Stocks were mixed yesterday with the Dow rising and NASDAQ taking a hit, led by negative reactions to earnings outlooks at Tesla and Netflix. Bond yields rose after strong economic reports suggest more than one additional rate hike by the Fed is needed.
The Dow is on course for its longest winning streak since 2017. NASDAQ names took a breather. Reports from Tesla and Netflix weren’t bad, they just weren’t good enough to keep the June/July surge continuing. Declines yesterday only returned both stocks to levels last seen a week ago, hardly a scary correction. But other big names declined in sympathy, even though concerns at Tesla and Netflix were very company-specific. Over the past several earnings seasons, the early reporters among the “Magnificent Seven” have set the table for the group’s overall performance during earnings season. These stocks have surged. All are up at least 30% year-to-date and three are up over 100%. As a group, the entire gain is P/E related. Earnings for 2023 are not expected to exceed those of 2022. Obviously, the surge is a function of future optimism aided by slightly lower long term interest rates.
Over the past few weeks there has been the beginning of a rotation toward other sectors in the market. As of last night’s close, the Dow is on course to rise over 2% this week while the NASDAQ is down about a half a percent so far. Recent economic news points to a delay in any possible recession with odds growing, at least according to consensus forecasts, that a recession might be avoided altogether. Employment demand remains solid as the consumer continues to spend on experiences. However, institutional investors remain skeptical with the majority still seeing a modest recession in 2024.
Whether the economy grows 1% or shrinks 1% during the next 12 months hardly seems to be a reason to alter one’s long-term asset allocation strategy. Some of the calamities predicted a few months ago, such as wholesale failures among small banks, haven’t materialized. While there are pockets of strength within the economy at the moment seeding ongoing growth, there are also pockets of weakness. Inflation-adjusted retail sales are spotty with weakness in home improvement, electronics, apparel, grocery stores and gasoline demand. Companies that had elevated business during the pandemic (e.g., Covid testing products and services) have seen a big pullback. Offices and parking lots are empty during the day. That mixture of good and bad is exactly what you would expect in a flat economy. Personally, I see no reason that won’t continue although the areas of relative strength and weakness will rotate.
I have used the word pivot quite a bit in recent letters. Good managements pivot their focus from business segments in decline to others that present opportunity. Investors should do the same. One segment that may be starting to show signs of life is healthcare. Many companies within healthcare saw a surge in business during the pandemic, particularly those who sold products and services related to the pandemic. Now those same companies are suffering negative year-over-year comparisons as few seek booster shots or testing any longer. But today’s soft business becomes an easy year-over-year comparison in 2024. Other parts of the health care sector are improving. Patients, particularly among the elderly, avoided hospitals since the pandemic started for fear that simply entering the building exposed them to illness. Hospitals deferred procedures as resources were diverted to Covid patients. But now, a palpable rise in activity is apparent. More knees are being replace. Other testing and procedure volumes are starting to increase. The health care segment is still under regulatory pressure from Washington, but so far, the threats haven’t translated into new legislation.
It isn’t just healthcare that appears to be reawakening. Storefronts shuttered during the pandemic are reopening. In some cases, they are being repurposed, offering consumers services rather than goods. Broken supply chains and legislative incentives are bringing some manufacturing back to the U.S. Even climate change is presenting opportunities. A summer heatwave over a large part of the U.S. is stressing electric grids that cry to be upgraded. Meanwhile, Americans continue to travel and eat out. There are plenty of opportunities beyond tech, and investors are beginning to discover them.
Obviously, all is not so rosy. If there is to be a recession, even a modest one, there are pockets of weakness as well. Regional banks are being hit by inverted yield curves, a slump in loan demand, and deteriorating credit quality. New home sales are strong, given the lack of quality existing inventory, but overall home transactions are down sharply. That is impacting the home improvement and furnishings industries. Slowing sales has led to inventory buildups which, in turn, have led to lower prices. That is true from many commodities to computer memory chips. But even there, the worst may be over. Oil prices have stabilized, Russian aggression in the Black Sea is sending wheat prices higher again, and there are signs of balance soon for computer chip demand. Indeed, this economic cycle has been different than any before due to the impact, plus and minus, related to the pandemic. So many economic segments have seen their own mini-cycles unrelated to the overall economy focused instead on demand factors related to the pandemic.
The bottom line is that investment posture today should focus almost entirely on individual company prospects. There is little macro cause to dive in or stay out of the stock market. Given that a recession might be pending at a time when money market funds pay close to 5%, there is certainly no urgency to put cash into the stock market. But fears shouldn’t be elevated enough to force one to avoid an attractive situation.
The sharp gains of June and early July beg for some sort of correction. Valuations are nowhere near as extended as they were at the end of 2021 but they certainly are above normal levels. At any time, for any reason, stocks could fall 3-10%. I said could, not would. But even modestly extended valuations should rid the temptation to chase. It’s always best to isolate what you want to buy and then pick an ideal price. Buying a little above that price is fine. If you constantly try to pick the bottom, the end result will be a lot of missed opportunities. But you do have to resist the temptation to overpay, chasing a rally that is running out of steam. Buying stocks after the longest winning streak since 2017 may not be great timing. Two things matter. The most important is buying stock of the right company. Whatever stock you buy should have persistent growth opportunities ahead. Valuation matters, it is the second consideration. If you buy the right company at the wrong price, you will eventually be bailed out. If you buy the wrong company, over the long-term, your chances of beating the market are slim even if you get a bargain price. Never buy a stock if the only positive attribute is that the price is cheap.
Today, Yusaf/Cat Stevens is 75. Film director Norman Jewison turns 97.
James M. Meyer, CFA 610-260-2220