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Strategist: How AI is reshaping the tech sector

Schwab Asset Management CEO and CIO Omar Aguilar joins Yahoo Finance Live to discuss how artificial intelligence will impact the tech sector, the outlook of tech companies refining their AI offers, investor sentiment amid U.S. credit downgrading, and expectations for the Fed's June meeting.

Video transcript

- Well, the tech sector, as you pointed out, was up more than 27% year to date, driven in part by the excitement around artificial intelligence. As the technology reshapes the sector, where should you place your bet? Let's bring in Omar Aguilar, Schwab Asset Management CEO and CIO. That's a question a lot of people are asking today given the incredible rally we're seeing in Nvidia. How are you looking at this space?

OMAR AGUILAR: Well, it's obviously a great story. And I think we have seen from the end of last year, probably like from middle of last year to end of the last year, all the excitement related to the developments of artificial intelligence. And in certain way, that has actually provided a significant amount of tailwinds for the technology sector all through 2023. And that has provided enough stability for the rest of the market. So that's obviously pretty good.

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I think what is interesting to see about artificial intelligence, it's twofold. On one hand, it is the typical component of everybody being interested about a future potential. The results that we saw from individual companies, especially the one today, obviously generates the fact that there is a significant amount of capital expenditures. There are significant amount of investments that ultimately generate revenue. There's a significant amount of players that are trying to get into the race to have something related to artificial intelligence.

When you have that level of excitement, investments still with a lot of corporations with a lot of cash in their balance sheets, this is a good way to deploy assets, so that you can potentially have those future areas. And as we know, in those particular cases, it's all about growth. It's all about future potential, as opposed to anything that has to do with fundamentals, which is in a way a good distraction for everything else that we have seen on the macro levels over the last several months.

So Omar, it sounds like you think that maybe some of this momentum is going to continue at least for this year. When it comes to just the narrow leadership that we have seen in the market, you mentioned the fact that it has been able to really lift up the broader market so far this year. Is that though going to remain the case as we look out to the rest of 2023?

OMAR AGUILAR: Well, it's a great question. And yes, a big concern of the rally that we have seen in equities through 2023, it has to do with two things. One is definitely the breadth is not there. We have seen that significant amount of the gains in these year equity markets, particularly in the large cap space, have been driven by a small number of stocks. And when you actually see that, that's obviously a sign of concern because when you extract tech away from the rest of the market, you actually probably see a more realistic scenario where what the macro conditions will tell you what is going to drive security performance over the next six months.

When you actually think about the implications of what we have seen for higher interest rates, a little bit more leverage, cash in the balance sheet starting to reduce, that level of activity has gotten into earnings, surprises that even though they are a little better, still continue on a downtrend as obviously, the pricing power that a lot of companies had last year is no longer there.

So I think a big part of this is like yes, there's going to be momentum. It's going to be fairly narrow in certain parts. Definitely, AI, it is a big driver of that. The rest of the market and the breadth of the market is something that we need to continue to pay attention, especially as we continue to see changes in the landscape when it comes out, particularly the consumer spending.

- Yeah. On that front, have there been any fundamental shifts in the narrative as you see it? If you're talking something like the consumer and the retail space, we've been on a number of calls over the last few weeks. Has anything shifted for you?

OMAR AGUILAR: Well, the biggest shift that I think has been a big surprise is that the economy, as it is today, especially related to the consumer, is less interest rate sensitive than what the original thought was. And I would probably say that has surprised even Federal Reserve officials.

Everybody thought that, well, as you increase interest rates, you will see that impact into the economy, and particularly, a big part of the economy tends to be consumer driven, that that was actually going to slow down. That demand was going to slow down, and therefore, we're going to see that downtrend in inflation to be faster, and that's sort of a little bit of the recipe of what the Fed wanted to do.

What we have observed though, is that because of the excess savings that a lot of consumers had during the COVID years, it hasn't been that change, or that hasn't been as dramatic as people expected. So the lag in terms of the sensitivity of the consumer to interest rates seem to be growing, and it has been an area of concern for us because what we can actually see is there's still savings out there, but it's still in the consumer, has been completely focused on the high earners as opposed to the rest of the economy.

