Inflation 'is definitely an issue' for markets in addition to Fed unwind: Morgan Stanley Managing Director

Morgan Stanley Managing Director Kathy Entwistle join Yahoo Finance to discuss inflation, the slowing support from the Federal Reserve, and the implications for markets.

Video transcript

KARINA MITCHELL: We want to stay on the markets. Investors digesting comments from testimony earlier from Fed Chair Jay Powell and Treasury Secretary Janet Yellen over the omicron variant and the timeline for tapering. Take a listen.

JAY POWELL: At this point, the economy is very strong. And inflationary pressures are high. And it is therefore appropriate, in my view, to consider wrapping up the taper of our asset purchases, which we actually announced at the November meeting perhaps a few months sooner. And I expect that we will discuss that at our upcoming meeting in a couple of weeks. Of course, between now and then, we will see another labor market report, another inflation report, and we'll also get a better sense of the new COVID variant as well before that, before we make that decision.

KARINA MITCHELL: All right, and we want to now bring in Kathy Entwistle, Morgan Stanley managing director, for her reaction to this and more. Kathy, thank you so much. You know, I want to ask you, are you surprised that the Fed Chair said that they would consider accelerating the timeline, and also by his comments that he sort of misjudged, you know, how quickly inflation might surge?

KATHY ENTWISTLE: Thank you for having me. And no, I'm actually not that surprised because we've been talking about this for a while now, that inflation is not transitory and that the fundamentals do have cracks in that sort of system and that the Fed was waiting too long to, you know, to make some changes and to loosen up what they were doing with the purchasing, you know, to lighten that up. So I think it makes sense that they're doing it. But I do think the markets were more surprised than maybe some of the rest of us were. And that is the disconnect.

It was interesting, your earlier guest had mentioned about uncertainty. And that, to me, is such a theme in this market. We are seeing such volatility with the uncertainty of what's going on in the markets. And I would say, for individual investors, the uncertainty is actually an opportunity to consider where your portfolio is right now and how you can improve it.

ALEXIS CHRISTOFOROUS: Well, let's dig into that a little bit because, I guess, first off, before you start to make changes to the portfolio, maybe you need to figure out what's the biggest threat to the market. And to your mind, is that now the new variant, omicron, or is that inflation, which Fed Chair Powell today basically said is no longer transient?

KATHY ENTWISTLE: Absolutely. So inflation is something that we have spoken on together on this show as well and that it was not going to be transitory or, you know, it was going to be longer lasting. You can't increase people's wages and then decrease them a year later. That's just not going to happen. So I think inflation is definitely an issue. And it's something that everybody needs to consider. And that alone is enough to have some concerns. But then we also have to look at having the Fed step in over the last year and prop up the economy.

At some point, they have to unwind some of the things that they've been doing. And that's going to also cause some disruption in the markets as well. And I think investors like to know the certainty that we had the Fed behind us supporting the markets. And now that that's not going to be the case anymore, we're going to see the real fundamentals of how the economy is doing and how the markets are doing. And it is going to fall back a little bit. You know, we believe that.

KARINA MITCHELL: And Kathy, you know, our earlier market guest said that we're in sort of an information vacuum right now. So for investors at this point, how should they consider reacting? Do they invest cautiously? Do they invest aggressively? What are your thoughts on that?

KATHY ENTWISTLE: You know, it's always tough to give individual advice, but across the board, I would say, at the end of the day, you've got to look at individual companies. You made mention of a technology company earlier that was performing well in this market.

What I would say is what we're going to see are those differentials. Some companies will do well while others aren't doing as well. And it's not going to be so much index investing going into 2022. We're really looking at the individual companies, what the valuations are. Not only what their earnings have been and how they've performed in the past because we've seen the last quarter and the quarters prior to that, some really great numbers come out.

But the concern is, what does it look like going forward? And what are the estimates going forward? What will inflation do? And what will inflation do to, for example, retailers that are low cost retailers? They don't have high margins. They don't have as much wiggle room to put up with inflation.

So I think there's different things that are happening in the markets that are causing this outcome that we're seeing now. And, you know, Morgan Stanley has said we're in this mid-cycle recovery, and we've been sort of waiting and watching for some of this to occur. I think this new variant is an accelerator, but it's not the only issue at hand. It's the fundamentals that need to be looked at and addressed.

ALEXIS CHRISTOFOROUS: And one of those fundamentals we know that really drives the market is earnings. And what are your expectations for this quarter and early next year? Because, you know, at some point, you have to wonder, how much can companies absorb higher costs? When is it just going to really whack their margins?

KATHY ENTWISTLE: Yeah, and again, it's going to be differentiating. There's going to be some companies that are going to be able to maneuver through, that they've put-- the acceleration key is in place for them, the digital transformation. They figured out, like, supply chain. They still know how to make money in their businesses.

So those are the companies that are going to do well. It's really about being careful about where you're investing and how you're investing. And again, I am not going to be, like, looking at indices going forward for my clients. I'm looking more for stock selection and also some particular areas of the market that we think that can perform better, based on what's going on with interest rates and so forth.

KARINA MITCHELL: All right, still a lot of unknowns to look out for. Kathy Entwistle, Morgan Stanley managing director, thank you so much for your time.