AlphaBetaStock’s Report (Premium Edition) 02-14-2022

Key Drivers & Actionable Takeaways 2-14

TIP – This is a brief bullet-point summary. It is a tool that gives investors and financial a fast and simple list of what to watch for and talking points for the week.

  • Rising Inflation & Recession Fears
  • Fed Hikes & Fed Talk
  • Earnings
  • Ukrain Conflict
  • Wednesday, February 16 – Fed Meeting Minutes
  • Wednesday, February 16 – Retail Sales (MoM) (January)
  • Thursday, February 17 – Building Permits (January)

Inflation figures have retriggered market panic, and the peak is yet to come. Volatility is being created by uncertainty regarding the length of this inflation surge and uncertainty surrounding central bank policy. This is an excellent opportunity for long-term investors to build up well-priced positions while others will wait for a drop.

A potential conflict with Russia over Ukraine is shaking up the markets. We have tried to talk to experts in the area to get an idea of a real invasion and what it would mean. Cutting through the noise, we know that the Russians have positioned troops and equipment to invade. However, there is not any real reason for them to invade. For that reason, we think Putin is using this as a political move to gain something else from Biden.

This macroeconomic calendar highlights four events: European Q4 2021 GDP, January US producer prices (Tuesday), Jan US retail sales (Wednesday), and minutes from the Fed’s latest meeting (Wednesday).

Financial advisors and investors should take note that the US 10YR yield went over 2% which is over the average S&P 500 dividend. Bonds are getting crushed, but we think investors will start moving out of equities into higher-paying conservative investments such as CDs.

We are bullish that Gold and Bitcoin. Due to higher inflation, they should be doing better, but both face different pressures. Bitcoin prices seem to be consolidating and seem to be oversold. Gold hasn’t made the jump up which I think is due to the US Dollar increasing value. Energy, consumer staples, commodities, and real estate performed better in past high inflation environments.

More aggressive investors may want to buy at the dip or sell longer puts on growth tech stocks such as Netflix that have rocketed up due to Covid.

Stocks & ETF Watch List

Tip: Use this section to find stocks and ETFs to add value to your portfolio by increasing the alpha (return) and decreasing beta (beta). Our list is updated monthly to help provide our readers with timely insights. Readers should do their own research before making any investment.ts.

All stock/ETF picks are updated as of January 1st and are now on one page. Click here to view them.

  • Inflation Stock Picks: List of stocks that we think should perform better in a rising inflation environment. 
  • Auto Parts Stock Picks: Auto parts companies are likely to see their stocks rise as the average age of cars and light trucks increased from 11.9 years in January 2017 to 12.2 years in January 2021, according to new data from IHS Markit. Below are the top auto parts companies that investors should buy now before the profits roll in. 
  • Solid Picks: This group of stock/ETF picks is likely to experience growth and perform well into the near future. 
  • Dividend Stocks: List of stocks that have excellent dividends and business performance. 
  • Dividend Growth Stocks: List of stocks that have a history of growing dividends. 
  • Dividend ETFs Picks: This list of ETFs is selected for their ability to pay dividends. 
  • Dogs of the Dow: This list of DOW stocks based on H. G. Schneider’s Article in the Journal of Finance in 1951 that used the price-earnings ratio. The general idea is that blue-chip companies that pay a dividend are more likely to withstand an economic downturn. 

Market Trends

Tip: Use this as a quick guide on the short-term direction (1-2 weeks) and long-term (1.5-5 years) of key markets. It is not a signal to buy or sell, just to show the trend. This is a quick cheat sheet to know the trend and help understand what is happening with the markets in the short term. I started making this section years ago because once had a client that would call me nearly every day asking the direction of the markets.

S&P 500 Sector Trends

Tip: Use this section to know the performance of various sectors, weight portfolios, or look for trades. Modern portfolio theory stresses the importance of diversification, but recently several sectors like technology have outperformed others like utilities. This is also a way to narrow the sectors to find investment opportunities.

