Market Recap: Friday, Oct. 22

Bill Baruch, Blue Line Futures President and Scott Kimball, Co-Head of U.S. Fixed Income for BMO Global Asset Management break down earnings season and what to expect from the markets as the end of 2021 nears.

Video transcript

- Let me start with you, Scott, because you say that inflation is episodic rather than transitory. As an investor, how should we interpret what you're telling us?

SCOTT KIMBALL: Well, I'll first give credit to the Atlanta Fed who made that comparison, not myself, and say that I merely just agree with it as a observer of inflation and a consumer who's grappling with it like everybody else. I think that what that really signals is that for a while, the inflation dialogue was centered on the word transitory, which just gave this air of the idea that it was just going to go away without any particular catalyst. It was just something that's supply and demand would just solve on its own.

But now, when we start thinking in terms of the COVID paradigm and the COVID world that we're in, that's really what the Fed was driving at, which is that we need to really see, whether it's the Delta variant or vaccination rates or just the persistence of the virus, really start to roll over before we start seeing some of these episodic symptoms decline.

I think the principal one that we would point to is if you think about capacity and production. So the situation at the ports with the backlog, having a hard time fulfilling the supply chain. Used autos, another one. Lack of production of new vehicles has led to an imbalance where used auto prices are up. So these are things that are not really transitory that won't just go away on their own. They're very much linked to the time and the era which we're in.

SEANA SMITH: Bill, how are you looking at the great inflation debate and what you're expecting to see over the coming months?

BILL BARUCH: Listen, I think that we're going to see asset prices higher. I think they'll continue to go higher. But it doesn't mean things move in a straight line. So right now I'm watching most closely the 10 and the 30-year bonds, as well as the 5-year. I mean, the yield in the five-year earlier this week hit the highest level since February of 2020. We're talking about, really, before the big move on the pandemic.

So the spread earlier this week to between 5 and 30s hit the tightest since April 2020. So we're seeing some pretty big moves across the yield space in the 30-year bond yield. I'm looking at a chart on the yield, not the prices, but it's hit against a trend line resistance several times this week before backing off. So again, then you got the 10-year up against 1.7%. And that's been a pretty big level that a lot of people are watching too.

So if yields go higher than here, I think we're going to see a little more pressure on tech. We've been overway looking at financials and energies. But I've also begun to trim energy just a little bit just for the near term, because, again, things don't move in a straight line. So I'm cautious but the risk sentiment right now is welcoming higher prices.

- Bill, when you talk about that, we're going to get some big tech next week: Alphabet, Microsoft, Apple. I doubt that they would talk about yields on the 10-year. What are the pressures might they be facing? We know supply chain. Are they going to try and hide what might be some things from us behind the supply chain and inflation concerns?

BILL BARUCH: Well, I mean, we can't ignore what Snap had talked about last night in some of the ad spending. I don't think it was just ad spending relative to Apple's privacy policies, but I also think that we're looking at, you mentioned supply chain.

If the goods are not accessible for the businesses, then they're not going to be spending on ads to advertise for them. So that's also a bottleneck that's just starting to hit some of these social media companies. I do look at Alphabet as maybe being able to be a little insulated to some of this, relative to more platform-based businesses, like Facebook or Snap.

And I think Apple-- I started paring back positions in Apple this summer, late this summer when that privacy policy was announced. I think it's going to be a little bit big of a deal in the coming months than we've seen recently. So I'm cautious, although Microsoft is our largest position and Alphabet is, you know, and single names is behind that.

But I am cautious in tech in general, and especially tech that doesn't make money. I mean, looking at, you know, Snap doesn't make money. And I think that's one of the reasons why it exacerbated a little bit of the move with that announcement yesterday.

SEANA SMITH: Scott, Bill was mentioning the 10-year yield pulling back a bit today. But when you take a look at what we could see playing out here into year end is the path of least resistance. Is it still to the upside and how high do you think we could potentially climb?

SCOTT KIMBALL: So I think interest rates, really, when we talk about cycles, this has really been a common theme throughout all of them, whether we go back to the financial crisis or we fast-forward to the COVID period, is that interest rates have been frustratingly low for investors. At the same time, they've been something that has benefited risk assets tremendously.

So when we look at where yields are today relative to where, I think, the longer-term potential is for let's say US GDP, there appears to be a gap. And that we think that potential GDP for the US, I think, we all almost unanimously agree is probably well above 2%, not 3% or 4%, but let's say 2 and 1/4% or 2 and 1/2%. And we compare that to a 10-year treasury yield and there seems to be a bit of a disconnect.

So our position is that there is still some upside case to be made for the 10-year yield. We don't think it's runaway inflation because we look at real yields, which is what we're getting after growth after we adjust for longer-term price effects. That seems to still be a pretty narrow margin. We're not seeing any real calls or any real signs of strong real growth because the inflationary pressure remains high.

So what that does is it gives some questions to the how much longer an economic cycle can go before we start seeing the nasty R word recessionary pressure showing up. So the 10-year is fighting that off. There's definitely a gap between where the 10-year is today and what our potential GDP is. But there's still some concerns about where we are in this cycle. How much longer does the COVID recovery have that's weighing on it?

So our target for the 10-year's basically about where we are. We've just said 1 and 5/8 to 1 and 3/4 is a pretty comfortable place. We can argue higher to the 180-190 range, but we don't think that's going to be sustainable long-term. There's too much jitteriness still percolating in the backs of some investor minds on the bond side.

- Scott, just very quickly. We got the statement today from Powell on the time to taper. Market seemed to react ho-hum because we knew that this is coming. But what's the next statement that might move the markets because no one seems to be in a rush to start raising interest rates even if it's mid-next year?

SCOTT KIMBALL: So if you look at the Fed funds futures market, you see that there is certainly some growing optimism, I would say optimism, that the economy will recover enough that the Fed will transition from tapering by mid-next year to rate hikes.

The one thing that we've kind of argued about is one, is the Fed funds future market tends to have some noise in it. There are some hedging and some things that go on that can kind of get investors off side by relying on that too much. Our view though, is that there's going to be somewhat of a lag as tapering goes through the market where the Fed has to react, and the Fed's reaction function in terms of when they switch from ending tapering and starting interest rate hikes.

There's going to have to be some period of digestion in between. Now if inflation and things and growth really continue to accelerate while the Fed is tapering, that's a different story. That's not really our base case. We think the Fed has been cautious and has approached the market with a lot of patience. And the transition to interest rate hikes, we think is at least three months or so after tapering concludes.