Archive for the
‘high inflation’ Category

By Dr. Charles Lieberman, Co-founder & Chief Investment Officer

Sizable decline in stocks and bonds reflects the shock to many investors who thought inflation would be tamed easily and must now accept that the Fed may be forced to raise interest rates more than commonly believed. While the Fed only recognized the problem after an inexcusable delay, it now appears fully committed to bringing inflation back to target. As they say, “Don’t bet against the Fed.” What remains unclear is just how much rates needs to rise. We expect policy rates to rise continuously until they bring inflation to heel.

Market hopes were quickly dashed for a near-term significant reduction in inflation towards the Fed’s roughly 2% objective. Inflation is running hotter than widely expected and it is broadening out and becoming more pervasive. In fact, the bond market is still not priced properly. For growth to slow sufficiently to bring down inflation, it is likely necessary for rates to rise somewhat above the rate of inflation, at least those parts of inflation that aren’t transitory. Until rates rise accordingly, negative real interest rates will be promoting growth rather than restraining it. Since inflation is running well above 4% even when stripped of those transitory factors, such as new and used car prices, shipping costs, and chip prices, market long-term financing rates almost certainly need to exceed that level. The good news is that we’re not that far away at this point.

Likewise, stocks are already far along to repricing to reflect these realities, with high P/E multiple and unprofitable companies bearing the worst of the carnage, as they should. 47.8% of NASDAQ Composite stocks are down at least 50% from their recent peaks, 25.7% are down more than 75% and 6.4% are down at least 90%. While the markets are likely to remain volatile over the coming months, valuations have fallen enough that many stocks can now be regarded as cheap and already, to a debatable degree, are priced for a potential recession. The S&P 500 is now trading around 17 times projected earnings, which means that many good companies trade below 12 or even 10. While we suspect the worst of the decline is behind us, stock prices commonly overshoot, so some additional declines should be expected. Rather than sell out at depressed prices to protect against any remaining downside, our view is that it is a time to reassess the prospects for companies and to swap into those that have been treated too harshly by investors. Indeed, corporations seem to share this judgment and stock buybacks are proceeding at record rates.

Fears of recession are, of course, a key component of the stock market decline, yet no recession is imminent nor is one assured. Fear mongering is also rampant, which is all too normal. In the most recent employment report, businesses added 390,000 net new hires, a number inconsistent with recession and far too high to be sustainable. There are simply not enough unemployed bodies around to continue adding new workers at this pace, even though there are still more than 11.4 million job openings. So, we expect hiring to slow considerably and expect this to show up in the data in the months immediately ahead. (In fact, it would slow even if the Fed did absolutely nothing.) The Fed needs to get hiring below 100,000 to ease some of the wage pressure that underlies inflation. Yet, some will argue that any decline in hiring is merely a step along the way to recession, despite the strong support underpinning major sectors of the economy.

Key parts of the economy are still constrained by supply bottlenecks. While some analysts focus on the rise in mortgage rates inhibiting housing, homes for sale and apartments for rent remain overly scarce and builders lack the labor and building supplies to increase production. Even worse, it will take a number of years for builders to catch up with demand after more than a decade of underbuilding. Thus, we expect housing construction to outperform considerably its historic sensitivity to higher mortgage rates. Similarly, auto production has some catching up to do after supply disruptions due to chip shortages. Capital investment will also benefit as the world shifts production closer to home after just-in-time production and globalization proved vulnerable to disruption. National defense spending will provide yet another source of demand. If the economy does lapse into recession, which is by no means obvious, it is likely that any downturn would be fairly mild.

It is easy to be gloomy with inflation running at levels not seen since the 1970s amid so much international and domestic political conflict. This is plenty to be gloomy about. But gloom doesn’t trigger recession, even if it does induce more people to follow the news. If so, we would never recover from recessions that are chock full of gloom. Instead, there are key developments yet to play out that could have very positive or negative consequences. It seems unlikely, but some of the gloom and inflation pressures could be lifted quickly if the government announced plans to suspend some of its anti-fossil fuel initiatives, even if only temporarily. The Treasury and the Fed have numerous cards to play. As investors, we must remain highly vigilant, so we can adapt quickly to new developments. Most assuredly, it is likely that there will be surprises aplenty.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.

