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Inflation is ‘the 800-pound gorilla’ in markets right now: Strategist

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Doug Sandler, RiverFront Head of Global Strategy, and Brian Jacobsen, Allspring Global Investments senior investment strategist, join Yahoo Finance Live to discuss investing amid market corrections, how consumers are positioned, inflation, China, and the Fed's interest rate hikes.

Video Transcript

[MUSIC PLAYING]

- And that was the closing bell on a Wall Street sponsored by Tastyworks, Dow, S&P, and NASDAQ all closing to the downside today on worries over an economic slowdown. Also what higher inflation might mean here for the market. Dow closing off the lows of the day, off 269 points. S&P off about 1%. The NASDAQ off 7/10 of a percent. In terms of the sector action that we're looking at today, all 11 of the S&P sectors closing in the red. Biggest losses coming from real estate materials weakness there, industrials, technology, utilities, financials among the biggest laggards.

Well, for more on today's moves and also what we could expect going forward we want to bring in Doug Sandler, RiverFront Head of Global Strategy. And Brian Jacobsen, Allspring Global Investment, a senior investment strategist. Brian, let me start with you. A down day losing some momentum that we have seen recently, worries over an economic slowdown. How do you see things shaking out or coming to be over the next couple of weeks?

BRIAN JACOBSEN: Yeah, my crystal ball is actually a black and it's a bowling ball. So I'm not exactly sure. I can tell you that at least here at Allspring on my multi-asset team the way that we're trying to position portfolios is anticipating that we haven't escaped this correction, call it a bear market if you want to even though it isn't down quite enough to constitute one of those. We haven't quite escaped this yet. We don't think we're going to really be able to get through some of this angst in the markets probably until more the middle of July. Once we get into earnings season and we see whether or not the outlook, the guidance that we get from companies is more positive or negative. So we're actually somewhat cautiously positioning our portfolios, kind of sticking a little bit neutral in terms of the overall risk exposures with a slight bias towards more defensive and low volatility parts of the market.

- Doug, do you get a sense the markets are waiting some data? And are they awaiting the inflation number for later in the week?

DOUG SANDLER: I think that's the 800-pound gorilla is inflation, right? That's what started this and that's probably what's going to end it. We don't need inflation to completely turn around though, we simply need a little bit better readings than people are expecting. So we're at 8.2. If we come in better than that, I think people can start to draw or extrapolate the line down. And I think ultimately we end up between 3% and 4%. And I think the short term pain we're going through will ultimately lead to the long-term gain, which is we cut a little bit of demand. We let supply chains catch up. And then I think that's going to solve the problem and take some of the pressure off the Fed.

- And Brian, I want to talk about some of the reactions or mostly the overreactions that we sometimes tend to see as soon as a piece of data comes out or we get a snapshot from a company in terms of earnings. What's your take on how we should be sort of managing our reactions to this and the sort of signals that we should be keeping an eye on to give us a good sense of what we should be focusing on?

BRIAN JACOBSEN: Yeah. Thanks for that question. And I think that may be one of the best things that you can do when you see the market react pretty extremely to some data point is to go for a walk, right? Clear your head. Don't be emotional about the reaction. But then to actually assess what's going on. And is this idiosyncratic or specific to a company, to a sector? Or is it more systemic, something that's affecting the broader market?

And I think that we saw that as far as with some of the major retailers when we heard the guidance as far as what's going on with their profit margins and then also with inventory accumulation. You know it's been very tough for a lot of businesses to calibrate their inventory to the changes in consumer spending. We saw that with COVID as far as the sudden demand for durable goods because nobody could go anywhere. And now people are shifting from buying TVs to more travel with luggage and apparel and things like that.

And so that's tough for a lot of businesses to really kind of I think re-calibrate their own inventory too. But it is something that they will adjust to. I don't think that the consumer is in a position where they're really going to slow down their spending all that much. On my team here at Allspring we actually have a positive outlook for the consumer staples area, thinking that maybe this action, the reaction of the markets to some of the news around inventories and margins with some of the big retailers is a bit overdone.

