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The Fed is looking closely at wage growth trajectory: strategist

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Omar Aguilar, Chief Investment Officer of Passive Equity and Multi-Asset Strategies at Charles Schwab Investment Management, joins Yahoo Finance Live to discuss the outlook for inflation and what to expect from Wednesday's FOMC meeting.

Video Transcript

JULIE HYMAN: Given that it's the beginning of a two-day Fed meeting today, so of course, the Fed's watching inflation. We want to bring in Omar Aguilar. He's Chief Investment Officer of Passive Equity and Multi-Asset Strategies at Charles Schwab Investment Management. Omar, as you look at these questions of where prices are going up, where it might be transitory, how are you thinking through goods versus labor and whether we could see some of the increases in labor costs and the regularity of those increases be more persistent?

OMAR AGUILAR: Great question, and good morning. The whole discussion about economic growth and inflation is really what is in everybody's mind, and the market's clearly been on hold at the moment thinking about how the Fed is going to take these two forces into consideration for what they may come out of their two-day meeting. As you well described, the inflation picture seems to be divided into two areas.

One is really more related to the supply and demand imbalances that you just went through. That is mostly driven by supply chains disruptions that happened during the pandemic period, as well as significant increases in commodities. Those historically tend to be heavily transitory, as supply and demand start to meet into one place, all of a sudden, the price pressure starts to just go back to a normal level.

At the same time, commodity prices for the most part historically, they tend to go in cycles and usually higher prices tend to come down by reversion to the mean, and at some point is stabilized in some areas. So when you think about those traditional sources of inflation, those seem to be transitory and for the most part, being very cyclical.

The other part of what you just mentioned, which is clearly the part of that is more on the Fed's radar screen, is related to the labor market and the labor growth and the cost of labor. And that seems to also be bifurcated into two areas, the service sector and the manufacturing sector. In the manufacturing sector, clearly the labor cost is something that is a little easier to do just with the price power. Companies do have this price power where they can transition the price pressures on labor costs to their consumers. And that seems to be something that is already going on.

Between the fact that there is that increase in production that you can actually have an inefficiencies in the market, that could easily reduce the cost of labor in the manufacturing sectors, that seems to be something that also could be seen as transitory. However, in the service sector, which is where we saw the biggest decrease in the labor cost from prior to 2020, that's where we actually see those wage growth pressures. And that's the area that could not be transitory.

I think when people get raises, usually don't get them back or they just don't go back. And that wage growth trajectory is something that clearly the Fed is looking at very closely, because that could be inflationary. And that could go very fast. And the fact that we do have a shortage of labor at the moment, that could actually trigger a significant increase in wage growth and pressures that could put the Fed a little bit more aggressive into what their headlines might look like.

MYLES UDLAND: You know, Omar, just thinking about the markets right now and about some of these trends that have really driven the story over the last nine months, it's obviously been all about value over growth. But we're starting to see maybe some signs that growth could become, could come back in favor for investors. How are you thinking about that idea? And where are your tilts today?

OMAR AGUILAR: Yes, this is an interesting conversation that has to do with the cycle and the length of the cycle. You know, we're in uncharted territory for this business cycle and the economic cycle we're living in. We went through the fastest recession we have seen in history last year to the quickest recovery we actually saw as well. And that happened literally within months during 2020.

And if you actually think about the cyclical recovery started when the vaccine started to roll out back in November, that particular trend and that rotation towards cyclicals, that rotation that continues to be, is still going to be with us until we actually can be fully out of that part of the economic cycle. Normally the deceleration will come as economic growth hits its peak.

That in the way that we look at, we still have maybe one quarter before we can get to that point. The cyclical rotation, if you think about energy, you think about financials, you think about where we are interest rates, as long as inflation stays where it is now, that cyclical rotation continues to do well. Now that being said, there is a component of secular growth that stayed with us back in the pandemic, those winners that we had because of people working from home, because of a lot of online shopping, those trends will probably stay with us.

And I think if you see a little bit of what it is with valuations, a lot of these adjustments on value versus growth have come down to how expensive was growth last year. And as value started to just gain some ground, we see a little bit of recovery. So our continued position to be is that the cyclical rotation will still be with us. Clearly areas in international markets have not caught up to that trend and there's still lagging behind, so going to that cyclical rotation globally is something that we continue to pay close attention.

And then secondly, keeping an eye on the fact that there is some growth companies that will continue to do well even after pandemic, and that will probably stay here doing very well as people will adapt to some of the new world and the new norms of working remotely.

BRIAN SOZZI: Omar, in the 25 seconds we have left, what's your best investment idea for the slow summer months?

OMAR AGUILAR: Well, I think it's continue to stay with your risk profile, rotate towards international. We do think that as especially as Europe and the UK are seeing the rollout of the vaccines, that particular cyclical rotation international, it actually benefits as valuations are actually pretty attractive internationally, and they're reopening, which is lagging the US, will take advantage of that piece that is not fully priced into the market just yet.

MYLES UDLAND: All right, Omar Aguilar with Charles Schwab Investment Management. Omar, always great to get your thoughts. Thanks so much for jumping on this morning, appreciate the time.