28 Mar Capital 19 Catch-Up
“Don’t be afraid to give up the good to go for the great.” – John D. Rockefeller
Weekly Index Movement
Aussie All Ords +1.6%
You know it’s been a hard start to the year when it takes until March for the indexes to put together back-to-back gains.
Sentiment seems to be shifting to positive with the S&P500 within striking distance of 4590, the February high.
Bears are in trouble here. If they can’t hold prices down with the support of spiraling inflation, a very hawkish Fed, expectations of no earnings growth this quarter and a war disrupting the world, they don’t stand a chance. The slightest positive news will send stocks even higher.
We came across this little piece of research by SentimeTrader
They have looked at how the market has performed so far this year and then matched it against similar moves in the past. They found 14 other stretches when the market moved similar to how it has this year.
Here are two examples of how those other times played out with this year’s action overlayed as a comparison
If the similarities continue, the bears are going to be in for a rough time here.
The Fed Is Getting Increasingly Hawkish
Less than a week after the Fed raised interest rates for the first time since 2018, Powell on Monday vowed to take “necessary steps” to address inflation. He noted that those rate hikes could go from the customary increase of 25 basis points to a more aggressive boost of 50bps if needed.
Although the market initially fell on this news, it had shrugged it off by the end of the day.
Our take – The Fed has two mandates. Maximum employment and contained inflation. Right now there are more job openings than there are unemployed. The Fed does not need to concern itself with employment.
But inflation is way beyond the 2-3% target.
The Fed will aggressively target inflation with much faster interest rate rises than the market expects. They will do 50bps in May and possibly another 50bps in June if we do not see a correction in inflation.
Which got us thinking, what happened in the past when the Fed started raising interest rates?
In the past 20 years there have been three times the Fed started a cycle of raising interest rates. Here is how the various asset classes performed each time.
We see no reason for this time to be any different, and it is clear what has performed the best.
Commodity companies and Large Cap Growth stocks is where you want to be.
As much as knowing where you want to be invested in this environment, is knowing what to avoid.
We suggest avoiding high debt companies and smaller companies that do not have the ability to increase their prices.
If you want to make it simple, if the company is outside the two favoured sectors, and it has a negative PE, consider selling it and replacing with a commodity company or large-cap growth.
Getting rid of your favourite small cap stocks is not easy. But it is necessary. They might have wonderful growth stories, but it is time to be defensive here and protect your capital. If they survive the coming interest rate barrage, they will be well placed for the future. Better to pick them up again later when the environment has changed once more.
Dividend paying stocks would be a good place to allocate funds too, as their yield provides a downside protection.
This idea of Large Cap Growth being the best place to allocate funds is already happening. Take a look at year-to-date returns:
Russel 2000 -7.5%
MSCI Emerging Markets -7.9%
But look at Large Cap US Growth
Apple (AAPL) -1.6%
Google (GOOG) -2.2%
Amazon (AMZN) -1.2%
This sector is already outperforming year-to-date. Expect this to continue.
Earnings Expectations Low
We are just two weeks out from the start of Q1 earnings announcements.
Analysts estimates are low, which means it should be easy for companies to beat. Here is the progression of S&P500 earnings per share by quarter from the June 2020 lows:
- Q2 2020 – $28.25 / share
- Q3 2020 – $39.40 / share
- Q4 2020 – $42.30 / share
- Q1 2021 – $49.09 / share
- Q2 2021 – $52.80 / share
- Q3 2021 – $53.88 / share
- Q4 2021 – $55.37 / share
But analysts are expecting just $51.85 / share for Q1 2022.
For the trend in rising earnings every quarter to continue, companies would need to produce an 8% beat. The average beat is 6% so 8% is not out of the question.
A $56 average earnings for Q1 2022 would change the story of slowing economic growth and draw a lot of buyers into the market.
The bears might as well say goodnight if this happens and the rest of the year could well turn out like the two graphs above.
This week we have house price data and GDP on Wednesday as well as consumer spending and inflation and then the employment report is released on Friday.
We will be watching the house price data (it contributes to inflation numbers) and the inflation reports. Any signs of reducing inflation will be positive for stocks but we doubt the employment report will make much difference as everyone knows the labour market is strong.
Employees of Capital 19 presently own shares of the companies mentioned in this report.
Stock values can go down as well as up. It is possible to lose 100% of your investment in a stock. Any advice given by Capital 19 is general advice only and does not take your personal circumstances into account.