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The market is in a ‘prove it period’: Portfolio Strategist

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Garrett Melson, Portfolio Strategist, Natixis Investment Managers Solutions, joins Yahoo Finance to discuss the market reaction to earnings, catalysts for the market, moves in the bond market.

Video Transcript

- Let's continue our markets conversation now with Garrett Melson, portfolio strategist at Natixis Investment Managers Solutions. Garrett, good to see you. So you just heard Christine a moment ago run through just a few of the highlights in terms of earnings for this week. I'm wondering what you are looking out for. And what do you think might be a catalyst for this stock market this week?

GARRETT MELSON: Yeah. Well, thanks for having me. You know, I think what we've seen is the persistent theme through this earnings season is, again, a lot of those Wall Street expectations have just been far too low. And that's really been a dynamic. That's colored a lot of this recovery.

Expectations revised down. So much now on the way back up. We're continuing to beat on the upside here.

One thing I'd highlight though, is that a lot of the reactions in terms of price action to these earnings haven't been quite as robust. So you can certainly argue maybe some of this was priced in even though a lot of these numbers are coming in above expectations.

I think it kind of hearkens back to an idea that we've been talking about quite a lot with clients is that I think we're somewhat in a private period. And so yes Q2 is very strong. But there's a very broad acceptance of this idea that quarter two of this year is going to be that peak and growth.

And a lot of investors and a lot of market participants are kind of forecasting a pretty rapid mean reversion back to lower levels of growth. And I think that's really kind of dominated the-- the market narrative more recently. And kind of led to some of that shifting in the leadership away from cyclicals over the last couple of months and back towards the tech story.

- I'm curious to know. I was reading in your notes, Garrett. And you talk about the markets seeming to be pricing in what you called a rapid rise to pre-crisis levels, and things that we're seeing like economic growth.

But there's a lot of signs here that some of that rise is not going to be as rapid as some originally thought, especially as we have that Delta variant right now spreading out. What do you think that's going to mean for the markets going forward, especially as we head is what you're describing more of a plateau?

GARRETT MELSON: Yes. I think this is really a key dynamic that's really colored our outlook moving forward. And it's that idea as I mentioned of a really rapid reversion to kind of that pre-crisis low growth, low inflation, low rate environment.

And I think what's really being missed is the fact that there's quite a lot of catalysts that are still in the pipeline. And so when you look at say quarter to GDP figures that hit last week, well, there's a lot of signs that not necessarily that growth is being destroyed. But it's simply being delayed and pushed out.

And so essentially what that means is maybe that peak that we're going to see this year in the second quarter is maybe a little bit lower. But ultimately, it stretches out the runway for an elevated period of growth for a longer period of time as we move forward into next year.

And I think that's a really powerful dynamic. When you really translate that back to how you can position in portfolios, it gets back to that earnings story, right? When you have higher levels of elevated GDP growth, that really does set off kind of that operating leverage-- operating leverage engine for a lot of these cyclical firms.

And so you know, I think we're still kind of in the grasps of that tech rotation. Although we've seen really somewhat of a sneaky rotation back towards some of those cyclical names. Really I'd say since the middle of July.

But I think is that dynamic starts to come back into better focus. You know, you think about it. We have all those enhanced child tax credit checks just starting to go out. We know that infrastructure spending in some form is on the horizon.

Capex, we continue to see expectations and intentions from firms rising. And a lot of that data is continuing to pick up. And again, from that Q2 GDP print, one of the bigger drags of the headline number was inventory draws.

And so as we look to the future, a lot of these companies that might be dealing with labor and supply, good supply constraints, well, that just turns into a tailwind moving forward is a lot of these companies have to restock their inventories. And I think those are a lot of catalysts for a number of others that we could certainly list off here that really support a very optimistic outlook for growth as we move forward. And I think that really does support a further rotation into the cyclical trade as we look at the back half of this year.

- Garrett, what are your thoughts on what we're seeing in the bond market right now, which continues to sort of puzzle bond traders. Because I'm looking at the yield on the 10 year today. It's off about 6% at now 1.16%.

Yet a number of Wall Street strategists we talked to are still looking at that yield hitting 2% by the end of this year. What's your take on that. And what could get us to that 2% mark in just a matter of months?

GARRETT MELSON: Yeah. So I'm not quite as bullish, or I guess bearish on rates, and being able to really reach that 2% threshold by year end. Certainly in the low ones, it doesn't really reflect that type of growth outlook moving forward.

But I think there's a couple of dynamics at play. One is if you go back to kind of that famous plot from June from the Fed, they essentially cut off the right tail of growth and inflation outcomes.

And so, you know, certainly a little bit more concern on-- on inflation. And that really kind of allowed the market to reprice this idea that the Fed would really allow things to run hot. And that essentially leads to this kind of self-fulfilling and self-reinforcing cycle of stronger growth and potentially higher inflation.

Well, that kind of scenario is off the table now. And I think rates coming back in reflects that to an extent. I also think that positioning has certainly played quite a significant role here as well.

If you look back to the surge in yields that we had in the beginning of this year, I think sentiment and positioning played a role in that surge higher and vise versa. What we've seen over the last couple of months here is a pretty aggressive unwind of some of those short rates positions. Certainly some curve steepness.

And if you actually look at some of the pension demand and from pension firm, pension funds, as well as insurance companies you can see that through the strip. So essentially, those zero coupon long bonds.

There's really a significant pickup in demand for that. I think that really speaks to this theme we've talked about for years. That there's simply not enough supply of high quality fixed income in the world to meet the demand. And that ultimately places somewhat of a lid on rates.

It might be a little bit of extreme. And we're maybe overshooting to the downside currently. But I think that really sets up a dynamic. And moving forward, that makes it really hard to bridge that 2% threshold by the end of the year, even if growth starts to pick up and outperform as we expect it to.

- All right. It's quickly becoming the debate of the year, where is that yield going to end up at the end of the year. Garrett Melson, Portfolio Strategist at Natixis Investment Managers. Thanks for being with us.