Markets: Why short-duration stocks have become a ‘major theme,’ according to strategist

Jeffrey Kleintop, chief global investment strategist at Charles Schwab, joins Yahoo Finance Live to discuss some of the major themes in the markets and why bond markets have been so volatile.

Video transcript

- --Live, we want to talk about what exactly is causing this massive sell off. And for that, we want to bring in Jeffrey Kleintop. He's Charles Schwab's chief global investment strategist.

I guess when you take a look at today's massive reversal, totally different story than what we were talking about at this time yesterday. What is behind today's drop?

- Well you call it a U-turn, and that's a good way to describe it. Yesterday I think the market had a sense of relief around the fact that maybe Powell took 75 basis points off the table for further rate hikes, suggesting the Fed might take a more mild path.

But you know, today I think the market's recognizing that there are risks associated with that-- higher inflation maybe. And that's certainly what we're seeing here with the yields spiking higher.

And to me, this is an enduring theme. This isn't just a phenomenon. Yeah, bond yields are up over 3% today for the first time definitively, but if you look all the way back to August of 2020, when the 10-year bond at 1.5%, there's been one major theme in the markets. And that is short duration stocks-- meaning low price to cash flow-- have been outperforming high or longer duration stocks, or high price to cash flow stocks, day after day, month after month.

And that is a trend that's going to continue here. And so I think investors should increasingly consider this in their portfolios as a way to protect from some of these really vicious downslides.

- What are some of the questions that you're hearing from clients in this sort of environment?

JEFFREY KLEINTOP: Well, there's everything from how can I protect myself from rising interest rates, which we're suggesting shorter duration stocks. But the other questions around well, what about a recession, or what about a tech wreck akin to 2000 through 2001 and that brief recession, but a very painful route for tech stocks?

And I think one of the things that we can look to is diversification. I know people often talk about diversification as this abstract concept, but it is paying off right now more than we've ever seen in the last 10 years. Sectors, stocks, countries are moving in opposite directions. I just noted that the UK stock market was up today when the BOE hiked rates. The point is the different parts of the market are moving in different directions, and that's paying off in terms of muting the volatility in your portfolio.

If you're just in a few tech names, if you're just in the energy sector, if you're just holding on to Bitcoin or something, you're seeing whipsaw volatility. But if you're diversified across a lot of different sectors, countries, asset classes, that diversification is paying off in a way we haven't seen in a long time. That's a key message for investors.

- Jeff, we heard the Fed lay out its plan of raising interest rates by 50 basis points. There was some speculation about whether or not we could potentially see a hike of 75 basis points down the line. Jay Powell saying yesterday that as of right now, the Fed is not considering it. What did you think of the Fed's plan? Are they making the right move?

JEFFREY KLEINTOP: Well, I think the Fed has to have a lot of credibility here around their inflation-fighting credentials in the near term, because they've lost a lot of it. But I think being a bit more flexible longer term-- I still think there are members of the Fed who believe that some of this element of inflation is transitory, and the Fed's forecast is for inflation to come down in the second half of this year.

I think what's interesting is when we get to the late summer. So basically, Powell telegraphed two 50 basis point moves at the June and July meeting. But we've got a big gap between July and September.

And the Bank of England today just hiked rates for the fourth time in a row. But what was really interesting is they're going through what the Fed may be going through this summer, say around Jackson Hole time in August. Because two members of the Bank of England said they don't necessarily need to hike any more. I think three members voted for another 25 basis point rate hike after today, and others feeling that 50 would have been the right move for today.

So they're starting to see this divergence of opinion, and we're not sure which way they're going to go going forward. I think the Fed could be going through that crisis of a real divergence among its members later this fall.

We'll see whether markets are content that inflation has ebbed by then, and that might be welcome news, or they still feel like inflation's a problem, even as the Fed begins to question its path. And that could lead to even higher interest rates and more favorable environment for short duration equities.

