Economic environment has ‘absolutely crushed’ bond investors, market strategist says

John Hancock Investment Management Co-Chief Investment Strategist Emily Roland and RSM Chief Economist Joe Brusuelas join Yahoo Finance Live to discuss markets, yield curve inversions, marginal pressures and the outlook for bond investors.

Video transcript

BRIAN SOZZI: Welcome back. Emily Roland and Joe Brusuelas are still with us analyzing those jobs numbers. Again, 431,000 jobs created in March. Below estimates, although hourly wages increased by 5.6%, it is really a nice recovery from February. Joe, to you, you pointed out a good statistic to us in the jobs report, just this increase in the number of people returning to the workforce. Why do you think this is? JOE BRUSUELAS: I think the salary mix is ​​going up, that some – part of the pandemic is clearly behind us. And I think there is something else. I think people are bored just sitting at home. So, a confluence of events increases the size of the US workforce, and that’s a definite positive in this report. JULIE HYMAN: Emily, can I ask you to tell the anecdote you told during the break? can we do this? Can we do it publicly? Because you have an exam– a real-world example– EMILY ROLAND: Sure. JULIE HYMAN: — of someone coming back to work. EMILY ROLAND: Yeah, I think my mom would love for her to know I was talking about her on TV, but she called me the other day. She is 72 years old. She had a long and successful career in sales. She retired at the height of the pandemic, even though she didn’t really want to. And she just called me the other day and said she was going back to work. He missed it too much. So unfortunately that means I’m losing some child care here, but I think it’s certainly a positive development for the US economy to have it back. JULIE HYMAN: Yes, most definitely. So that’s an example for you, Joe. You can also put it in your research note. Emily’s mother may also feature on television and in Joe’s research. So this is just one example. JOE BRUSUELAS: I’ll use it. JULIE HYMAN: Yes. So Emily, as you sit in the strategy seat and watch this report, is there anything you see today that changes the way you position your portfolios or perhaps strengthens your thoughts on how you position yourself? EMILY ROLAND: Yeah, nothing really in today’s report. You know, I think it’s always important to remember that employment data tends to be a coincident indicator. So it doesn’t really give us the ability to detect what might happen in the future or when a recession is coming. In general, recent economic data has had a nice little edge here, as Joe mentioned, Omicron is behind us. We see very strong manufacturing data, things like the surprisingly higher PMI. We watch the Conference Board’s Leading Economic Indicators Index, and it’s growing about 7% year-over-year. The US economic data is therefore quite solid at the moment. But as we talked about, it slows down as we go. I think when it comes to the markets, the hard data, the super hawkish Fed, this revised estimate when it comes to Fed rate hikes has led to a period where bond investors have been completely crushed. We’re all looking at the first quarter data right now, and the BarCap Ag, Aggregate Bond Index is on course for its worst quarter since the first quarter of 1980. And clearly, we’re seeing negative sentiment building around bonds. The investors I’ve spoken to are kind of starting to raise their hands and say, I don’t want to own bonds anymore. And we actually see that as a potential mistake as we progress through the year. Investors tend to hate bonds just before we love them. And as we get closer to the end-of-cycle momentum, we get closer to the potential recession in the second half of 2023, which is our base case, you actually want to add duration to the portfolios and start embracing bonds more. Again, not quite there yet, but we still want to watch where the puck is going. And we think bonds are starting to look a lot more attractive at these levels. JULIE HYMAN: Joe, I want to go back to what we’re seeing in terms of inflation with the dynamics of the Fed, okay, and how that feeds into everything that Emily is saying. In other words, I continue to pay attention to this wage growth not keeping pace with inflation as it is. And when the Fed raises rates, it’s not just going to bring down, or so the Fed hopes, headline inflation. It will also bring down wage inflation, right? So in other words, if people are in a tough spot now because gas prices are going up and their wages aren’t keeping up, when everything slows down, I mean, won’t that pose- it not a problem? If it’s problematic now, won’t it just get more problematic? JOE BRUSUELAS: Well, that’s why you don’t want to fall behind, right? So, yes, in the next six to 12 months things are going to be tough. No matter how good the economy is, public opinion is going to be sour. This will therefore be a significant challenge for US households, especially those at the lower end of the income scale, in terms of adjustment. I mean, we already talked