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Stephanie Link, Hightower Advisors

Portfolio > Economy & Markets > Economic Trends

Staying Diversified in a Jittery Market

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What You Need to Know

  • Fed Chairman Powell says tightened monetary policy will continue for some time until inflation is under control.
  • Since September is typically the weakest month of the year, a pullback would not be surprising.
  • With many companies struggling with higher input costs and customer sensitivity to inflation, be selective and cautious when taking big sector bets.

This year has been an emotional roller coaster for investors. After a steady march downward the first half of the year, we saw a sharp decline in mid-June followed by a rebound this summer as it became clear that corporate earnings did not collapse, and recession did not set in. The market has remained volatile, however, and dipped once again following hawkish statements last week from Federal Reserve Chairman Jerome Powell.

Speaking on Friday at the Fed’s annual symposium in Jackson Hole, Wyoming, Powell announced that we will have tight monetary policy for some time before inflation is under control. He said continued rate increases will result in slower growth, a weaker job market and “some pain” for households and businesses.

Last week, the market also received the news that the Fed’s preferred inflation indicator, the core Personal Consumption Expenditures price index, is still far above the Fed’s 2% target, coming in at 4.6% for July, year over year, down from 4.8% in June. 

Despite persistent inflation, the economy is holding its own. S&P 500 earnings for Q2 were better than expected, up 10.3% from a year earlier, well above the 5.6% the market had forecast. We’ve also seen relatively positive news on retail sales, employment, industrial production and new orders. 

Though we’re not currently in a recession, remember that when the Fed raises rates, it can take six to nine months for those increases to affect demand and the overall economy. As a result, in my barbell portfolio, I am overweight value, emphasizing energy, materials, financials and defensive health care. On the tech side, I’m highly selective, focusing on quality companies with strong balance sheets that fall into the value or enterprise-spend categories rather than traditional growth.

Notable Bright Spots in a Mixed Economic Picture

When it comes to retail demand and employment, it’s evident that the momentum sparked by extensive fiscal and monetary stimulus in the past two years is still with us — for now. July retail sales were up 10.3% year on year, and excluding autos and auto parts, rose 12.3% year on year. 

Jobs are still plentiful, with 10.7 million open jobs in the U.S., according to the latest JOLTS survey. There are still more job openings than unemployed people: In July, the number of jobless people edged down to 5.7 million, and the unemployment rate edged lower to 3.5%.

Manufacturing output, meanwhile, rebounded 0.7% in July after declining 0.4% for each of the two previous months. July’s increase was far above market forecasts for a 0.2% rise. In the past several months, we have seen a notable shift in consumer demand from goods to services. In the Institute for Supply Management’s Services ISM Report on Business, the new orders index — a leading indicator — came in at 59.9% in July, versus 55.6% in June, comfortably above the expansion threshold of 50. I see this as a strong sign for the months to come.

Despite all the bright spots, consumers, particularly those with lower income, face significant struggles paying for food and gasoline. In July, the all-items consumer price index rose 8.5% year on year, a smaller increase than the 9.1% for the previous month, but still way too high. We continue to watch the stickier parts of inflation such as rents, wages, education and health care costs.

And as expected, housing remains in a downturn if not a recession. Sales of new U.S. single-family homes plunged in July, falling 12.6% to the lowest level since January 2016. I expect to see continued softening of the housing market as potential buyers hold back due to higher mortgage rates. As housing softens, so too will demand for items such as appliances, home decorating supplies and all the goods people purchase when they move into a new home. 

How I’m Investing Right Now

Despite the summer equities rally, as we’ve seen in the recent retracement, we are headed for choppy waters. September is typically the weakest month of the year, so I won’t be surprised if we see a pullback. For my portfolio, I remain data dependent and very selective, seeking pricing-power stories as well as companies with strong balance sheets and free cash flow.

S&P 500 earnings forecasts for Q3 call for just a 5.5% increase, with a rebound back to 8.5% in Q4. With many companies struggling with higher input costs and customer sensitivity to inflation, we continue to be selective and cautious when taking big sector bets. 

I currently favor the energy sector, as companies are generating enormous free cash flow thanks to higher prices, and are using it for dividends and buybacks. Break-even for an oil company is $40-$50 per barrel, and current crude prices are over $90 per barrel right now. Aside from the Ukraine war, we are seeing tight supply in the U.S. because energy companies have prioritized renewables over building new refineries. Supply will only get tighter this fall as supply from the U.S. Strategic Petroleum Reserve runs out. 

Another sector I like is materials, where companies are also benefiting from higher prices and greater free cash flows. Widely used commodities such as copper are hard to produce and are in demand for a range of uses, including homes and electric vehicles. Financials are also on my list, as banking revenue rises when rates rise; they are also rewarding shareholders with dividends and buybacks.

While the economy is slowing this year, we have yet to feel the effect of the recent rate increases, with more to come. We are still not out of the woods when it comes to recession, possibly in 2023. 

Heading into September and what’s sure to be a volatile market, I am staying diversified in my portfolio, focusing on quality and emphasizing value with selective exposure to growth. The consumer has remained resilient so far, and since consumers represent 75% of the U.S. economy, we will be watching demand closely.

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.


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