Stock market dealing with 'the shock in interest rates,' Clearnomic CEO says

Clearnomics Founder & CEO James Liu joins Yahoo Finance Live to discuss the market outlook amid inflation and interest rate hikes, the Fed's monetary policy, wage growth, and investing in cyclical sectors.

Video transcript

- We'll keep it on the markets and bring in our markets guest James Liu, Clearnomics founder and CEO. James, thanks so much for joining us. Another head-spinning day in the equity space. And I just want to start off by getting your sense of what's going on in the markets. You know, typically heading into rate hikes, equities actually perform quite well. But there is so much volatility. What are investors concerned about? Are they worried that the Fed is going to go too fast too soon or not do enough?

JAMES LIU: Hi, Kareena. Great to chat with you. Well, to use the pandemic analogy, the Fed is preparing to vaccinate the economy against inflation. And we're basically seeing the market have this prolonged side effect as it adjusts to that period. And the reality is that that adjustment period will eventually wane.

At this stage in the business cycle, it's less about the level of rates than about the shock in interest rates. And that shock eventually will wear off. And we basically saw the same story last year in the first quarter, when the 10-year jumped up quite a bit from something around 0.7% to 1.7%. And you basically have that exactly today. You need a period where the market gets used to the fact that the Fed may have to accelerate interest rates.

Now, I think what compounds this and what makes investors even more nervous is the fact that the Fed has basically been behind the curve this entire time. And so now they're catching up to what many economists and investors had been thinking about and calling for in terms of fighting inflation. So that's only happening now. But, overall, we think that eventually the market settles down here, the rotation underneath the surface will continue to happen between growth and value, and, therefore, sector positioning is very important. But from an overall index perspective, we still like US equities here at this stage in the business cycle. And we think international stocks are also very attractive.

- Yeah. I'm glad you brought up international stocks, James, because I want to expand on that a little bit. Emerging markets tend to be overlooked by lots of US investors. And I'm wondering if this is gonna be the breakout year for those EM markets, and if so, where should investors be looking to pour their money?

JAMES LIU: Yeah, Alexis, that's a great point. You basically had almost a 10-year period where US stocks just did really, really well year in year out for most of the last cycle. And that was generally because the economy was just growing really steadily. The US as the engine of world growth was doing really well. And, you know, there were signs that that could potentially change. It's only been a couple of weeks to start this year, but the emerging markets are outperforming other regions.

And there's also the notion that they should catch up to the rest of the world because they've been lagging behind with the pandemic response. And so the benefits that we've seen in the US and even parts of developed markets over the last two years, we could potentially see that with emerging markets not just over the next year, but over the next few years as they catch up there. So overall, you know, the point is not to dive deep in all at once. The point is to have that proper asset allocation where you're not ignoring emerging markets or developed markets, but you're holding a nice allocation alongside US equities to balance all the different regions.

- And James, you know, big banks just wrapped up their earnings outlook. And one of the overarching themes was more operating costs, bigger expenses, wage inflation. Yesterday we heard 33% from one of the big banks.

So is that a narrative that we hear going forward into the rest of earnings season? And then how does that affect profit margins? We saw P&G come out with earnings today and said the way they're handling it is they're raising prices. So far the consumer is accepting that, but how long does that continue?

JAMES LIU: Yeah. I think what really helps is that consumers are still in the strong position. But, you know, you kind of hit the nail on the head. The question is do we get some sort of wage price spiral? From an inflation perspective, that is the concern for economists and the overall market. And right now the answer seems to be no.

I mean, that's the difference between today versus the '70s and early '80s where inflation got out of control and it became baked into expectations. And it got out of hand in terms of what the Fed could basically do without inducing a recession. Today, if you think on inflation, it is still very much the case that inflation is high because of year-over-year comparisons and because of supply chain disruptions, not necessarily because of monetary policy.

Now, if that goes on for much longer it could be baked into wages and cause a wage price spiral, but that's really not what most forecasts are calling for. They're calling for inflation to start to temper and to start to maybe fall by the second half of this year. Again, it's hard to predict because it's due to supply chain disruptions, but that's really the expectation. And if that's the case, then inflation could stay higher than average, especially compared to the last cycle. But it's not something where we need the Fed to dramatically accelerate interest rates and Fed fund rate hikes in order to try to combat it.

- And James, what are you doing with tech right now? Tough start to the year, and especially with regards to mega caps like the Amazons, the Metas of the world. What are you doing with these stocks?

JAMES LIU: Yeah. I think the challenge in tech, Alexis, is that it represents a number of different themes and a number of different trades. I think the initial reopening trades, the work from home trades, all those were very much long in the tooth, even in the second half of last year. You know, the things that worked before will probably not work going forward, right? The momentum factor that we saw worked really well in 2020 and the first half of 2021. That's already starting to reverse.

And so looking forward, the parts of tech that should do well are those with just long-term secular stories about digital adoption and things like that. The problem with tech also is that valuations are high. So at this point, it's very much a case-by-case, stock-by-stock story, not a overall sector story. And instead, what we would prefer, if we look at it from a sector perspective, are the more cyclical sectors that will benefit as interest rates are rising, as the economy continues to grow into the sustained expansion.

So, you know, obviously areas like energy have already done well this year. But you have areas like industrials-- parts of the economy that will do well as we enter this middle phase of the business cycle with the normalization of Fed policy, those are the areas we would rather be in rather than simply investing in the things that had worked and the places where valuations are already very high.

- All right. Definitely a lot of cherry picking that has to go on this year compared to last. We will leave it there. James Liu, Clearnomics founder and CEO, thanks for stopping by today.