Wall Street is likely to focus today on interest rates once again. Before the stateside open, we received news that the European Central Bank (or ECB) has mimicked the U.S. Federal Reserve with a three-quarter-point hike in the ECB benchmark short term interest rate. Later today Fed Chairman Jerome Powell will hold a question and answer (Q&A) session with the media. The investment community will be trying to gain more insight into the central bank’s thinking ahead of its next monetary policy decision later this month. Equity futures are quite muted ahead of Chairman Powell’s commentary, indicating that the ECB move was widely anticipated. The view that the U.S. economy is not cooling much in the wake of previous Fed moves gained a bit of support with this morning’s jobless report, showing 222,000 new filings, below a consensus guess of 235,000. Investors appear unwilling to make a major move in either direction until the Fed leader speaks. That said …
The cat appears to be out of the box with regard to the Fed’s thinking on monetary policy. Two key central bank leaders spoke yesterday (more below) and both struck a hawkish tone with regard to interest-rate policy. The commentary raised the odds (now considered to be over 80%) of a three-quarter-point hike to the benchmark short-term interest rate at the next Federal Open Market Committee (FOMC) meeting. The ECB hike of 0.75% this morning represented the biggest increase in its history.
Cleveland Fed President Loretta Mester said that the federal funds rate should be near the 4.0% mark (versus today’s range of 2.25% to 2.50% ) and that the lead bank will need to see several more data points on slowing inflation before it changes course. She added that this course could bring some pain for the U.S. economy. Then later Wednesday, Vice Chair Lael Brainard noted that the central bank plans to fight inflation for as long as it takes to bring prices down. However, one comment from her prepared remarks was viewed as dovish and it ignited a second-half buying spree in the equity market. Specifically Ms. Brainard said that the central bank needs to be careful not to overdo it on the rate-tightening front. The higher-growth stocks, which have struggled since Chairman Powell‘s last comments (at the late-August Jackson Hole, Wyoming meeting) that the public deemed very hawkish, were in demand in what looked to be a relief rally on Wall Street yesterday.
Then there is the state of the U.S. economy, which has market watchers a bit nervous. The only notable report this morning, as we highlighted above, came in the form of initial weekly jobless claims. The Labor Department read-out of 222,000 initial claims was down 6,000 from the previous week. In general, investors are worried that too-restrictive monetary policies from the Fed may push the economy into a recession. The continued inversion of the Treasury securities yield curve and the drop in crude oil prices are signs of a weakening economy. Such signs have recently prompted a move to securities deemed safe havens on Wall Street, and are also reflected in the continued surge in the foreign exchange value of the U.S. dollar. The dollar has been rising in large part because the Federal Reserve is on track to increase interest rates faster than other major countries. The more-defensive equity sectors, including utilities and healthcare, have also garnered some attention during the current three-week decline for the stock market.
Meanwhile, the release of the Federal Reserve’s latest Beige Book summation of economic conditions (at 2:00 P.M. (EDT) yesterday) confirmed some of Wall Street’s concerns. Overall, it made for uninspiring reading, with the Federal Reserve noting that economic growth remained generally weak. It highlighted that the real estate market weakened notably, as home sales fell in all 12 Federal Reserve districts. Conversely travel and leisure activity picked up and manufacturing grew in several districts.
The price of oil has fallen sharply in recent weeks (hitting a seven-month low yesterday) on the aforementioned economic fears. And it is again down this morning after news surfaced of renewed COVID-19 lockdowns in parts of China, which will likely reduce near-term oil consumption for the world’s second-largest economy. The drop in both oil and gas prices is weighing on the energy stocks, which were relative underperformers during yesterday’s market rally. This recent retreat in energy stocks may be making for a more enticing entry point into the oil patch, especially for those betting on a possible energy crisis in Europe this winter, as potentially reduced shipments from Russia and shorter supplies for Europe may push oil prices higher over the winter months and garner some support for energy equities.
So what is an investor to do with the growing apprehension on Wall Street about the Federal Reserve tightening the monetary reins too hard into a period of slowing growth and possibly pushing the economy into a recession? We think a portfolio of high-quality stocks and ample cash may be the best near-term option. This strategy would include looking at companies that are best equipped to weather an economic downturn and have demonstrated an ability to maintain their dividends during difficult stretches. That said, investors may want to take a more cautious stance on the stocks of the multinational companies that do a good deal of their business overseas. The continued strength of the U.S. dollar will likely reduce those entities’ profits and have a negative impact on their third-quarter performance.
Having an ample amount of cash on hand also allows for investors to potentially take advantage of high-quality stocks that may become oversold. Some investors may want to consider a dollar cost averaging strategy in the current environment. Dollar cost averaging is the practice of investing a fixed dollar amount on a regular basis, regardless of the share price. It's a good way to develop a disciplined investing routine, be more efficient in how one invests and potentially lower one’s costs. Over time, this strategy could lower the average cost per share, compared to what an investor would have paid if he/she bought all shares at once when they were more expensive than the average.
– William G. Ferguson
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.