- Doug, what do you think? Do you agree? Is some of that reaction overdone? Are you confident that the consumer is still strong at this point in the economic cycle?

DOUG SANDLER: Yeah, I would agree with that part. I think the consumer is in good shape. You look at balance sheets of the average consumer and they're really good. I mean, people paid off debt. They're getting wage gains and they feel really secure in their jobs.

But one part I would disagree, and maybe it's just a timing thing, is that things like consumer staples, utilities, I think of them as umbrellas. And the time to buy those isn't when the storm is raging, it's before the storm. And they're expensive right now and we're already wet, so to speak. So there's probably a good time to buy those, but today wouldn't be my preference.

- And Brian, just following up there about the consumer, where will we see that reflected in the months ahead? And can the consumer keep us out of a recession?

BRIAN JACOBSEN: Yeah, I think that's really the story of America, as far as the strength of the consumer and our ability to skirt recessions thanks to consumers doing what they do best, which is to consume. We have seen where wages aren't growing as fast as what overall prices are increasing as far as inflation. But when you add in the increased number of hours worked, actually they are keeping pace with consumer price inflation. And they also do have some accumulated savings, it fits to the tune of about $2.5 trillion. And if you think about retail spending is about $677, $670 billion per month.

They have enough in reserves to really carry them through a rough patch even if we do see a slight slowdown in the pace of hiring. So we'll probably see some evidence when we get into the next month when we get the personal consumption expenditure and the retail sales data. Retail sales numbers are coming out, I think that's next week or the week after, as far as with just before the FOMC meeting. And that's probably going to show that a continued shift in spending more towards services, but it doesn't mean that they're giving up on buying goods in general. So I think that the consumer is still in pretty good shape.

- And Doug, I want to ask you about what people are doing in terms of inflation hedges. As you look internationally, is there anything that looks attractive to you there, as people do try and hedge their bets in the US?

DOUG SANDLER: Yeah, well, it's inflation. I think the greatest inflation hedge is owning something that has the potential to offset rising prices. So I think about any sort of corporation earnings grow when inflation rises. So if I'm McDonald's, I can simply raise the price of French fries and that offsets higher costs. Not everybody can do it. And certainly if you own a bond, you have no ability to raise your coupon based on inflation.

International markets we're attracted to. But I would say the U.S. is probably the thing that pulls out first. So we're overweight in the U.S., we're underweight international. I'd say the place we like the least is emerging markets, and that's because emerging markets is all about China. And our view is China, the blooms come off the rose and I think there's going to be some struggle there for a longer period of time.

- Brian, you mentioned you like consumer staples before. Outside of consumer staples, what are you buying as an inflation hedge?

BRIAN JACOBSEN: Yeah. Thanks for asking that. So here it Allspring we've done quite a bit of research as far as what does well during higher inflationary periods? So if you think about it as far as the level the persistence and the breadth of inflation, all different flavors and it can favor different areas.

And I agree with Doug as far as the idea that maybe focus a bit more on quality, right? Those companies that can maintain their profit margins in the face of inflationary pressures. Because if they were able to expand them when you had rising inflation, just imagine what they'll be able to do if you actually have some pullback in inflation. Probably really begin to expand their market share.

But some areas like consumer staples do typically do a little bit better in higher inflation environments. REITs, although there's a lot of interest rate sensitivity there. On my team we actually think that yields while they can go slightly higher, probably 3.5% on the 10 year treasury, we might be somewhat topping out in terms of the move higher in yields. And so we don't mind getting some of that interest rate risk in the portfolio through an area like REITs, which do tend to move up and down with interest rates. So those are two areas that I would highlight right now would be the consumer staples thinking about those. And then focusing on quality regardless of which sector you're looking at.

- OK. Brian Jacobsen, Doug Sandler, appreciate you both being here. Thanks so much.