CWS Market Review – March 19, 2021

”Indicators of economic activity and employment have turned up recently.”

So said the Federal Reserve in this week’s policy statement. Actually, that’s a big deal for the Fed, to say publicly that things are getting better. You have to understand that central bankers are trained from birth to couch any statement in qualified, hesitant terms.

Fortunately for us, dear reader, your humble editor is well versed in the arcane language of Fedspeak. As such, I’ll translate this week’s Fed statement into plain English. The bottom line is that Chairman Powell tried to calm the markets, and it worked. On Wednesday, the Dow and S&P 500 both rallied to new all-time highs. The Nasdaq is still a few percentage points away due to Big Tech’s getting pinged last month.

The bond market, however, is still a little nervous. The yield on the 10-year Treasury got as high as 1.75% on Thursday. I’ll explain what’s been going on. I also have some Buy List updates for you. Shares of AFLAC have been red-hot for the last few months. Higher bond yields are a big help for their business. Shares of Hershey have also perked up in the last few days. HSY has closed higher nine times in the last 11 sessions, and it just touched a new 52-week high. But before I get to all that, let’s look at what the folks at the Fed had to say this week.

The Fed Walks a Narrow Aisle

On Tuesday afternoon, the Federal Reserve released its latest policy statement. Along with it, the central bank also updated its economic projections for the next few years. I’ll warn you that the Fed has a pretty lousy track record predicting the economy, but still, it’s important to hear what it has to say.

In its policy statement, the Fed did acknowledge the improving economy. It also made it clear that it intends to keep interest rates low for a long time.

One of the less-discussed stories of the pandemic was the massive and early response by the Federal Reserve. Once the evidence became clear that the economy was going to take a massive hit, Fed Chairman Jerome Powell didn’t go in for any half measures. He immediately cut interest rates to 0%. In fact, he even effectively went below 0% by buying huge amounts of Treasury and mortgage bonds each month.

There’s no doubt that the Fed’s actions were more for Wall Street’s benefit than for Main Street’s. Still, the Fed’s response probably helped cushion the blow for a lot of rank-and-file workers.

Now we’ve come to a difficult position for the Fed. The economy is clearly improving, and COVID finally appears to be losing. In the newsletter from three weeks ago, I laid out the case for a rational optimism for the economy.

The Fed, however, had not yet acknowledged the improving economy. That’s why the line I put as this week’s epigraph was so important. According to the Fed’s December forecasts, it saw the economy growing by 4% this year. Several Wall Street investment houses now see much stronger growth. Goldman Sachs thinks the economy can grow by 8% this year.

This left Chairman Powell in a delicate position. He wanted to affirm that the economy is getting better while maintaining his commitment to low interest rates. Indeed, along with this week’s policy statement, the Fed also updated its economic projections. The Fed made it clear that it doesn’t see a need to raise interest rates this year, next year or even the year after that.

So the message from the Fed is, “yes, things are improving, but seriously chill out about interest rates.” With all the stimulus and vaccine news, Wall Street is still skeptical. The first policy to go could be the massive bond buying. In fact, that’s probably why interest rates on long-term Treasuries have climbed higher. In August, the 10-year Treasury got down to 0.5%. This week, it hit 1.75%.

This has had a big impact on the economy, most prominently with mortgage rates. In fact, mortgage-refinancing demand is down 39% in the past year. Personally, I think the bond market is very premature here.

There’s an old saying on Wall Street: “don’t fight the Fed.” That’s certainly true. Of course, they have a lot more money. This time, the Fed is on the side of investors. We should take the hint.

What’s happening is that everyone seems to be reacting to events that are expected to happen but that haven’t happened yet. For example, everyone thinks the economy will get better, but there are still millions of Americans out of work. The stimulus checks are expected to help, but they’re only now getting on their way. The bond market is reacting to inflation which simply hasn’t appeared yet. The stock market is rallying on earnings which aren’t here but that are expected to arrive shortly.

Here’s a fascinating graph that explains much of where the market is right now.

