The month of March begins with a light schedule on the economic front. Before the bell, there were no reports significant enough to have a major impact on the direction of trading. However, a half hour into today’s trading session (at 10:00 A.M. EST), we will receive the latest reading on manufacturing activity from the Institute for Supply Management (ISM), a Tempe, Arizona-based trade group. The ISM reading has come in below 50 (the dividing line between an expanding and contracting sector) for three straight quarters, which suggests that manufacturing is contracting and may be a sign of slowdown in industrial growth in the coming months. The expectation is calling for a February reading of 47.6, which would represent a slight improvement from the January figure, but still an indicator of a weakening sector. This morning, the Dow, NASDAQ, and S&P 500 futures are not too far removed from the neutral line, but have turned modestly negative as we move closer to the start of trading. This comes on the heels of yesterday’s selloff into the closing bell.
On the earnings front, the calendar was a bit more populated, with reports from a number of retailers since the close of trading yesterday afternoon. The headline report came from home improvement giant Lowe’s (LOW). The company posted better-than-expected profits, but revenues came in slightly below expectations. Lowe’s also issued a soft sales outlook, noting that inflation is forcing consumers to pause spending on home-related projects. The stock is down modestly in pre-market action. The news was far worse for retailing chain Kohl’s (KSS), which reported a big loss on a sharp drop in quarterly sales. Shares of Kohl’s are down notably in response. In other news, personal computer and printer producer HP Inc. (HPQ) delivered mixed results, exceeding earnings-per-share expectations, but missing notably on the sales line. HP shares are looking at a modestly higher opening today.
In this reporting season, the news from the retailers has been better than anticipated, with mass merchandisers Walmart (WMT) and Target (TGT) beating expectations. However, both of the industry heavyweights warned that 2023 will pose challenges, with inflation still running stronger than expected and the economy likely to slow in the second half of this year when the full effects of last year’s increasingly restrictive monetary policies on demand for goods and services are realized. This has been the overall consensus among the retailing companies’ leadership teams.
Market participants are glad to see February in the rearview mirror, as the month, which is historically not a good one for equities, was quite volatile. Overall, the Dow Jones Industrial Average, the NASDAQ Composite, and the S&P 500 Index were down 4.2%, 1.1%, and 2.6%, respectively. The major averages gave back a portion of the January rally on concerns that the Federal Reserve will be more hawkish than most expected this year. Indeed, stronger-than-expected January price data and outsized job gains to start the year brought fears that the Fed will need to push the benchmark short-term interest rate comfortably above 5.00% and keep it at that level for an extended stretch to effectively fight inflation. That sentiment pushed Treasury market yields and the value of the dollar (against a basket of international currencies) higher and that weighed on the stock and bond markets. The equity market has historically not performed as well during a period of monetary tightening and that was certainly the case again last month.
As we look to the trading month ahead, we think the success or lack thereof will depend on the readings on consumer and producer prices in the coming weeks. If those reports show that inflation remains sticky, it will intensify the calls for a half-point federal funds rate hike at this month’s Federal Open Market Committee, and may well lead to more selling on Wall Street, especially among the higher-growth sectors that tend to have more unprofitable companies whose valuations are based on future cash flow potential rather than actual earnings. Conversely, if the price data show some moderation, it may bring some of the buyers off the sidelines. Next Friday’s report on February employment and unemployment also will be closely monitored by the Federal Reserve. It could be the case of bad news for jobs creation is good news for the stock market or vice versa.
So what is an investor to do with so many variables in play that could drive trading? Given all the uncertainty, we think the best strategy is to maintain a portfolio consisting of high-quality companies and cash, while sprinkling in some short-term duration bonds and Treasuries. With regard to the equity component, we advise investors to maintain a significant weighting of defensive stocks in their portfolios, along with selective holdings of financially strong growth-oriented companies that may lead the market up once we get to the other side of the current interest rate increase cycle. – William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
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