The name of the game on Wall Street the last few weeks has been volatility. With so many variables in play and so many questions yet to be answered, most notably whether the Federal Reserve will be able to get inflation under control, the major averages have been searching for some direction. For the most part, the market bears have held the upper hand, with strong price data on both the consumer and producer levels and a healthy labor market raising sentiment that the Fed will continue to tighten the monetary reins to try to tame inflation. That has put upward pressure on Treasury market yields and sparked some selling in the equity market. It should be noted that healthy intraday gains for the three major indexes yesterday were erased by the closing bell.
This morning the equity futures are relatively unchanged with a slightly positive bent, as there is little earnings and economic news for investors to digest. Fourth-quarter earnings season is now in the history books, and the economic data don’t heat up until later this week with a number of important releases on the labor market, including Friday’s report on February nonfarm payrolls. Given the recent signs that inflation remains sticky, investors will be paying close attention to the February average hourly wage figure. That reading has the potential to impact the direction of the market on the final day of trading this week.
The equity and bond markets will be closely monitoring Federal Reserve Chairman Jerome Powell’s testimony before Congress. The two-day biannual monetary policy testimony kicks off later this morning and may provide some additional clues about what the central bank thinks about inflation. The current consensus among senior Federal Reserve officials is that the short-term benchmark interest rate needs to go above 5.00% and stay at that level for an extended period to effectively fight inflation. As noted, this has put upward pressure on Treasury market yields with the 10-year note briefly broaching the 4.00% mark last week. This has not been good news for the higher-growth, but unprofitable companies, whose stocks are valued on potential cash flows. The higher discount rate reduces the cash flows when reduced to present value terms and that often makes the company less appealing to investors.
The economy will come into more focus tomorrow, with the Federal Reserve’s latest Beige Book summation of economic conditions released at 2:00 P.M. (EDT). The economy has proven resilient in recent quarters, but investors will have to determine if the full effects of the central bank’s most restrictive monetary policy course in 40 years have yet to be realized. There have been signs of stress in both the manufacturing and housing sectors. If the consumer sector was to weaken and the job gains were to moderate it could bring more worries about modest recession, at the very least. The Treasury market yield has been inverted for a long stretch, which often portends a recession is coming.
So what is an investor to do in this environment? 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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