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Inflation: The energy market is ‘the wild card' amid the Russia-Ukraine war, strategist says

PNC Asset Management Group Chief Investment Officer Amanda Agati joins Yahoo Finance Live to discuss the state of the labor market, the February jobs report, and volatility across the oil and energy markets as the Russia-Ukraine war continues.

Video Transcript

JULIE HYMAN: And let's talk about how people should and are trading this report, as well as, of course, the backdrop with Russia-Ukraine. Amanda Agati is joining us now, chief investment officer of PNC Asset Management Group. Good morning, Amanda. It's good to see you, as always. So looking at this jobs report, seems like we're still on track for 25 basis points. But when you look at this economic backdrop, what does it tell you about where people should be looking in the stock market right now?

AMANDA AGATI: Well, there's so many dynamics at play here, but it does feel as if we are on track, as you said, for a 25 basis point hike. Powell all but confirm that in his testimony with Congress. We think that's the right first step. We felt right along that 50 was way too aggressive right out of the gate. Then when you layer on the Russia and Ukraine conflict on top of that, there's just too many moving parts here to move that aggressively.

I think net, net from our perspective, we're telling our clients that we prefer US over international in terms of equity exposure, larger over small, and really a growth tilt over value. And it's really reflective of the very shifting macro backdrop that we're seeing. Larger tends to be a bit more defensive. Certainly, we're seeing that play out on a year-to-date basis.

Growth is really somewhat of a contrarian point of view here, as everybody has sort of felt like that got way overextended from a trading perspective. But we actually think there's a lot of defense and quality and fundamental characteristics that continue to power through despite this shifting backdrop. So nothing is table pounding cheap out there, despite the reset that we've seen. But there are definitely pockets of opportunity.

BRIAN SOZZI: Man, I would say this was an inflationary jobs report. Upward revisions to the prior two months, a little under 100,000, I believe, in a better than expected print. Why does this market continue to just, I would say, laugh in the face of these higher inflation readings?

AMANDA AGATI: Well, the market, I think, is much more focused at the moment on what's happening with Russia and Ukraine. The market's really focused more on the headlines and headline risks related to that. And so there is a bit of looking past some of these near-term indicators. I think from our perspective, the report today clearly is positive. It's a step in the right direction, but it's been a very uneven recovery as it relates to the labor market.

And so, again, I come back to this idea that the Fed does need to take action. It certainly needs to take a step in the right direction here. But I don't see anything in today's report that suggests they need to move that aggressively right out of the gate. And so I think the market is able to work through some of what we're seeing in terms of the headlines because we're starting to get some clarity on how far and how fast the Fed is going to move.

But the wild card still continues to be, I think, what happens with the energy market as it relates to Russia and Ukraine. Historically speaking, geopolitical disruptions do tend to create pretty volatile backdrops in the short run for markets. We're definitely seeing that right now. But that's been a theme really since the onset of the pandemic. The wild card always tends to be what happens with energy. Are we going to see structural disruptions to the energy markets? When that starts to come into the narrative in a significant way, that's where markets tend to struggle for a more significant period of time.

BRIAN SOZZI: I hear you on all that, Amanda, but if the market is focused on Russia and Ukraine, that event is really the reason why you've seen Brent crude almost at $120 a barrel this week. And maybe I'm reading too much of my dusty old CFA textbooks, but doesn't that mean a company like a FedEx here is at risk? And not to single out FedEx, but a company like that, multinational transport company, they're at risk from an earnings warning in the first quarter, just not delivering up to Wall Street estimates because of the inflation they are, in fact, seeing.

AMANDA AGATI: That is absolutely a key risk. Let me just step back for a second and say Q4 earnings season, while, clearly, prior to all of what we're seeing right now, came in well ahead of expectations, and we saw really strong positive revisions and positive guidance for 2022, Q1 is definitely going to be a wild card. We're going to have to watch very, very carefully what happens with rising input costs, wage pressure certainly. Now we have the energy story coming into the equation.