- And it's interesting, because you mentioned in your notes that international stocks had a solid April, outperforming US stocks. But then when you see these central banks sort of moving in these different directions or, as you mentioned, they are foreshadowing of what the Fed can expect based on what the BOE is doing. What should people be looking at in terms of international stocks or international markets that could be a good place right now?

JEFFREY KLEINTOP: That's a great question. International markets have been outperforming-- again, in April outperformed by the second widest margin in 20 years. And this is in part because we've got a lot more short duration stocks.

I mentioned the UK market was up today. In part yes, a lot of energy staples and financials make up that index. It's a short duration part of the market. So that's when UK stocks are actually up this year.

So I think looking outside the US, the US mostly has longer duration stocks-- a lot of health care, a lot of technology. If you take a look outside the US, you get much more of those shorter duration areas of the market that are really benefiting from the environment we're in, not just from rising commodity prices, but in defensive of higher rates.

So I think investors looking to diversifying outside the US, even though yes, certainly there's a potential for a recession in China. There's certainly war related pressures in Europe, yet their economies are holding up quite well here, and their stock markets are increasingly outperforming.

- Jeff let's bring it back here to the US, because some of the big movers today-- Shopify, Etsy, eBay-- all moving lower on the heels of earnings. One common theme amongst those three companies, and that's the fact that online spending-- e-commerce at least-- seems to be plateauing, even pulling back in some areas. How big of a concern is this, and what do you think it tells us? Is the consumer maybe not as strong as we initially thought?

JEFFREY KLEINTOP: Well, the consumer does seem to be retrenching a little bit here in terms of their momentum, but that's maybe not surprising given the reopening we've seen in the US. Increasingly, overseas where some of these companies still draw a lot of their revenues, we are seeing solid growth.

As a matter of fact, some of the loosening up of the omicron restrictions in Europe has really led to a boom in a number of these types of companies. I just point to OpenTable dining reservations or box office movie receipts.

So people are engaging more in services activity rather than goods. And so that might be a support for the economy, maybe more so overseas then in the US. But it's something that we're not hearing as much of. We're focused on maybe these goods producers in terms of some of the disappointments. But on the service side, we're seeing some pretty strong results.

- And I don't want to ask you as we talk about consumer sentiment and consumer spending, at what point do you think we're going to start seeing this showing up in earnings reports?

JEFFREY KLEINTOP: I think later this year. So we've been talking about this shift from shortages to gluts. And I think we're already starting to see that in terms of inventories, and that's an early sign that consumer behavior is beginning to slow down-- not that it's slow, but beginning to slow down, as all the supply chain issues are beginning to bring a lot more products to the market. They're finally being maybe not resolved, but they're not getting worse. And that's allowed a lot of this product flow through.

So I think importantly, as we think about earnings we could go for an environment where a number of companies have ridden this wave of demand shortages and pricing power. They could be looking at a very different environment in the second half of this year.

Of course, we've already seen that with some of the pandemic-related stocks-- the Pelotons, the Netflixes of the world. But it can really extend into areas even like semiconductors, so something to be focused on. Guarding against gluts in the second half of this year can be an important message for investors.

- Jeff, tomorrow we're going to get the jobs report. Obviously that will likely influence the market's move at least tomorrow morning. What are you expecting to see?

JEFFREY KLEINTOP: You know, another solid month for jobs. We're not seeing a letup here in terms of labor demand. The question is, what does it mean for wages?

And so far, we've certainly seen a push on wages, but not maybe as much as some might have feared. So that'll be the real issue tomorrow. Are we seeing a real spike up in wage effects that would alarm the Fed and force them to be even more aggressive going forward?

But you know, I think the overall job count suggests still a relatively tight labor market. It's hard to find workers out there. And so you're not seeing maybe a strong a number as you'd see otherwise if there was a larger pool of available labor.

- All right, thank you so much, Jeffrey Kleintrop, the Charles Schwab chief global investment strategist for your insights. Thank you so much.