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Inflation: There will be ‘further layoffs’ that will be ‘fast and furious,’ strategist says

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Quant Insight CEO Mahmood Noorani and Brandywine Global Portfolio Manager John McClain sit down with Yahoo Finance Live to talk about recent market volatilities, outlook on tech stocks, the Fed's interest rate hikes, and positioning against Fed risks.

Video transcript

[MUSIC PLAYING]

[CHEERING AND BELL RINGING]

RACHELLE AKUFFO: There you have it, your closing bell there for May 23rd. Let's take a look at how the world markets ended the day. All three major indices in positive territory. Quite the turnaround from the past week. The Dow up almost 2% there, 618 points. The S&P 500 up about 1.86% there, about 72 points. And the NASDAQ not the biggest winner of the day-- that went to the S&P 500-- but still in positive territory, 1.6% there, up 180 points.

Let's break down the market action with our panel now. Let's bring in Mahmood Noorani, Quant Insight CEO, and John McClain, Portfolio Manager at Brandywine Global. Thank you for joining us, both of you.

So John, I want to start with you because, obviously, a lot of focus still on the Fed and what's happening with inflation. And you've said that the Fed will be the unicorn slayer. Break that down for us.

JOHN MCCLAIN: Oh, sure. Yeah. So what we've seen is an inflation shock that has led to unprecedented rate volatility post the GFC, which has led to, you know, really challenging environment for risk assets across the board. And so what we've seen is rising rates have led to high flyers in my market, like Uber and Carvana. They're pivoting from growth to free cash flow or a coin base that's focused on limiting cash burn. And so these companies have to right size their employee mix and I think we're going to see further layoffs. They're going to be fast and furious and this is going to have broader spillover. Because tech companies spent, spent, spent over the last decade, and now, finally, the bar tab's coming due. And we're going to see-- we've already seen a meaningful wealth destruction in this part of the marketplace. You know, a lot of these employees were deep in the money on equity options nine months ago, and now they're wondering about layoffs. And if you look at the convertible bond market as a proxy here, many former Wall Street darlings, companies like Affirm, Beyond Meat, SoFi to name a few, you know, they're trading like they have serious bankruptcy concerns.

SEANA SMITH: Well, Mahmood, what do you make of the recent market action? Because I think a lot of investors out there are scratching their heads wondering whether or not this recent volatility that we've seen, if that's going to continue, whether or not we have seen a bottom. What's your outlook now?

MAHMOOD NOORANI: So no doubt that the move higher in real rates has done the damage to risk assets and has really driven this rotation from growth to value. And clearly, when you're looking at technology stocks companies that don't have a lot of free cash flow, that are unprofitable, that are promising you jam tomorrow, that need a lot of financing when real rates rise, those companies suffer. And that's exactly what we've seen.

Looking at this week, what's interesting is that we saw real rates actually fall across the curve a little bit in the last four or five days, and that has brought a bit of stability to global equity markets. But if you take a step back, the big picture here is that the fact is that the Fed is still in play. And one thing that global investors really don't like is uncertainty. And the problem we've got right now is we don't know when the Fed is going to stop. They have not signaled the terminal rate. And as long as we have the Fed in play and that uncertainty hanging over the market, the sort of rallies we've seen in the last few days, in my opinion, are going to be relatively short lived.

We're not at a long term bottom. The bottom will arrive very close to the time the Fed signals that it's done. And the Fed's only really just getting started.

RACHELLE AKUFFO: So John, with that in mind then, do you think the markets are accurately pricing in the risk perhaps of recession or more-- the Fed being more aggressive than it needs to?

JOHN MCCLAIN: No. I think we've been conditioned over the past decade, really, since the global financial crisis, that the Fed is the White Knight. And I really think-- I 100% agree with the other guests here. The Fed's going to change the goalposts on inflation targeting as well. I mean 2% inflation targeting wasn't a thing 20 years ago.

So I think that, really, they're going to try to contain inflation. And they don't care about your 401k. They don't care about risk asset valuation here. Because we're still 75% up on the S&P from the trough during COVID here. So I do think that markets are not appreciating how aggressive the Fed is going to be over the coming few months here.

SEANA SMITH: So Mahmood, how are you positioned then? Is it time to take even more risk off the table? What's the defensive way, I guess, to go about it right now?

MAHMOOD NOORANI: Yeah. I think that the sort of rallies we've seen in the last few days are an opportunity to indeed take some risk off the table. And we would look at sectors that benefit from higher real rates, continued higher inflation. Interestingly, our data shows us and has shown for a while that energy has been trading as a defensive. Historically, it's been very cyclical for obvious reasons. But right now and in recent months, it's been trading positively with real rates.

You know, all sorts of more defensive sectors, I think, are the place to rotate to. And remain wary of the growth sector for the time being. And that probably changes when the Fed finally signals that it's done.

And as your other guest mentioned, one of the things that made it very easy for the Fed in the last 20 years to be the white knight was the fact that they had a very low inflation world being driven by increasing globalization, falling labor costs, technology and so on. So they could apply stimulus and they didn't have to worry about inflation. The problem for the Fed today-- and this is where the Fed put strike starts moving a lot lower-- is they can't do that now because they have completely different inflation context.

RACHELLE AKUFFO: And John, I want to ask you about China. Obviously, we're seeing the economy starting to slow down. The central bank there cutting rates there to try and boost their economy as well. Given their reliance on some of these huge companies that have obviously a lot of dependence on China's market, how concerned should we be about any sort of contagion from that?

JOHN MCCLAIN: Well, it really depends on what asset class you're looking at. So for us, with high yield, we have very limited exposure. It's much more of a small cap focus. So it's much more invested in the US. But certainly, I think you're seeing that priced into European stocks at this point because China's much bigger trading partner for them.

And I would be concerned about what's going on over there. And I would be concerned still it's a value trap from an equity and debt perspective with offshore dollar denominated as opposed to Yuan denominated types of vehicles. You know, it really is, to us, very difficult to analyze. And so we would echo sentiments of others saying it's rather uninvestable from my perspective.

SEANA SMITH: Mahmood, what's your reading just on the strength of the consumer right now? Because after last week's retail reports, we're going to get a couple of other big companies set to report tomorrow and over the next couple of days. We have Best Buy, Abercrombie, Macy's just to name a few. Is the retail sector, is that a sector that you see still struggling over the next quarter or two?

MAHMOOD NOORANI: Yes, we do see that. And we find that a lot of retail stocks in our framework are negatively sensitive to higher inflation. And I think we're starting to see consumer behavior shift. There is a tightening of belts and a pushback to rising prices, and that's resulting in falling demand. I think the tricky thing for the Fed is that if you look at real GDP growth this quarter, we're not in recession. However, taking a more forward looking view on it, we are going to be very likely heading maybe not recession but towards very low growth numbers.

And we're sort of in a bit of a perfect storm. You know, China GDP growth has probably dropped by half in the last three months. That's impacting Europe. US GDP growth is undoubtedly slowing, although it's not in recession.

You have the energy supply shock that's sitting there and the effects of that are still being felt. You have inflation that's stubbornly high. You have a Fed that's in play. I'm sort of struggling to find any real bright spots just at the moment.

SEANA SMITH: Certainly. All right. Mahmood Noorani, Quant Insight CEO, and John McClain, Brandywine Global Portfolio Manager, thanks to you both for joining us.

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