The Dow Jones Industrial Average set another closing record on Tuesday. Scott Kimball, Co-Head of U.S. Fixed Income for BMO Global Asset Management and Larry Shover, D. Alexander Capital CIO joined Yahoo Finance Live to discuss.
Video Transcript
EMILY MCCORMICK: Energy, financials, and industrials the outperformers. And here’s the closing bell.
[MUSIC PLAYING]
ADAM SHAPIRO: All right. We have the closing bell. And let’s see where we’re going to settle. The Dow is going to settle up, over 200 points, about almost well a little over half a percent. The S&P 500, flat essentially down 3 points. NASDAQ will end the day down a little over 1% off 210 points. Just want to point out to you sector action today, energy sector once again on fire. It was up over 3%, almost 3 and 1/2%. I bring that to mind because as we go to the panel, I wanted to go first to Larry because you’ve pointed out that gas, energy is a kind of tax as we pay more for whether it’s at the pump or for heating on days in New York City when it’s 32 degrees.
Do you see any relief in sight? Because investors are looking at ways to play what’s going to be the increase in energy prices.
LARRY SHOVER: I think the issue is is that’s a big risk for 2022 is that is energy going to continue to be as high as it is now or even higher? And will that act, and we know it will, as a tax on consumption? We know that the consumer has been out in force in 2021. And if that gets cut away a little bit about higher energy prices, then it’s going to be hard to repeat what we saw in 2021. So that is a big risk that perhaps a lot of people aren’t covering, but realizing that it’s really the consumer that’s done a lot to drag this economy along last year.
And if energy continues to increase, it’s going to be very, very difficult to repeat.
EMILY MCCORMICK: Scott I want to turn this next question over to you. Taking in a look at the US treasury market, we’re seeing treasury yields especially for the 10 year, 20 year, 30 year yields all moving sharply higher again today. How do you think investors should be interpreting these moves?
SCOTT KIMBALL: I think it’s important to put them in the time context. They’re moving sharply higher today, or in the very recent past. But they’ve been stubbornly low when you compare them to what the inflationary talk has been. There’s been lots of discussion about runaway inflation, the fed being behind the curve, all of that would translate into a long end, 10, 20, 30 year portion of the US yield curve. That’s a lot steeper or a lot materially higher even in absolute terms than it is right now.
What we would point to is similar to what you started off talking about, energy prices. Where do we see energy prices have the most effect on the yield curve? Well immediately on the front end. Break even inflation rates on inflation linked securities, or just regular treasuries, five years at end, that’s where the energy price volatility lives. But as we transition to longer term, the consumer and the long term prospects for the economy dictate the long end. If energy prices are stubbornly high, and that does work, and I agree as a tax on consumption, which is what’s driving the US economy always, that can lead to stubbornly low, longer rates.
So you’re seeing some relief on the long end, some indications of some relief to those concerns. But relative again to where inflation expectations are, I think the long end is actually stubbornly low.
ADAM SHAPIRO: Scott, I want to follow up on these expectations, especially because we’re going to get the FOMC minutes tomorrow. And sometimes, people like you can read between the lines when they give us the quotes. They don’t say who, sometimes they do, might be saying from the FOMC. What are you looking for in those minutes as to lift off? I know they’re going to talk about taper. But it’s the lift off that we’re all watching.
SCOTT KIMBALL: So our biggest concern that we have, not just for our own portfolios, but for the markets as a whole is, is the fed operating under an old or outdated playbook for the issues they’re tackling today? Specifically, you made mention of, I think I was listening a prior interview where someone was talking about the fed Jerome Powell and now he’s been reconfirmed talking hawkish again. That’s all well and good, but the fed has no idea or really has had a very difficult time talking about what the neutral rate is for the fed funds rate.
So if you’re going to lift off and you’re going to talk hawkish, you need to have some indication of what you expect the transmission mechanism to be. So as you raise rates 25 basis points, what do you think– what slack are you trying to take out of the economy? The reality is we see some inflationary pressures, but do we see a lot of slack? I don’t really think so. I think we’re seeing that there’s some transitory things as they’ve talked about. And there’s some things that are carrying over from the pandemic.
But do we have slack in the economy that suggests the fed needs to be overly aggressive? I don’t think so. So that’s what I’m listening for is an indication that the fed is starting to have a little bit more of a balanced talk about the terminal point of their tightening cycle.
