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Investors are 'throwing out anything' in 2020, looking towards 2021: Strategist

The market saw its best August performance since 1986 as tech stocks continue to rally. State Street Global Advisors Chief Investment Strategist Michael Arone joins the On the Move panel to discuss.

Video Transcript

ADAM SHAPIRO: And to help us break down just the incredible trajectory onward and upward, we invite into the stream Michael Arone. He is State Street Global Advisors. Good to have you here.

I mean, where do you want to begin, Michael? We've got a weak dollar. We've got Fed policy that's almost forcing us to go into equities. It seems like there's no other alternative for our money to invest in. What am I missing here?

MICHAEL ARONE: Well, certainly the economic environment has been recovering. We continue to see that this morning with the manufacturing data. Earnings were much better than expected-- a very low bar, but we stepped over it easily. You mentioned tremendous amount of fiscal and monetary policy. And I do think there continues to be this optimism about a potential solution for the pandemic, at least at some point in the not-too-distant future, all driving the rally.

I think what we're missing is that as we turn the page from 2020 to 2021, expectations for next year are really high. So I think, really, one of the drivers of what's been going on in this rally is we've been easily surpassing very low, very modest expectations. Next year, it's going to become a lot harder to do that. And I do think that poses a risk later on in the year, as we focus our attention to 2021.

BRIAN CHEUNG: Michael, it's Brian Cheung here. What is there to be gleaned from the bond market movement? Because despite the run-up in stocks that we've seen since, really, the end of this spring, it seems like bond yields didn't really start going up until the beginning of this month. So the 10-year, for example, up 20 basis points from where it was at the beginning of August.

What does that lag tell you in terms of how investors are approaching this current market? Does this mean there's actually more runway to go?

MICHAEL ARONE: I think there could be, and the fact that I think, really, what's happening now is 10-year yields, the pickup in those yields are finally catching up with kind of improving inflation expectations. Now, I don't anticipate a big move in inflation. But rather, we are pivoting from kind of a deflationary scare to a more normal inflationary environment. And certainly, the Federal Reserve has told us they're going to let things run a little hot. So I think you're starting to see long bond yields catch up with that potential kind of rise in inflation expectations for later on this year.

I think one of the natural conclusions is that there's this disconnect between the market and the economy. And that's mostly reflected in the fact that bond yields remain low while equities remain high. And equities maybe have it wrong. But typically, what you would normally see is defensives and other kind of components doing well if, in fact, the bond market did have it right in terms of concerns around a recessionary environment or a double dip.

That's not what we have at all. We have cyclicals doing well, growth companies doing well. So I do think that it's more likely that bond yields will climb than fall as the economy recovers.

AKIKO FUJITA: Michael, is it fair to say there is still that disconnect, though, between the real economy and what we're seeing in the markets? We've had a number of guests on who have said, look, it's just that the markets are looking six months, seven months ahead. And that recovery story remains intact down the road, even if the economic data we're getting right now just doesn't support that.

MICHAEL ARONE: I think that basically, investors have kind of thrown out anything in 2020. They're looking towards 2021. As you rightly point out, they're suggesting we're going to see a 25% increase in earnings-per-share growth next year. We're going to see a significant rebound in the economy and a significant improvement in the labor market. And they're paying up now for that improvement.

So I do think that the risk, as I was kind of saying earlier on, is that if we miss those expectations, I think that is going to be a concern. I think there's some element where perhaps we've priced in perfection for 2021. And we do have some kind of risk to the downside in terms of do we see a kind of real resurgence during flu seasons in cases? So far, markets have been able to shrug that off.

What happens if we go over the fiscal cliff and we don't have that income replacement? US-China tensions have certainly been climbing. What happens if that affects trade? And certainly, there's a lot of anxiety about the election the potential outcome, will we get a result, when will we get a result, those types of things. So I do think that there are a number of risks here later on this year that could pose some challenges for the incredible summer surge that we've seen.

ADAM SHAPIRO: So based on what you just said, we have a guest coming up later in the next two hours who's going to advise some of the viewers that they might want to consider protecting money in something like a muni bond. What case would you make for those of us who don't have time to-- you spend hours and hours every day studying different markets. For those of us who are trying to protect some assets, is this the time to be cautious? Or should we still ride the equity wave?

MICHAEL ARONE: And that really is the challenge. And that is because we all kind of recognize these risks, this anxiety we're feeling, yet the economy is rebounding. Earnings are doing better. And we have this massive monetary and fiscal policy that has provided this bridge from recession to recovery.

So it's difficult to get overly defensive. So what I suggest is a balance of growth assets, for example, in areas that have high organic growth rates and competitive advantages and compound cash flow. So we like technology. We like consumer discretionary.

Fixed income, you can't get anything. Brian was asking me the question. You can't get anything from typical treasury yields. So you have to take some risk. So why not invest alongside the Fed in corporate credit, for example, pick up some additional yield without taking on too much risk?

And finally, to hedge against all kinds of these unexpected, we think having some allocation to gold makes sense. So I do think it is kind of a balance of those things in terms of growth potential, hedging those risks with gold, and kind of holding your nose in the fixed income arena and taking on some risk, but not too much, while investing alongside the Fed in corporate credit, for example.

ADAM SHAPIRO: Michael, I'm checking gold futures right now. They're at roughly $1,975-- not necessarily a bargain, but hey, a lot cheaper than when they were over $2,000. Thank you so much for being here with us. Michael Arone, State Street Global Advisors, all the best to you.