‘The good times aren’t over yet’ for markets: Strategist

Brent Schutte, Chief Investment Strategist at Northwestern Mutual Wealth Management, joins Yahoo Finance Live to discuss investor worries, the bond market, small-cap companies, and outlook on the Fed.

Video Transcript

KARINA MITCHELL: We're going to stay on the markets and bring in our next guest, Brent Schutte, chief investment strategist at Northwestern Mutual Wealth Management. Thank you so much for being here, sir. So earnings continue--

BRENT SCHUTTE: Thank you for having me.

KARINA MITCHELL: --to roll out, and they continue to be, for the most part, pretty good. We have some hits and misses. But how long do the good times continue? Where is market sentiment right now? Because you say there are three types of traders. Explain who they are and what they're thinking.

BRENT SCHUTTE: Yes, so we've really been in a trendless market since about mid-May, where you had these three worries type emerge. And so if you think back to May, you had an economy that was reopening and strong. You had COVID going down, and you had vaccinations rising. And over the summer months, people began to think about what's next. And that's where the three camps of worry came in.

You had that too much camp, the inflation camp, which is still very much out there. You had the too little camp, which was really worried about economic growth rolling over. And you have seen growth slow, and you will see it in Q3 GDP reported tomorrow that it has slowed quite a bit. And last but not least, you had the people who were worried that stocks had gone up so far, therefore, they could not go up any higher.

We do believe-- and you're already seeing it, I believe. We do believe that, as you move towards the end of the year, these worries will actually begin to subside, and people will once again refocus on what you just talked about, earnings and economic growth, which will be strong into the end of the year. And that will actually lead markets to move higher as we push into 2022. So I guess, in short, the good times aren't over yet.

JARED BLIKRE: Brent, I want to get your take on what's happening in the bond market today, because we're seeing a big drop in yields, as investors rush into bonds. And I'm just wondering. I also want to throw out that the spread between the 5 and the 30-year in the US, that is the narrowest since March of 2020. So that's basically the beginning of the pandemic. I'm just wondering, is this end of month effects that we're seeing right here? Is it part of something bigger? What does this say to you about the environment that we're in?

BRENT SCHUTTE: I certainly think there could be some end of month trading going on. It's been a strong month so far. And some people could be booking some profits. You also mentioned that tech's doing well and a lot of other things aren't doing so well. And I do think there are investors who've been investing more towards the belief that the growth rolling over that I mentioned will continue. I think that's misfounded. I think the economy will grow strong into the end of the year. You actually have LEI up 11.1% on a six-month annualized basis. And I think on the inflation front, which is certainly another worry, I think that will also roll back.

And most importantly, the Fed isn't going to do anything quicker than what they have to do. Yes, they'll taper, but they're going to take their time to be patient and try to let the employment situation play out. And so I think it's a combination of all those things kind of coming to a head here. And I think as you move towards the end of the year, I do think interest rates will move higher, albeit central banks are going to continue to weigh on them through QE and other things. And that will keep a lid on them, but certainly higher in the intermediate term.

KARINA MITCHELL: And then, so with this picture that you paint, going forward, how should people position themselves? What should they be looking at?

BRENT SCHUTTE: Yeah, and I know tech's very popular. And certainly, it is a secular grower. And that's what most of these conversations start with. And certainly, it has a lot of tailwinds. It's been amped up over the last 18 months. COVID has absolutely been a tailwind towards the tech sector. And certainly, it's growing pretty fast, but I think investors have to ask themselves, how much are you paying for that? And how much is already discounted?

And so, you know, I look at things like the S&P Pure Growth Index, which trades at 35 times earnings versus the S&P Pure Value at 10. And so I still think there's longer term opportunities in tech, but I do think, as you see these worries continue to abate, as you see growth restrengthen, people are going to refocus on things like value stocks, cyclical stocks, and really, small cap stocks, where if you think about it, small cap earnings next year are expected to outpace large cap earnings by almost double.

They're quite a bit cheaper, and I think people are underinvested in there. So, at a minimum, investors should not focus on one sector. But I also believe there's an opportunity to tilt towards other things like I just mentioned that will do better in the near term, when growth is actually strong.

