CWS Market Review – February 15, 2022

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Why You Should Avoid Market-Timing

Although the stock market will be closed this Saturday, it will mark two years since the stock market peaked before Covid-19 changed the world. On February 19, 2020, the S&P 500 closed at 3,386.15. Then all hell broke loose. The index fell for seven days in a row, and that was only the beginning.

In a dramatic stretch of 23 trading days, the S&P 500 lost 34%. Within a few days, the S&P 500 experienced its second-, fifth- and 13th-worst percentage days in history. If that’s not enough, the index also had its fourth-, 11th- and 19th-best days in history.

There has been nothing like that market in decades. On March 12, the Dow lost 2,350 points. Four days later, it fell another 3,000 points. Of the six worst daily point losses in the history of the Dow, five of them came during a nine-day period. The whole world, it seemed, was losing its mind. I remember how scary it was.

The S&P 500 eventually bottomed at 2,237.40 on March 23. Three years of gains were wiped out in a single month.

Yet, almost as remarkably, the market staged a dramatic turnaround. It turns out that magical things can happen when our friends at the Fed pull out all the stops. By June 8, the S&P 500 had rallied nearly 1,000 points, or 44%, off its low. In just 11 weeks, the market had made back 86% of what it had lost. By August, the market reached a new all-time high. It took less than five months to make back everything it had lost.

Where am I going with all of this? I can faithfully say that I didn’t see either event coming. Nor did anyone else. Yet by being fully invested, we survived the crash and the recovery. In fact, we’ve gone on to make some nice profits since then. I don’t have any profound takeaway from the events of two years ago except to say that it’s a good reminder to avoid trying to time the markets. The market can be far more temperamental than you can imagine.

I’m reminded of the words of Bernard Baruch, “Don’t try to buy at the bottom and sell at the top. It can’t be done, except by liars.”

The Fed Needs to Prove It Is Serious

Speaking of things temperamental, let’s turn to the U.S. economy. In last week’s issue, I said that if Friday’s inflation report comes in hot, then Wall Street will not take it well. Well, that’s exactly what happened. The U.S. government said that inflation had reached a 40-year high. The S&P 500 fell on Friday and again yesterday.

The real action, however, came in the futures pits. Within a few days, the odds of a 0.50% rate hike in March by the Federal Reserve went from a longshot to a very real probability. The latest prices I saw place the odds of a half-point increase at 57%. Before that happens, the Fed will need to announce that it has halted all of its bond buying. That could happen any day.

James Bullard, the top banana at the St. Louis Fed, has suggested that the Fed needs to hike by 0.5% at its next two meetings. He said that the Fed’s credibility is at stake. I’m afraid he may be too late on that. He appears to be in the minority. The odds of four rate hikes by May are currently at 10%. There’s a good chance that the Fed will target overnight rates at 1.50% to 1.75% by this summer. Even that is still well below inflation.

The Fed must do two things. First, it needs to convince Wall Street that it’s seriously committed to fighting inflation. So far, that’s not been the case. Second, it needs to prove to investors that it’s left the “transitory” language behind. That was a big mistake for the Fed and the data has proved them wrong.

Today, in fact, the government said that the Producer Prices Index rose by 1% in January. This data series is important because inflation tends to appear here before it works its way down to consumers. Over the past year, the PPI is up by 9.7%. That’s close to an all-time record. To give you an idea of how much things have changed, a year ago, the 12-month PPI rate was just 1.6%.

Before the Financial Crisis, setting interest rates for the Fed wasn’t that hard. When the economy was in rough shape, you needed to bring interest rates down to being in line with the rate of inflation. When the economy was booming, you then brought rates to about 3% above the rate of inflation. Of course, I’m oversimplifying, but not by much. That’s pretty much what the Fed did for many decades, until the crisis of 2008-09.

Right now, inflation is running much higher than interest rates. To get back to anything resembling normal would require much higher interest rates and much lower inflation. The problem with inflation is that once you see it, it’s already too late. It needs to be fought early and hard. Another issue is unanimity within the Fed. Some members appear to be unconvinced that inflation is a major problem.