Weekly Report – Fed & Inflation

Market data and inflation continued to make markets gloomy last Wednesday. The markets are being shaken by a possible conflict with Russia over Ukraine. To get a better understanding of what a true invasion would look like, we spoke with military experts in that region. They reported that the Russians have deployed troops and equipment in order to invade. There is no reason to invade. We believe Putin is making this a political move in order to get something from Biden.

Biden and Putin spoke to each other last Saturday in a conference call. Biden stated that the US would respond decisively to Ukraine’s invasion. He and his allies would then “impose swift, severe costs.”

Despite the Western attitude toward the situation, Ukraine’s president Volodymyr Zelensky has encouraged calm and Yuri Ushakov (the Kremlin’s top foreign policy advisor) has called the US warnings “hysteria”. NPR reported that there are no signs of panic in Kyiv or other major cities of Ukraine. However, the Kyiv mayor has a plan for an emergency evacuation in place.

Bottom line, we tend to think the Ukrain situation is just noise at this time.

Turning to the Fed and Inflation

Sometimes we want to talk about something else than inflation. But how do we do that when prices are constantly rising in the United States, and the Fed must react quickly? According to Thursday afternoon statistics, the cost of living increased by 7.5% on average between January 2021-2022.

The Fed’s already strong impression of having to catch up is reinforced by this higher-than-expected reading (economists expected that the surge would only reach 7.2%). It might be necessary to increase rates by half a point rather than the usual quarter-point, in other words. This could cause damage to the real economy and credit. CME’s FedWatch tool predicts a double rate increase on March 16. We don’t want to repeat ourselves but let’s not forget that phases of monetary tightening can be very favorable for stocks if they are carefully planned. The market is not as keen to react abruptly.

Many Presidents of Federal Reserve Banks made statements about where they see the country heading in terms of interest rates, debt, and the economy’s future direction, including Mary Daly from San Francisco, Kansas City, and Patrick Harker from Philadelphia.

George is concerned about the Fed’s “monetary policies being out of tune with the economic outlook.” This outlook includes a 40-year high inflation rate, bleeding jobs, and an overall economic slowdown. She recommended that the Fed immediately reduce its balance sheet and warned that the transition to a more stable environment could prove problematic in terms of markets and the “recalibration” of supply and demand.

She said that the Fed should gradually raise interest rates and believes that the Fed will be able to slowly increase interest rates if the balance sheet is reduced quickly. However, a slower decrease in the balance sheets will likely result in a faster increase in rates, and this could cause more market turmoil.

An increase in interest rates too rapidly would “distort incentives to private sector intermediation” as well as “risk greater economic or financial fragility,” which includes the increased possibility of runaway inflation throughout the year. The national debt, which is now at $30 trillion, is one of these fragile financial elements.

According to the Congressional Budget Office (CBO), more debt makes the United States’ fiscal situation more susceptible to higher interest rate increases. We are now approaching the point where the interest on the national debt will begin to grow at the fastest pace each year.

Talking about debt – Ellon Musk

Tesla and SpaceX CEO Elon Musk warned about the national debt this week saying that “something has got to give.”

“True national debt, including unfunded entitlements, is at least $60 trillion – roughly three times the size of the entire US economy. Something has got to give,” Musk tweeted Thursday.

Goldman Sachs 3 Scenarios

Goldman’s Chief U.S. strategist David Kostin gave three different scenarios on a call last week. He sees a two-sided risk to their baseline S&P 500 forecast but with a “larger downside tail” and offers three alternatives for stocks that are different from the baseline view.

  1. The Fed continues to increase its interest rates, despite inflation remaining high. This raises the terminal funds rate above the market’s expectations and Goldman’s. The net result is that equity costs would rise and the S&P 500 would fall by 12% to 3,900.
  2. Inflation falls more than anticipated, which means that there are fewer Fed increases, which will lower equity costs and trigger a stock rally that would lift the S&P to 5,500. This would be a 24% increase from Friday’s close.
  3. The U.S. enters a recession and experiences the 24% peak-to-trough price drop that would bring the S&P down to 3,600.

I have the greatest respect for Kostin, but it appears that Goldman is not sure what is going to happen. According to them, we could see a massive swing in the markets both ways and only time will tell.

