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The market now has ‘a little bit more faith in the Fed’ regarding inflation: Strategist

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Shawn Cruz, TD Ameritrade Senior Market Strategist, joins Yahoo Finance to discuss the outlook on the market, the Fed’s inflation expectations, and moves in the bond market.

Video Transcript

ALEXIS CHRISTOFOUROS: Let's stick with the markets and bring in Shawn Cruz now. He is senior market strategist at TD Ameritrade. Shawn, always good to see you. So I'd love to know if what we heard from the Fed yesterday has changed things for you when you look at clients' portfolios, the fact that the Fed raised its inflation expectations and signaled that it's going to raise interest rates at least twice by the end of 2023, even though it's still calling inflation transitory.

SHAWN CRUZ: Yeah. And I think it's interesting how the market is reacting to that because if you actually look at measures of inflation expectations in terms of some of the breakeven rates, it actually came down after what we heard from the Fed. And you maybe would have thought well, if the Fed's saying they actually think inflation is going to move higher, it's going to merit some rate increases at some point in time here in the next two years or so, then I would also expect inflation breakevens to maybe go higher as well.

But I think what this is telling you is the market thought the Fed was going to be behind the curve when it comes to keeping inflation in check. And by the Fed at least now coming out and acknowledging that there are going to be some inflationary pressures, they are going to have to tighten policy, I think the market now has a little bit more faith in the Fed to keep inflation under control.

So that, to me, was my read-through just on how some things in the fixed income complex reacted. We're also seeing the yield curve flatten out a little bit. So we're seeing yields on the front end, the two-year yield, actually, a pretty noticeable rise yesterday. And you saw the five and 10-year sort of tread water and actually even reverse and come lower here today. I think that's something that's probably going to be a little bit of an overhang on some of those curve-sensitive sectors like financials.

But I think moving forward, it really is now going to be a question of labor markets. And I think that is going to be one thing the Fed may key off of. And you also want to make sure you're keeping an eye on what they do in terms of asset purchases and tapering because I think, long before they even get to the point of increasing interest rates, which right now looks like 2023 is, generally speaking, where a lot of people do see that happening. Some think it could be sooner.

But I think they're going have to start tapering asset purchases well before we get there. And I think they're going to key off the labor market to make that determination if they continue to believe that inflation will just be transitory.

KRISTIN MYERS: So Shawn, I think one of the biggest questions that a lot of investors have right now is how they should be looking at their portfolios and making allocations in their portfolios, especially to hedge against inflation. What is the approach that they should be taking there?

SHAWN CRUZ: So one sort of generalization that you do hear in the investment community is that equities are a good place to be in an inflationary environment. So now if we say, I should be in equities. But what does that mean? There was the stay-at-home trade, which would lean towards more of a tech-heavy allocation. There's the reopening trade, which would lean towards more of a cyclical-type allocation.

I think now, because you've had such a sizable move in both of those sort of themes over the past year, a more broad-based, generally diversified approach, to me, makes sense. And so that doesn't mean it's up towards go to the NASDAQ 100 for the stay at home, go to the Russell 2000 for the reopening. I think the S&P 500, a more broad-based diversification strategy but still remaining focused in equities, makes sense right now for the time being until we get into later on this year.

And that's when I think we'll start to hear some change in terms of monetary policy from the Fed, something. Tapering might start in December. That might be a time to maybe reassess. But at least for now, going into summer and into fall, I think it makes sense to still have a pretty diversified equity allocation.

ALEXIS CHRISTOFOUROS: Hey, Shawn, when you visit us, you always bring some stock picks with you. We love to pick your brain. What do you like right now? Where are you seeing some opportunity?

SHAWN CRUZ: Well, especially if you look right now, I was looking at industrials and materials. If you do think there's going to be some bottlenecks, there's going to be a lot of demand and not a lot of supply to meet that, I think that would favor sectors like materials and industrials. And maybe today, looking at some of those industrial names, the way they're getting hit, you could use this pullback today as a buying opportunity, looking at names like Caterpillar, looking at names like John Deere, Newmont Mining.

A lot of those names, right now I think-- the pullback today, I don't think it's the start of a broader selloff. But looking in the material and industrial sectors, I think, is one spot where you maybe could do a little bit more of an allocation than what the traditional portfolio might. You might want to lean into those two sectors moving forward.

ALEXIS CHRISTOFOUROS: All right, we're going to have to leave it there. Shawn Cruz of TD Ameritrade, thanks for being with us today.