A gradual increase in yields can be ‘constructive for the market’: Portfolio Manager

Ellen Hazen, Portfolio Manager and Principal at F.L.Putnam Investment Management Company, joins Yahoo Finance’s Alexis Christoforous to discuss growing inflation expectations and measuring the threat of rise in yields.

Video Transcript

ALEXIS CHRISTOFOROUS: Ellen Hazen, she is portfolio manager and principal at FL Putnam. Ellen, good to have you on the show. You just heard what Brian had to say about inflation and the Fed. How much are your clients talking about inflation and maybe repositioning their portfolios in the expectation that we're going to see inflation move higher this year?

ELLEN HAZEN: Most of our clients are not looking at inflation yet, but we have been expecting inflation to increase sometime over the next few years ever since the beginning of 2020. I think in the short term-- in the short to intermediate term-- we're unlikely to see more inflation than we have in the past because we have an output gap, because we still have unemployment higher than it had been pre-pandemic. But longer term, we do expect that we're likely to see inflation for a number of different reasons.

One of the reasons is that with all the fiscal stimulus and monetary accommodations that has happened over the last year, historically that would have led to inflation. There are a number of reasons to believe that this will happen in not this year, maybe not even next year, but in a couple of years after that. And that's very different from what we saw in the great financial crisis where we also had a lot of money printing but we didn't see inflation. And the question is, why not?

Back then a lot of that money, first of all, went to banks and they deleveraged. Banks are already deleverage now, so you don't have that disinflationary effect. You still had a decade of globalization in front of you and that was disinflationary. You don't have that this time. You also have money going directly into the pockets of households now. And that, historically, would lead to higher inflation.

So as we look at what asset classes make sense to own in terms of higher inflation, we have put our clients into TIPS, or Treasury Inflation Protected Securities. Stocks do better than bonds in an inflationary environment, as we all know. And also we think there's a role for real assets to play, whether it's metals or whether it's real estate or other real assets. So we do think that in the next one to two years, because of the weaker economy now, inflation isn't that likely. But a couple of years out we think it's fairly likely and that really indicates going against owning and overweighting bonds in the portfolios.

ALEXIS CHRISTOFOROUS: How much of a threat are these rising yields that we're seeing in the bond market right-- I mean, if we put it in perspective, a yield on the 10-year of 1.36% or 1.39%, which it hit just a couple of days ago-- a one year high-- is still relatively low. But we are seeing the pressure it's putting on the equity market. So how much of a threat, if at all, do you see these rising bond yields being?

ELLEN HAZEN: Ultimately, we think that bond yields are rising because inflation expectations are growing and also because growth expectations are growing. And those are both generally good indicators for stocks. And so even though, on an absolute basis, rising rates might be bad for stocks, if it's indicative of rising inflation and a growth economy, then that's actually-- that's actually good for stocks. And the thing is, in that case, you want to own stocks that have pricing power. And those are the ones that will be able to push through increases in inflation.

ALEXIS CHRISTOFOROUS: And what might some of those sectors be? I would imagine the interest rate-sensitive bank stocks would be one area you'd be looking at.

ELLEN HAZEN: Absolutely. We've seen the yield curve steepen over the last year from an inverted yield curve, just over a year ago in the fall of 2019, to the 210 spread being over 120 basis points at this point and still rising. Particularly as the 10-year increases, as you point out. And so with banks you get a double effect on that front. Because, first of all, they're going to see increased loan growth with the accelerating economy that we expect to see in 2021. So we're going to see increased demand for loans. But they're also going to see their net interest margins expand.

And on top of that, corporate leverage is pretty good. And so we don't think that credit costs are going to materially get worse from here. So with banks trading at under two times book value-- and in some cases close to one times book value-- for high single digit to low double digit ROEs, we think banks are very good areas to own in a steepening yield curve environment.

ALEXIS CHRISTOFOROUS: Ellen, before we let you go, at what level would yields become truly problematic for stock investors, do you think?

ELLEN HAZEN: Historically, the stock market can tolerate fairly high yields. But what tends to derail stock investments is when they increase very rapidly. So if we saw 150 point increase-- 150 basis point, I should say, increase from here in the 10-year inside of a six-month window that would be fairly alarming and that would derail stocks. But if we see a gradual increase in the 1o-year bond going forward that could be very constructive for the market. So there's no absolute level. It has much more to do with the speed with which rates increase.

ALEXIS CHRISTOFOROUS: All right. We're going to leave it there. Ellen Hazen of FL Putnam. Thanks so much for being with us.