Stocks sink as inflation jitters spook investors

Natixis Investment Managers Solutions Portfolio Strategist Garrett Melson joins Yahoo Finance Live to discuss the latest market action as inflation surges in April.

Video Transcript

ZACK GUZMAN: We are seeing a continued rotation away from tech. Two sectors right now in the green for the S&P 500. That would be energy and financials, the standouts, as we've been discussing here on the show. But for more on that, I want to bring on our first guest today. Garrett Melson is Natixis Investment Manager Solutions Portfolio Strategist. He joins us right now. And Garrett, I mean, when we dig into that, talk to me about what you're seeing in the reaction to these inflation numbers, just given the fact, you know, that this has kind of been the trend away from big tech for quite some time. What's your reaction?

GARRETT MELSON: Yeah, you know, I think you guys hit it really on the head in terms of what we [AUDIO OUT] the data prints today. You know, I think first off, what we tell a lot of our clients is a lot of these prints that are coming in, they're just the first of many to come. And so, I caution against really drawing too much in the way of conclusions from one or two months of data. I think the issue is going to be looking out to the back half of this year, it's not a matter of whether inflation is going to be firming. Over the next couple of months, it really shouldn't surprise anyone that it will.

The bigger story is whether we're seeing a persistent and structural shift higher in prices. And from our opinion, we're simply not seeing it. I think a lot of the issues are sectors and areas of the economy where you're seeing some of that pressure. It should be expected. Used cars, rental cars, lodging, airlines, tickets to sporting events and other recreation activities, you add those all up, they're relatively small components of the inflation basket, and they're about 6% of core inflation. But they've actually contributed about 65% of today's month over month increase in inflation.

So, you know, from that perspective, I don't think it should be surprising. And that really points to this idea that it's more of a supply issue than anything else. To us, what this really just highlights is that the economy is doing very well. It's likely going to continue to be very robust in the back half of this year. There's going to be supply chain and labor market bottlenecks. But those likely will get worked out. And ultimately, I think that sets us up for a continued rotation in some of those cyclical sectors. And certainly, you're seeing some of that today here with tech, obviously, taking a bit on the chin. And financials and energy, as you mentioned, sitting nice and in the green right now.

So for our perspective, you know, again, not much of a surprise here, but it continues to really keep the narrative in place. Inflation is going to be worrying a lot of people. But I think that's kind of missing the forest through the trees here. That's going to happen. But ultimately, it's a structural issue that we're more focused on. And we're not seeing signs of that just yet.

AKIKO FUJITA: And Garrett, I wonder if you can weigh in on how we've seen the market react to this. I mean, we have seen a big sell-off in some tech names, not just in response to the CPI data today, but in response to these inflation concerns that have continued to tick higher. And yet, you say these are all the companies that have a bit more of a cushion when it comes to inflation.

Why do you think that we have seen such a significant sell-off? Is it really about that and the concerns about higher rates? Or is it the broader story about potentially growth slowing, as more people sort of get out of their homes, and those names that gained a lot of strength during the pandemic may not see the kind of growth they've seen over the last year?

GARRETT MELSON: Right, yeah. You know, I think you hit a couple of key points there. We've heard a lot in the way of this idea of peak-- kind of peaking growth, a lot of people pointing to the recent PMI prints slipping off their eyes. But keep in mind, they're still very much in elevated territory, above 60 for both manufacturing and services. So, you know, I'd say at this point, levels are probably more important than the momentum. Those PMI numbers give you a little bit better sense of momentum, not quite as much insight into magnitude. And if growth really was slipping, you actually would expect to see some of those growth names probably outperforming the secular growth names like technology.

So in our opinion, a lot of the reasons for some of the technologies' weakness, you know, rates moving higher, inflation, I think that's kind of a bigger issue is actually correlation, rather than causation. If you think about it, the whole idea boils down to your discounted cash flows because rates are moving higher. It's not really the big driver for growth names. It's the actual growth numbers that these companies are posting. And you can look at Q1 numbers just to prove that.

So in our opinion, the biggest issue for tech over the short run here and maybe the intermediate run is just becoming a funding source. You've seen significant flows into that sector, really, over a number of years. It still remains very, very crowded. We've seen, really, some reluctance from a lot of our clients and in other investors out there to really tilt heavily into the value and cyclical names. I think that still persists. And it sets you up for some of these violent rotations, and the taste of that in the last couple of days and certainly seeing that again here today.

ZACK GUZMAN: Yeah, and lastly, Garrett, I mean, when we dig into maybe how much farther we have to go on some of those jitters, you were pointing out in your note the valuations have already come down pretty significantly when you look at the NASDAQ QQQ. What are you seeing there maybe in terms of historical values to see how much farther we could go and maybe your expectations there on how bad it could get?

GARRETT MELSON: Yeah, so we don't put a whole lot of weight in terms of valuations. I think if you actually look back historically, you can see some pretty structural shifts and distinct regimes. And I think we've probably justified a shift into a structurally higher regime for valuations moving forward here. I think we saw that in the last cycle as well. And so, I don't put a whole lot of weight in terms of looking at historical comps from a valuation perspective. But that being said, you know, if you do look at some of these tech companies, valuations have actually come in quite a bit.

As you look at relative performance for technology, it's actually lagged quite a bit if you look back to about August of last year relative to the broader market, and more importantly, in our view, to kind of that equal weighted S&P 500. And so, valuations have actually moderated a bit because of performance, but also because they've kind of grown into these bigger earnings surprises for this year and probably into next year.

And so, you know, I think that's going to continue to support the tech sector longer term. I think it's probably just more of a shorter to intermediate story here, where tech continues to be somewhat of a funding source into those still underowned cyclical sectors. But longer term, tech continues to be really the growth engine for the global economy. And I think that still generates significant profits, still very, very sound fundamentals. And I think that still supports tech over the long run.

ZACK GUZMAN: All right, Natixis Investment Manager Solutions Portfolio Strategist, Garrett Melson, appreciate you coming on here to chat with us today. Be well.