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Supply chain disruptions, wage growth are key factors for inflation outlook: strategist

Yahoo Finance’s Julie Hyman, Brian Sozzi, and Myles Udland break down today’s market action and outlook with Liz Ann Sonders, Schwab Center for Financial Research Chief Investment Strategist.

Video Transcript

As we look at earnings season, we can kind of start to draw some conclusions about what we have learned. Liz Ann Sonders going to help us do that. As well chief investment strategist at the Schwab center for financial research.

Liz Ann, it's good to talk to you at all. Good to talk to you, as always. Wow. I guess it is the end of earnings season because I can't speak anymore.

So Liz Ann, as we look back here, you know, there's been all of this talk about whether we're at peak earnings. We just-- we're having that discussion regarding Walmart kind of where does it go from here.

How are you thinking about earnings in that way in terms of I know you can't talk to about Walmart, specifically but in terms of sectors, where we might have peaked, and where there's more room to go.

LIZ ANN SONDERS: Yeah. So I think it's almost unquestionable for second quarter to be the peak. Not growth, but growth rate. So earnings will continue to grow. I think the consensus for the third quarter is as close to 30%.

But I don't think we're going to beat the nearly 100% gain in the second quarter. But there are a vast sector differences. Energy has been a big swing factor for obvious reasons given the fluctuation in oil prices.

I think what's really key looking ahead is the profit margin story, which so far, they've been maintained at a pretty high level. But given the ongoing wide spread between input prices and final goods prices, I think the profit margin story becomes maybe even more important than the headline earnings story next quarter.

- Liz Ann, you're just staying on Home Depot in a Walmart. These companies that we're seeing slowing growth from them. And to me, that is indicative of a maturing economic cycle.

And to that end, where do you go? Where should you invest? What companies could are good investments in when you're in fact seeing growth?

LIZ ANN SONDERS: So I think that the focus should be more on sort of factors or characteristics than either sectors or styles. I think especially in this world of still popular passive investing. Often people either gear themselves toward a particular sector, or style indexes. Large growth small growth large or small value.

But the factor-- the factors I should say that have been outperforming all year. And I think will continue are tied to quality within growthier sectors, within more value oriented sectors.

So strong balance sheet, strong actual earnings growth, strong free cash flow yield, to sort of a quality value factor in there. We only have one outperform rating right now on sectors, which is health care. Because we think it offers that hybrid of decent value still growth characteristics.

But if you're a stock picker, I would focus more on those factors around quality, and not limit yourself at the sector level or at the style level.

- You know, the same we talked to a number of folks this summer who have talked about the idea of the market going through a rolling correction of sorts. And you talked about these factors styles, what have you.

We've seen 10% corrections in some pockets of the market even deeper than that. But the overall index has remained elevated. How do you explain really what's been holding the index level at a record basically when there's plenty of discomfort under the surface?

LIZ ANN SONDERS: There is. And I think maybe because a lot of the real speculative excess the speculative froth that we saw earlier this year was concentrated in areas outside the traditional indexes and the leadership name. So it's clearly been in the meme stocks, and crypto, and SPACs, and nonprofitable tech.

Some of those somatic areas, where during the worst phase of their drawdowns. You're talking 30%, 40%, 50% even more in some cases.

So I think those as I have been calling them microbubbles have gotten pricked. And you've seen a significant drawdown because that's where the speculative froth was most concentrated less so in the major indexes.

Right now, though, the problem is that S&P still trading near an all time high decent breadth. But much weaker breadth statistics under the surface for indexes like the NASDAQ and Russell 2000. And that's a flooding concern because of that and on confirmation.

And Liz Ann, I also want to ask you about an interesting chart you brought us, which talks about a different kind of excess. I guess a real one, which is supply shortages. And you talk about what business leaders, company leaders have been saying about supply shortages saying the mentions of supply shortages peaked in May, which lends credence to the whole idea that inflation is going to moderate. But what other conclusions are you drawing from that?

LIZ ANN SONDERS: Well, and you've also seen it in things like I was a manufacturing supplier deliveries, which finally started to come down. The road more recently though is with the surging Delta variant, and the greater willingness, and speed with which a place like China shut things down with-- with port closures.

We could start to see that supply problem kick back in-- in earnest which-- which clearly has been a factor in the spike in many of the inflation statistics. We've seen--

So Delta also acts as a depressant on the demand side of the economy. But I think the-- the impact on the supply side, it's probably a more significant component. Meaning the weaker demand is not going to be an offset to the supply disruption. So that part of the inflation story is looking maybe a bit less transitory because of the impact of Delta.

- And just quickly, Liz Ann. What are you going to be looking at that indicator? Are you going to be looking at ISM as we go forward? What are going to be your keys to trying to figure that out?

LIZ ANN SONDERS: Well, short term, I think we're past the base effects. So the supply chain disruptions I think continue to be the big factor both short and medium term. And then wage growth.

I think key to the longer term inflation story is how sticky some of these wage increases we are seeing, whether it becomes not just a one time reset. But an ongoing issue then that potentially feeds into more of a wage price spiral.

We don't think those conditions are in place yet. But that's what I keep an eye on over the next couple several months.

- All right. We will too. Liz Ann, thanks so much. Liz Ann Sonders is Chief Investment Strategist at the Schwab Center For Financial Research. Appreciate it.