Is it time to pull back some of the monetary stimulus?

John McClain, Portfolio Manager at Brandywine Global, breaks down the latest market action and where things could head in September.

Video Transcript

JOHN MCCLAIN: I mean the question everybody was looking at, did we see substantial further Progress? And as you said before, Powell was fairly dovish here. I mean, good progress to improving unemployment, but still a ways to go.

Inflation is high. But it should wash out. And we've been below target for a really long time. And I kind of tend to disagree here. I think wage growth is pretty consistent. But I think it's going to go higher. Competition for labor is evident at both the low end and high end. And the question really should be what Larry Summers was saying about the appropriate stance for fiscal and monetary policy for today is because incremental moves can get you into trouble. But at the end of the day, very dovish. And the market was positioned for the potential of a little bit more hawkish speech, which is why we're seeing risk assets rallying and the dollar a little bit weaker.

And I think if we could--

ADAM SHAPIRO: John? What Powell said today, we had been preparing at the beginning of this year that they would prepare us as investors well in advance with a talk about the talk about when to taper. So help us understand. Isn't that what's playing right now? Because some people are interpreting this signal as that the Fed could begin the asset dial back this year. And for most of us as investors, what would it really mean? It seems as if the market is saying, yeah, OK, meh.

JOHN MCCLAIN: Yeah. I think that's right. It is a meh. We're not going to get a taper tantrum. I think Bernanke shot from the hip. And today's Fed's overly communicative. And we will get the tapering, but that's a drop in the bucket. I mean, markets needed training wheels in the depths of COVID. But we've taken the bike around the block countless times at this point. And I think it's time to take the training wheels off.

So I think we really should get to pulling back some of the monetary stimulus at a minimum because stimulus is lagging, right? We still have a lot of monetary stimulus in the system. We still have fiscal stimulus coming in and the potential for meaningful additional fiscal stimulus with this 3 and 1/2 trillion dollar bill that's in Congress at the moment.

SEANA SMITH: So John, what are you favoring at this moment in this environment? I guess, what do you expect to lead then, over the next couple of weeks or couple of months?

JOHN MCCLAIN: Yeah, it's difficult, right? Because from an economic perspective, the economy is kind of humming along. From a micro perspective, we've seen very strong earnings out of companies. But that's offset with fairly rich valuations both in equity and in fixed income. I would say we're a little bit bearish on bonds because I don't think inflation is as transitory as the Fed expects.

And you had a chart up there with the Fed's balance sheet. I mean, it's billions of when you talk about my book. I can't imagine what Jay Powell is doing with an $8-plus trillion balance sheet. They've got to talk their book at this point.

So I think we're going to be a little bit choppy into the back half of the year. I think you're going to see enhanced volatility.

ADAM SHAPIRO: Does that include enhanced risk for-- because you had talked about today's quality BBs are not Michael Milkins, BB-rated bonds, I mean. Those bonds were probably about as real as his toupee. But what risks are you taking on if you're looking at lower-quality-rated fixed income?

JOHN MCCLAIN: Yeah. I mean, I think if you're looking in high-yield, I think we think spreads are going to remain fairly range-bound in this 300 to 400 basis point range, barring a substantial equity draw down. Again, I think high-yield companies are supported by extremely large equity cushions, growing EBITDA that should be up 20% year over year, a lack of real yielding fixed income alternatives in the marketplace, and stuff with strong liquidity and access to a variety of forms of capital.

So I think it's OK to be positioned in high-yield right now because we are in the part of the cycle, probably mid-cycle, where companies are growing earnings. And the economy is doing well. So you want to take on additional credit risk. We kind of find the Goldilocks part of the market to be the single B part of the market and relatively short duration.

I don't think you want to take on too much interest rate risk right now. And you don't want to take on the very bottom part of the credit spectrum in the CCC part of the market. I think there's still too much leverage in that. So single B stuff feels like the sweet spot.

SEANA SMITH: John McClain, portfolio manager with Brandywine Global. Thanks so much for taking the time to join us today.