Tapering is fully priced into the markets as a non-issue: Strategist

Jon Adams, BMO Senior Investment Strategist joins the Yahoo Finance Live panel with the latest market action.

Video transcript

- Let's bring a guest to maybe put it into context for where we're at in the market right now. Jon Adams, BMO senior investment strategist joins us right now. And Jon, that's the narrow focus picture on the earnings front, when you back up and look at maybe where we're at right now as we move farther and farther into Q4, how do you maybe gauge the market's strength right now to wrap up the year?

JON ADAMS: Sure. We think investors have been too pessimistic on earnings expectations, we were hearing concerns about peak earnings in Q1 and then, of course, Q2. But it does look like Q2 was likely the peak, but Q3 is going to be strong, probably above 30% year over year earnings and it's been pretty broad-based strength. It's been energy and materials in particular, of course, but also areas like financials and consumer discretionary posting some very nice year over year comparison.

So, we think the strength will continue into the fourth quarter, we're not overly concerned about profit margins. We are closely monitoring supply chain issues, increasing wage pressures but still think that profit margins are at healthy levels and that there's more upside to come.

- Supply chain concerns in inflation, price increases really dominating the earnings calls we've had so far. We had P&G this morning talking about how they are looking to add additional price hikes to try and offset the increased cost coming on the back end, whether that's from freight, higher fuel prices.

I mean, to what extent do you think that's likely to cap the gains that we're seeing at a time when a lot of these companies are starting to gain some momentum coming out of the pandemic?

JON ADAMS: Sure. You know, I think the evidence that we've seen so far in kind of early stages is that many companies have been able to pass on those price increases to consumers. So again, we'll be watching that dynamic very closely but if you look at wages, for example, they're not overly concerning levels yet, with wage growth around 4%, so still below those headline inflationary figures that we're seeing.

But we'll be closely monitoring labor market data, that's been one surprise is that the unemployed workers have not really come off the sidelines, come back into what's been an increasingly strong labor market here over the past couple of months. So, we'll be monitoring those profit margins but, again, nothing's at kind of concerning levels yet.

We think that those companies, especially more value biased companies, will be able to pass on a lot of those price increases, they are much more correlated with things like nominal GDP. And foreign income-based investor, those companies are still very attractive.

- And Jon, when we look ahead to maybe how this is all impacting the thinking at the Fed, of course, the wide expectation has been signaling towards tapering at the November meeting. And when you look at that, I mean, I don't know if it's even worth talking about if everybody is on the same page now that it's been kind of, I guess, signaled so hard here from Jay Powell and company. I mean, what's your expectation there as we move towards it?

JON ADAMS: Yeah. I think you're exactly right. I think tapering is fully priced into markets right now is kind of a non-issue, it's going to take a lot, very weak economic data, for example, to knock the Fed off course, tapering probably to the tune of $15 billion per month starting in November or December. But I think the bottom line is it'll be done by middle of next year and then the discussion will focus very intently on when and if the Fed will be able to hike interest rates.

But we think some of that fear is overdone, we think the Fed will continue to lag behind. But the longer we go with inflation running significantly above expectations, it's going to get harder and harder to make this transitory argument. And some would argue the goalposts have kind of changed for policymakers over the last few months on what is transitory actually mean.

But from our perspective, if we're sitting here maybe the end of March and inflationary pressures haven't abated to some degree, it's going to be very difficult for the Fed to continue to make that transitory argument, and a lot of that is due to factors outside their control like increased demand and supply chain issues.

So we'll be watching that very closely. But our base case is that tapering will go on as expected, it'll be kind of a non-issue for markets but that the focus will be heightened on potential interest rate increases and how long after that tapering cycle is over does the Fed begin to discuss that issue.

- Jon, we have some of the bigger growth names reporting this week, Netflix today after the bell, we've got Tesla later this week as well. Where do you stand right now in this growth versus value debate? Which side are you more overweight?

JON ADAMS: We've been fairly balanced over the last couple of years. Looking back two years ago, we were much more biased toward growth companies but we've actually moved toward a slight tilt toward value companies on a year to date basis, that's been a nice position. We look at that as partially, talking about the inflation issue, that's a partial hedge against higher inflation, we think that value companies would hold up better in that environment.

And you are seeing companies, again, like financials performing very well from an earnings perspective. So we wouldn't advise investors to tilt too much toward value versus growth but we think that a slight tilt there makes some sense from an asset allocation perspective. We're kind of hedging against that inflationary scenario by remaining overweight equities broadly versus underweight fixed income, and also that small tilt toward value versus growth.

- All right. Jon Adams, BMO senior investment strategist, appreciate the insights there.