JARED BLIKRE: I want to drill down into your call, your take on the small caps because we are in an environment where we have-- we're expecting rates to rise. A lot of these companies, the smaller companies, the so-called zombie companies, aren't making enough in profits to cover their interest expense. And so do you look at balance sheet strength? How do you how do you drill down into the small cap space to figure out exactly what you want to invest in?

BRENT SCHUTTE: First of all, we focus on a higher quality small cap index, and I think the Russell 2000, which is the one that people mentioned. And so the S&P 600 is a higher quality index in general by definition. And so I would look there. I just think that, you know, some of these companies have not done well over the past few years because growth hasn't been strong. So before COVID, it was the trade war. It certainly robbed the economy of cyclicality. And then you had COVID pile on top.

We had that brief period of time from about, I believe, October of last year to about mid-May, where small cap and cyclicals did much better. And then over the past few months, it's been more along the lines of the more defensive trade or tech doing well, albeit some other cyclical sectors did OK, like finance and energy. But I just think that as you move into the next year, a lot of these companies, look, they're still able to get capital. Real rates are still negative. Growth is still strong. The consumer has plenty of cash. They've deleveraged their balance sheet, and I just think that leads to a more friendly environment for small cap stocks, where this is kind of the backdrop.

KARINA MITCHELL: And how does the Fed play into all of this at the moment? We've seen Bank of Canada say they're going to accelerate a timeline for accelerating rates. ECB reports, Bank of Japan also reports. What does the Fed do next week? And does it move markets at all?

BRENT SCHUTTE: The Fed tapers next week. They announced that that condition has been met. I think they taper. They do so and kind of follow their forecast and certainly get to bottom mid-July next year, where the taper is probably done. But I remind you, the balance sheet at that time is not decreasing. They'll probably be reinvesting proceeds in interest rates or interest payments. And then they start talking about hiking. We're talking about a year before they begin to hike by plan.

Now, certainly, that can change, but the Fed, to me, has changed the reaction function. This is the big difference from today's Fed versus the Fed of 40 years ago. They marked this in stone, I suppose, at Jackson Hole in 2019. The Fed is focused more on the employment side of the equation. Yes, right now, there's a labor shortage. But there are millions of people who fell off continuing claims in the past few months or the past month. I believe those people are going to need to find a job at some point, which will help alleviate some of those concerns that we have on inflation and supply chains.

But more importantly, the Fed wants to bring them back into the labor market. I can't imagine them tightening the economy into submission when the labor market is in a place like it is today, where millions of people are still out of work post-COVID and the participation rate is at lows that we haven't seen in decades. And so, I guess, patient, but certainly moving towards raising rates, but not towards the last rate hike-- towards the first rate hike.

JARED BLIKRE: Got it, and then for investors who want to hedge against inflation in their portfolio, I know you're looking at a couple of things. What stood out to me was gold. Interesting because it's been rather quiet, although it's up about 2% for the month of October. Where do you see the possibilities for gold fitting into an investor's portfolio here?

BRENT SCHUTTE: Yeah, certainly a small location, and we put gold in our portfolios last year when we went overweight equities. And so I think this is a difference between professional investors and retail investors. We have humility. I know that I don't know everything, that there are risks that I want to play off against each other. And so we went max overweight back in April of last year. I wanted to put in hedges on the opposite side of that. And certainly, that's the way I thought about gold. And the fact that gold has underperformed has not been a big concern because the rest of our portfolio has done quite well.

I think moving forward that investors who haven't seen inflation for 13 years, and so people don't like things like commodities. They don't like things like gold. They don't like things like TIPS, although they're warming to those things. I think investors need to think about this cycle as being different. This cycle, you don't wake up every morning and think about deflation. You wake up every morning, thinking about inflation. And the Fed is going to let it go and run. And so, in that instance, you want to continue to own inflation hedges because, to me, as you mentioned earlier about what does the Fed do, they're kind of the only thing that can change the story. And you want to make sure you have some protection as a just in case.

KARINA MITCHELL: Well, all eyes are on the Fed to see what they do next week. Thank you, Brent Schutte, chief investment strategist at Northwestern Mutual Wealth Management, for your time and your insight. We have--