Before The Bell
The attention of Wall Street, which has been focused on the Federal Reserve since the conclusion of its two-day monetary policy meeting last week, turns to the business beat for direction after two tranquil trading sessions that saw the major equity averages trade in a tight band around the neutral line. This morning we received three reports on the economy and they all represent positive readings. The futures, which were nicely higher heading into the economic reports, are holding most of those earlier gains and presaging a higher start for the U.S. stock market.
At 8:30 A.M. (EDT), we learned that initial weekly unemployment claims, which unexpectedly rose last week, reversed course a bit in the latest week, falling to 411,000. On a more positive note, continuing claims fell to a pandemic era low. Likewise, durable goods orders, which fell in April, rebounded strongly last month, climbing 2.3%. These reports were two more indicators that the U.S. economy is recovering sharply. That sentiment was reinforced by the final reading on first-quarter GDP growth, which held steady at an annualized rate of 6.4%.
This spike in output up until recently had given a jolt to the value stocks in the cyclical industries. However, with valuations in those sectors now higher and Treasury yields pulling back recently, we have seen some recent rotation out of the cyclical areas. That said, we still think that the so-called inflation trade remains intact. That is, the better stocks to invest in are those of companies that will do well in an expanding economy exhibiting some price inflation, and we think this will be so even if the recent higher pricing proves transitory down the road as the Federal Reserve predicts. Investors should note that the central bank raised its 2021 inflation target from 2.5% to 3.4% last week, prompted by the recent record year-to-year surges in producer and consumer prices. Within the cyclical space, we like the sectors where the companies have pricing power and the ability to push costs along to customers. Two areas that come to mind are energy and basic materials. The latter sector also may get a boost from an infrastructure spending bill, and reports are now indicating that the Biden Administration and Senate Republicans are getting closer to hammering out a deal. Another cyclical area, the banking sector, will be in the spotlight this afternoon, as the latest round of stress tests are announced. This may pave the way for future dividend hikes, which could interest the income seekers.
We also think that investors would be prudent to keep a healthy amount of technology in their portfolios, as the tech sector offers the highest long-term growth potential. The high-growth names got a big lift recently from the pullback in Treasury yields, especially on longer maturity bonds. The lower bond yields, along with soothing comments of late from Fed Chairman Powell on monetary policy and inflation, has prompted movement back into tech stocks, helping to push the NASDAQ Composite to record highs the last two trading sessions. In the technology space, our recommendation is to give the blue-chip stocks of technology heavyweights with the strongest earnings, biggest cash positions, and healthiest balance sheets a serious look, as these companies are best suited to withstand any correction down the road if inflation proves more than transitory. The mega-cap Internet names–such as Google parent Alphabet (GOOG)—have outperformed the broader technology space this year, with the spread widening this month. The semiconductor stocks also remain an interesting play. The current industrywide supply/demand imbalance for processing chips, especially as industrial production strengthens, will allow the chip makers to raise prices. The semiconductor stocks are looking like an inflation protection/growth combination play right now.
Although the possibility of a pickup in volatility like we saw heading into and out of last weekend when the Dow Jones Industrial Average produced daily moves of more than 500 points in each direction exists, we continue to recommend that investors keep a significant portion of equities in their portfolios. The old adage “don’t fight the Fed” remains very much in play on Wall Street. The central bank has flooded the system with liquidity to fight the pandemic’s impact on the economy and although there are signs that the FOMC members are becoming slightly more hawkish, future interest hikes are not likely until late next year, at the earliest, and at that point the monetary tightening is likely to be quite measured. Too, the central bank is still making asset (bond) purchases to the tune of $120 billion a month. These accommodative monetary maneuvers, along with Fed Chairman Jerome Powell’s calming comments on interest rates and inflation, are providing downside support for equities.
– William G. Ferguson
