Markets are watching central banks and coronavirus, strategist says

Brian Jacobsen, a senior investments strategist at Allspring Global Investments, joins Yahoo Finance to discuss the stock market, the Federal Reserve's next moves, and his outlook for 2022.

Video transcript

- I want to stick with the markets and welcome in Brian Jacobsen, Senior Investment Strategist at Allspring Global Investments. Brian, welcome to the show. Of course, we want to get into the Fed and expectations for later in the week. But first, just your take on the aggressive selling we're seeing here on Wall Street to start the week. What do you think the momentum is today?

BRIAN JACOBSEN: Yeah. I think that a lot of the story right now is waiting and watching for what central banks are going to do, but then also reacting to some of the somewhat negative news around the spread of the Omicron virus. We see the enhanced lockdowns in different countries, even the United Kingdom flagging it as a risk.

So I think it's really this push, pull kind of market where you have anticipation, expectation, optimism about what 2022 might hold. But, unfortunately, we've got to get there first. And there are a few hurdles in our way, Omicron being one. And then the other one, of course, being any sort of shift in central bank rhetoric or policy.

- And then the Fed has been stuck, as you say, between a rock and a hard place in your notes. And how delicate a dance are they playing at this moment leading up to that two day policy? Because, obviously, they're trying to buy time now. It's expected that they will taper quickly and then have the luxury of a little bit of time to decide when they hike rates. When do you see those rate hikes coming?

BRIAN JACOBSEN: Yeah. As far as the actual timing of the rate hikes, I think that the Fed wants some flexibility as to when they're able to do it. If the data supports it, they would like to do it a little bit sooner, let's say May. But, otherwise, my base case scenario is that it's going to be likely June and then again in December, assuming that financial conditions don't tighten too abruptly in response to that initial hike.

And if you think about the tapering program, that in itself, really, is a crisis era response. And they feel comfortable withdrawing some of that support, but that doesn't mean that they necessarily need to at the next meeting, or even at the same meeting that they wrap up the tapering is to hike rates.

It's kind of incredible to me when I read a lot of the sell-side commentary, the extent to which a lot of those investment banks have jumped on to the almost triple hike bandwagon. The idea that, oh, they're not going to hike at all in 2022 to suddenly, oh, now we're going to pencil in three hikes for 2022.

And if you think about the hawks versus the doves on the Fed and changing the tone, birds don't change their feathers that quickly. And I don't think that the Fed is going to suddenly go from tapering to saying that, hey, now we need to start hiking three or four times next year.

So I think that right now, we have a little bit of angst and anxiety around what they might do, the signaling, but I'm pretty confident that the Fed is really going to try to take it slow when it comes to actually hiking rates.

- I want to talk about what you're liking in 2022 in terms of sectors, but also in terms of markets. I mean, emerging markets have sort of taken a backseat over these past few months. Do you see them taking sort of a leadership position in the new year? And if so, Brian, where?

BRIAN JACOBSEN: Yeah. We do expect that. Right now, I think emerging markets have taken a leadership position from headlines if you look at, oh, things going on in, say, Turkey and then in Brazil and in China. Now, when will they actually have their day as far as taking the lead in terms of the market? And we think that 2022 could be a good year broadly for the emerging markets, although with a couple of caveats.

We're still not all that optimistic about the market outlook broadly for China. We do like China and we think that there are some tremendous opportunities if you're doing more stock selection. And so, we like working with individual portfolio managers who can sort of navigate this environment as the government tries to probably provide some stimulus, but they also want to make sure that it's inclusive growth environment.

And that could be a little bit more challenging to navigate than in the old days when you could just buy some sort of index tracking product and invest there comfortably. So we do like the emerging markets, but we would have to say that it's more along the lines of EMX China, and then treat China more as a bit of a wild card in the portfolio.

- And then, Brian, I want to turn your attention to the labor market. Obviously, very tight right now. So where do we see wage inflation going? Because I just read a survey where 99% of employers say they're considering giving their employees some sort of raise next year to try and keep up with inflation. So what does that do to companies, to their margins that are sort of labor intensive? And then what does that do to the inflation picture overall? When does it start to ease?

BRIAN JACOBSEN: Yeah. Well, we actually think that the inflationary pressure is going to begin easing as we get these supply chain issues slowly resolving. The issues themselves are really idiosyncratic depending upon the company and the sector, but broadly for the economy as a whole.

We actually think that we are probably going to see the improvement on the inflation front already with the data that will be coming out at the beginning of January for the consumer price index. So we're looking at those month-on-month improvements, not necessarily year-on-year changes. Those numbers can be really distorted by what are called the base effects. But the month-on-month on month improvement, we think, should improve as the year comes to a close and then as we get through 2022.

Now, for companies, that does present a bit of a pickle, especially for those that are more service-oriented, that have labor costs as a bigger part of the costs of the services that they're providing. What does that mean for their profit margins? Wages tend to be lagging of inflation, and we don't think that the wage increases are going to necessarily reinforce the consumer price inflation that we've seen. If anything, we think that productivity improvements will have a rebound.

And so, the key metrics to really be watching will be what's called unit labor costs. So it only comes out quarterly, unfortunately. And it wasn't that great in the third quarter, but that is actually kind of a productivity adjusted way of looking at wages because it's fine pay higher wages. It doesn't have to be inflationary, as long as productivity has improved along with it.

So, we actually think that could be the big thing for 2022 is a nice surge in productivity. So even if we get this wage growth, it doesn't necessarily have to feed into consumer price inflation because productivity is likely to more than offset that inflationary impulse.

- So Brian, how does that play out, though, for small and mid-cap stocks and companies where inflationary pressures, wage increases could have a material impact on their profit margins? We know that the Russell 2000 was near bear territory recently. They've had a tough go of it these past few weeks. What's your outlook for those small and mid-cap stocks next year?

BRIAN JACOBSEN: Yeah. We're actually looking for a rebound because we actually believe that the market has been forward-looking on this, anticipating that there was going to be that profit margin compression for those small to mid-cap companies. Because if you look at their cost structure kind of across the sectors when comparing large to mid to small, is small cap stocks, they tend to have labor costs as a larger part of their cost structure.

And so, we actually think that the market has actually already kind of priced that profit margin compression in. So we're not too worried about it. And that's one of the reasons why we've been rotating more into small caps as it did enter into a bear market. We don't think that this bear market is really going to persist through 2022 for small caps. We're anticipating a decent rebound.

- All right, Brian Jacobsen of Allspring Global Investments. Thanks for being with us and kicking off the week here on "Yahoo Finance Live."