This morning, we received another important report on the economy and, in particular, the inflation situation. At 8:30 A.M. (EST), the Labor Department reported that April producer (wholesale) prices climbed 0.5%, which was far less than the eye popping 1.4% advance recorded in the previous month and in line with the consensus expectation. On a 12-month basis, producer prices did surge 11.0%, and when excluding the volatile food and energy components, 8.8%. The year-to-year figures were a bit higher than expected. Meantime, we also learned that initial weekly unemployment claims for the week ending May 7th totaled 203,000, which was a slight uptick from the previous week’s tally. The equity futures, which were lower heading into the releases, retraced some of the earlier losses, but are still indicating another weak start to the trading day stateside.
The producer pricing data comes on the heels of yesterday’s companion report on consumer prices. That release showed that prices for April climbed 0.6% month to month and 8.3% over the last 12 months. The figures were higher than expected, and raised sentiment that the Federal Reserve may have to act more aggressively on the monetary front at the coming Federal Open Market Committee (FOMC) meetings. Inflation, particularly in the energy, food, and home rental markets remains stubbornly higher. From a stock market perspective, the releases did not remove the uncertainty whether we have indeed reached peak inflation, and that is likely behind the continued heightened volatility we are seeing on Wall Street.
On the earnings front, the headline report came from The Walt Disney Company (DIS) after yesterday’s closing bell. The entertainment giant reported solid results and also said that subscriptions to the Disney+ streaming service rose last quarter. However, the stock is trading lower in pre-market action on the company’s near-term operating forecast. Although second-half results are likely to be better than the first six months, the gap up is now not expected to be as large as Wall Street was looking for heading into the quarterly release. This may be an indication that inflation and the overall higher cost of living, especially with regard to the prices for necessity products, like food and energy, are starting to take a toll on the consumer’s spending on discretionary items, like vacations and travel to the Disney theme parks.
The elevated inflation and the talks of an even more-restrictive central bank pushed the yields on Treasury market securities higher yesterday, with the rate on the 10-year Treasury note rising above the 3.00% mark. (It is retracing that gain this morning, as nervous investors looking for more-defensive holdings are seeking fixed income securities to buy.) All of the 2021 gains in the cryptocurrency markets have been wiped out in the broad movement out of risky assets. The overall higher fixed-income yields are hurting the technology stocks, especially those of the less profitable companies. Many of those entities are valued on future earnings potential, so when those estimated gains are discounted back to present value terms at higher rates, they become less attractive and investors are not willing to pay a high premium for a position. For this reason …
We continue to recommend that investors maintain a well-diversified portfolio of higher quality names, though on days like yesterday when investors are worried about a more hawkish Federal Reserve on the monetary policy front and higher lending rates, even the most-established names like Apple (AAPL) (down 5.2% yesterday) are not immune to the selling. It was a weak session yesterday for the technology behemoth and fellow mega-cap Tesla (TSLA), with the latter dropping sharply on reduced electric vehicle production at its China-based factory, as mandated COVID-19 shutdowns are slowing the production process there. Nevertheless, we believe the companies with strongest balance sheets, a history of steady earnings growth, and ample cash flows are best positioned to weather any economic or financial storms. The better-capitalized companies also have the ability to take advantage of the lower equity prices via the share-repurchase market.
To date, this year has seen a highly volatile and mostly bearish performance for both the equity and bonds markets. (The NASDAQ Composite is in bear market territory, which occurs when stocks are trading more than 20% below a 12-month high.) When both the fixed income and equity markets are under pressure, which is a very infrequent occurrence (they have both finished the year in negative territory only four times in the last 90 years), high inflation has often been the reason. Thus, we recommend keeping a percentage of one’s portfolio in cash. That provides a cushion and also gives investors the wherewithal to jump back into the market if inflation is seen as cooling down and buying opportunities emerge. That may not be too far off, as the S&P 500 companies are now trading at just above 17 times their 12-month forward earnings estimates after trading above 21 times earnings coming into 2022. The historical norm had been around 16 times earnings.
Meantime, oil and gas stocks, which have been the big winners in a weak trading year to date, were under pressure yesterday. The selloff was prompted by demand concerns. The latest report on the energy sector lowered projections on oil and gas consumption in the coming months, prompted by the COVID-19 mandated shutdowns in China, a major consumer of oil, and less people stateside consuming energy at the recent elevated prices, possibly traveling less during the peak vacation season.
– William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
