Inflation: High oil prices and rising rents weigh on investor sentiment

Stuart Kaiser, UBS Head of Equity Derivatives Research, discusses inflation concerns among investors as earnings seasons gets into full swing.

Video transcript

SEANA SMITH: Emily was just talking about the strong earnings that we've gotten so far in this earnings season. We're only about a week in, so we don't want to jump to any conclusions too quickly. But just real quick, what's your takeaway of some of the results that we've gotten so far and what you're going to be looking for over the coming weeks?

STUART KAISER: Hey, good afternoon. Thanks for having me on. You know, I think our takeaway is similar to yours which is relatively positive start, but still very, very early days-- particularly a small number of stocks and obviously very concentrated in the financial sector, so a little bit hard to read across more broadly. You know, I think the two things that we'll be most closely following is one is pricing power.

So how much does input cost inflation and wage inflation start to impact corporate margins? During Q2, we saw that theme, you know, pretty actively traded especially within the consumer staples space, where a lot of those companies talked about price pressures and their shares made kind of big moves on earnings. And the second, I think, will be just the performance of large cap tech.

You know, tech had performed quite poorly in September. Our view was you kind of wanted to own upside exposure in those large cap tech stocks into earnings on the view that they'd produce strong fundamentals and you'd kind of get those stocks to move higher along with the market. So I think, you know, those two categories, what's going on with input cost inflation, and does tech have another leg to run here if they post strong results will be two areas of focus for us.

ADAM SHAPIRO: Hey, Stuart, when you talk about stagflation and the moves in yields having a stagflation feel, for a lot of investors, they weren't alive the last time we had stagflation. So what would that look like? And where are their opportunities if we move into that kind of scenario?

STUART KAISER: Yeah, it's a great question. I think it's kind of a scary question too. To your point, you know, a lot of investors probably don't have a very updated playbook for how to deal with, you know, stagflation. You know, last week, we definitely saw inflation expectations higher but real yields lower, which is kind of what a stagflation market would look like. And I think trading that is quite tricky.

I think the deflation side of it is a little easier. You know, we know that commodity sectors perform quite well when inflation is moving higher. If interest rates were rising, that tends to be quite good for financials and banks. It's the stag part that's a little trickier, right? If you've got this inflation but you don't have a ton of real economic growth, you know, which are the companies that can withstand at the best?

And you know, I would kind of circle back to pricing power a bit. You know, the companies that can pass on pricing power or phase margin pressure are the ones that might come under the most pressure. So you almost might end up in kind of a barbell here where you're long some of the inflation stuff like energy, materials, and maybe banks, but maybe you're also long some of that large cap tech, which has, you know, very strong defensible margins. So I think the fact that we're discussing it and the fact that a lot of investors don't have a good answer to it is why it's so topical and why it's potentially a risk to the market as we move ahead in the next few months.

SEANA SMITH: And, Stuart, going forward, I guess, do you expect this to continue to weigh on investor sentiment? Because it feels like we move in and out of this wave where investors become obsessed and all we're hearing about is talk of inflation potential stagflation, and then it kind of seems like that fear subsides. Do you think this conversation is at least going to continue over the coming months?

STUART KAISER: I think it definitely will. I mean, I think the reason it's been impacting investors or retail investors' minds so much recently, frankly, is because oil and gas prices have risen. And that's something that's kind of near and dear to people's hearts. I think for the institutional community, what's caught people's attention has been rents and wages-- but rents in particular a big part of the inflation basket and also kind of sticky and slow-moving.

So you know, I do think this is going to be an issue. We don't have inflation really peaking until end of the first quarter, around that timing next year. So I think this is a topic, high oil prices and rising rents, that's here to stay at least for the next few months. And you know, to your point, the market's fickle. It may not talk about it every week or every month, but you know, every big inflation print, this is going to be a topic-- you know, holiday season coming up, going to be a topic. So yeah, we think this is something that's around for more than the next week, for sure.

ADAM SHAPIRO: Stuart, we were all talking about Bitcoin being at $64,000. There's the news now-- you can buy the ETF of the futures. I was curious, does this become a distraction for your clients who might be looking at derivatives as a way to hedge their portfolios when you throw in Bitcoin as well as the other cryptocurrencies, because we're expecting a lot more ETFs to come down?

STUART KAISER: Well, I mean, it's the $64,000 question, I guess. Look, I think from my perspective, Bitcoin, obviously, is an institutional product, but it's also a big retail product. And you know, to that extent, yeah, I think it is important for our markets, because, you know, I think we've discussed this earlier in the year-- the amount of retail participation in the options market was so large, you know, let's say in January and then last September-- it has come down substantially.

We would estimate retail is about a third of the impact today, you know, that it was, you know, as recently as January. So you know, things like Bitcoin, things like simply being able to get out of the house and go to a sporting event, I think all of those things probably to some degree reduced retail participation in my market. And I think the question will be if you can trade you Bitcoin ETFs and that provides additional liquidity to those markets, does it further distract?

I think potentially. But you know, that said, there had been ways for people that wanted to invest in Bitcoin to invest in Bitcoin, right? This isn't sort of the gates opening. I think it's more of the gates widening. So yeah, definitely a consideration-- and you know, it's the first day of trading, so we'll just have to monitor it over the next couple of weeks and months and see what the impact is on retail investment flows and sentiment.

SEANA SMITH: And, Stuart, real quick before we let you go, I want to get your take on what's going on in the bond market, because we have the 10-year yield moving up slightly today-- we're above 1.6%, but we know historically speaking, that's still significantly low. What do you think it's signaling to us right now? And do you expect us to remain relatively range-bound at least for the coming months?

STUART KAISER: I mean, our expectation is you get up to about 1.8% around year-end and a little higher than that early next year. I think the tricky part is, I think, what we saw last week, which was inflation expectations higher, real yields lower, and then the curve flattened. And that sort of combination of things suggests kind of the Fed hiking a bit more, a little more inflation risk, but then less term premium out the curve. And that combination is probably not sustainable long-term.

So you know, our view would be get higher yields and you get the term structure to steepen out a little bit. I think the question is, what caused those moves last week? And you know, I think it's complicated. It's probably one group of investors trading one thing and another trading another. And I think you could actually just relate that back to the FOMC.

You know, if you look at the FOMC's outlook for the dotplots and stuff like that, you basically have two schools of thought. And when you put two conflicting schools of thought together, sometimes you don't get a clean outcome. So I think over time, you'll see this normalize. But for now, it's a little bit hard to draw a very good conclusion from it, unfortunately.