So I do think that there is an element of risk to it. But I also think that the underlying fundamental story is pretty strong. We have margins and profitability sitting at all-time highs, cyclical highs, even relative to prior cycles. And so there is a little bit of room, I think, and headroom, shock absorber, however you want to describe it, for companies in the short run to absorb some of these increasing pressures.

Wild card again-- the longer this continues, obviously, the more that potentially erodes profitability and earnings growth. But I think over a quarter or so, companies can manage through it OK. It's not going to be pretty, but I think companies can handle it all right.

JULIE HYMAN: Well, and it does seem like at some point, this will be resolved. And to be grim, I mean, short of nuclear annihilation, you know, life goes on. Eventually, you will see some sort of resolution, obviously, acknowledging the terrible human toll that this is already taking. But given that, how do you look past, right? And how do you perhaps put this in the context of other geopolitical events that we've seen in the past and how they've affected the market?

AMANDA AGATI: Well, we spent a lot of time looking at geopolitical disruptions through history. Going all the way back to the 1960s, a number of scenarios that we can tie some similarities to. In most cases, over a week, a month, a quarter or so, the markets have been able to shrug off those tensions and disruptions and forge a path higher, at least forge some stability, and then ultimately, a path higher.

The two scenarios, going back to the 1960s, where the market continued to struggle, it's really the oil embargo of '73 and when Iraq invaded Kuwait in 1990. Those led to fairly significant extended periods of pressure for markets. And so that's why I said earlier, you know, we're very fixated on what ultimately happens with energy markets here because that really tends to be the key variable and key driver.

We haven't seen meaningful disruptions, even though prices have responded very significantly. Acute spiking, right? Acute signs of stress building here, but we haven't necessarily seen structural impairments in energy markets yet. And I think it's also very indicative why policymakers have really been very careful to thread a needle with rhetoric, policy implementation, sanctions, et cetera, to be very targeted, so that they're going after the financial aspects of Russia, as opposed to shutting off Russian oil production to the globe.

That will have very significant sweeping effects that hasn't been on the table as of yet. It's obviously a tool in the toolbox. And while that is not our forecast necessarily, that is where we might start to see meaningful structural impairment in energy.

BRIAN SOZZI: Do you think the Fed has a freak out moment later this year, where they finally realize that, you know, despite what's going on with Russia and Ukraine-- I'm just assuming that the event goes on for some time-- that they are well behind the curve on inflation, and they're going to have to drop the hammer with a 50 basis point rate hike?

AMANDA AGATI: Well, I think a 50 basis point rate hike is certainly a possibility. That being said, I'm not necessarily convinced that the Fed is fully behind the curve. I know I'm sticking my neck out in a big way and saying that relative to where the consensus view is, but coming into this year, we actually felt like comparisons were going to take some of the inflationary fire out of the backdrop, all else equal. We thought supply chain normalization will also help.

And so there were a number of factors in the fundamental backdrop. Also that shift from durable goods, buying like crazy, to potentially more of an emergence from the pandemic and the lockdowns, and a shift to more services, leisure, hospitality, travel, et cetera might also be a key to helping take some of the inflationary fire out of the backdrop.

I definitely think that the Fed needs to act. Our economics team thinks that we'll get about five rate hikes this year, all else equal. So I think 50 is certainly a possibility. But I'm not necessarily convinced that the Fed is really that far behind the curve, because we were coming into this year thinking that some of this was going to settle on its own. And so we were actually concerned, when there were a lot of conversations even a month ago about an intrameeting hike and that it needs to be 50 or more right out of the gate. We thought that was way too aggressive, given the backdrop.

And so we're not thinking that the Fed is necessarily behind the curve, but they are going to have to continue to chip away at it. The wild card, of course, is what's happening with Russia and Ukraine. And so I think that is going to slow down this potential for supply chain normalization. And so the inflationary fire may certainly linger with us a lot longer than anybody would like. But I think the Fed can take systematic action here to get it under control.

JULIE HYMAN: Oh, we all hope that you're correct, Amanda. Amanda, good to see you on this Friday morning. Amanda Agati is chief investment officer of PNC Asset Management Group. Thanks, as always, for your perspective. Appreciate it.