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Portfolio Manager analyzes Tuesday's market sell-off

In this article:
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Andrew Slimmon, Morgan Stanley Investment Management Managing Director and Sr. Portfolio Manager, joins Yahoo Finance to make sense of Tuesday's sell-off and preview what to expect from the markets in 2022.

Video transcript

ADAM SHAPIRO: We live to fight another day. We also live to trade another day. So we're going to bring into the stream Andrew Slimmon. He is Morgan Stanley Investment Management Managing Director as well as Senior Portfolio Manager. And it's good to have you here.

Did you read into-- I mean, we like to make headlines and talk a great deal about things like we're no longer going to call inflation transitory. But from an investment standpoint, when I'm watching the Dow off now, you know, almost 600 points, I get a little worried-- what does it matter if inflation is transitory or not? What were your thoughts?

ANDREW SLIMMON: Yeah, it was a fascinating interview. I really enjoyed listening to it. Look, I think it's important to take a step back and really think about some of the truisms of investments. And one of them is, don't fight the Fed. When the Fed is extremely dovish, when the Fed is pumping a lot of liquidity into the system, you want to be maximum bullish.

And that's really been the story of 2020 since the March low and this year until recently. And the Fed is telling you, we're not turning, you know, tightening, but we're beginning the process. So I think it's logical that we should expect that the market isn't going to generate the great returns it has since the March low.

It doesn't mean it's turning bearish, it just means lower your expectations. And the problem with that is when the market's up 20%, it can go up pretty much all year without much of a pullback. But if I said, hey, over the next year or 13 months, the market's going to be up 8% to 10%-- well, the market can move 1% or 2% any day and it's open 250-some odd days a year.

So that's a lot of volatility around a kind of single-digit return. And so I think the most important lesson is, look, expect more volatility as the Fed begins to transition to this more moderate policy and expect lower returns. But it's not the beginning of the end and I think that's important. So take advantage of pullbacks. I don't think we're done pulling back here. But take advantage of it, you know, don't hit the panic button.

JARED BLIKRE: Well, and let me ask you, Andrew. Let's say that we go down 10%, enter correction territory. When you're down 10%, it feels like you're going to enter a bear market-- might as well be down 20%. Kind of difficult to dip your toes in the water sometimes. But I'm wondering, what would you be buying on the other side if we did have a pullback?

ANDREW SLIMMON: Yeah, well, let me just touch on one thing. In the last 100 years, there's been about 100 10% pullbacks, but only 24 of them have morphed into 20% pullbacks you need to see the yield curve invert. You need real yields much higher than we're seeing today for that to happen.

So I think a 10% pullback is very possible. But I think it's way too early in this economic recovery to think we're going to have a 20% pullback. But the point is, and the market's only down 2.5%, 3% from the high. So I think it could pull back further here, I just don't think it's going to turn into a disaster. What I would be buying-- now, again, remember, in a more moderate return environment, if you-- let me rewind the clock. Since the low, it's really paid to take a lot of risk.

Have speculative stocks, whether they're value side or growth side, have a lot of speculative stocks I think as you think about portfolio construction going forward, you still want to have some of those types of stocks but you've got to marry them with a little lower risk-- the stuff that has lagged like consumer staples, REITs, utilities. They've lagged. So I think it's more of a balanced portfolio within a long equity portfolio versus early in the cycle, you want to take more risks.

So in a pullback, it would depend on what pulled back. But if we had a big pullback, I still think financials will do just fine. But I wouldn't own just financials. I would marry them, again, with some of the staples type stocks, which are probably outperforming today and will continue to outperform into this pullback.

ADAM SHAPIRO: Do they do they perform, those that are outperforming, do you think regardless of Omicron and the headlines?

ANDREW SLIMMON: Yeah, I don't think COVID is going to cause a 10% correction. Because, you know, we know the facts. Viruses become more, you know, transmissible but less virulent. And also the second thing is I've learned in this business, investors don't react to the same news as harshly multiple periods as they do the first time.

So the next big pullback is more likely going to be because the Fed's changing policy than COVID. I just don't think. Now, having said that, I'm not-- look, we bought a lot of the reopening stocks-- the cruise ships, the casinos, the airlines early in the recovery. But those have big betas. Those have high risk to them.

So I wouldn't be nosing around in those stocks at this juncture. I think there's too much risk in those. And so I think, you know, like, you get another outbreak and they go down again. Those aren't the stocks I would be focused on.

JARED BLIKRE: And, Andrew, you touched on the bond market briefly, and I just want to talk about the bond market volatility because that ticked up several weeks ago and kind of foretold the spiking VIX that we saw just recently. But I'm wondering, you know, you look inside-- you got the tips yield, you got break-evens, you mentioned the real yield. And can you put your-- can you put it all together for us? What are you watching in the bond market and what is it telling you about how to position yourself, say, going to the end of the year and maybe the beginning of the next one?

ANDREW SLIMMON: I'm really glad you touched on that, because that's the key thing. I think it's the yield curve you need to focus on. Because, you know, as much as today's discussion was around an increase tapering, the Fed fund futures have suggested that the Fed is less likely to tighten next year. And so that's the key question.

The equity market will do well until the market starts to worry that the Fed isn't just tapering. They're going to start to hike rates. And so I think a way to judge that will be the yield curve. Now, the yield curve has come down a little. It's in the-- the 2 to 10-year's in the 90 to 100. But I think you really see the yield curve flatten a lot more, that will be an indication that, no, the Fed is going to be raising rates in the near future.

If that doesn't happen, then I think next year will be a good year for equities, it just won't be as strong as we've seen in the last two years.

ADAM SHAPIRO: But even that, when you look at what the S&P 500 even today is up, what, 24% year-to-date-- so what does, it won't be as strong next year look like? 12%? I don't think anyone would be mad at that.

ANDREW SLIMMON: Yeah, no, I don't think it'll be that much. Because here's the thing-- you have a battle going on. You have tighter financial conditions. OK, the Fed is-- they're not raising rates, but they're tapering. That is tighter financial conditions.

You also have a discussion of a higher capital gains rate, higher corporate taxes. So monetary and fiscal policy is moving in the wrong direction-- so that's financial tightening. The offset-- and this is what happens in the third year-- is you have very strong earnings growth, OK? So I think earnings are going to continue to surprise on the upside.

And this is the story of this year. Don't lose sight of the fact that at the beginning of the year, the S&P was supposed to earn $165 a share. Now, we're over $200. So the E has been very wrong and the E has had to move up. I think that will continue next year.

So there's a battle between tighter financial conditions and stronger earnings. And I think that's why in the third year coming out of a low, you get single-digit but positive returns. I think that's what we're looking at-- 5% to 10% returns wouldn't surprise me. Now, again, going back to your question before, which I think is excellent, how will you know if you're wrong?

And I will be wrong if the yield curve flattens. Then, I think, you know, it's more likely a negative return for equity. But that would be very unusual this quickly in a recovery. So I think it's-- when the dust settles on December 31, 2022, I think the market will be up, but there is going to be more volatility because it's just really hard for the market to move slowly up to a, say, 8% return on the year.

It will overshoot and undershoot. And that will create more opportunities to make money in the market as long as you don't let your emotions grab hold of you.

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