Before The Bell
This has been a volatile trading week. Three-straight losing sessions find the bulls searching today for a catalyst to turn the tide. That will have to come from the business beat, as earnings season is winding down and results from technology giant Intel (INTC) after yesterday’s close failed to excite investors. Traders have been spooked by inflation concerns and the worry that higher prices may force the Federal Reserve to raise interest rates sooner than expected. This morning, the futures are above their overnight lows, helped by some positive news from the labor market (more below), but still suggesting a mixed start for the U.S. stock market.
At 8:30 A.M. (EDT), the Labor Department reported that initial weekly jobless claims in the latest week came in at 444,000, the lowest figure since the start of the coronavirus pandemic stateside. This was yet another sign that the U.S. job market is improving and the domestic economy is recovering sharply from last year’s COVID-19-driven setback. The strengthening output and accompanying inflation concerns are responsible for the rotation out of the high-growth stocks and into the value names, particularly in the cyclical sectors that benefit from recovery.
The stocks of companies that are likely to benefit from a continued post-virus crisis reopening of the U.S. economy have fared the best over the last fortnight, and we expect this trend to continue in the near term. Mass merchandiser Target (TGT) reported impressive results yesterday, with investors most pleased to hear positive commentary about the second half of the year. Target’s management echoed what competitor retailer Walmart’s (WMT) leadership said on Tuesday, stating that a stronger economy and a vaccinated consumer will likely boost retail sales over the final six months of 2021, especially in the apparel category.
Meantime, notwithstanding this week’s profit taking, the sectors that are likely to perform the best during an environment of elevated prices—and possibly higher interest rates—are industrial, energy, financial and consumer staples. These cyclical groups have done much better than the higher growth technology and small-cap equities recently and may continue to do so if worries about inflation and a less accommodative central bank persist. On point, the minutes from the Federal Reserve’s April FOMC meeting (released at 2:00 P.M. (EDT) yesterday) did not quell the narrative that the lead bank may have to ease up on quantitative easing (bond buying) sooner than expected. The readout showed that more voting members were thinking about the possibility of tapering than in prior meetings. The question that could present a headwind for investors over the summer months is when, not if, the lead bank will raise interest rates to possibly keep the U.S. economy from overheating.
So what is an investors to do in this volatile market? Value Line subscribers may be best served to take a closer look at the stocks ranked 1 (Highest) and 2 (Above Average) for Safety. This group of stocks, which includes many of the blue-chip names, have historically outperformed the broader market when a correction occurs. The NASDAQ Composite enters today down nearly 5%, month to date, and on pace for its fifth-consecutive losing week.
Investors should note that with many of the top hedge funds recently taking profits in the high-growth areas where valuations are stretched after tremendous advances last year, there is an enormous amount of cash sitting on the sidelines, estimated to be upwards of $4 trillion. This trend can either be good or bad news for traders. If further profit taking occurs, or if the funds simply hold their large cash balances, it could put further near-term downward pressure on stocks. But if the economy continues to recover and the inflation concerns prove transitory (the Federal Reserve’s current stance), there could be a rush of buying later this year. In this environment, even with the uncertainty of inflation and possible changes to the U.S. tax code lingering, we would recommend keeping a significant portion of funds in the equity market, particularly in the value and cyclical categories that will get a boost from further re-openings. With fixed-income yields low, bonds are still not providing much of an investment alternative to stocks.
– William G. Ferguson
At the time of this article’s writing, the author did not hold positions in any of the companies mentioned.
