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Robust Demand Is Keeping Stocks Strong, Despite Naysayers

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What You Need to Know

  • Earnings are better than expected, consumer demand is robust and annual GDP is on track for 6%-7% growth.
  • Forward-thinking companies that began preparing for supply chain disruptions 12 months ago are well positioned to benefit from renewed consumer demand.
  • In a year of back-and-forth market rotation, value stocks make sense in the historically strong fourth quarter.

The fourth quarter is historically a strong period of the year for the equities market, and this year that seasonal advantage appears on track. Earnings are coming in better than expected, consumer demand is robust and GDP is on track to finish the year at 6%-7% growth. Earlier this month, all six of the largest U.S. banks beat earnings expectations for the first time in years, and we will be watching closely as more companies announce results in the coming weeks.

Despite the recent market choppiness, the economy is stronger than many market strategists believe, and I see considerable room for growth in key cyclical and reopen sectors. Those who have called for a market correction are underestimating the amount of liquidity still in the system.

The Federal Reserve is set to start cutting back on its asset purchases soon, but even with the taper, it will still be injecting significant liquidity into the system through mid-2022, to the tune of roughly $105 billion per month. And the new infrastructure spending, which will likely amount to $1 trillion to $2 trillion, will eventually come and continue to stimulate economic activity.

Heading into Q4, I continue to focus on macro fundamentals to guide my portfolio choices. Through year-end, I am seeking opportunities in cyclicals and reopen stocks, emphasizing value vs. growth. 

Macro Indicators Point to Growth, Higher Inflation

Persistent supply chain issues and resurgent demand are stoking inflation. The September consumer price index (CPI) rose 5.4% compared with September 2020. Some prices are rising rapidly and are clearly not transitory. The indexes for food and shelter rose in September and together contributed more than half of the monthly all-items seasonally adjusted increase. Rent rose 0.5% versus August — an enormous number, and suggests the Fed is behind the curve in monetary policy initiatives.  

Many areas of supply chain disruption will not be resolved quickly. Just look at the semiconductor shortage: At a conference last week, Commerce Secretary Gina Raimondo remarked: “This is one I feel confident saying it’s not going to be fixed in a month or two, or six, or 12 months.”

While manufacturing companies face ongoing supply issues, especially the auto industry, for the third quarter as a whole total industrial production rose 4.3% at an annual rate, its fifth consecutive quarter with a gain of at least 4%. Industrial production remains just 2% below pre-COVID levels, according to Merion Capital.

September retail sales confirmed strong demand, up a huge 20.6% compared with September 2019, pre-pandemic. U.S. third-quarter credit card billings were up 25.2% versus the same period in 2020, according to an analysis from Merion Capital — showing that consumer spending is roaring ahead.

Since the consumer constitutes 70% of the economy, I’m watching the surge in spending closely. Note that we still have pent-up demand, which bodes well for the overall economy. The consumer savings rate, according to the St. Louis Fed, was at 9.4% in its latest reading in August, still well above the historical average of 5%, amounting to $2 trillion in consumer excess savings, according to Merion Capital and Cornerstone Macro.

What to Look for When Choosing Stocks

Many U.S. companies have done an enormous amount of work keeping their companies focused, restructured, lean, and delivering — and it’s “so far, so good” on earnings. This correlates with indicators showing spending, higher wages and expanding employment as select companies continue to thrive. 

That said, as earnings reports roll in, expect to hear from “haves” and “have-nots.” For instance, some companies have the ability to raise prices to address inflationary pressures without affecting the bottom line, while others clearly do not. This pricing power is a key factor in their ability to gain operating leverage, protect margins and stay profitable.

I am also drawn to forward-thinking companies that foresaw the supply chain issues 12 months ago and planned for possible disruption. They expanded their raw-material or finished-product sourcing to multiple countries, instead of just relying on one or two. Now, a year later, these organizations are well positioned to benefit from renewed consumer demand. I am staying away from companies that lacked this foresight and are scrambling to fill orders, with negative impacts on their bottom line.

I remain optimistic about equities, with caveats. Because I think inflation will stay stronger for longer, I am favoring value stocks, those that stand to benefit from the recovery, and reopen names that are seeing resurgent demand. Economic indicators are telling us that the economy is doing just fine, as the delta variant has receded. Thus, in a year of back-and-forth market rotation, value stocks make sense in the fourth quarter. 

We have our V-shaped recovery, which explains why the S&P is up over 20% year to date. Looking ahead to 2022, however, the Fed will have its work cut out for it getting inflation reined in without sacrificing growth. 

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