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Portfolio > Portfolio Construction > Investment Strategies

Where to Find Stock Opportunities as the Economy Heats Up

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What You Need to Know

  • Rising inflation and yields are signs of a normalizing economy.
  • Recent economic stimulus has fueled the recovery in a stunning way, particularly with productivity.
  • Value stocks are preferred right now, but watch for secular technology firms with revenue growth opportunities.

The U.S. has made significant strides against COVID-19. Success combating the virus, combined with the massive stimulus delivered in the past several months, has served to reignite economic activity across multiple sectors of the economy. About 36% of Americans are now fully vaccinated, and this number will continue to rise now that children ages 12-15 have been cleared to start receiving the vaccine.

Rising inflation and yields are signs of a normalizing economy. In April, the core consumer price index (CPI), which excludes volatile food and energy prices, exceeded industry estimates. It increased 3% on an annualized basis, and ticked up 0.9% versus March, compared with predictions for 2.3% and 0.3%, respectively. Bond yields continue to reflect concern about inflation, but with the U.S. 10-year yield hovering at 1.60%, it could be much higher.

Although higher inflation has spooked investors, it is, in my view, simply a sign that the United States — flush with liquidity from fiscal and monetary stimulus — has started to reopen faster than many anticipated. As economic activity, including consumer spending, starts to hum, inflation rises.

In my large-cap core portfolio, I remain focused on economically sensitive stocks that will benefit from the recovery. I’m skewing toward value names that have increased productivity through lean operations, as well as toward companies with the ability to raise prices to address the higher cost of materials.

Accelerating Economic Activity 

Since last year, we’ve been talking about how the stimulus will fuel recovery, and we’re now seeing this come to fruition in a stunning way — particularly with productivity growth. In the first quarter, U.S. GDP grew by 6.4% on an annualized basis, reflecting the continued economic recovery, business reopenings and impact of policies such as direct payments to consumers, expanded unemployment benefits and Paycheck Protection Program loans.

Household income also rose, as did consumer confidence. U.S. personal income rose at a record pace of 21.1% in March, for the largest monthly increase since record-keeping began in 1959. In April, the Conference Board Consumer Confidence Index rose sharply to 121.7, from 109.0 in March. 

I expect spending to accelerate in the coming months due to record household savings and more reopenings. Flush with liquidity, consumers have begun expanding their purchases to services as well as goods. Though April, retail sales were flat following a 10.7% surge in March attributable to stimulus checks.

Consumer savings are still quite high: In March, the rate stood at 27.6%. Compare this with a historical rate during “normal” times of just 5%, and you have the recipe for robust spending moving forward.

All this activity is fundamentally inflationary. While core CPI exceeded expectations in April, so did the overall CPI, which rose 4.2% from a year earlier, compared with expectations of a 3.6% increase. Overall, April CPI gained 0.8% versus March, against the expected 0.2%. 

I’m also keeping an eye on eurodollar futures, which measure interest-rate sentiment and Federal Reserve policy expectations. Recent activity shows the market is pricing in the chance of a more hawkish Fed policy by September.

As I speak with companies, I’m hearing from many that they’re feeling pressure in the form of higher commodities prices. Spot iron ore started climbing this time last year and has seen record highs in recent days. Copper is still on the rise, also hitting record highs in May. Lumber, too, has reached record highs, putting pressure on homebuilders. Some companies can adjust prices and still be profitable, and some cannot.

The jobs picture is mixed. While many eyes were on the weak non-farm payroll number, I always look to the monthly Job Openings and Labor Turnover Survey (JOLTS), which tracks data on job openings, hires and separations. The number of job openings reached a series high of 8.1 million on the last business day of March. Job openings increased in several industries, with the largest increases in accommodation and food services (up 185,000); state and local government education (155,000); and arts, entertainment and recreation (81,000).

Allocating to Leverage Value vs. Growth

Increased economic growth, inflation and interest rates benefit value over growth stocks, and in recent months we have continued to see a market rotation to value. Year to date, the Russell 1000 value index is up 17% as investors seek out cyclicals over defensive technology and high-multiple growth stocks. 

My current allocations reflect my preference for economically sensitive cyclical stocks in these five areas, which have the most to gain from a recovery: financials, industrials, materials, energy and consumer discretionary. I am opportunistic in choosing companies with the operating leverage to withstand commodity price pressure as well as growing unit labor costs. 

My barbell may skew toward value right now, but I continue to maintain interest in holding select secular technology companies with demonstrable revenue growth opportunities over the coming decade, such as SaaS cloud, retail e-commerce and wearable tech.

As for corporate earnings, I expect to see continued above-average trend growth, even if the Fed decides to taper its monthly asset purchases to keep interest rates low — signaling it wants rates to rise. 

With the U.S. fully on the mend after a traumatic year, beating back the virus globally is now an essential priority to maintain a healthy world economy that will move us all forward.

Stephanie Link is chief investment strategist and portfolio manager at the national wealth management firm Hightower. She leads the firm’s Investment Solutions Group, which specializes in outsourced chief investment officer services, model portfolios, separately managed accounts, investment research and due diligence for Hightower advisors. Follow Stephanie on LinkedIn and Twitter @Stephanie_Link. 


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