Aon Partner of Portfolio Strategy Jas Thandi and Michael Kushma, Morgan Stanley Investment Management CIO of Broad Markets Fixed Income, examine the Fed's interest rate hikes, GDP outlook, and market sell-offs.
SEANA SMITH: All right, stocks ending the day mixed. You can see the NASDAQ holding on to gains. I guess the sliver of hope in this market selloff that we have been dealing with for the past several trading days. NASDAQ closing up just around a quarter of a percent. S&P and NASDAQ, though, in the red once again. S&P off just around 2/10 of a percent, Dow closing off its lows of the day, but still off 123 points.
All right, for more on today's broader market action, let's bring in our guest. We have Michael Kushma. He is a Morgan Stanley Investment Management chief investment officer of broad markets for the fixed income team. And we have Jas Thandi, Aon Partner of Portfolio Strategy.
Michael, let me start with you just in terms of the action that we've been seeing play out in the bond market because that, of course, has been driving the moves that we've been seeing in equities. We have the 10-year yield continuing that march higher, not too far from 4%, the spike that we've seen in the two-year. What's your takeaway from that action?
MICHAEL KUSHMA: I think what we're seeing is the market throwing in the towel that the Fed is serious about raising interest rates as far as necessary in order to beat down inflation. In this month's FOMC meeting, while, on the face of it, seemed like they did exactly what everyone thought they'd do, raising rates 75 basis points, but what they did do was raise their expectation that the terminal rate, the final highest yielding on Fed funds would be 4 and 3/4, almost up almost 100 basis points from where, previously, they had estimated. And the market is embracing that in the sense that it's a reasonable expectation, given the Fed's commitment to reducing inflation.
RACHELLE AKUFFO: And Jas, we heard from Fed chair Powell. Look, he's saying I'm going to be looking at three-month, six-month, 12-month views when I'm looking at this thing. But the markets, though, seem to react to every single data point that comes out. How should they be digesting the messaging from the Fed versus what they're hearing from these data points that come out?
JAS THANDI: I think it's the data. I think the fed has made it clear they're going to be data dependent to drive their views through data. So I think the data will drive volatility going forward. What we've seen is any bit of news, you would react if the stock markets react. When we look forward, this next week is going to be a big week. We've got GDP coming up, confidence numbers, next week income numbers. And all of that is going to drive future volatility. Because that is what is ultimately going to dictate the fed's path.
As Michael mentioned, markets are more realistic now in their pricing. But I think it's-- markets really don't know how far, how fast, and how the fed does it. Because we haven't been in this environment before. So we expect the volatility to continue.
DAVE BRIGGS: Michael, if the markets are throwing in the towel, how long do they stay off-- on the mat? And what gets them up off of it?
MICHAEL KUSHMA: Well, I think we have to see some change in economic performance. Or up till now, the labor markets have been rock solid. And the fed believes, as most market analysts believe, that wages drive inflation in the medium term with US labor markets staying very tight, wages rising 6% to 8% depending upon what you what you look at. There's very little to be optimistic about that inflation will drop back to the 2% level any time soon.
So the key factor is, what will drive consumers' spending down? What will drive consumption down? What will make the labor market loosen up a bit? Then the market will say, ah, maybe rates have finally reached their peak.
SEANA SMITH: Jas, when you're trying to look for any good news here in this market, can you find something for us?
JAS THANDI: I think it's really good. I think we could end up in a world where bad news becomes good news. What we've had now is good news is bad news because the fed has to continue to tighten. But I think it's really going to come down to seeing some of that economic numbers roll over. I think it is slightly confident, and we have seen some of the growthier sectors perform OK today. But I see that bout continuing.
I don't see much out there. I think there could actually be more bad news based on what's going on with earnings right now with how that's looking for the expectations for next year, which are close to 9% earnings growth year on year for next year, which seems that it could be an adverse number for next year.
RACHELLE AKUFFO: And Michael, what do you think is the best way to position your portfolio when you do have this environment and when you have the fed looking at inflation, and then also perhaps with that lag now, of course with the real economy data behind it?
MICHAEL KUSHMA: That's a very good point, that the stuff that we're looking at, the labor market, consumption spending, consumer confidence, some of this stuff is lagging. It's looking backwards. And the danger of course is that the fed stays, it keeps its eyes on the backward looking data, the lagging data, and raises rates too far. So the danger is the fed keeps going when they shouldn't keep going because the labor market responds with a lag. Next year's wages, wage settlements, wage growth is probably depending on what happened this year, not so much what people think is going to happen the next 12 months.
So I think in terms of what we're positioning is valuations are getting better in the bond market. We haven't seen yields like this in a long, long time. As we saw, the 10 year treasury is closing in on 4%. Cash rates are 4%. I don't think-- I think it's a bit premature to get too optimistic that we've seen the peak in yields, whether it's an investment grade credit, or US treasuries, or other high quality bonds. But we're getting to the point we're on a longer term horizon looking out toward the end of next year.
The yields are getting to levels which look like OK. In other words, they're high enough to weather future volatility. But in the very short term, meaning now into the next couple of months, we think staying conservative, shorter maturity assets, short rates may have peaked. Even if they haven't peaked, they're not likely to rise by only a fraction of what they've risen recently. So it's all looking a little bit better in terms of getting enough income, which is what fixed income is about, in order to protect you from any uncertainties and volatility in the future.
DAVE BRIGGS: And Jas, we'll tag you in on a strategy with all these headwinds. You recommend investors build resilience in their portfolio. How so?
JAS THANDI: Yeah, so for us with our clients, it's really looking at things that are backed by real assets, like real estate, some type of infrastructure funds based on the Inflation Reduction Act spending that's going on. And this is all about really insulating yourselves from the possibility of the equity bond correlations becoming more positive now on a more permanent basis.
So for us, it's really about adding those assets that have less correlation to those two main bellwethers of portfolios to create that diversification for our portfolios.
DAVE BRIGGS: All right, Jas Thandi and Michael Kushma, appreciate you both being here weighing in on this tough environment. Have a good one.