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Inflation is investors' top concern -strategist

RiverFront Investment Group's Rebecca Felton tells Reuters' Fred Katayama inflation will be temporary but could be painful. She explains why she has raised her allocation to fixed income.

Video Transcript

FRED KATAYAMA: Inflation jitters sending stocks on Wall Street south Monday afternoon. Let's get some views on the implications of inflation for investors for Rebecca Felton, she's Senior Market Strategist at RiverFront Investment Group in Richmond, Virginia. Good afternoon, good seeing you again, Rebecca.

REBECCA FELTON: Good to see you as well. Thank you.

FRED KATAYAMA: Rebecca, you see inflation as temporary, not entrenched, but if that's the case, if you're a long-term investor is it necessary to hedge against inflation or if not, if so, what steps should you take, what should you buy?

REBECCA FELTON: Well, we're not necessarily suggesting hedging against inflation per se. what we do believe is that it is transitory and that by the end of the year things will have settled out a little bit. But that doesn't mean it won't be painful while we work through some of the experiences we're seeing right now.

And obviously, as we navigated through Q1 earnings reporting period with management teams really noting that as their chief concern. I think it was over 30% of companies reporting noted inflation as a concern and we had really expected taxes might be at the top of their list but it was inflation and we're hearing everything from cost of shipping, inability to attract workers, there all sorts of reasons. But it should settle down as we navigate through this pandemic comparison if you will, against last year at this time.

FRED KATAYAMA: You say painful, how painful can it be for equities?

REBECCA FELTON: Well you know, the markets don't like uncertainty, right. That seems to be particularly at a 22 times forward earnings multiple, uncertainty is problematic. And as inflation works its way into potentially impacting earnings negatively next year, you know, we've got a 30% plus growth rate for 2021 versus 2020 but then when you look ahead to 2022, you have consensus still moving around a little bit.

So you have to wonder you know, we've grown into this multiple if you will when we've seen the growth trajectory resume in earnings, but then what do earnings look like for next year? And right now consensus is probably settled in at around a 10, 12 growth rate. So I think that there's a lot to digest if you think of it in those terms.

FRED KATAYAMA: Rebecca, looking at your notes, you're optimistic about the outlook for the US equity markets. That being the case, why are you boosting your allocation to fixed income?

REBECCA FELTON: Well, we believe that what we're going to see with equity markets here is probably they're going to grind forward a little bit you know, one step ahead, two steps back, but ultimately, work through this again digesting the expectations for maybe headwinds with earnings next year. We still have some policy uncertainty, right. They have not determined how we're going to pay for the infrastructure spending that we know that this administration wants to do. Now there's some encouragement over the last week that there's progress in terms of bipartisan progress. The Republicans have been instructed by the president to come back with their own proposal.

So getting that cleared up could absolutely be positive for markets in terms of how we're going to pay for the infrastructure spending and that could alleviate some of the pressure in the near term. Because we believe fundamentals are very positive obviously, with the earnings growth that we just talked about, as well as the fact that the consumer has come back, retail sales last week were somewhat disappointing but you still have year over year comparisons of 50% plus. So the healthy consumer at 70% of GDP, that's a big deal. The housing market is obviously very strong. And while unemployment has been uneven from week to week. The trend is still positive, we're down at you know, in the 6s, which is still a far cry better than where we were this time last year. So we think there's a lot of fundamentals in place that can move equities ahead.

FRED KATAYAMA: All right, if you've got cash on the sidelines in what equities would you put your money into and what fixed-income investments should they put money into?

REBECCA FELTON: Well, you know, from a fixed income standpoint to your point, we did just increase our allocation to fixed income but that was as much as anything about buffer right, against downside volatility. We still prefer equities over fixed income for long term in terms of the total return vehicle because rates are still so low and your dividend growth rates are better. But if you're looking at the equity sectors that we like we are still overweight technology, not as much so as we were, we prefer software services inside of that.

But we've also boosted our exposures to some of the more cyclical sides of the market, industrials, we are overweight inside of industrials, to infrastructure, more construction engineering type of places. We also are overweight discretionary. We have neutralized energy and materials, we're still not willing to go overweight there.

And if you then look at the fixed income side of the equation we've got some exposure on the short end as well as the long end, so it's sort of a barbell approach. If you think of it from a style standpoint we like to say that we're sort of straddling the fence between growth and value. Again, with the sector differences that I just showed you or mentioned to you in terms of where we're overweight. We think that it's really prudent right now to be selective and to not go one way or the other in terms of that growth-value paradigm.

FRED KATAYAMA: OK thank you, Rebecca. So optimistic overall but with a buffer in case there's volatility.

REBECCA FELTON: Yes. With a buffer, yes.

FRED KATAYAMA: Our thanks to Rebecca Felton of RiverFront Investment Group. I'm Fred Katayama in New York. This is Reuters.