about it. If I spend $200 a month on food and food prices go up 10%, will I notice? Probably not. Is a family of three living on $55,000 a year? Yes, this is a real problem. And that’s, I think, the best way to look at it. Now, in the economy — and it’s unfortunate, isn’t it — we have real economic inequality. In our economy, essentially 62% of expenses are borne by 40% of households. The other 60% of households, they are only responsible for 38%. It is this cohort that worries me the most. The top cohort will drive the economy forward. I’m not really worried about them. They’ll be fine with that adjustment, right? But politically, it is a real problem. And let me say one more thing about this report before I leave. This report really gives us a good idea of ​​the resilience of the economy. If you think about the sampling period from mid-February to mid-March, what happened? We had Mr. Putin’s price shock via the Russian invasion of Ukraine. That didn’t scare the American business community away from hiring. And there were some really big economists this month with – had zeros in front of their forecasts, and basically they thought everything would come to a halt because of the price shock. This is not the case. And I think that’s a very important piece that we don’t want to overlook, how, A, how resilient the economy is, and, B, how well the American business community intends to respond to demand and pay labor for it. And it’s a good story. BRIAN SOZZI: Emily, is that point from Joe – and of course it’s really well taken and it’s something we see in a lot of companies. But is that enough to stay bullish on equities when we’re here, sitting and talking about a recession, an inverted yield curve, exploding food prices? Is it enough to have more equity allocation in your portfolio, instead of cash? EMILY ROLAND: Brian, what I would watch — and Joe pointed to the resilience of the US economy — the resilience of US corporate earnings. We continue to see earnings growth estimates over the next 12 months rising here. We know there are companies with strong operating leverage, great pricing power, that have been able to grow their margins in this time of high inflation. Will it get harder? Yes. Some of these entries will increase. We’re going to see some margin pressure, but the fundamental business context is there right now. You want to be careful where you are assigned. As the economic cycle progresses, as we get closer to the end of the cycle, you want to think about parity value. So right now we’re in a weird place where we want to own some cyclicality. We like areas like US industrial stocks, US mid-cap stocks for that offense, that inflation protection in portfolios, but we want to start associating that with quality growth. We want to own stocks and sectors that have high earnings stability, that have the ability to grow organically even in a more normal or slower growth environment. So it’s really important to be thoughtful, I think, in terms of the stock markets and how you’re distributed in this very unusual time of high inflation and slower growth. JULIE HYMAN: And Emily, well, kind of tied to that point, Brian and I have been on watch — on earnings watch, like we always are. And we’ve noticed that there are certainly companies that are – there’s kind of a spike in concern on company conference calls about input costs and also, in some cases, a drop in demand. One thinks in particular of Tempur Sealy, the mattress company, RH, alias Restoration Hardware. Are there any areas that you are more concerned about right now that you want to do without? EMILY ROLAND: Yes, there are definitely areas where we’re seeing a decline in consumer demand. And what that’s really the result of is all the progress of purchases in certain areas like that. In fact, when we look at the data, areas like furniture is one piece that I think consumers really ran out of budget for during the height of the pandemic. So really, where we want to focus is, again, sectors and stocks that have the ability to grow organically, even as we see a slower economic climate heading into recession. So for us, that brings us to quality growth areas, like technology and communications services, but again, pairing that with more cyclical areas like industrials that have high fixed cost investments , properties, plants and equipment. There aren’t a lot of additional investments or variable costs associated with these types of businesses, but they can still pass those higher prices on to consumers. I think companies that have higher variable costs, things like merchandise at a retailer, are going to be in a tougher position here as we move forward, and margins get squeezed. JULIE HYMAN: I love having you here. Joe gives us perspective on the report, so does Emily, and then Emily breaks it down, how to trade everything. I really appreciate it, guys. Emily Roland, Co-Head of Investment Strategy at John Hancock Investment Management, and Joe Brusuelas, RSM’s Chief Economist, thank you both. Have a great day, guys, and a weekend, too. The weekend is here.