This shows the S&P 500 in blue along with the 10-year breakeven rate in blue. The two lines are nearly like waltzing partners. The breakeven rate is the market’s guess as to the inflation rate over the coming 10 years. What this shows is how closely aligned inflation expectations and the stock market are.

If the stock market is nothing more than earnings expectations, you could say that earnings expectations have become inflation expectations. It’s not me saying that. It’s the financial markets.

I used to talk often of the spread between the two- and ten-year Treasury yields. Whenever that goes negative, it’s often a precursor to a recession. This simple indicator has a very good track record. The spread turned negative in August 2019 and the recession was six months away. Now, however, the spread has grown very wide. That’s due to short-term rates staying where they are and longer rates going higher. Just this year, the 2/10 spread has nearly doubled from 80 basis points to 155 basis points.

The same formula for the market remains in place. Stocks over bonds. Cyclicals stocks over defensive stocks. Value over growth. Small-caps over large. This is a very good environment for our Buy List. Indeed, several of our stocks have touched new highs in recent days.

I expect the market to remain stable over the next few weeks. Things will heat up again as we get closer to Q1 earnings season in April. Now here’s a look at some recent news impacting our stocks.

Buy List Updates

AFLAC (AFL) had a solid earnings report last month. I probably should have raised the Buy Below then, but I’ve decided to do it this week.

One of the truths about investing in stocks is that their behavior can be highly erratic. My friend Louis Navellier described stocks as behaving like rabbits. They sit and sit and sit, and then they suddenly dash off. That’s pretty much what’s happened with AFLAC. The shares are up more than 52% in less than five months.

Last year, AFLAC made $4.96 per share. That’s up from $4.44 in 2019. AFLAC had a very tough year in 2020. Given what they had to deal with, the company performed admirably. The recent 18% dividend hike reflects that.

The higher bond yields are a benefit to an insurance company like AFLAC. This week, I’m lifting our Buy Below on AFLAC to $55 per share.

More good news for Disney (DIS). The company said that Disney World will reopen on April 30. More than 10,000 workers will go back on the job. That’s very encouraging news. Last week, Disney said that Disney+ now has 100 million subscribers. Not bad for 16 months. Disney remains a buy up to $200 per share.

Two weeks ago, I told you that Ross Stores (ROST) missed expectations and the stock took a hit. Well, it only took a few days for the stock to rally back to a new high. This is one of the great advantages of owning high-quality stocks. They’ll get knocked around, but they usually bounce back. The deep-discounter also reinstated its dividend, which they had canceled at the start of COVID. I’m raising our Buy Below on Ross to $130 per share.

FactSet (FDS) is due to report its earnings on March 30. This will be our only earnings report for a long stretch. We won’t see more earnings until mid-April when the Q1 earnings season starts. For the coming year (ending in August), FactSet sees earnings ranging between $10.75 and $11.15 per share. I’ll have a more detailed earnings preview in next week’s issue. FactSet is a buy up to $340 per share.

I love Danaher (DHR), but the stock’s been a little sluggish in recent weeks. At one point, the shares fell for eight days in a row. For all of 2021, the company expects revenue growth “in the low-double-digit range.” That’s pretty good. To reflect the recent weakness, this week I’m dropping our Buy Below on Danaher down to $230 per share.

Also remember that Sherwin-Williams (SHW) will soon be splitting 3-for-1. Shareholders will have three times as many shares, but the share price will drop by two thirds. Our $750 Buy Below price will split along with the stock and become $250 per share. The split will take effect on April 1.

That’s all for now. There are a few key economic reports due out next week, especially for the housing market. On Monday is the existing-home sales report, followed by the new-home sales report on Tuesday. The durable-goods orders report is due out on Wednesday. Then on Thursday, the Q4 GDP report will be updated for the second time. According to the last update, the U.S. economy grew by 4.1% in Q4. Be sure to keep checking the blog for daily updates. I’ll have more market analysis for you in the next issue of CWS Market Review!

– Eddy

Posted by on March 19th, 2021 at 7:08 am


The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.