George Hosfield, CFA, discusses Ferguson Wellman's quarterly strategy titled, "Inflation's Flame Flickers," which addresses the narrow market leadership, the impact of higher interest rates on inflation and how assets are priced at this stage of the economic cycle.
George Hosfield, CFA, discusses the firm's quarterly strategy titled "Stalemate," which highlights the Fed's ongoing battle to tame inflation along with our views on the health of the banking industry and capital market expectations for the balance of the year.
Director and Chief Investment Officer George Hosfield, CFA, discusses the Fed raising interest rates, peaking inflation and our view on equities and volatility across all asset classes in our Investment Strategy titled, “Balancing Act.”
This week, there was a plethora of economic and company-specific news for investors to digest. Specifically, the release of first quarter U.S. GDP, reported quarterly earnings by major technology companies and the unanimous vote by Twitter’s board to approve Elon Musk’s offer to take the company private. In response to this news, the market declined 4%, with all of the weekly losses occurring Friday afternoon.
A week that began with the sharpest pullback in equities since last fall concluded in remarkable fashion, as investor concerns about the economic repercussions of rising COVID-19 infections gave way to an increasingly constructive second quarter earnings season.
by Jason Norris, CFA
Executive Vice President of Research
Exit Stage Left Wednesday’s release of The Federal Reserve’s meeting minutes raised more of a hawkish tone. On the surface, the minutes may be viewed as negative; however, due to an improving labor market and an indication of a better growth environment we would welcome an increase in the Federal funds rate next year. As expected, the Fed did formally end its quantitative easing (QE) program with its final active purchase of mortgage-backed securities and government bonds. This is a positive sign for the equity markets and the U.S. economy at large. Coincidentally, U.S. Gross Domestic Product (GDP) data was released this week showing a solid 3.5 percent growth rate, which was better than most expectations. Our forecast has been for the U.S. economy to pick up steam throughout the year, and this data has confirmed that call. This information has supported stocks, yet it has a minimal effect on the bond market with the 10-year treasury yielding 2.3 percent.
Signals Third quarter earnings reports have reinforced our belief of continued economic growth. Seventy percent of the companies in the S&P 500 index have reported earnings to date and the results have shown year-over-year earnings-per-share growth of nine percent and revenue growth of four percent. Healthcare and technology companies have led the way with higher reporting of 11 percent and nine percent top-line growth, respectively. These are two sectors we favor in our equity strategies. These positive earnings reports have enabled stocks to reclaim their footing in this bull market. From the recent all-time high in September, the S&P 500 fell 10 percent over the subsequent four weeks. However, in the last two weeks we have seen a nice snap back with equities sitting just below the record of 2020 set on September 19, 2014. At current valuations (the market is trading 15.5x forward earnings) and with the strong earnings we are witnessing, we continue to favor stocks over bonds.
Different Stages The quarter’s earnings season has not been friendly to the higher growth, momentum stocks. Last week Amazon “cautioned” investors that they are going to reinvest more money into “growth”. Historically, this wouldn’t have been viewed very negatively but it seems investors may be getting impatient for their return on investment as the stock declined by almost 10 percent. Over the last 10 years, Amazon’s profit margins have fallen from six percent to under one percent, while the stock has been a stellar performer. It looks like investors are shortening the leash. Twitter suffered a similar fate this week. Twitter’s growth metrics (advertising, users, etc.) were disappointing, resulting in a 20 percent decline this week. The overall growth of the company is still strong, but investors may be getting anxious when they are paying over 100x future earnings. While many of us are big users of both of these companies’ services that does not make the underlying stock a great investment. Investors need to make sure that the price they are going to pay for future cash flows allows them to earn a competitive return. We just don’t see that in these two names at this time.
Our Takeaways for the Week:
by Shawn Narancich, CFA
Executive Vice President of Research
Suspended Animation
Despite an improving job market and a spring thaw that appears to be lifting the economy out of its winter doldrums, U.S. equity investors felt the chill of a sell-off that left benchmark stock indices underwater for the year. Confronted by the dawning reality that the Fed’s ultra-accommodative monetary policy is going away and, by implication, that projected inflation premiums are rising, high-flying tech stocks like Facebook, Twitter, and Amazon have been particularly hard hit. In contrast, amid a bond market rally that few foresaw at the start of the year, interest-sensitive stocks within the utility sector and REIT space have performed quite well. In general, value stocks are outperforming growth and, from out of the blue, emerging market stocks have begun to excel. Despite the distinct possibility that tighter monetary policy in countries like Brazil, South Africa and India could push these economies into recession, the markets of these BRICS constituents have rallied recently. For our part, we expect waning fiscal headwinds and a renewal of fortunes in the energy and manufacturing sectors to produce faster U.S. economic growth as the year progresses.
Shoulder Season
With the dawn of April, U.S. natural gas markets have officially transitioned from heating season to what is known as “injection season.” Commonly, the clean burning commodity falls in price this time of year as cold weather wanes and heating demand disappears (often referred to as “shoulder season”), allowing natural gas producers to start injecting gas into underground storage caverns in preparation for next winter. Front-month gas prices are down from the $6.00/Mcf level reached in February, but prices have been notably firm around the $4.50 level recently, and are much higher than the $2.00 lows reached in 2012. Prices have risen because of demand growth from utilities using more gas to generate electricity, but more immediately because of an unusually cold winter that has depleted storage inventories to 10-year lows. Surprisingly, a more than doubling of gas prices has happened without a lot of fanfare, as gas bears beat the drum of supply response from “gas behind pipes.”
Gas Bulls
The key question now is whether a domestic energy industry more focused on drilling for shale oil will be able to replenish gas supplies in time for the next heating season. At current prices, count us as skeptics. Natural gas directed drilling is at the lowest level since 1992, and while associated gas from oil directed drilling has provided a key source of supply, we doubt it will be enough to adequately refill depleted storage caverns. The reality is that curtailed gas flow doesn’t exist on any meaningful scale, and with the typical shale oil project still much more profitable for producers, we don’t expect adequate gas drilling to materialize until futures prices reach the $5.00-to-$5.50 level. Because of the substantial lead times necessary to transport drilling rigs and hydraulic fracturing equipment from oil to gas basins, combined with the time it takes to actually drill and complete new gas wells, the industry will not be able to turn on a dime. As a result, price spikes could occur until adequate new supplies materialize.
A Tradition Unlike Any Other
As the world’s best tee it up at Augusta National this week, money managers are gearing up for a pursuit of their own, less affectionately known as earnings season. Aluminum producer Alcoa kicked things off in acceptable fashion earlier this week and, following early reports from Wells Fargo and JP Morgan, reporting starts to kick into a higher gear next week.
Our Takeaways from the Week
