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Inflation: ‘I don’t see particular evidence’ that it’s peaked, strategist says

In this article:
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Melissa Brown, Qontigo Managing Director of Applied Research, and Sean O’Hara, President of Pacer ETF Distributors, join Yahoo Finance Live to discuss the inflation outlook, the Fed's interest rate hikes, economic pressures from Russia-Ukraine peace talks, and CPI data.

Video Transcript

DAVE BRIGGS: And there's your closing bell for this Tuesday, April 12. So much for Bitcoin being a hedge against inflation. A quick look at those numbers Jared just talked about, a lot of red on the board. Dow, S&P, NASDAQ all dropping. Again, it is the NASDAQ, once again, leading the fall, down just 0.3%, but muted losses for the indices on the day.

With that, another hour of Yahoo Finance Live. Dave Briggs, Rachelle Akuffo, Brad Smith here breaking down the markets, how they reacted to the CPI number. Let's bring in our panel. Melissa Brown, Qontigo managing director of applied research, and Sean O'Hara, president of Pacer ETF Distributors, nice to see you both. So Melissa, let's start before we dive into the markets with the CPI number, 8.5%, up the highest since 1981. Is there any good news here? Has inflation finally peaked?

MELISSA BROWN: It's not clear that inflation has peaked. Maybe it could level out at this high level. But I don't see any particular evidence that it's peaked out. And so it's really been hard to find-- for me to find good news in this inflation number.

RACHELLE AKUFFO: So Sean, as we look at this, then, obviously, the markets were already bracing for a high inflation number. Still came in slightly higher than they expected. But we were expecting this much of a sell-off following that announcement.

SEAN O'HARA: Oh, thanks for having me, first off. You know, I think there's going to be some difficulty going forward. There's almost an inverse relationship between rising rates and rising inflations and PEs. And so for the last decade prior to the last year or so, we've had a free ride-- loose money, low interest rates, no inflation. You can expect to pay higher multiples for stocks. I think going forward, we know the Fed's going to tighten. They're going to start reducing the balance sheet. And inflation looks like a challenge.

And so what I would say to investors is, it's time for you as an investor to lower your overall portfolio's PE ratio, price to earnings, before the market does it for you. That doesn't mean you need to get out of stocks. There are places to go in this market to make profits. We have two large funds at our-- I was saying just before we went on air that our large cap US fund was up for the day. But that's because we own low PE, high free cash flow for names in that portfolio.

And so I think that's the general view from our perspective, is that it's going to be difficult, unless we can get inflation under control, because it looks like the Fed is going to continue along their path. And it's kind of a scary thing to me if we're sort of sitting here, hoping that the Fed chickens out and stops raising rates, but it's not a surprise what happened today.

I think there's more tough days ahead as inflation and interest rates continue to persist. And what will really be a challenge is if we don't get the 5% to 7% earnings growth that we expect after the robust earnings growth over the prior year. But things come in a little below that. Then I think things will get even more difficult.

BRAD SMITH: So a lot of the market activity today for sure pricing in what the Fed may or may not do, and especially with the economic data reading that we did get on the CPI front, but then additionally, on the international conflict side, around midday, you actually had Russian President Vladimir Putin speaking at a joint press conference with the Belarusian president and saying that the invasion of Ukraine is going to proceed as planned ahead. And peace talks have reached a dead end. To what extent, Melissa, do you believe that the markets were actually paying close attention to that as well?

MELISSA BROWN: Well, I'm sure the markets were paying attention to that as well, although that inflation number is just so eye-popping that I think investors have a hard time knowing what to focus on, because I think those are two pieces of very bad news. But I think in terms of the markets, the inflation is the important number, not-- maybe not for tomorrow, but looking out because, typically, historically, wartime has not necessarily brought markets down. Now, obviously, there are other many horrible things about war, but it typically hasn't been so horrible for markets. But inflation-- high inflation has been.

DAVE BRIGGS: So let's get back now to those earnings you talked about, Sean. Tomorrow, we start seeing the first of the big bank earnings come in. JP Morgan will be the first. How important are those? What are your expectations? And how important is the language that we hear from execs like Jamie Dimon?

SEAN O'HARA: Yeah, so we're coming off of really easy comparables. You know, and we had earnings growth of 30%, 35%, 40% in some cases, but that was because we were coming out of the pandemic. I think what will be most important to see is, number one, do we get that 5% to 7% earnings growth over last year's number that everybody expects?

And then I think we should be listening particularly closely for guidance, as you mentioned. Because guidance will tell us what they see that is going on day to day on the ground in the companies. And that guidance will tell us whether things are going to get better or stay the same or perhaps turn worse.

RACHELLE AKUFFO: And Melissa, to that point then, as we look at the picture, as we see perhaps inflation persisting, we know that consumers are still willing to spend. But depending on how long that lasts, at what point do you think we might start to see that eating into earnings?

MELISSA BROWN: Well, again, as Sean just said, I think we'll have to listen very carefully to what the guidance is because it may already have started to eat into earnings. And maybe not necessarily for the banks, but when the consumer companies start to report, and we're seeing some evidence actually underlying that, particularly in consumer companies have become much more volatile recently, as compared to where they ended last year, for example. And so I think there's already some concern about the consumer. And so if it doesn't show up in earnings, that will be good news. But if it does, then I think we'll have to watch that very carefully.

BRAD SMITH: Sean, from your perspective, what do you believe the best portfolio positioning is, heading into an earnings season where you could see an impact to some of the forward guidance that companies are offering like this?

SEAN O'HARA: Yeah, I mean, I think the consumer side, you buy staples versus discretionary. I think the consumer is going to get tapped out at some point. High inflation, high gas prices, high food prices, which are not going to get better. So overweight staples on the consumer side. I would overweight energy. That's just an obvious thing to me, with what Putin said today that war is not going to end anytime soon. It doesn't look like, so I think more potential global disruptions on the energy side. That's good for the energy companies in terms of their profits and their free cash flow.

Overweight materials, which is an inflationary patch. We own US Steel, for example, as one of our names. It's not a cocktail party name, like, oh, I own this great stock. I mean, US Steel is a boring, old company, but it's up, like, 22% or 23% year to date and still trades at three times earnings.

And then lastly, health care. Health care has grown its free cash flow in lockstep with technology for the last 15 years. It's grown its earnings almost as much as technology, up 130% the last six years versus 162%. But stock prices only went up 130%, whereas technology went up almost 400%. And so that's a safer equity portfolio, given some of the turmoil.

So, again, lower your overall portfolio PE. Find the places to be that makes sense in this environment before the market does it for you because if inflation continues, interest rates continue to rise. We're going to go back to normal PE ratios, which are not 20, 22, 24 times. They're going to be 18 times, 16 times. And so if you're an investor in the markets, find the place to go, and get a portfolio that works for what's going on today. Don't go away from stocks entirely.

DAVE BRIGGS: Melissa, Fed Governor Lael Brainard stated the obvious today-- getting inflation down is going to be our most important task. The question being, will they find that soft landing? How big a risk do you think a recession is next year?

MELISSA BROWN: I think either maybe the Fed didn't act soon enough, or the consumer, as consumers pull back, they're going to cause the recession, even excluding what the Fed does. So I think it's going to be really tough to find that soft landing. Just maybe they should have tried to do it sooner. But it's tough. I think they've got a very fine line that they need to walk.

RACHELLE AKUFFO: Indeed, and as you mentioned, that late start there certainly not helping. A big thank you to our market panel today, Melissa Brown, Qontigo managing director of applied research, and Sean O'Hara, president of Pacer ETF Distributors. Thank you so much.