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Finding Stock Bargains in a Strong Economy

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What You Need to Know

  • Despite the delta variant, Fed watching and China concerns, strong economic fundamentals favor equity market bargain hunters.
  • When seeking opportunities, consider the year-on-year growth of select networking companies and their recovering pipelines.
  • Identify the top one or two players in each industry and wait for them to go on sale.

Last week, the Federal Reserve confirmed what the markets had already priced in: It plans to slow the pace of its asset purchases later this year, likely in December, and will likely raise interest rates late next year or in early 2023.   

Though Chairman Jerome Powell’s overall tone on Sept. 22 was measured, leaving the door open to a policy pivot if the Fed doesn’t meet its targets, in my view the current plan to cut back on emergency economic stimulus is justified.

U.S. retail sales, employment and manufacturing data continue to indicate fundamental strength in the economy. Wage and shelter cost increases are real, and so are global supply chain issues, which are pushing up input costs for goods and services.

The Fed’s asset purchases are $120 billion each month. If tapering means reducing purchases by, say, $15 billion per month, that still leaves us with enormous liquidity in the system through mid-2022. Add to that the new infrastructure spending, and it’s no surprise that the equity market doesn’t seem rattled by the Fed’s plans.

While the uncertainty of the delta variant, Fed watching, seasonal choppiness and China concerns are driving sentiment, the backdrop of strong economic fundamentals is creating favorable conditions for equity market bargain hunters. Across several sectors, even the best economically sensitive companies with solid financials can see their stock prices decline, providing active investors with the opportunity to get top companies on sale. 

Indicators Point to Ongoing Strength

The latest U.S. retail sales report shows that consumer spending, which constitutes 70% of GDP, is strong. Retail sales rose 0.7% in August versus expectations of a decline of 0.8%, despite delta and supply chain concerns. Control group retail sales (excluding receipts from volatile sectors such as auto dealers, building-materials retailers and gas stations) were up a whopping 12% year-on-year. For a pre-COVID comparison, retail sales were up 18.6% compared with two years ago, according to an analysis from Merion Capital. 

Clearly, consumers are gaining confidence to spend. When you consider that the personal savings rate is still quite high at 9.6%, compared with the historical norm of 5%, we are still sitting on some pent-up demand. This bodes well for future GDP growth and corporate earnings. 

The jobs picture is also trending better. The latest four-week moving average for U.S. initial weekly jobless claims was 2.804 million, a decrease of 15,750 from the previous week’s revised average. These numbers showed that claims hit the lowest level for this average since March 21, 2020. In the latest U.S. non-farm payroll report, wages continued to accelerate, rising 4.3% on a year-over-year basis and 0.6% on a monthly basis, versus estimates of 4% and 0.3% respectively.

Competition for employees is fierce: The Bureau of Labor Statistics’ Job Openings and Labor Turnover Survey (JOLTS) showed the number of job openings nationwide increased to a series high of 10.9 million on the last business day of July, versus 10.1 million at the end of June. 

Though supply chain issues persist in manufacturing, August industrial production came in at just 2% below pre-COVID levels. By comparison, last year at this time we were down 17% versus pre-COVID levels, demonstrating the V-shaped recovery, according to Merion Capital.

Business conditions are improving in some key metropolitan areas. The Federal Reserve Bank of New York’s Empire State business conditions index rose an impressive 16 points to 34.3, compared with expectations of a 17.2 reading. The manufacturing survey showed that new orders, shipments, and unfilled orders all increased substantially, as did plans for capital and technology spending.

Labor market indicators pointed to strong growth in employment and the average workweek. The Philadelphia Federal Reserve’s business activity index, meanwhile, also far exceeded expectations, rising to 30.7 in September from 19.4 in August.

Business expectations are clearly improving as vaccines and boosters become more widespread and consumers return to stores, restaurants, stadiums and hotels.

Look at the attendees at the Ryder Cup! I attended a conference earlier this month with some of the largest U.S. manufacturing and industrial companies, and the message from company executives was clear: Demand is robust, and they can’t keep up due to supply chain issues. One semiconductor capital equipment company said it is building yet another manufacturing center — its fifth in the U.S. — a sign that the company believes demand will stay robust for some time.

As economic activity heats up, so do inflation concerns. The U.S. 10-year bond yield has climbed to 1.48%, considerably above the 1.17% level we saw in August. Supply chain issues are driving up input costs, wages are rising considerably, and shelter costs are climbing — none of which is transitory. 

Where to Find Opportunity

With the data showing us that the economy is indeed recovering and inflation is ticking up, I continue to recommend a diversified portfolio approach. In my barbell, I am overweight select cyclical and reopen names — companies that will benefit from both consumer and business spending in sectors such as travel, consumer discretionary, retail, manufacturing, energy, financials, IT networking, online dating, ride hailing and casinos.

On the other side of my barbell, I maintain an allocation to growth stocks, focusing on, for instance, secular tech names with significant market share and large total addressable markets that aren’t overbought. In tech, I’m particularly interested in companies that are benefiting from renewed enterprise IT spending, which is roaring back post-pandemic.

During the stay-at-home period, many companies invested in technologies such as cloud storage and security software to address COVID-era needs and held back on enterprise spending. When seeking opportunities, consider the year-on-year growth of select networking companies and their recovering pipelines.

China is a looming concern, as the government cracks down on a variety of industries: internet/technology, gambling, real estate and cybersecurity. There are a lot of unknowns as to how this translates into their economic growth and for U.S. companies that do business in China.

I believe there are selective ideas of U.S. companies in this region that have strong market share and balance sheets, and free cash flow. In particular, I believe the gambling and casino companies are oversold and on my short list. They stand to benefit from increased tourism once COVID wanes, and are part of the reopen trade that I find attractive.  

When bargain-hunting with the U.S. recovery as a backdrop, consider companies with strong management teams, sizable market share, a large total addressable market, upbeat earnings guidance, free cash flow and good margins. My best tip? Identify the top one or two players in each industry and wait for them to go on sale.

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