Summary of the Fed

Most Fed Presidents agree that at least three interest rates will increase by 2022, and the Fed may increase this number later in the year. All the presidents agree that interest rates should rise sooner than expected to combat inflation. However, this approach must be slow and cautious to avoid financial instability and unintended inflationary pressures.

The Fed will probably change their projections regarding hike magnitudes in the future, given the changes in the landscape over the past three months.

Market participants and analysts anticipate a 50-basis point increase in interest rates. This is likely because the Fed does not want to interfere with any upcoming elections, and the Fed can wait for the elections to pass before raising rates again. However, this could have a negative impact on markets and economic stability in the short term.

The Fed and government economist are saying that inflation will peak in the summer and fall towards the end. However, I think they are wrong, and rising inflation will continue much longer, much like the 1970s, until we hit stagflation.

Jobs data shows a staggering loss.

According to the ADP National Employment Report in January, the US lost 301,000 jobs, which is significantly more than the 207,000 jobs gained estimated by leading economists. According to the ADP National Employment Report, it was also the first decrease in employment. An economist from Goldman Sachs stated that the details of the ADP Employment Report indicate that Omicron’s January employment impact was likely to be temporary.

Disposable Income decreases

The Bureau of Economic Analysis (US Department of Commerce) showed that December saw a 0.2% increase in disposable personal income (DPI), while real DPI (which measures DPI with inflation) decreased 0.2%. This means that Americans had less disposable income at the end of 2021 despite an “increase” in income.

Bonds

The prospect for an accelerated rate increase caused a fall in bond prices, which in turn drove the 10YR US yield up to 2.01%. Simple mechanism: rising consumer prices should prompt the Federal Reserve to adjust its key rates quickly. This impacts the yield curve, with the T-Bond yield exceeding 2%.

This is a significant move that will likely cause investors to shift funds away from equities (S&P 500’s dividend rate is 1.27%) and to higher-paying income investment. The German Bund rose by 0.26%, while the French OAT rose to 0.73%, currently at 0.24%.

Crypto

After long weeks of turmoil, the cryptocurrency market is now thriving. Bitcoin’s price has risen by more than 15% over the past seven days and is now back above $43,000 when this article was written. This does not necessarily indicate a rapid return to historical highs three months ago.

It still experienced a 50% decline over the same period. The road ahead could be long and difficult before bitcoin can erase its counter-performance, mainly because the macroeconomic environment does not always favor it. Crypto’s performance has been somewhat correlated to the stock market, but may be finally breaking free.

OIL

The last five sessions have seen oil prices stabilize, but it’s not enough to stop their seven-week streak of consecutive increases. The tensions in Ukraine remain high, and the unexpected drop in US inventories in the past two weeks supports oil prices. Buyers must deal with the resumption in negotiations on the Iranian nuclear issue, and Washington appears ready to make concessions to reach an agreement.

An increase in Iranian oil supply would increase almost 2 million barrels per day, which is a breath of fresh air in a tight market due to the dynamic of crude demand. North Sea Brent, the European benchmark oil, trades at USD 92, while WTI barrels are USD 90.2 at USD 90.2.

Precious Metals

Although gold gained some ground this week, it has dropped sharply after publishing high inflation figures from the United States. We do expect it to climb, but uncertain when as it has failed to keep up with inflation.

Industrial metals are much more comfortable in the air due to the improved economic statistics in China, where credit growth has accelerated in January. Copper is now trading at USD 10,000 per metric tonne, nickel at USD 24,050, tin at USD 44,445, and aluminum at USD 3,300.

AG

Soybeans continued to rise in Chicago despite the USDA’s more pessimistic forecasts. The USDA revised its world stock estimates downwards due to the poor weather in South America. Wheat stabilized at 776 Cents while corn gained to 646cents a bushel. The surge in lumber prices has been noted, with more than 20% gained in five sessions. Supply disruptions are making lumber prices volatile, and they are particularly affecting Canadian production sites, which are having trouble getting their product to the United States.

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