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Markets haven’t ‘fully embraced’ Fed hawkishness yet, strategist says

F.L.Putnam Chief Market Strategist Ellen Hazen joins Yahoo Finance Live to discuss Fed consistency, inflation, interest rates, continued volatility, economic headwinds, consumer demand, investor sentiment, and energy.

Video Transcript

[AUDIO OUT]

BRIAN SOZZI: The hawks have been out in force lately, despite some readings of US inflation showing signs of stabilizing. Fed Chair Jay Powell says the central bank will stay the course. Those sentiments echoed by the likes of Thomas Barkin and Loretta Mester. We're joined now by FL Putnam's chief market strategist Ellen Hazen. And Ellen, good to see you this morning. This week, we're gonna have a lot of Fed speak, notably by Vice Chair Lael Brainard. What do you think we might hear from these members now that we have started to see signs of inflation rolling over?

ELLEN HAZEN: Thanks for having me. I think that the Fed has been very consistent over the last four weeks or so. Ever since the market had that kind of unexpected rally after the July meeting, the Fed has been very consistent, speaker by speaker, to say that we are going to keep interest rates higher for longer as long as is necessary to tame inflation. And of course, that culminated in Chair Powell's speech at Jackson Hole a week and a half ago, where again he was unequivocal in saying that we will keep rates as high as we need to in order to tame inflation.

So despite the fact that inflation has softened a bit, from 9.1 down to 8.5, we don't think that that's sufficient evidence for the Fed to begin to soften their stance there. So we're expecting Lael Brainard, as well as others, to remain quite hawkish.

JULIE HYMAN: And so then what are the implications of that, Ellen? I mean, I think that that's-- first of all, I would ask, has that actually been priced into the market at this point? Did the last few weeks mean that stocks and maybe also the bond market have now gotten that message?

ELLEN HAZEN: They're beginning to get it but I don't think they have fully embraced it yet. So one way that we look at that is by looking at the equity market PE multiples. If we look at what happened in the month of August, the PE only contracted a few percent. If the market really believed that rates were going to remain higher for longer, the PE would have contracted by more than that.

So we think the bond market is closer to pricing it in than the stock market is. The stock market is still trying very hard to be optimistic. So we still think that we're likely to see continued volatility as the realization continues to grind into investors that rates will stay higher for longer.

BRIAN SOZZI: Well, then, Ellen, how do you navigate this environment? What moves should you be making and not making to portfolios?

ELLEN HAZEN: What we're doing is we are reducing-- and have been for several months now-- exposure to economically-sensitive areas, like retail, which is facing such an inventory correction at the moment as well as shifting consumer demand, and like some areas of energy where we may see gas prices and oil prices continue their modest decline. And we're also reducing exposure to home areas, such as the home improvement retailers and home builders, et cetera.

And where we're increasing exposure are classically defensive areas. Areas like defense, areas like pharma, and areas like consumer staples. So we don't think it's too late to be making those shifts. As I said, we've been making them for a few months. But we still think that's the right move to be making.

JULIE HYMAN: And when you look at defensive groups, how-- I mean, when rates go higher, do they just sort of navigate that environment better or are they more resistant in that environment?

ELLEN HAZEN: That's absolutely right. So the key thing to look at is long term real rates. And long term real rates have gone from being negative over the last couple of years to being positive. So that significantly affects companies whose cash flows are far out into the future.

The characteristic of defensive companies are that their cash flows are near in. So the reason those stocks are able to better navigate this type of rising real rate environment is because less of their value is embedded in those very far out future cash flows, which are the ones that are directly being negatively impacted by higher real rates.

BRIAN SOZZI: Very helpful perspective. FL Putnam's chief market strategist Ellen Hayes, and good to see you. We'll talk to you soon.