‘We do expect cyclicals to take back the baton from growth’: Strategist

Gabriela Santos, J.P. Morgan Asset Management Global Market Strategist, joins Yahoo Finance Live to discuss the outlook on the overall market, moves in the bond market, and consumer sentiment.

Video Transcript

SEANA SMITH: Take a look at some of the selling action that we're seeing for yet another day here on the Street-- the Dow off 181 points. The biggest laggards in the Dow today, Dow Inc, Caterpillar, and we're also seeing losses from Apple-- Apple stock off nearly 2%. A lot of those big cap companies among the biggest laggards today.

In terms of the sector action, materials, communication services, and technologies are the worst performers so far. So let's talk a little bit more about some of the selling that we've seen recently. And for that, we want to bring in Gabriela Santos. She's JP Morgan Asset Management.

And, Gabriela, let's just talk about the selling and what we have seen, because the big question is whether or not this is something a little bit more substantial than maybe a little bit of a pullback that we have seen over the last several trading days. What's your current read on what we're seeing play out?

GABRIELA SANTOS: So I think if we look back, perhaps, to early June, we started to see investors price in some deceleration in economic growth driven by the emergence of the Delta variant, which is impacting, clearly, consumer spending on certain services, as well as some supply-driven constraints restraining sales and production of things like autos.

So since then, we've seen value, for example, underperform growth by about 15 percentage points. That's a way to see that sentiment has weakened a little bit at the margin. Over the last month, though, I would say that it's just a market lacking direction.

We have so many questions going into the fall about the growth deceleration, about inflation, the Fed, earnings, and we just don't have a lot of answers. So there's a lot of noise, not enough signal. And you get these meandering days that we've been having here in September.

SEANA SMITH: Gabriela, it sounds like we could see some more of these meandering type of days, then, at least over the next couple of weeks as we do wait for clarity on some of those issues.

GABRIELA SANTOS: I think so. And the data this week didn't really settle any of the important questions we have. First, around growth, we continue to see some effects of the Delta variant and supply constraints. We saw them in retail sales and inventory numbers this week. Next week, we'll get September PMIs. We might get some interesting information from the services as well as the delivery subcomponent, but nothing definitive.

On inflation, nothing for this August CPI really settled the transitory versus permanent debate. Next week, we'll be looking at input output prices, but they're unlikely to show a definitive answer either. And then in terms of earnings and the Fed, we don't expect any sort of conclusive announcements, either from Congress or the Fed.

So it does seem to us like we'll have to wait a little bit longer. Ultimately, we do think that growth will reaccelerate, inflation will largely temper, bond yields and earnings expectations both will move higher. That's still a better environment for risk assets than bonds. But we might be in a bit of a sideways range here for a little bit longer into the fall.

SEANA SMITH: Gabriela, you mentioned the re-acceleration that you're expecting to see in growth. I guess, what are your estimates, then, going into the final months of the year? And then, more importantly, into next year in 2022?

GABRIELA SANTOS: So if we remember in the second quarter, the US grew about 6.6%. For the third quarter, there seems to be a deceleration-- we expect sub-3% GDP-- I mean, not bad, but a deceleration on a sequential basis. For the fourth quarter, we expect that re-acceleration, driven by the fading of the Delta variant as well as some easing in supply constraints-- so growth should move back up to 5% and remain at near 4%, 4.5% in the first half of 2022.

That's still significantly above potential. That is a good environment for earnings growth. It's a good environment for cyclical sectors. So we do expect cyclicals to take back the baton from growth. And crucially, the last thing I'll say is we do expect bond yields to resume their march higher. So we shouldn't be lulled into complacency by this move lower in yields we've seen over the last six months. This is still a danger zone here for fixed income.

SEANA SMITH: When you say, bond yields will resume their march higher, I think that's been the big question here as to when and how much higher we could expect to see yields over the coming months. I guess where do you see that trading range?

GABRIELA SANTOS: So I think we'll need to get some confidence about that re-acceleration in growth that we haven't had since early June. But more than that, I think it's been a lot about the technical factors depressing bond yields. So we'll need to see a raising or a suspension of the debt ceiling from Congress, which would allow the Treasury to go back to issuing new debt.

And we'll also eventually need to see that announcement and the beginning of tapering from the Fed, which we expect to get in November. So that's why we mentioned it might still be another 90 days here until we see a resolution, including of some of these technical factors depressing bond yields. Regardless of when exactly it starts, I think, with the 10-year sitting at 1.35%, it's pretty probable the march is higher as we still have a long ways to go to get back to some semblance of normal for the 10-year, which remember back in 2018, was at 3%.

SEANA SMITH: Yeah, seems like a lifetime ago at this point. Gabriela, one of the data points that we did get out this morning was consumer sentiment. And I know you're relatively positive on the growth that we're expecting to see going forward into 2022. But when the market sees a print like it did this morning, I guess what is the big takeaway that the market is looking at from that number? Is it able to just shrug it off?

GABRIELA SANTOS: So it's interesting-- we've been seeing a bit of a difference between this measure-- the Michigan Consumer Sentiment Index-- which trended significantly lower in August and didn't move up much in September versus the Conference Board Consumer Confidence, which is much, much higher. And that's because it's much more tilted towards the labor market, which is still very, very solid, whereas this survey might be showing some of the temporary effects of the Delta variant and high inflation.

So if, indeed, we do see that fading of COVID-19 over time and as inflation normalizes a little bit further, combined with the strong labor market, we should see the consumer reaccelerate. Now, consumption has been very strong in the third quarter at about 2%. But it should reaccelerate as consumers draw down on what are still very elevated savings. So anything related to the consumer is still a good theme, both on the equity side and also on the bond side through things like mortgage-backed securities and asset-backed securities-- some bright spots within fixed income.

SEANA SMITH: Gabriela Santos, always great to speak with you-- JP Morgan Asset Management Global Market Strategist. Have a great weekend. We look forward to seeing you again soon.

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