Inflation is a ‘force to be reckoned with,’ market strategist says
Todd Jablonski, Chief Investment Officer at Principal Global Asset Allocation, joins Yahoo Finance Live to discuss inflation and economic growth as well as the strength in mid-cap stocks.
Video Transcript
BRIAN CHEUNG: Todd Jablonski, appreciate you stopping by this morning. Todd, again, a lot of eyes on that inflation report. Wondering how you're parsing through it and whether or not you think the market reaction, very positive this morning, is warranted.
TODD JABLONSKI: Well, who would have thought 8 and 1/2% inflation could be so warmly received by investors? But that's definitely the case today. You're seeing price action move very favorably for risk-on investors. And I think that's a bit of a surprise, right? I think that's a bit of a surprise for investors who had expected inflation to begin to taper, as we did as well, but likely moving down at a faster pace than most investors realized this morning.
BRIAN CHEUNG: So, again, I'm trying to kind of parse out the market reaction here. So is the interpretation that that lower inflation number, because it came in less than expected, less than what Wall Street was projecting, means that the Federal Reserve doesn't have to be as aggressive as some had feared prior to or after the jobs report last Friday?
TODD JABLONSKI: Precisely. With the moderating level of inflation, that gives investors a sense that the Fed may not have to be as aggressive. That gives optimism for investors who've really struggled, I think, to respond to not only the increase in inflation, but also the increase in short-term rates this year.
Those two forces have led to, of course, a repricing on fixed income, something people typically like to own for income and stability, but also for equities, where you've seen a tremendous rerating lower in the first half of the year on valuations. I think that's another reason why investors are willing to enter better entry points here at midyear.
BRIAN CHEUNG: Well, I want to elaborate on that point because the large gains that we're seeing today makes that bottom perhaps in the middle of June look even better, in retrospect. I guess I'm wondering, though, you've had some warning that this bear market bounce doesn't necessarily mean we've reached the bottom, that maybe we could still get another precipitous drop from here. How do you view that situation? Do you want to buy here, or do you want to wait?
TODD JABLONSKI: You know, I think investors would be wise to look at their strategic true north, what is their strategic level of equities, and own that exact amount today. We're neither under nor overweight equities because we see a balance of opportunities and risks as investors, again, digest a slowing pace of growth.
The key feature to remember here is that not only is inflation, of course, the force to be reckoned with, but also the pace of economic growth. So we do believe that caution is warranted as investors begin to digest perhaps slower earnings revisions, perhaps more negative earnings surprise, and perhaps more negative economic surprise that I think leads to some restraint for deploying risk assets today.
BRIAN CHEUNG: So when we talk about the risk assets side of the equation, obviously, the earnings have gotten a lot of attention because the story about margin pressure as inflationary factors come down, as demand also comes down, is very much a part of the near term to medium term future. So what does that tell you? Do you like certain cap stocks? You know, let's say, for example, large versus mid versus small, based off of the margin story that is kind of playing out now.
TODD JABLONSKI: I think the margin story is a key feature to an asset allocation call. But I also think you have to take a look at those valuations again. By mid-year, you found that US large cap equities remained the only expensive pocket, really, of global capital markets. But where you can find, in fact, better valuations and better pricing power than small caps is right in midcaps.
And that's why we think mid-caps are really at the sweet spot of having that pricing power and having that US domestic focus. That's one of our more favored equity asset classes. I'd also point over to the fixed income side where you can look, for example, at preferred securities as an up and risk alternative to high yield credit. Preferred securities and mid-caps, we think, are well suited for this environment.
BRIAN CHEUNG: Yeah, I was going to say, we talk a lot about stonks sometimes, but it's important to remember the fixed income side of things as well. But look, it's been a very volatile year when we talk about the rates markets, considering that the 10-year rocketed up at the beginning of this year and then actually kind of reversed as of the last six to eight weeks. So when you see yields falling and prices going up, you still want to get in here, or have you kind of missed the boat?
TODD JABLONSKI: You know, we'd recommend that investors consider an underweight to their fixed income portfolios today if you do see potential volatility and a potential surprise as investors misprice Fed action, as they misestimate inflation reads. In fact, looking away from core fixed income, there is opportunity in real assets as a substitute for that lower volatility exposure. In particular, we think commodities, natural resource stocks, and infrastructures investments can offer an alternative to some of those core fixed income holdings and be more exposed towards the cyclical inflation aspects.
