Investors turn defensive as Fed focuses on inflation: Strategist

TD Ameritrade Head Trading Strategist Shawn Cruz examines the Fed's inflation strategy after the latest FOMC meeting, commodity price drops, and the bond market.

Video transcript

- Joining us now to break some of that market action down further is Shawn Cruz, TD Ameritrade head trading strategist. Thank you for joining us again, Shawn. So as we've seen, the markets really taking off on what they heard in the minutes. Talk about what you saw in those notes. And what do you think the markets are really holding on to from those minutes?

SHAWN CRUZ: I think what you're seeing here is-- and I think this is to some extent playing out in these markets-- is a little bit more of a defensive type of a trade. To me, there wasn't anything Earth shattering that changed what we heard from Powell at the press conference after the last FOMC meeting. These minutes are fairly consistent with that.

But I think it does show that the Fed is, for the time being, singularly focused on getting inflation under control. And they're a little bit less sensitive to what impacts that might have on growth. The one caveat, I would say, is they talked a lot about some of the incoming inflation data that came in just before their meeting. So this puts a lot of onus, I think, on the CPI and PPI data that we're going to get next week. But if you look at almost any measure of commodity prices, they've come down I think dramatically since this meeting, and especially in the end of June. So I think that is where you're going to see maybe a little bit of faith that perhaps inflation is going to start coming down a little bit and moderating.

And any inflation break even that I've been looking out there-- the 10-year break even rates, the 5-year break even rates, those have all also come down almost to levels they were at back in January. So I do think right now the longer run expectations for inflation have moderated closer to what the Fed is expecting. And we're seeing some of the commodities that were drivers of a lot of those elevated inflation expectations also come down recently.

- Shawn, I got to talk to you about the commodities that we were talking about here. I'm looking at the Y-Fi Interactive. And I'm seeing some incredible moves. This is only after the last month. Now, we have natural gas. That is down 40%. Oats right there with it down 36%. Cotton down 30%. Wheat, 26%. What are you making of these moves? We have a much higher stronger dollar. But when the commodities come off like this, that can create its own reverberations in the financial system.

SHAWN CRUZ: I think so. And I really think a lot of this is just growth expectations coming down. Think about what we saw a lot of the indicators flip to. Even in the Atlanta Fed's estimate for GDP, that actually flipped to a negative sign. But there was a lot of concern that actually showed up in the second half of June and a lot of the incoming data that drove a lot of investors, a lot of economists, a lot of analysts to the sense that there is probably going to be a pretty significant slowing of growth in the second quarter.

We're most likely going to get two quarters in a row of negative GDP growth. The question is, how is the consumer going to handle that? But I think when you just see commodities across the board-- and I'm sure, Jared, you've been looking at copper. I know you like to really focus in on a lot of those commodities. It's come down dramatically. And copper, they call it Dr. Copper. It's a very good barometer of expectations for economic activity and economic growth. That's come down. Crude oil's come down.

So a lot of these commodities that we tie to economic activity have been coming in significantly. And I think it makes sense when what you're seeing in the housing market. You've seeing rates move higher, causing a little bit I think of at least a slowing in investment in some of those larger more durable purchases which uses up a lot of commodities. So I think what you're seeing is growth expectations coming in. The question is just, what sort of a pullback or slowdown in growth are we going to get? That, to me, is what I think is still up in the air right now.

- And to that point regarding commodities, and especially oil, obviously, we're seeing the prices tick down there. Demand destruction. Fear of recession. A strong dollar. In terms of some of these factors, what do you think are going to be the biggest determining factors going forward?

SHAWN CRUZ: If we're looking at biggest determining factors for markets in and of themselves, I would want to see how some of the items that have changed very recently are going to be factored into outlooks that we hear from these management teams when they start reporting earnings here pretty soon. The other thing is, what's a strong dollar going to do to a lot of these multinationals? Microsoft came out a little over a month or so ago. And they actually had to lower their earnings per share forecast. And they treated that to strengthen the dollar. And that's when the dollar was trading down around 101. Now we've got the dollar up at 107.

These big multinational companies that have heavy weightings in a lot of these indices may have a pretty significant currency valuation adjustment that could really hit earnings pretty hard. The question would be if investors look to that. I'm already expecting to hear adjusted for constant currency or on a non-currency adjusted basis. Be ready to hear that from a lot of management teams. But I think what we hear for guidance going forward for the second half of 2022 is really going to be key to how markets react here.

- Yeah. FedEx might not be alone citing the strong dollar finally this quarter. But I want to ask you, investors who are shell shocked, their portfolio is down, the 60-40 having the worst start in at least five decades. What are investors to do going forward? Because the strategies that we have right now, correlations are either 1 or negative 1.

SHAWN CRUZ: Yeah. And I think that's something that has been interesting to watch from our own client data. And we just put out IMX where we look at what clients are doing, just in terms of making new trades or new positioning. And we've actually seen since you saw this rise in rates-- and we had the 10 year up above 3% at one point. It was at 3.2%. We actually saw clients moving into fixed income type instruments, particularly into treasuries, around that time.

So I think when we look at the 60-40 portfolio, I actually think there was a lot of this gravitation away from 60-40, which in some cases did mean they were a little bit more overweight in stocks. But we've seen a little bit of a retrenchment and a little bit more of a defensive pullback out of clients in terms of where they're positioning in their portfolio. Our IMX data has been coming down the entire year, which shows they're getting away from some of those frothier more volatile names and getting into more of those core quality type names, but also have been moving into treasuries and locking in some of these elevated rates.

I do think it's going to be interesting to see how the 60-40 portfolio behaves. And your allocation across the different credit qualities that are out there is going to be key because you are seeing some of those credit spreads start to widen out. And the question is really how far down that risk spectrum do you want to go to try and pick up more and more extra yield, particularly if some of these companies may run into cash flow issues here moving forward. But I certainly think there is a swath of clients that are going out there and taking advantage of some of these elevated rates that we're seeing right now.

- Who would have thought quality finally coming back? And important after a decade of near-zero rates. Always great to see you. Shawn Cruz, TD Ameritrade head trading strategist.