Before The Bell
This morning, we received a few more reports on the U.S. economy. The Labor Department reported that initial weekly jobless claims for the week ending January 15th came in at 286,000, up 55,000 from the revised figure of 231,000 recorded in the previous week. We also learned that manufacturing activity in the greater Philadelphia area, measured by the Federal Reserve there, improved over the last month, with the headline figure coming in at 23.2, up from the December reading of just 15.4. While neither of these reports moved the needle much on the equity futures, which are presaging a higher opening to the trading day, the latter manufacturing figure was encouraging nonetheless, and when combined with yesterday’s strong figures on housing starts and building permits, is alleviating some growing concerns on Wall Street about a slowing domestic economy. At 10:00 A.M. (EST), we will get the latest figures on existing home sales.
The main drivers of trading during this week, which has so far been a very difficult one for investors (the Dow Jones Industrials, the S&P 500 Index, and the NASDAQ Composite were down 2.5%, 2.8%, and 3.7%, respectively, over the last two trading sessions), have been the negative reaction to rising fixed-income yields and concerns about just how aggressively the Federal Reserve in Washington will tighten monetary policy (i.e., remove some of the liquidity from the financial system) to rein in inflation. Prices for finished goods and components soared in 2021 and are not expected to moderate much in the near term. Our expectation is that the central bank will end its bond-buying program by early spring and then start to raise short-term interest rates thereafter, with three or four hikes possible by year’s end if the performance of the economy cooperates. The Fed must be careful in its attempt to rein in prices, not to apply the brakes too hard, leading to a slowdown in economic growth.
In general, the rising Treasury market yields of late have hurt the stocks of the more speculative and less capitalized higher-growth companies, with the technology-dominated NASDAQ Composite down more than 8% since the start of 2022. The yield on the 10-year Treasury note, which is used as a benchmark for setting the rates on longer-duration fixed-income securities, topped the 1.90% mark this week (its highest level since December, 2019) before pulling back a bit during yesterday’s session. The higher borrowing costs, which many pundits expect to rise further in the coming months as inflation and the Fed concerns are priced into the market, make the cost of doing business more expensive. Hence, the selloff we are witnessing in the companies with thin operating margins and inflated price-to-earnings multiples entering the year. The expected higher cost of capital going forward may hinder their ability to secure financing as easily as they did during the highly accommodative monetary environment of the past few years.
Meanwhile, the financial stocks, which were trading at record highs at the start of this year, have sold off sharply over the last few sessions, prompted by a dour reaction from Wall Street to the latest quarterly results from banking giants JPMorgan Chase (JPM) and Goldman Sachs (GS). Investors were mostly disappointed with the near-term outlooks from these industry behemoths and have bid their stocks lower, which, in turn, has put downward pressure on the financial sector and the performance of the Dow 30. That said, we think that with the economy expected to expand further this year, albeit not at the feverish pace of last year, lending rates on the rise, and the Federal Reserve wedded to raising short-term rates multiple times this year, the banks are positioned for a solid year, and the recent selling in that sector is creating an attractive entry point for long-term investors.
Conversely, the oil and gas stocks have performed well so far in 2022, with a sharp increase in crude oil quotations both here and abroad providing the impetus for investors to gobble up energy issues. The increased demand for oil and gas, as much of this country is in the midst of its peak winter heating season, combined with a short supply of crude oil, is pushing prices notably higher, much to the delight of those investors holding positions in the oil and gas companies.
So what is an investor to do in the current environment, one where both the high-growth and the value-oriented sectors have experienced their share of selling in recent weeks? Our recommendation is to build or maintain a well-diversified portfolio of quality companies, with strong balance sheets and ample cash-flow generation. These companies have the financial wherewithal to continue operating their business without a hitch, even as prices for most raw materials, supplies, and wages continue to spike due to COVID-19-driven supply-chain disruptions and labor shortages. We also believe the companies that have the pricing power to push some of the operating cost inflation onto their customers, via price hikes, will perform the best in an inflationary environment. On point, shares of Procter & Gamble (PG) were nicely higher yesterday in a weak market after the consumer staples company predicted for fiscal 2022 (ends June 30th) sales growth from established operations of 6% , with fully half that gain being driven by the company’s ability to raise prices.
On the earnings front, today’s news is mostly encouraging, with the investment community reacting positively to the latest results from American Airlines (AAL), Travelers Companies (TRV), and Signet Jewelers (SIG). The quarterly reports also included some positive outlooks, with signs that the impact from the Omicron variant of the COVID-19 virus on their companies is starting to lessen.
– William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
