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Stephanie Link, Chief Investment Strategist and Portfolio Manager, Hightower

Portfolio > Economy & Markets > Economic Trends

Seeking Balance in a Volatile Market: Be Careful What You Own

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What You Need to Know

  • Amid rising inflation, the Fed will raise rates quickly and shrink bond holdings more aggressively,
  • Now is the time to pick solid companies, not take big sector bets.
  • Focus on companies with real earnings, strong balance sheets, free cash flow and quality management — and press your advisor to stay the course.

Late last year, we knew that 2022 would be a slower growth year as fiscal and monetary stimulus came to an end. We knew that inflation would be higher than trend and that it will remain so for quite some time. We also believed the Federal Reserve was behind the curve — but seeing the data, the Fed is much further behind, and as a result has been more aggressive with its tightening plans. No one could have anticipated the impacts of the war in Ukraine, however.

It’s these three issues that have pressured the equity and bond markets this year, and we continue to believe these unknowns are reasons we will be in a trading range for the medium term.  

The equity market is volatile, and the latest inflation data added fuel to the fire. This week’s consumer price index rose an enormous 8.5% year on year and 1.2% vs. February. Rising gasoline prices accounted for over half the increase from February to March. The energy index rose 11% in March vs. February, while the food-at-home index rose 10% year on year, in the largest annual increase since March 1981. 

The PPI was also hot at 11.2% year on year, and the hottest on record. Services inflation rose 8.7% year on year and goods increased 15.7% y/y. The services sector matters a lot more than goods because it affects consumption, income and inflation. Services spending is two-thirds of total consumption, four-fifths of employment and 60% of the CPI. 

The Fed has made it crystal clear that it will raise rates quickly and shrink bond holdings more aggressively — by $95 billion a month starting in May. As Fed governors grow increasingly more hawkish, expectations are for bigger and more numerous rate increases this year, possibly totaling as much as 250 basis points. There is also speculation that the Fed will raise rates by 50 basis points at the next two meetings in May and June, respectively.

Though equities are the best hedge against inflation, at times like this, investors need to be highly selective about what they buy. Now is the time to pick solid companies, not take big sector bets. For my portfolio, I’m sticking to companies with strong fundamentals and free cash flow growth using our barbell approach, owning both value and growth.

Inflation Heats Up, but Economy Shows Resilience

Many are talking about “peak” inflation, and while we hope that is the case, we strongly believe inflation will remain elevated. The stickier parts of inflation are worrying. In the March nonfarm payroll report, hourly earnings surged 5.6% year on year. When compared with the latest CPI, it’s clear that wage increases aren’t keeping up with inflation; if inflation isn’t reined in, it could affect consumer demand. 

Home prices nationwide increased year over year by 20% in February 2022 compared with February 2021, according to S&P CoreLogic. Not only are the headline home prices a concern, they will affect rents as they follow home prices on average by 12 months. The Dallas Fed forecasts average rents will be up 6.9% by 2023 from the 4.5% levels reported from the BLS. Of course, we know rents in many areas of the country are much higher.

The Fed has stated that it will be data-dependent this year, and there are positive signs that indicate the economy is resilient enough to withstand rising rates. The March ISM survey, a leading indicator, highlighted healthy expansion across both services (58.3) and manufacturing industries (57.1). New orders in ISM services surged 4 points to 60.1 — which is a leading indicator. 

Survey respondents shared commentary on continued business and demand strength with elevated backlogs, yet supply chains remain unstable and labor continues to push costs higher. Lastly, shipment of core capital goods increased at a 15.6% annualized rate in Q1, emphasizing demand-driven business activity and a focus on supply chains and inventory to help meet that demand. 

Nonfarm employment increased by 431,000 jobs in March, remaining above trend and led by services, particularly leisure and hospitality, underscoring our emphasis on reopening themes where significant pent-up demand remains strong. Professional and business services also showed strength. The unemployment rate is down to 3.6%, and job openings are at 11.3 million. Job demand is significant; those who want a job can find one, and they will get paid more to do it.

Recent ADP data showed private sector employment is strong in the U.S. The U.S. nonfarm payroll’s service component also showed resilience. Both are indicators of an economy that still has pent-up demand and excess consumer savings. Just look at the latest U.S. retail sales, which were up 1.1% on the month (excluding motor vehicles and parts), with the prior month posting higher revisions.

Confidence and willingness to borrow is high among younger generations of consumers: 60% of millennials, 57% of bridge millennials and 54% of Generation Z consumers say they are interested in using bank-issued “buy now pay later” plans, according to a recent survey.

How I’m Investing Right Now

The bond market is reacting as expected to news of continued high inflation and rising rates, with the 10-year yield climbing 100 basis points since March 1. We saw a brief inversion of the yield curve in the last two weeks, which historically is an accurate predictor of recession. That said, going from 6.9% GDP in Q4 2021 to negative growth would be very drastic and is unlikely this year. We don’t see a recession for 2022 as our base case — there is simply too much momentum in the system, especially from the consumer. 

Either way, now is not the time to make big sector bets or own long-duration assets. I am seeking to maintain a value/growth balance with my barbell portfolio, owning some cyclicals, more reopen and some defensive growth stocks. I’m seeking out companies that have the ability to raise prices to keep up with input costs while maintaining margins and growing profits in inelastic demand environments. 

We are also watching for Q1 earnings reports, expecting 5% earnings growth for S&P 500 companies, with revenue up 10.8%. Excluding financials, we see S&P earnings growth of 12%, with revenue up 14%, according to a CSFB analysis.

For my own portfolio, I see outsized opportunities among energy, materials and industrials. Energy and materials benefit from the increasing demand for their goods at higher prices. Energy stocks were the first mover in 2022, rising nearly 40% in Q1. Materials have increased 6.4% in the past month — the second-best performing sector to consumer discretionary over that time horizon. A key theme across many of our industrials is automated-intelligence providers and capex beneficiaries. 

In the past three years when markets were rising, an investor could have thrown a dart at a stock and potentially made money. We have entered a very different market cycle, with several unknowns and volatility that is likely to be with us for months to come.

More than ever, investors need to focus on the fundamentals — companies with real earnings, strong balance sheets, free cash flow and quality management teams. And lean on their advisors to help them stay the course and resist the temptation to take bets on companies that offer more risk than reward.


Stephanie Link is chief investment strategist and portfolio manager at the national wealth management firm Hightower Advisors LLC. 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 LLC. Follow Stephanie on LinkedIn and Twitter @Stephanie_LinkRead her regular market insights here.