EMILY MCCORMICK: David, the Federal Reserve kicked off its first day of its latest policy-setting meeting today. Do you think the volatility that we've seen over the past couple of sessions and really past month now might deter the Fed from going in as hawkish a direction as it might have otherwise?
DAVID BAILIN: I do. If you think about what's taking place in the market, it indicates the degree of sensitivity that market participants have to what is going to be the new rate environment and the new liquidity environment. The Fed made a major reversal, right, about five weeks ago when it said that it was going to raise rates and also to consider quantitative tightening, which effectively means that you and I are going to have to finance the debt that is necessary, you know, issued by the Treasury instead of the Fed.
So with all of that, I think that they're going to look at what happened, and they're going to say, you know, our goal here is not to shut down the economy and to make things actually slow. Right? The goal here is to signal their willingness to fight inflation to the extent that they can.
And, really, they also acknowledge the limit of their ability to fight this kind of inflation. You know, when you're dealing with shortages of semiconductors, making the economy go slower is not the best way, right, to actually address those kinds of issues, those kinds of shortages.
So I think that the Fed is going to notice the impact that it's had. It wanted to send a message. And that message was, it intends to be on the lookout for inflation. But, in no means, do they think that they have gotten to peak employment at this point and therefore really need to slow an overheated economy.
ADAM SHAPIRO: So, David, in a note to your clients, you wrote that the torrent of monetary fiscal stimulus and COVID-driven supply distortions over the past two years caused major supply demand imbalances and labor market distortions. At this moment in time, looking six months forward, investors hearing that are saying, OK, what do I do?
DAVID BAILIN: Yeah. So I think that you have to take a look at the data, which we really also spent a lot of time talking about. So let's talk about labor, right? We have several million people who have not returned to the job market yet who are seeking jobs, a few million. We've got about three million people who are entering the job market who have not yet been employed. So about five million people is our capacity.
We've got an enormous number of people switching jobs right now across many, many industries, creating a real turnover, right? And we have a lot of friction in the world in terms of where people are living. They're unable to move and leave their apartments or they don't want to leave their apartments or homes. And so all of that, what I would say is that kind of friction, right, is what's causing us to have higher labor costs in some sectors, leisure and retail in particular.
So I don't think that we've got long-term inflation in terms of wages. I think we have a gap up. And with that type of view, what you want to do is, you want to invest in certain areas of the market in this part of the cycle. You want to be investing in consumer staples, which are beneficiaries of lower prices for commodities, lower prices for shipping, and, obviously, greater consumer demand.
The second thing you want to do is be in dividend stocks more broadly. You want to get paid instead of fixed income on those coupons of companies that are increasing their earnings. And one of those is consumer staples. But the other is, interestingly, health care and information technology. Some of the great IT companies are also dividend payers, so we like those.
And then we also are looking overseas at certain markets in Southeast Asia and the United Kingdom. And the UK right now has dividends on some of their stocks of 5% and 6% with growth rates that are parallel to those in the United States.
So you build a portfolio that has this kind of diversification, but you don't look back to technology broadly or any of these things that were mean reversion trades that took place during the early and mid-stage of the pandemic. Those are done. You go to this more conventional, more mid-cycle investment strategy.
EMILY MCCORMICK: David, when we think about the major stock indexes more broadly, one of the things that our previous guest pointed out was that, since 1950, the stock market has done well even when the Fed raises rates and undergoes tightening, so long as real earnings are rising. At the stock index level, is that what you're expecting to see this year?
DAVID BAILIN: Precisely. I think that, you know, your last guest is correct on two levels. One, they talked about the idea of not market timing. Market timing is a very dangerous thing. And yesterday and the day before are going to, in my mind, when we look back, be poor days to sell, and especially poor days to sell some of the better-quality technology names.
So what we want people to do is to rotate their portfolio to stay fully invested and to move into the sectors I think that are going to be better for us but to stay invested. And the reason is exactly as you say. Earnings for the next two years are going to rise, we think between 7% and 8% on average and better in certain segments. And so, as a result of that, it's very hard for the market to go down unless the Fed overreacts.
If you think about 2018, which I think is a remarkably important data point, only when we had nine interest rate hikes then and only when the Fed began quantitative tightening and removing liquidity to an extent that the market thought was too much, did we have a major correction. That event just occurred in this market, and the Fed has done nothing yet. So I think there's a lot more tolerance and resilience in this economy, you know, that can tolerate the Fed rates being higher.
ADAM SHAPIRO: Quickly, would you advise keeping your money in the United States, or should you be looking overseas though for a better return?
DAVID BAILIN: Well, I think that what we have to be conscious of is that, right now, you know, we can't have as many bonds in the portfolio, right, as we would have before because of the incredibly low and negative yields that they've got. So you have to seek diversification.
Why do you want to be in China? They're going to be lowering rates while the US is raising rates. Why do we want to be in certain emerging markets like Southeast Asia and Brazil? Those markets are trading at very low valuations, and when the economy stabilizes and Omicron is over, we're going to see a broader recovery in those markets. Why do you want to be in the UK? It's gone through Brexit, and it's trading very poorly right now, and, yet, it's the gateway to Europe.
So there are reasons to be in each of these markets, right? And I think that if you are globally diversified, you're going to have less of the volatility that we've just experienced. Also, I think, from a trend perspective, the US at 62% of the world's market capitalization rarely ever gets higher. In fact, this is at really an all-time peak. So, from my perspective, global diversification has, really, those two big benefits.