'The question is: When will the inflation numbers start coming back down?': Strategist

BMO Global Asset Management CIO Ernesto Ramos joins Yahoo Finance to discuss inflation, the Fed, and implications for the stock market.

Video transcript

- We're going to stay on the markets and bring in our next guest, Ernesto Ramos, CEO of BMO Global Asset Management. Sir, thank you so much for your time today. And you know, the market is having a really good day. A risk on session, at session highs. Dow is up 700 points. So looking past the omicron variant for today, at least, right?

So good news there. But I want to move a little bit further ahead to the end of the week when we get our next CPI read. Is the market ready for a handle that looks like it could come in very close to 7%?

ERNESTO RAMOS: We think so. We think that the market has priced in higher inflation for the time being. The question is, when will the inflation numbers start coming back down? Because the market certainly expects that by the end of next year, we're probably going to have lower numbers, and we believe that to be the case.

So for right now, we do expect a high number on Friday. But as we go into next year, those numbers will start to come off. For a couple of reasons, supply chain bottlenecks will start to ease on their own as the market resolves them. And also, there's, a base effect-- there was a big jump in CPI starting in March of this year. That will start to come off.

That base will become higher for the numbers that are going to March and further out in 2022. So for various reasons, we expect the CPI numbers to start to come off. And as well as the fact that the Fed has now signaled a rapid pace-- a more rapid pace of tapering, as well as potentially Fed rate hikes for next year.

- But Ernesto, I wonder what's going to happen to market valuations, because a lot of them are pretty bloated right now. I think the S&P is trading at something like 22 times forward looking earnings. Where are you seeing value right now? And do you think that the early part of next year is going to bring a pullback and some of these lofty valuations?

ERNESTO RAMOS: Well, yes. So again, going back to the Fed is definitely removing liquidity. That takes a lot of support away from stock prices, especially stock prices that are on the higher end. So we think that the stock market is still a better place to be than the bond market as a whole. But you have to be quite selective. And right now, we're finding that selectivity, that opportunity more to be in higher quality, but not too expensive stocks.

Off the top of my head I could tell you things like AutoZone or Waste Management, companies that have very stable and solid operating models that are trading at a discount to their intrinsic value is. And they're not necessarily the fad or the stocks that everybody's piled in, such as your high tech companies that are now not leading the way anymore. And perhaps not going to lead the way into 2022, because they did so well for the last three years, and their valuations got so high. And as I said again before, the Fed pulling back doesn't support the case for such high valuation stocks to continue to do well.

- And then Ernesto, I want to turn your attention to earnings. So we had a pretty good season, right? And the companies that did well, we saw, were the ones who were able to absorb inflationary costs or pass them on to the customer. But how much longer can they keep taking this sort of punch to the chin from inflation? Because right now, consumers are you dealing with it. They'll pay more because wages are raising.

But as inflationary pressures, as you say, will creep up even further going into the first part of the year, wages may not increase at the same rate, or may start to slow. So what happens to companies then?

ERNESTO RAMOS: Yeah. And that's-- so right now we have inflation. We have wages. We have the labor market in general. We have Fed policy. All of these are not as easy to forecast as they were a few months ago. And the fact that the outcomes for all of these-- which are, of course, interrelated, have become much more flatter or diversified means that you have to take a very selective approach to the stocks that you want to own.

Because you just don't know if inflation will-- we know it will tick up in the short term. But when will it start to tick down? Economic growth, we know it's going to probably come off with these levels. But when exactly? We just don't know. There's so much uncertainty right now that you have to diversify your portfolio. And again, for earnings, you have to look for those companies that have a good earnings forecast in front of them.

But one with reasonable certainty. And again, companies that do not depend so much on the economic cycle, and do not depend so much on their own intrinsic prospects for growth, because they tend to be so expensive, are the places to be. So again, go back to the examples I just gave you. AutoZone, a company where it's related to self-repair of cars, or Waste Management a company that is going to be-- there's going to be trash no matter what part of the economic cycle we're in.

And they're going to grow at a steady high-single-digit pace. Those are the companies right now because of their valuation that we favor because of the uncertainty of the environment. We just don't-- we can't really pick precisely what part of the market is going to do well. So we'd rather take a safer view and go to high quality, profitable less expensive companies such as the ones I just mentioned to you.

- And Ernesto, I'm curious how much of your portfolio is dedicated to Chinese stocks. I mean, just today we've got that troubled real estate developer, Evergrande, inching closer to defaulting. Yet to be seen if the government's going to run into to catch it. But do you have exposure to China? And if so, where?

ERNESTO RAMOS: No, we do not have exposure to China. We have a couple of-- in our global portfolio we own a couple of stocks in Hong Kong. But we're making sure that none of these are exposed to the real estate market in China because you just mentioned yet again another risk. What do we know about Evergrande? We know that every month it struggles to make its interest payments and somehow or other it manages to do so. For how much longer?

Probably for the foreseeable future the government will step in and help out as needed. But there's another source of uncertainty. And of course, if the real estate market in China were to get beyond the ability of the government in China to help it out, that would cause major ripples in the entire financial sector worldwide. So we don't want to-- we don't want to see that. And there's a small probability that will happen.

But there is still a chance that could happen. So another source of uncertainty for these markets, besides all the ones we've talked about. So really unprecedented uncertainty levels about so many things these days. So again, stay safe, stay in companies that are high quality with stable operating models, and not to attractive-- not too expensive for safety's sake and downside protection.

- And Ernestso, really quickly I want to ask you, what impact do you think DC politics has on markets going into the near future? Because we still have this Build Back Better plan that's up in the air. We don't know if it will pass, probably not in its current form. How does that impact markets, in your opinion?

ERNESTO RAMOS: Well so far, the fact that Build Back Better hasn't passed, I think, has been taken quite well by the market because that would be another source of inflationary pressures, and another source of ramping up the debt. And it's really not so much an infrastructure problem as a program as a social equity program. So people and the markets themselves are not convinced that this would be good for the economy.

And so I'm quite happy to see it languish there and get cut back aggressively down to what really is focused exclusively on economic growth and in economic initiatives, and away from the more social welfare types of provisions in it. So I think thanks to Manchin-- Senator Manchin and Senator Sinema, it will come down from certainly we're from where it started, which is $3.5 billion. Now it's down to $1.75 and probably headed even lower than that. So that's quite good for the markets we see as we see it from here.

- I guess we'll all have to wait and see. Ernesto Ramos, CIO of BMO Global Asset Management. Thank you so much for your insight today.