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Investing: 'Get used to a more volatile world,' strategist says

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BlackRock Americas iShares Investment Strategy Head Gargi Chaudhuri joins Yahoo Finance Live to discuss inflation, market volatility, jobless claims, equities, bond yields, and the outlook for central bank policy.

Video Transcript

[MUSIC PLAYING]

- Welcome back to "Yahoo Finance Live," everyone. Embrace volatility. That's the view of our next guest as central bankers around the globe tighten policy in a bid to tame rising inflation. Happy to welcome back to the show, Gargi Chaudhuri, who is the head of iShares Investment Strategy of the Americas over at BlackRock.

Gargi, always a pleasure to speak with you and get some of your insights. So help us break down this theme of embracing volatility, especially considering central bankers and what they're even grappling with or digesting this morning from the decisions from the ECB.

GARGI CHAUDHURI: Good morning. Great to be here. Thank you for having me back. So just like we saw this morning, I'd probably say a little bit of a surprise on the ECB front. Perhaps some of us had expected them to go 50 basis points. But obviously, the large expectations were still a 25 basis point hike.

So we're already seeing some of this volatility play out in the market. We saw that with the Fed in the last FOMC meeting where, obviously, they went more than expected, and they had hinted at that even prior to the 75 basis point hike. And a lot of this is coming because of the backdrop of higher inflation. And I'll also add to that, it's not just inflation. It's also about increased politicization and what that does to market.

And we're seeing that, obviously, in the Italian markets today with the resignation of Mario Draghi. So all of this to say is that investors, if you're watching right now, get used to a more volatile world in the months and years ahead and really think about looking at parts of the market that give you that lower volatility, or minimum volatility as we call it, in an effort to minimize some of the vol-adjusted return in your portfolio.

JULIE HYMAN: Gosh, how do you do that, Gargi, because it's been tough to find areas that haven't found-- that haven't been as volatile? I mean, even if you're looking cross asset, right, volatility in stocks, volatility in bonds, volatility in commodities. So where do you find that stability?

GARGI CHAUDHURI: Yeah, Julie. Great question. So you're absolutely right. When the front end, the risk-free rate in the market, is as volatile as it has been, obviously that translates over to equities, and growth equities, et cetera. What we're recommending clients do is actually focus on US MV, which is our US Minimum Value-- Minimum Vol strategy. And that's one way in which investors can still remain invested in the market, still participate in the upside when that happens, but have a more lower volatility experience. And what we've seen so far is with US MV, every time that the market has dropped 2% or more, this strategy has outperformed about 87 basis points. So I think there are some strategies.

I would also say that with interest rates having moved higher as meaningfully as they have, I'd say that the front end, and actually at this juncture even probably a little bit further out the curve, even the belly, is beginning to be a little bit more attractive than certainly the view that we had coming into this year, where we certainly didn't like fixed income at all. But I think you're getting that better vol-adjusted carry in your portfolio, even in government bonds or front-end credit such as IGSB and SHY.

BRIAN SOZZI: Gargi, it's still early in the earnings season, but the S&P 500 earnings are tracking down 7% or 8%. But the stock reactions after some of those bad reports have been positive. Are you surprised by that?

GARGI CHAUDHURI: You know, it's been interesting. So I think there was so much macro negativity or peak pessimism or whatever you want to call it priced into the market that I think there's a little bit of a relief that's taking place or, the way I'm viewing this, as that the earnings season isn't as bad as expected, so you're getting that relief. I'd love to see a little bit of the micro come back to the market.

What we've seen in the past few earnings seasons has been that despite earnings beats or misses, everything was punished. And I'd love to see a little bit more of that industry specific or subsector specific or even stock specific micro narrative that comes back to the market. And I think with rising volatility, as you know is one of our base cases, I think that we'll come back to the market. And obviously, we saw that in a couple of names such as Netflix, et cetera, earlier, and I think we might begin to see some more of that across industries going forward for the next couple of weeks.

JULIE HYMAN: So unfortunately, I have another macro question for you, Gargi. Are we going to start to see the reassertion of the inverse relationship between bonds and stocks? Because obviously, that has been a big spoiler for returns this year.

GARGI CHAUDHURI: I think so. I think so. I think that we're getting to some level-- so, for example, the 30-year real rate right now is back at above 1%. I mean, that's obviously the inflation-adjusted real rate. I think as we get back to some of these, call it, 3 and 1/2% on 10-year treasuries, I know we're not there yet, but as we start to move higher in real and nominal rates alongside as we slow down, as we begin to see some of the data worsening-- I mean, I know you guys focused on the Philly number out this morning.

We're seeing initial jobless claims pick up just a little bit. As the data probably continues to worsen, as the Fed wants it to do, they want to tamp down on demand, I think the negative correlation between equities and bonds can return because obviously that income, and especially that volatility-adjusted carry, begins to be pretty superior again, especially up in quality in the fixed income markets

- Gargi, just following on something you said with regard to this broader earnings season. Given that there is so much of this move off of just relief, that it's not as bad as it could be, perhaps, would that kind of put in place or set in place a bear market rally, even, that we might see over the course of this earnings season? And how kind of aware should people be about that potential and the potential for even more downside even on the other side of that?

GARGI CHAUDHURI: Yeah. So a few important things, obviously, coming up. We heard from the ECB. We're still hearing from them as the press conference continues. But all eyes obviously on the Fed for next week, right? So expectations are that they will go 75 basis points, or at least that's my expectation, that they won't get to 100.

But I think what matters is how they guide us for the rest of this year and next year. And look, if they are telling us that they're going to take that funds rate a lot past neutral and they're going to be excessively restrictive, I think that probably poses some downside risk for the equity market because that will show the market that they don't care about putting the economy into a recession. What they care about is bringing inflation back to 2%.

Now, as you know, and I've spoken about this in the show before, we think that a lot of inflation is supply side related. It's not likely to come back to that pre-pandemic level of 2% anytime soon. So the Fed should actually learn to live with higher inflation.

And what that means is they should stop after they've gotten through, call it, maybe 3 and 1/4% or so on the Fed funds rate. And if that happens, and if they can actually signal that effectively, perhaps in the next meeting, perhaps in the September meeting, and so on, I think that could be OK for the equity markets. I hope that the second half won't be as bad as the first half. But a lot of this relies upon the Fed and how they deal with this trade-off between growth and inflation going forward.

BRIAN SOZZI: Good point, indeed. Gargi Chaudhuri, BlackRock America's iShares Investment Strategy Head. Always good to see you. Have a great rest of the week.