In a week that has been very light on economic and earnings news, the attention of the investment community has turned to the Federal Reserve, inflation, and the renewed upward movement in fixed-income yields.
The final day of trading this week will begin with the major equity averages, particularly the technology-dominated NASDAQ Composite, on pace for a losing five-day stretch, despite yesterday’s modest rally and the futures pointing higher this morning. The early-week selling was prompted by increasingly hawkish monetary policy commentary from a number of Federal Reserve leaders, among them Fed Governor Lael Brainard, who said that the central bank will likely have to be very aggressive with regard to tightening the reins to reduce liquidity in the financial system and combat inflation. This process will probably include a few 50-basis-point hikes to the benchmark short-term interest rate and rapidly reducing the number of assets on the Federal Reserve’s nearly $9 trillion balance sheet.
In general, a more-restrictive Federal Reserve and rising borrowing costs are not a good backdrop for equities. In fact, the last time the lead bank raised the federal funds rate multiple times in a year (2018), the stock market turned in its worst performance in the last decade of trading. That said, with the yields on Treasury market securities on the rise—and bond prices falling—stocks still look to be the best near-term investment option.
So what is an investor to do with volatility picking up again after a retreat in late March? Our recommendation is to try to avoid broad-based sector-driven investing. This is because just about every sector, at one time or another, has been in Wall Street’s crosshairs during the first three-plus months trading in 2022. This is not totally surprising either, as the market was ripe for some profit taking this year after a record performance for equities in 2021. For instance, rising borrowing costs have especially hurt technology stocks for much of this year, but with the recently growing sentiment that the U.S. economy may be headed toward a recession down the road—sparked by the recent partial inversion of the Treasury bond yield curve—higher-growth companies may again become an appealing investment option.
Our recommendation would be to focus on individual stock picking, based on company fundamentals, and giving consideration to all 11 equity groups. We would suggest investors look at the stocks of well-capitalized companies that have the strongest balance sheets and generate ample cash flows, which are the better positioned to weather any economic or financial downturn than smaller, less profitable companies. These entities also have the capability to support share earnings through stock repurchases and are more apt to continue paying healthy dividends. The stocks ranked 1 (Highest) and 2 (Above Average) for Safety by Value Line often fit this description, and these groups have historically performed better than the broader market during volatile stretches. Some of the mega-cap technology names fall under this umbrella of safety, while also offering more growth opportunities than value-oriented stocks, especially if the economy is starting to slow down.
Looking ahead to next week, the economic and earnings news will pick up notably. The first-quarter earnings reporting season officially kicks off on Wednesday, April 13th with the latest quarterly results from JPMorgan Chase (JPM). The big bank will be the highlight of a slew of releases from the banking industry. In general, we think investors will again be looking at what companies are managing the inflation situation the best. Those companies that show the best pricing power and an ability to pass some of the rising costs onto the consumer are likely to garner the most interest from Wall Street.
Meantime, next week’s economic releases will include reports on consumer and producer prices, retail sales, consumer sentiment, weekly unemployment claims, and industrial production. The Federal Reserve will be closely monitoring the pricing data, and if those figures are still running hot—which is the consensus expectation—it may prompt selling, as it would further increase the likelihood of a 50-basis-point interest-rate hike from the central bank at next month’s Federal Open Market Committee (FOMC) meeting.
– William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
