carefully at things like Treasury inflation protected securities. So we do see inflation pressures over the next couple of months. Look, the earning season, we'd be lucky to end up at 81% better than expected, right? Some of the financial companies that report early, particularly the banks, aren't as pressured, right, by some of the supply chain issues that we've been seeing and talking about.

So we do think that settles into probably a 75% beat, still an exceptionally strong quarter. And I do think that our forecast for the year for S&P earnings of 200 to 205, if anything, might turn out to be a little bit conservative. But that's OK, right? That can still get us to that 4,600 to 4,700 level on the S&P. I should mention, too, an amazing amount of cash still sitting on the sidelines, right?

The Investment Company Institute reported yesterday, still $4.5 trillion sitting in money market funds alone. So we're still near the pandemic levels of cash. A lot of investors have been waiting for that 10% or 20% pullback. And we think a lot of that dry powder might prevent that larger correction that so many have been looking for, for so long.

ALEXIS CHRISTOFOROUS: Yeah, a good point there. Certainly is a lot of dry powder sitting on the sidelines, looking for a home. Leo Grohowski, CIO at BNY Mellon, thanks for being with us.