So high earners tend to be a little slower to spend that cash. On the other part, the rest of the consumer tend to be a little bit more sensitive to housing prices, so tend to be a little more sensitive to changes in certain areas. We haven't seen that yet, and I think a lot of that has to do with unemployment.

- Omar, when it comes to some of the big concerns here from investors, debt ceiling negotiations down in DC, the lack of progress. We just heard Fitch last night placing the US on ratings watch negative as the uncertainty around those talks persist. We've seen this before when it comes to an actual downgrade back in 2011. If we do see a downgrade this time, What's the potential fallout, and what do you think we'll see in terms of the reaction, the selloff in stocks?

OMAR AGUILAR: Yeah. Definitely, based on the experience of 2011, I would probably say that the market understands what that means in terms of just having the US on a downgrade. And I think the experience that we heard back then is that we should expect short term volatility to basically take place and the implications that had to do with certain investments in certain areas that required certain qualifications and certain grades for their investments to actually suffer as there's going to be some sellout.

I would probably say we saw that back in 2011. The credit downgrade is definitely the least amount of the problems than if we were to go into an actual default. So I think while the credit downgrade may not be as welcome to anybody, it still is not going to be as critical as if anything happens now. And as we can actually see in short term yields, there is a significant amount of premium pay at the moment, reflecting the fact that there's still uncertainty about having a debt ceiling agreement.

- Yeah. Even with that said, it does feel, when you look at the market action, that the Fed is still a primary driver here. We're a few weeks out from the June FOMC meeting. Expectations are now in favor of a 25 percentage point hike to interest rates. Committee members Christopher Waller, Lorie Logan, Michelle Bowman, and John Williams, we've heard them all speak out in favor of raising rates in order to fight inflation. What's your expectation of the meeting?

OMAR AGUILAR: Yeah. This has been fascinating. We have had this discussion just three weeks ago. Actually, the market was pricing a pause for sure and even just significant amount of rate cuts down the road. I think what has changed is the fact that we saw with GDP revisions today and we saw with unemployment claims that the economy has been extremely resilient, and that has actually provided the Fed quite a bit of support for their actions against inflation.

I think the biggest question mark is with a 25 basis points additional increase in rates, what is the upside when it comes down to the inflation? Clearly, the downside is that this has been incredibly aggressive already. And we also need to understand that we had the banking crisis that has created a tightening lending standard that also has created a very tight conditions monetarily for the market.

So when you actually combine tight lending standards with a potential 25 basis points more for the Fed, that will basically create a very, very tight environment for the remainder of the year. So our position at the moment still being in a 50/50 chance for what we call a hawkish pause or potential 25 basis points, considering the new data that supports that the economy seems to be stronger, it seems to be still growing, and that the labor market seems to be tied. And again, thanks to the AI, financial stability is there because the market seems to be digesting all these fairly well.

- So Omar, what's the best way for investors to take advantage of all this uncertainty out there and potential short term volatility that we could see?

OMAR AGUILAR: Well, what would we continue to encourage investors to think about the long term investments. Most likely in this environment, a lot of these portfolios have actually been out of their strategic asset allocation. And try to take opportunities to rebalance their portfolio. Now what is interesting about this moment, again, we just talk about potentially 25 basis points additional increases in rates, these actually allows you to look at your overall fixed income portfolio and potentially start thinking about, well, if this is going to be the last time that the Fed is going to raise rates, potentially the last time, should we start increasing duration in your fixed income portfolio? And at the same time, use the volatility to potentially use tax loss harvesting in areas that have been lost in price to potentially rebalance your strategy overall.

So look at your fixed income portfolio. Try to think about at what time do you want to start increasing duration given that the potential for short term rates to basically get to the terminal rate that's coming soon. And then second, use volatility to try to rebalance your overall strategy consistent with your long term investment objectives, but to try to take advantage of potential tax loss opportunities.

- It's all about balance. All right, Omar Aguilar. Great to have you here. Schwab Asset Management CEO and CIO. Thanks so much.