The Fed doesn’t want to talk about raising rates: CIO

Ernesto Ramos, BMO Global Asset Management U.S. CIO joins the Yahoo Finance Live Panel to discuss the latest market action.

Video transcript

- But want to shift over to digesting the updates we got there from Loretta Mester in that interview with our own Brian Cheung earlier today. Interesting to see her comments about inflation. Of course, we know the Fed's been signaling this for quite some time-- that movements above 2% inflation wouldn't be bad news, wouldn't be time to panic, seeing as we've run so long below 2% inflation here in that Fed target.

So for more on that and where we go from here, I want to bring in our next guest. Ernesto Ramos is BMO Global Asset Management US CIO. He joins us right now.

And Ernesto, good to be chatting with you. I'd be curious to get your take, given the way that we saw valuations kind of stretched here, heading into these jitters in this rotation out of tech names. Where would you put us at now? And your take on what we heard from the Fed earlier this morning?

ERNESTO RAMOS: Well, I think certainly, inflation is an issue that's worrying. I think the Fed is talking very softly about it, but it's on the horizon. It's actually here. I mean, you look at the prices of clothing, the prices of food, commodities, financial assets. Inflation is a reality today. We'll see tomorrow, CPI number, where it sits. The Fed does not want to talk about raising rates. They don't even want to talk about tapering their bond purchases yet. But that will have to happen at some point.

And I think, of course, the market's our discounting mechanism. And so they will anticipate that. And when you have elevated valuations, especially in the growth areas of the market, like technology, those are the ones that are going to take that potential rise in interest rates much, much harder on the chin.

On the other hand, on the very positive side, you have incredibly strong GDP growth brewing. Some people are calling for 12% Q2 growth relative to Q1. So the whole year 2021 could be a 10% GDP growth year for the markets, which would translate into very strong earnings growth. So there's good things going on in the market in terms of GDP growth, [INAUDIBLE] growth, but the potential for pullback, given the elevated valuations and the rise in bond yields, is certainly there.

- Ernesto, it felt like last year there was a time when, when in doubt, tech was sort of the safe haven play. And here we are talking about nobody wanting to get near tech because of the concerns around inflation. And I wonder how much of this selloff that we've seen you think is actually overdone? Or do you think this is pretty justified, given those valuations you just pointed to?

ERNESTO RAMOS: Yeah, I think that the correction in tech was certainly justified. I think the whole market probably will see a short term correction, given the elevated valuations as a whole. But that's just going to be a pause, because there is so much liquidity in the system. I mean, you have fiscal stimulus in the order of $6 billion roughly speaking, between the recovery and then the subsequent plans that Biden has put forth. And you have monetary stimulus, which is absorbing all that fiscal stimulus. So it's incredibly favorable for liquidity conditions.

Now that also brings up the other concern that we have, leverage. As you have so much liquidity in the system, you start seeing leverage grow in some hidden corners of the market. We don't know right now, but where is the next Archegos, for example, going to take place? And so there'll be a shoe to drop somewhere along the line. It may be a big shoe. It may be a small shoe. But there's going to be some pockets of cracks, given leverage and incredibly easy economic conditions, that will rattle the markets.

That might bring a correction at some point or another, but generally speaking, the earnings growth-- we're estimating 48% for 2021 versus 2020 on the S&P 500-- will be able to sustain the market going forward. But there's going to be bumps along the road, for sure.

- Yeah, and I guess when you're looking out, it seems like more emphasis is being placed on what we might see in 2022, when it comes to earnings there, looking past these quarters of bounce-back in this recovery. What that year is going to look like. And so, when you're talking to people out there who are looking at the tech selloff and saying, look, I'm not sure if this is going to get any better the farther along we go in the year, if these jitters are going to sustain and continue. Maybe I should be shifting over to the value side. So when you do look at cyclicals, where are you seeing the best value for continued outperformance? If it is energy, financials, or some of those other names that you like here? Where would you be rotating to put new money to work?

ERNESTO RAMOS: Well, on a second perspective, I definitely like financials here. The conditions are incredibly good, because you've got the low end of the curve anchored down by the Fed with rates, but then the longer-- Sorry. The short end of the curve anchored down by the Fed. The long end of the curve will rise as inflation expectations go up. And that's going to create a very favorable net interest margin for financials.

And on top of that, you get very strong GDP growth in financials. At the end of the day [INAUDIBLE] are placed on the cycle and on the economic cycle. So you're going to have those two very favorable conditions. And valuations of financials are generally quite low. So you have low valuations and two very strong positives for markets in terms of the slope of the yield curve and economic growth. So that's one of our favorite sectors right now.

Energy will depend on the price of oil, of course, but in general, that should strengthen as the economy strengthens. So that's another. And industrials are going to benefit from all the infrastructure spend that is going to be coming down the pike. So all of the cyclical sectors look good.

And then, technology is a safe haven, but you're going to pay a dear price for that safe haven and it may not be as safe right now, given the elevated valuation and the potential for a rise in interest rates, which will bring them down.

- All right. Ernesto Ramos, BMO Global Asset Management US CIO. Appreciate you stopping by here to chat with us today Be well.