Investors are gearing up for the Federal Reserve to start rolling out interest rate cuts starting in June. The array of economic data and inflation prints coming out of February may show a conflicting narrative on whether the Fed is ready to initiate rate cuts. On top of all of this, markets try to make sense of the tech trade in early 2024.

Innovator Capital Management Head of Research & Investment Strategy Tim Urbanowicz joins Yahoo Finance to discuss the Fed's inflation outlook on recent data — "That is not something that shows me this battle is over and it's done" — and how AI hype could be raising the odds of entering into an "irrational" tech market.

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Luke Carberry Mogan.

Video Transcript

BRAD SMITH: Tim, you just heard the setup coming into this next meeting. What do you anticipate will be the prevailing thought among the FOMC members?

TIM URBANOWICZ: Well, Brad, coming into this year in our 2024 outlook, our call was for no interest rate cuts this year. That was a very unpopular view back then, it remains an unpopular view today. But the evidence coming out we think is stronger and stronger to support that.

And if you look at consensus in the market right now, there's this idea that the inflation battle is done, simply for the fact that there's a disconnect between what we're seeing in the inflation data and where housing costs are, where rent prices are, and I couldn't disagree with that more. If you look at the print that we saw this month, CPI, the average component of that basket rose 30 basis points. If you strip out shelter costs from core services, we saw a 50 basis point increase month over month. That is not something that shows me that this battle is over and it's done. And I think jumping to cuts soon, especially in the first half of this year, would be a mistake on par with the transitory mistake that we made coming into this.

SEANA SMITH: So what does that mean then for equity holding? And what does it mean for investors at this point?

TIM URBANOWICZ: Well, I think there's really strong implications here. The most notable is that if you look at the correlation between bond yields and equity prices, we have never seen them more negative right now. If you look at the Russell 2000, S&P 500, very, very negative. And what this comes down for us is how you're adding protection in the portfolio matters, and the most important thing is that we need to find ways to decouple relying on interest rates to come down to provide protection in the portfolio.

Investor psychology has shifted. Bond yields remain the number one driver of equity prices, and that doesn't look like it's changing anytime soon. So how we're finding that protection in the portfolio, we need to look outside of traditional risk management tactics, like bonds.

BRAD SMITH: I guess correlated with the bond yield activity that you're seeing, what are the sectors that are most likely to prevail?

TIM URBANOWICZ: So it's all about tech right now, and I think there's two driving forces to this market. One is obviously bond yields. The other is all of this hype and excitement around generative AI, what is that going to do. We don't see that trend necessarily slowing down here.

We do think it's important to get other exposure and be broadly diversified, absolutely. But for us right now, when we look at sectors, it's really all about built-in risk-management and known levels of risk management in your portfolio here, and again, disconnecting interest rates coming down with relying on low-volatility sectors to provide protection or bonds to provide protection. So a lot of investors that we're talking to right now are gravitating towards strategies like managed floor ETFs. One in our lineup that has been very popular ticker, SFLR, 10% managed floor on US large cap equities. So that is very important, also seeing a lot of interest in buffer or risk managed ETFs. And I think the main driver of that right now is they don't rely on interest rates having to come down to provide that ballast in the portfolio.

SEANA SMITH: When you take a look at the leadership that we saw at least last year, early this year, obviously we have started to see a bit of a divergence between a lot of those larger tech names. But the ones, though, that have been able to hold on and weather this uncertainty, are they going to continue to lead as we do maybe potentially see more of a broadening out?

TIM URBANOWICZ: It doesn't look like the trend is slowing down anytime soon. And we are outlining the case for two possible scenarios here. One, irrational market that we're heading into, which really points toward just lower returns, overall, for the remainder of this year.

But we think there's a very good chance we also could be heading into an irrational market, Seana. And that really comes down to all of the hype and excitement that we're seeing over AI, the infrastructure build out here. And there's a lot of substance behind that, don't get me wrong. But when we look at irrational markets and the formation of bubbles, it really comes down to investors just getting way far out ahead of ourselves, extrapolating those cash flows far out into the future. And I think there's a very good case to be made right now that we're starting to see that formation in the US tech sector, overall.

SEANA SMITH: All right, always great to get your perspective here. Tim Urbanowicz, Innovator Capital's Management Head of Research and Investment Strategy. Thanks, Tim.