‘Investors are still misunderstanding the Fed,’ says this chief investment strategist

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The stock market still has room to run this year despite investors’ rising concern over inflation, according to Brent Schutte, chief investment strategist at Northwestern Mutual Wealth Management Company.

“I think investors are still misunderstanding the Fed,” Schutte told MarketWatch in a phone interview Tuesday. “The Fed isn’t tightening anything, even if we get inflation in the coming months, until they make up all the losses and more back on the employment side.”

Even after last week’s strong labor market report and positive economic data Monday from the Institute for Supply Management, Schutte expects the Federal Reserve will let inflation rise as long as it sees gains can still be made under its employment mandate. That leaves him feeling optimistic that the stock market may continue moving higher this year, albeit potentially at a slower pace.

Small-cap, mid-cap and value stocks RLV, +0.02% will probably continue to lead equities in the broadening economic recovery that is being fueled in part by the Covid-19 vaccination rollout, according to Schutte. But while value stocks remain relatively cheap, and small and mid-sized companies are poised for higher earnings growth, he expressed concern that individual investors may not be positioned to capture related gains in the economic rebound.

“I do worry that a lot of retail investors have gorged themselves on growth and tech stocks,” said Schutte, explaining they risk missing investment returns from the rotation into value, small-cap and mid-cap stocks that he expects to continue.

Tesla Inc. TSLA, +0.08% is up 4.5% this week through Tuesday, while shares of Apple Inc. AAPL, +0.25% have risen 2.6% over the same two-day period. Amazon.com AMZN, -0.09% is up 2% this week.

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The current economic expansion is one in which “we actually, eventually worry about inflation,” he said. But while inflation will cause more volatility, Schutte is not overly concerned that it will “dramatically” change fiscal policy or the Fed’s stance anytime soon.

“The leash is a little bit longer on the employment side than I think people realize,” he said. “That is what the Fed is focused on.”

Schutte believes some inflation would be welcomed by the central bank as its goal is 2%. “You still have more room left before you have to get more worried,” he said.

The Fed probably won’t rush to raise interest rates for fear of “short-circuiting the economic recovery” underway in the pandemic, particularly with millions of Americans having dropped out from the labor force, according to Schutte. And in his view, the recent selloff in Treasuries reflects a strengthening U.S. economy, and he noted that 10-year Treasury yields remain relatively low from a historical perspective.

The yield on the 10-year Treasury note was TMUBMUSD10Y, 1.657% 1.66% on Tuesday afternoon.

Still, the Northwestern Mutual chief investment strategist believes investors would do well to have some hedge against inflation in their portfolio. He suggested buying commodities, for example.