Markets likely to be ‘less dismal’ in second half of 2022: Strategist

Mona Mahajan, Edward Jones Senior Investment Strategist, joins Yahoo Finance Live to break down market outlooks during the Fed's quantitative tightening, inflation amid geopolitical concerns, and volatility forecasted for late 2022.

Video Transcript

RACHELLE AKUFFO: But for more on the markets, let's bring in Mona Mahajan, Edward Jones senior investment strategist. Good to have you back on the show. So what do you think the markets are digesting right now, as we continue to see August really not off to the best of starts?

MONA MAHAJAN: Yeah, you know, it's interesting, the last month or so the markets really climbed several walls of worry. And I think that included, not only in earnings season that actually ended up being slightly better than probably a lowered bar of expectations. That included a Federal Reserve meeting where we got the 75 basis point rate hike, but perhaps some indication that there may be a slower pace of rate hikes going forward. And then finally, of course, the inflation worry which has been front and center for investors.

We have started to see-- not only commodity prices rollover, you know, that's a volatile series, but areas like inflation expectations, consumer inflation expectations break even, inflation rates start to come down as well. So I think that combination really not only supported equity markets but helped bring yields lower as well.

We saw the 10 year move from a high of about 3.50 down to almost 2.60 levels, kind of settling in at 2.70 today. That supported risk assets broadly, especially those kind of growth tech parts of the market-- what we call longer duration parts of the market. Going forward, the question is, can those dynamics last? Especially the yields which we think can start to climb higher as the Fed continues raising rates and that quantitative tightening kicks in.

DAVE BRIGGS: And Mona, to your point, the markets really bounced with that Fed meeting. Maybe they just heard what they wanted to hear. Because today, it was Mary Daly from San Francisco, saying our work on inflation is far from done. And then Charles Evans, Chicago, says 50 points reasonable in September. But 75 would also quote, "be just fine." Did the markets just hear what they wanted to hear?

MONA MAHAJAN: You know, I think generally, the markets and the Fed are finally coming closer together. Now, of course, when you look at market expectations at Fed Funds Futures, they are expecting about 3.5% terminal rate by the end of this year and through, you know, mid next year before starting to price in rate cuts.

Now, you know, Chair Powell in his conference, somewhat endorsed or referenced that 3%, 3.5% rate or range by year end as well. That implies about 50 to 100 basis points more of tightening in the next three meetings, which could imply a slower pace. You know, those 75 basis point rate hikes may be behind us. We still have 50 basis point rate hikes, potentially, and a couple of 25s ahead of us as well.

So the direction of travel for the Fed funds rate is going to be higher. And keep in mind, some of the data we got already-- Q2 GDP growth, Q2 earnings-- hasn't yet factored in some of the 75 basis point rate hike tightening we're about to get and the quantitative tightening, you know, reduction of the balance sheet, removing liquidity of the system.

So you know, some of that growth that's already been slowing could potentially slow even further. Financial conditions could tighten from here, especially for those interest rate sensitive parts of the market. We're already seeing an impact on housing, potentially on consumer demand for durable goods in particular.

SEANA SMITH: Mona, what about the geopolitical risk. It's a huge focus today with House Speaker Nancy Pelosi landing in Taiwan. We have seen a bit of a reaction in the markets. I mentioned there at the top that there is a Chinese battery company that's now delaying plans for a North American plant. We're seeing some tech names selloff on that. We're seeing some semiconductors move to the downside. But what's your assessment of the risk that this could potentially pose to the market?

MONA MAHAJAN: Yeah, you know, we have been dealing with, and investors have been dealing with, geopolitical tension really since the beginning of this year, starting with Russia and Ukraine, which had a significant economic impact on inflation, in particular you know, oil, energy, food, grain prices all higher and in part driven by that tension.

Of course, then we kind of shifted focus to China, the ongoing lockdowns we faced this year. And now, of course, thinking about the geopolitical tension in China, potentially as investors may see it, a Russia-Ukraine 2.0 between China and Taiwan with potentially more severe impacts, especially on supply chain and those inflationary pressures.

But we'd say for now, it's still a tail risk. We don't yet see any economic disruption coming out of the region. But it's something we're monitoring carefully. The rhetoric and headlines may intensify, you know, especially as this trip progresses. But generally speaking, a tail risk for now but one that should not be ignored, especially given the potential implications.

RACHELLE AKUFFO: So then when you factor in, obviously, the data points in the economy as well as the geopolitical tailwinds you were discussing, what does that mean for what we should be rotating in of or out of, or whether you should be holding on to your cash at this point with the markets?

MONA MAHAJAN: Yeah, you know, we still recommend remaining fully invested in this market here. We think the second half will be less dismal than what we got in the first half, and could be actually interesting for investors broadly. Now, keep in mind, we do think there could be some volatility as the economics and earnings fundamentals catch up to really what the market had been projecting or maybe foreshadowing in the first half of the year when we were in bear market territory.

That being said, a lot of the work to the downside had been put in. We certainly could see yields continue to grind higher from here after coming down quite rapidly. So we'd say, generally for now, still a little bit of a defensive tilt, both in equity and bond markets.

But you know, if we start to see inflation rollover in earnest, you know, call it two, three, maybe and four inflation readings lower, that's when we really could see, you know, the Fed in earnest start to-- not only move at a more gradual pace, but perhaps endorse a pause or so. And that's when equities, we think, and markets broadly will sustain a more-- or mount a more sustainable rally.

And so that's when you may start to see the growth parts of the market really pick up. So we'd say now, defensively oriented and tilted. But if we gradually start layering in some of that growth as a barbell or a complement to your defensive positioning in the months ahead, that really puts together a nice portfolio that could be set up nicely as we enter the back half of this year in 2023.