This morning, trading in the U.S. equity market will mostly likely be driven by the continued reaction to the Federal Reserve’s monetary policy decision announced yesterday afternoon. The initial response to the Fed statement was positive, but the mood turned more dour after Chairman Jerome Powell, in a question-and-answer session with reporters following the Federal Open Market Committee (FOMC) announcement, said that the central bank will “soon” embark on a more-restrictive monetary policy course to rein in inflation, which, in time, will include the reduction of the bank’s balance sheet. Such action would actually reverse the multi-year course of the Fed’s buying bonds and thereby injecting cash or liquidity into the financial markets. The equity futures, which were down notably last night, rallied this morning from their earlier lows and are now suggesting a modestly higher opening stateside. If anything, the rollercoaster pre-market performance may be an indication that it will likely be another volatile day of trading in the U.S. equity market.
Investors will also be eyeing another batch of quarterly earnings reports today. In general, the earnings releases since yesterday’s closing bell, which included top- and bottom-line beats from Intel Corp. (INTC), Tesla (TSLA), and Seagate Technology (STX), have made for good reading. However, investors elected to focus on slightly softer-than-expected profit margins for both Intel and Tesla, and were bidding the shares of each company lower in pre-market action. (Seagate stock is pointing sharply higher.) The margin compression seen in each of those two tech giants’ quarterly statements was mostly the result of ongoing supply-chain issues and associated higher unit costs, and investors are worried that a continuation of this trend could pressure overall earnings some in the coming quarters. This scenario likely hurt a giant of a different industry, McDonald’s, in the latest quarter. Big Mac missed Wall Street’s earnings expectations, and the company’s stock is looking at a modestly lower opening this morning.
Meantime, on the economic front, we received from the Commerce Department, the initial estimate on fourth-quarter GDP, which showed that the nation’s Gross Domestic Product (GDP) expanded at an annualized rate of 6.9%, up from the 2.3% advance recorded in the previous three months and well above the consensus forecast of 5.5%. Within the GDP release, the inflation figures were running very hot though. Turning to the labor market, initial weekly jobless claims for the week ending January 22nd came in at 260,000, versus the previous week’s tally of 286,000. Conversely, durable goods orders fell 0.9% last month, but the figure, excluding autos, was down only 0.4%.
As noted, it was confirmation from Chairman Powell that the central bank will act aggressively to reduce prices and bring inflation closer to the Fed’s revised near-term target range of 2.6% to 2.8% that has investors skittish. The lead bank’s plan will include the conclusion of its monthly bond-buying program by early spring, the likely start of interest hikes at its March monetary policy meeting, and the commencement the of the reduction of the central bank’s $9 trillion balance sheet (possibly as early as this summer). The latter was revealed in a “Statement of Principles” that accompanied the Fed’s monetary policy statement.
Chairman Powell also went on to say that with the U.S. economy showing signs of strength and near full employment, the central bank can focus more on the other half of its dual mandate, which is to promote stable prices. We think investors took this as a sign that the upcoming era of monetary tightening may be far more aggressive than what we saw in the past (particularly in the second half of 2018) when inflation was quite benign. It also is worth noting that when questioned by reporters, Mr. Powell did not shoot down the possibility that the first increase in interest rates could be more than 25 basis points and that the central bank is not wedded to just raising rates during every other Federal Open Market Committee meeting, which was the prevailing expectation leading into this week’s FOMC meeting.
The more-hawkish stance weighed on nearly all the major market sectors yesterday, save for the technology group (which had sold off notably in the week heading up to the Fed’s decision) and financial companies. The latter is not surprising, as banks would benefit from higher lending rates down the line. And if the Fed is intent on reducing the balance sheet later this year, the move is expected to put upward pressure on long-term rates, which would also benefit the banks.
So what is an investor to do during a period in which the central bank plans to significantly reduce its level of monetary support and in a year with much less fiscal stimulus cash flowing out of Washington? We continue to believe that investors should maintain a well-diversified portfolio, with an umbrella of quality companies that can weather the storm that could persist as the Fed embarks on a period of quantitative tightening, which will remove a significant amount of liquidity from the financial system.
In general, we think the companies with stout balance sheets and strong cash flows will be able to operate their businesses with fewer disruptions, including those resulting from the ongoing supply-chain shocks and labor shortages. The stocks of these companies also tend to trade at more reasonable price-to-earnings valuations, leaving them less susceptible to severe selloffs than the more-speculative, less-capitalized companies. This has been quite noticeable during this volatile trading week on Wall Street, where the declines in shares of Apple (AAPL), which reports in latest quarterly results after today’s closing bell, and Alphabet (GOOG) have been far less than those of high-flying stocks, like Cloudflare (NET) and Block (SQ). Over the last three trading sessions, the Dow Jones Industrial Average has seen intra-day swings of 1,214, 752, and 649 points, and the CBOE Volatility Index (VIX) has surged above 30; that VIX “fear gauge” is up 85% since the start of the new year.
– William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