The five-year “breakeven” rate, which is basically the market’s guess as to what the annual inflation figure will be over the next five years, is currently a tad below 3%. If you’ve been reading me for some time, you’ll know that I’m a fan of watching the spread between the two- and the 10-year Treasuries. That has had a better track record of predicting the economy than a roomful of Nobel laureates. Notice how the spread has gone negative just before each of the last four recessions (the shaded areas).

The 2/10 Spread has dropped down to 40 basis points. This is very unusual and it’s the kind of thing you’d see late in a business cycle. Does this mean that the Fed is close to pushing the yield curve negative? For now, we can’t say for certain, but it is cause for concern.

Either way, this calls for two things. One is that the Fed needs to be clear about its intentions to fight inflation. The other is for investors to adopt a defensive posture. This has already been a tough year for many growth stocks, and it could soon get worse. Speaking of high-quality defensive stocks…

Zoetis Is a Buy up to $210 per Share

We’ve had a very good Q4 earnings season for our Buy List, and that continued today with a nice earnings report from Zoetis (ZTS).

If you’re not familiar with Zoetis, it’s the world’s leading animal health company. Zoetis was spun off from Pfizer a few years ago. Today, the company has more than 12,000 employees and last year had revenues of $7.8 billion. Here’s a recent interview the CEO did with Jim Cramer.

Zoetis is also an excellent example of our style of investing. We added the company to last year’s Buy List, and it was an immediate flop. By March, we had a 12% loss in Zoetis. Still, business was doing well. As we know, stock traders can be a fickle bunch, so I wasn’t too worried about the poor share performance. This is the business we’ve chosen. ZTS then turned around and rallied strongly. By the end of the year, ZTS had made a 47% gain for us. (By the way, have I mentioned that we have a premium newsletter? You can sign up for it here.)

Once again, business is looking good, and the stock has been lousy so far in 2022. For Q4, the company said it made $1 per share. That was four cents better than Wall Street’s consensus. Quarterly revenue rose 9% to $2 billion. For the whole year, Zoetis made $4.70 per share. That’s an increase of 25% over 2020.

“In 2021, Zoetis delivered its strongest performance ever, thanks to our innovative, diverse and durable portfolio, and the talent and commitment of our colleagues,” said Kristin Peck, Chief Executive Officer of Zoetis. “We grew revenue 15% operationally, which is once again above the expected market growth rate in the $45 billion animal health market. We also grew our adjusted net income faster than revenue, at 19% operationally, while continuing to support investments in our latest product launches and future pipeline of innovations.”

“Looking forward, we believe this momentum sets us up for a strong 2022. We expect to continue growing revenue faster than the market in the coming year, driven by continued strength in petcare; expansion of our diagnostics portfolio internationally; and significant growth in both livestock and companion animal product sales in emerging markets, including China and Brazil. As a result, we are guiding to full-year operational growth of 9% to 11% in revenue,” said Peck.

For Q4, sales in its U.S. business were up 9% to $1.04 billion. Sales in the international segment were up 8% to $902 million.

Zoetis recently received approval in the U.S. for Solensia, the first injectable mAb for the control of pain associated with osteoarthritis in cats. It’s also approved in the European Union, the U.K., Canada and Switzerland. Kristin Peck noted that spending on pets has increased and spending per visit to the vet has increased.

Now let’s look at guidance. For 2022, Zoetis sees revenues ranging between $8.325 billion and $8.475 billion. The company also sees earnings ranging between $5.09 and $5.19 per share. That’s earnings growth of roughly 8% to 10%. (In last week’s premium issue, I predicted $5.05 to $5.20 per share.)

That’s a bold forecast and it tells me that we don’t have to worry about the stock’s downturn in January and February. This week, I’m lowering our buy below price on Zoetis to $210 per share.

That’s all for now. I’ll have more for you in the next issue of CWS Market Review.

– Eddy

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Posted by on February 15th, 2022 at 5:57 pm


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.