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Investors ‘are wrestling with the highest inflation we’ve seen in almost 40 years’: Strategist

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Matt Kishlansky, principal and head of asset allocation at GenTrust, and Todd Jablonski, CIO and head of asset allocation at Principal Global Investors, join Yahoo Finance Live to discuss what's driving market sentiment and how much inflation is weighing on investors.

Video Transcript

DAVE BRIGGS: To break it down, Matt Kishlansky, GenTrust Principal and Head of Asset Allocation, and Todd Jablonski, Principal Global Investors Chief Investment Officer and Head of Asset Allocation. Matt, we'll start with you on the story of the day, which was early in the day about Target and their bloated inventory, really pared back some of those losses and finished down, yes, over 2%, but not as bad as it looked early. What's your big picture takeaway from the sector?

MATT KISHLANSKY: Well, first of all, thanks for having me. I think the overall takeaway from the sector is it's a bit too early to tell what the inventory impact will be for somebody like Target. They're trying to figure out where demand trends are moving. I think the overall economy is really trying to figure that out.

As we look in at the overall market, let's talk about the S&P to start with, I think the sentiment has moved from the beginning of the year to now from kind of one of a saturday night sentiment to more like a Sunday morning type sentiment. You could almost say we've kind of moved from crypto to Pepto. There's been a little bit of queasiness about where we are as far as how far down we've come and how much more things really could cheapen from here-- they really, in a lot of ways, look fairly priced.

SEANA SMITH: Todd, what's your take on where we are right now and what we could expect to see over the next couple of weeks?

TODD JABLONSKI: Well, I think investors today are wrestling with some very difficult challenges. On one hand, you have to make an estimate of the pace of growth and the level of economic activity. And at the same time, investors are wrestling with the highest inflation we've seen in almost 40 years.

I think they put those elements together, and as the Fed moves to sort of arrest excess demand and move back into price stability, I think that bodes actually not too well for risk assets. You could see equities, fixed income, other asset classes, I think, struggle to deliver the kind of returns we've certainly seen over the past decade. I think, if anything, it's giving a lower return volatility alternatives a bit of run. It's giving real assets, I think, a bit of an opportunity to shine, even as equity, dividend, and rate beta begins to be a bit of a challenge for investors.

RACHELLE AKUFFO: And, Matt, obviously, depending on who you ask, you get very different answers about whether we're going to go into a recession, when it's going to happen, and the Fed's ability to sort of help the economy bounce back from that. What are you keeping an eye on in terms of the signals to focus on when you're making your investment decisions right now?

MATT KISHLANSKY: Well, I think, first of all, there's a pretty wild divergence, as you alluded to, to whether we're heading into a recession. We hear estimates of 25% to 30% from some economists. We have others closer to 60%. And I'm pretty skeptical, and I think we are at GenTrust, that anybody has really figured that out up to this point, let alone figured out a way to position portfolios for that potential recession.

I think the most important point to make around recessions, certainly for our clients, is that market participants have their eyes wide open and companies have their eyes wide open towards this potential recession. And I think that strikes me as pretty different than some of the other recessions we've lived through in our lifetime.

I think balance sheets have been fortified with the record issuance of debt at then-record low levels of interest over the last few years. As much as we've seen target to some extent Walmart be offsides with their inventory, it's not clear that that's true for the broader economy. And there are a number of different indices that reflect what could be relatively low inventory yields.

And, having just gone through COVID, there's been kind of a once in a lifetime exercise for companies to manage their workforce and explore all the different operational efficiencies, or inefficiencies, in some cases. So I think companies are, in a lot of ways, well prepared for this recession. Whether we're going into it or not kind of remains to be seen.

And I think that leads to the other point for a lot of investors as they stare out at a potential recession. For the first time in quite some time, investors can look out at a market that looks pretty fairly priced. They're looking at fixed income, where there's been stability in the yield curve. Certainly between the two-year and the 10-year, there's been relative stability over the last month and a half.

We look at the VIX that today went below 24, which certainly reflects that there isn't tremendous urgency from those of investors. So new cash coming into the market has a reasonable expectation that they could achieve long-term returns, and you couldn't really say that beginning of the year looking at almost historic PE and looking at incredibly low fixed income yields.

DAVE BRIGGS: And, Todd, to Matt's point about the wide range of opinions, from sunny skies to the economic hurricane that Jamie Dimon forecasts, what do you see on the horizon the rest of the summer and into the end of 2022? And to his point about companies baking in a potential recession, how will that help them weather the storm?

TODD JABLONSKI: Well, I think the Fed is going to continue to tighten aggressively. We're likely to get a couple more 50-bip moves, a couple of 25-bip moves towards the end of the year, ending 2022 with a Fed funds target rate pretty close to 2.75%. You know, what I'm really focused on is where the Fed [AUDIO OUT] from accommodative monetary policy to more restrictive monetary policy.

And that could happen, in fact, by later this year-- later in 2022. With that shift, you do expect to see a delay until it shows up in the economic activity levels. But that sort of portends economic weakness. Really, in the back half of '23 and at the beginning of '24, our economists do see the most heightened level of threat for recession in that early-2024 period.

We used a lot of different analogies, whether it's weather or whether it's athletics I think the Fed is trying to execute a splashless dive from an increasingly higher platform. That's not easy to do. And I think that it's going to be a mountain they'll have to tackle to reestablish price stability, which I think has to be the overarching goal.

SEANA SMITH: So, Matt, with so much uncertainty out there for investors who are looking to mitigate that risk, how should they be positioning their portfolio at this point?

MATT KISHLANSKY: Well, I think that they're going to be rewarded for discipline. And I think they have been so far. There's a lot of talk over the last few months that the 60-40 portfolio has failed investors, that there's been nowhere to hide. But the reality is that if you were disciplined coming into this year, there have been ways for you to mitigate some of this drawdown.

A portfolio that had a 5% allocation to commodities is down 9% this year versus a 60-40, which is down closer to 12%. So the first answer is hopefully they were well prepared coming in to where they are. I think beyond that, the challenge is to stay relatively neutral. I think at GenTrust we're, for the first time in quite some time, neutral to our equity benchmark, or thereabouts.

And I think there are really kind of two cases. There's a bull case and a bear case for equities at this point. And an investor has to stay kind of a neutral position for either.

I think on the bear case, there's a concern that rates will continue to climb even higher. And if we go-- and I agree with a lot of Todd's numerical targets-- but I think if we see the 10-year creep up to 3.5% range or even potentially higher, which we don't think is likely, but I think if we get up towards that level or above, we'll see a significant sell-off in equities.

And I think that the bears are out there saying PE peaked in January. The best case scenario for E is that we match the last two quarters' earnings. And because rates have moved up, PE is always going to be lower-- or will remain lower until rates continue to come down. So that's the bear case.

I think on the bull case, there are a number of indicators that say, we may have seen peak inflation already and there may be reason to be hopeful that some of the supply chain snarls will disentangle over the next coming months. And given all that's priced into the market already, that could be fairly bullish-- and particularly could be a Goldilocks scenario for some corporations that have already baked in higher prices expecting higher costs that then just don't materialize as much as they planned.

So I don't think we have any certainty towards that path. And therefore, the discipline is to remain balanced, such that you can withstand movements in either direction.

SEANA SMITH: Matt Kashlansky and Todd Jablonski, thanks so much for taking the time to join us this afternoon.