Following its worst week since March 2020, the S&P 500’s losing streak extended into a fourth week as the bellwether index has now fallen more than 10% since its early January highs, with the brunt of selling most concentrated in growth and smaller companies. Wall Street refers to a slide of this magnitude as a “correction,” and, in our view, it indicates investor nervousness around the Fed’s anticipated monetary tightening policy as well as the future path of corporate earnings – all while inflation remains elevated and geopolitical tensions continue to rise.
Importantly, further insight on the Fed’s thinking will be revealed later this week following the central bank’s policy committee meeting on Wednesday. Investors aren’t giving the market the benefit of the doubt for now, even as initial corporate earnings have come in rosier than expected (albeit with lackluster profit guidance due to concerns around input cost pressures and supply chain woes). It appears as though “buy-the-dip investors” are using any short-term pop in markets to sell as sentiment has shifted.
The JNBA Investment Committee has become slightly less bullish (but not negative) on stocks as a more hawkish stance by the Fed, with its updated plans for faster-than-expected interest rate hikes, has pushed up short-term rates and flattened the yield curve. The speed and magnitude of the move higher in short-term rates in the last few weeks has been noticeable, as investors fear an overly aggressive Fed may derail the economic expansion that is currently underway. However, the silver lining could be that the Fed’s future rate hikes may bring inflation under control before higher financing costs become a more permanent fixture in the economy. This is critical since much higher inflation, if sustained, could challenge the profitability of companies and valuation multiples accorded to stocks. To use a popular analogy, the Fed is attempting to take away the punchbowl before the party gets too far out of control. In other words, interest rate hikes now might help prolong the economic expansion by moderating the Fed’s need to be too aggressive in the future in order to bring inflation under control.
While there is uncertainty as to how far the Fed might go and how quickly it will try to get there, the JNBA Investment Committee believes it is highly likely that any future rate hikes will be data dependent as the anticipation of higher rates are themselves often able to slow down the economy and inflation enough so the Fed doesn’t actually have to hike as much or as quickly. Fortunately, even with the recent backup in interest rates, companies looking to access the capital markets have a very favorable backdrop even as credit spreads have widened somewhat since equities peaked earlier this month.
Our investment approach at JNBA has avoided many of the popular, thematic investments featuring potentially questionable business models – those stocks experiencing the worst of the market’s downturn. Instead, our focus has been to own highly profitable, cash-generative firms with sturdy balance sheets and a track record of dividend growth that have historically proven resilient in downturns such as this one. Since no one has a crystal ball with which to time the market, we believe the key is to be valuation sensitive and have focused much of our recent purchasing on inflation hedge instruments as well as international and value stocks. While we recognize that any withdrawal of liquidity from financial markets may create turbulence for short-term traders, we take a long-term view to owning the companies in our portfolios and purposely try to avoid those companies that are dependent on cheap money sustaining their business models or even demand for their shares from leveraged investors. In the long run, we are confident that stock prices will mirror the growth in corporate profits and therefore expect stocks to do well relative to bonds as inflation comes under control and earnings continue to grow at a measured pace (see chart).
Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from JNBA Financial Advisors, LLC.
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