Dr. Charles Lieberman

Dr. Charles Lieberman

Dr. Charles Lieberman is the Chief Investment Officer and co-founder of Advisors Capital Management, LLC. Dr. Lieberman began his professional career as an academic at the University of Maryland and Northwestern University. After five years in academia, he joined the…
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By Dr. JoAnne Feeney, Portfolio Manager

The headlines of late have indeed been worrisome, whether it be high inflation, rising interest rates, China’s zero-Covid policy, or war in Europe. (But that is the nature of headlines.) Market risks remain above normal. Elevated risk and higher interest rates tend to lower stock valuations, while higher future earnings raise valuations. We have seen many stocks decline because of the former, but we are now entering a period where earnings fundamentals have the chance to dominate the narrative as companies report first quarter results and provide guidance for 2Q and the full year. Should we expect good news and how much should it matter?

When companies reported their 2021 results earlier this year and provided guidance, many turned cautious and more companies cut guidance than not. Omicron was causing a spike in Covid cases, and consumers were pulling back on activities. Companies noted elevated risks and pointed to ongoing supply chain issues, but they also remarked that Omicron would be short-lived, the supply chain was starting to improve, and the second half of the year should be better. Investors remained skeptical.

Now, three months on, companies have seen Omicron fade, but other disruptions have come to the fore. Russia’s invasion triggered sanctions, reduced exports of metals and grains from that region, and worsened the global shortage in the supply of oil. China’s zero-covid policy once again disrupted the production of consumer electronics and cars and slowed the flow of products in and out of Chinese ports. Statements by Federal Reserve officials imply that several rate hikes lie ahead. And CPI inflation hit a hew high.

Understandably, we shouldn’t expect much optimism from companies regarding sales and earnings for this quarter, but the state of the US economy suggests we may very well hear indications of improving growth prospects for the second half of the year. As our Chief Investment Officer, Chuck Lieberman, wrote a couple of weeks ago, it is premature to anticipate recession, regardless of headlines to the contrary, because the US is unambiguously still in expansion territory (and has a long way to go). Now that earnings season is upon us, we will hear from companies as to the conditions they are seeing on the ground. More importantly, we will get clues on their positioning for the rest of this year and whether they are likely to be able to power through these macro risks.

Last week may have started out with those high inflation numbers, but it finished with a very strong read on US manufacturing. Friday’s Industrial Production report came in better than expected with output up 0.9% month over month versus an expected 0.6%. This strength was driven by greater production of autos (as shown in lower half of chart) and business equipment. Moreover, capacity utilization is up to 78.7% from 78.1% in February; it is the highest it’s been since 2007 (but has room to increase further). Firms are having some success filling job openings. This matters because more workers enable factories to run hotter and provide households with more income to boost spending. This creates a positive backdrop as we are likely to hear from companies over the next several weeks.

So, while the recent narrative has been all about the macro negatives—especially high inflation and rising rates— now it’s earnings chance to dominate the news, as companies begin reporting first quarter results and provide guidance for 2022. While risks and rates can only go so high, earnings can keep going higher year after year after year. This is the critical force behind the attraction of long-term investing that has powered the S&P 500 up over 1,000% over the last 30 years. While we should be prepared to hear continued near-term caution, we need to focus more closely on the clues companies provide on plans that will drive the longer-term trajectory of their sales and earnings. And because we are in a period of elevated risk, while we position portfolios to take advantage of both cyclical and secular growth, we are also building in holdings that will do well even as inflation, rates, and geopolitical tensions remain high.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.

About the Author
Dr. JoAnne Feeney

Dr. JoAnne Feeney is a Portfolio Manager and a member of the investment committee with Advisors Capital Management, LLC (ACM). Prior to joining ACM, Dr. Feeney was senior equity analyst for more than 10 years at boutique sell-side firms including…

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