EMILY MCCORMICK: Larry, picking up on this point here, how do you expect the composition of the fed this year and the policymakers who will actually be casting votes is going to impact the actual policy path forward for the fed versus the signaling that we got from the committee last year?
LARRY SHOVER: Yeah, I mean that’s actually another risk for 2022 that isn’t really very well reported. And yeah, it could definitely change the composition and the wrinkles with regards to being overly dovish or hawkish. But that said, right now, the fed is framing the pandemic pressures as inflation as opposed to growth. And it’s setting the stage for higher rates. So is it a good time to bring in somebody who is going to go opposing that? I mean, Jerome Powell had always said, he’s very open, and embraces opposing opinions.
But the way the markets reacted the last couple of days, I wonder how that’s going to be filled and what they will do. I mean, right now, the market thinks the fed’s action is adequate enough in fighting inflation. And the recovery is on track. And we know that the fed does not have a good track record as an inflation fighter.
ADAM SHAPIRO: Larry, given that fact, and the expectation that interest rates are going to go up, one of the things you’re preferring right now is defensive tech over cyclical tech. Doesn’t tech suffer, though, as the interest rates go up? Or does defensive tech not suffer?
LARRY SHOVER: Yeah, when I say defensive tech, I’m talking about earnings. Because we know that earnings is what has driven the rally this past year. I mean you’re estimating that operating earnings, the S&P 500, rose 70% last year with margin expansion and cutting costs. So with that said, I mean, underneath tech, there’s a group of stocks that pay healthy dividends and have good balance sheets. And return on equity is solid. And so I would prefer to be holding something like that. Because 2022 is going to be all about earnings.
And are we going to be able to continue to expand? I think we can. But at that rate, probably not. So defensive tech to me makes the better bet.
EMILY MCCORMICK: Scott, taking a look here at some of your notes as well, you mentioned that 2021 was only the fourth negative year for the broad bond market since 1976. Interest rates are expected to move higher this year. Is now the time for investors to allocate to bonds? And if so, where should they be looking?
SCOTT KIMBALL: So the big– that’s an important question. Because I think what gets lost in the conversation about rising interest rates and what that means for bonds is, what role is fixed income playing in your portfolio? A number of our investors are institutions. And if they’re using the fixed income portion to manage liabilities, either short dated or long dated, it doesn’t matter where yields are. You’re supposed to be actively engaged in the bond market. That’s your tool for hedging the balance between your assets and your liabilities on your balance sheet.
If you’re an investor who is investing for the long term and you’re a saver for your own retirement, or education, or a home purchase, fixed income can definitely have a role in the portfolio of producing income, which can be stressed in environments where yields are low. So the only place if you’re an income seeking investor where you’re going to find it is in the corporate bond market principally high yield. If you’re looking at fixed income for liquidity and to be a defensive mechanism against other investments you have, for example, stocks, or even real estate, or in some cases, some private investments, then really fixed income, again, the yields don’t really matter.
The question is, does it provide that diversification benefit in the event of volatility in other riskier assets remains high? We think this is the most important point to make because, again, not to belabor the fed too much, but they’re fighting inflation. Yes. But why have they been so ineffective at that historically? It’s nothing they don’t know. Not all of inflation is anything they can tackle. Can the fed solve energy prices? Sure. They can raise rates and stifle demand and crash the growth component. That’ll get energy prices down by weak demand.
But that’s not really a step we want them to make. So we would make the argument that even though yields are low, if the fed makes a mistake like that, or any global central bank these days makes a policy error like that, it doesn’t matter where you’re starting yields are. They’re going to do very well in total return to support the rest of the portfolio that may see some volatility.
ADAM SHAPIRO: Larry, let’s wrap this up. And I know that you have a lot of warnings for what could go wrong, the risks in 2022. Let’s flip this. There’s a ton of money still in savings. Consumers want to spend. There could be some real upside. What sectors do you see most likely to benefit from that?
LARRY SHOVER: Yeah, again, to me, it’s almost like I could say large cap over small caps. Because if we do have increased credit conditions, large caps can absorb that easier. And also, with regard to higher input costs and higher wages, large caps could also trump small caps. But beyond that, I would just get into more of a defensive mode just thinking, our economy is trending above trend still. However, are we going to repeat what we saw this past year? I doubt it.
So therefore, I’d rather be more defensive and looking for industries throughout that provides a good return on equity, good dividend history, whether it be consumer discretionary, or health care, et cetera. And also defensive tech over cyclical tech. Just it’s more about the balance sheet and less about the sector.