CWS Market Review – May 3, 2022

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The Worst Stock Market in 83 Years

On Friday, the S&P 500 dropped 3.63% to close at its lowest level since May 19, 2021. It was the market’s worst day in nearly two years, and it also marked the S&P 500’s worst four-month start to a year since 1939.

Yikes! But as bad as the S&P 500 has been, the Nasdaq has been even worse. The tech-laden index peaked on November 19 at just over 16,000. By Friday’s close, it had lost more than 23%.

It’s no secret what’s causing this. By raising interest rates, the Federal Reserve has altered the math behind investing.

Let me explain. When Covid broke out, the Fed lowered interest rates to the floor. They didn’t want to be caught flatfooted as they had been during the financial crisis. As a result, the Fed effectively took the risk out of the market, and the riskier sectors of the market boomed. Meme stocks took off. The thinking on Wall Street (and in social media) was, “Who cares about archaic things like P/E Ratios when interest rates are free? Just buy any growth name and enjoy the profits!”

That strategy worked beautifully. Now it’s not. With the Fed raising rates, all those formerly-hot, riskier stocks are falling apart. Meanwhile, more conservative areas of the market like value stocks and low-volatility stocks are holding up quite well. It turns out that P/E Ratios aren’t quite so archaic.

Check out this chart of the S&P 500 Value Index (in blue) compared with the S&P 500 Growth Index (in black):

One part of the stock market is getting slammed while another part has barely been touched.

Here’s the thing: The Fed isn’t close to being done. The central bank began its latest meeting today and it will conclude tomorrow. The policy statement will come out tomorrow at 2 p.m. and we can almost certainly expect a 0.5% rate increase.

The futures market currently has the odds of a 0.5% hike at 98.7%. That seems about 1.29999% too low, but I’m not an FOMC member. Tomorrow’s rate increase will bring the target range for the Fed funds rate to 0.75 to 1%. This is the rate at which banks lend their excess reserves to each other.

For the next meeting, which takes place in mid-June, futures traders see the Fed hiking rates by 0.75%. That’s followed by 0.5% hikes in July and September. Add those up and it brings the target range for the Fed funds rate to 2.5% to 2.75%.

After that, it gets a little hazier. I’m also suspicious of forecasts going that far out. Anything can happen between now and then, although futures traders are leaning toward a few more hikes coming in late 2022 and early 2023. That’s certainly a possibility. Harvard economist Kenneth Rogoff said the Fed may have to go as high as 5% to fight off inflation.

The important thing for investors to understand is that all those rate increases will punish growth stocks and help the relative performance of conservative stocks. For example, on our Buy List, we’ve been doing very well over the last few months with Hershey (HSY). It’s hard to think of a name that’s as conservative as the chocolate folks. The shares are up more than 30% over the last few months. Last week, Hershey’s earnings report trounced Wall Street’s consensus and the company raised guidance.

When the market turns against a sector, it will show no mercy. Stocks like Netflix (NFLX) are down by two-thirds this year. Remember Moderna (MRNA)? That stock jumped 25-fold in 18 months. It’s now down 70% from its peak.

How Low Can We Go?

“I’ve been a doubter of this rally nearly since Day #1. It’s moved too fast, too soon, and it’s been too concentrated in higher-risk stocks.” So wrote your humble editor five weeks ago. As it turns out, that coincided with the market’s recent peak.

As much as I’d like to take credit for calling the top, that really isn’t the case. Truthfully, no one can “call” tops or bottoms. Bernard Baruch said, “Don’t try to buy at the bottom and sell at the top. It can’t be done, except by liars.”

When will this downturn end? Beats me. On Friday, I tweeted, “Going by history, there’s a good chance most of this correction is over.” That tweet got some pushback and I think readers thought I was predicting a bottom. That’s not the case. Instead, I was pointing out that we never know at the time when the bottom is being made. That only happens in retrospect.

Ryan Detrick points out that since World War II, there have been 24 stock market corrections, meaning falls of 10% or more. The average correction has been 14.3% and has lasted 133 days. We’re already at 117 days and the market is down 13.9%. In other words, what’s happening right now is, in fact, perfectly normal. Of the last 21 times the market fell more than 10% in a given year, it closed positive 12 of those times.

The plain fact of history is that lousy markets are good times to buy. The price of that is that you have to be a little patient.

The U.S. Economy Contracted in the First Quarter

On Monday, we got the latest report from ISM on its Manufacturing Index. This is often an interesting report for a few reasons. One is that it usually comes out on the first business day of the month. As such, it doesn’t suffer from the lag time of other economic reports.

The ISM Manufacturing Index for April fell to 55.4. That’s down 1.7 from the report for March. Any number above 50 means that the factory sector of the economy is expanding. This was the lowest number in the last 18 months.

These reports tend to line up well with economic expansions and recessions. The magic number is around 45. Whenever the ISM Manufacturing Index drops below 45, there’s a good chance that the economy is in recession. We’re not there yet.

The other report that came out last week was the Q1 GDP report. The report showed that the U.S. economy contracted by 1.4% during the first three months of the year. Wall Street had been expecting growth of 1%.

Some explanation is needed. Consumer spending isn’t that bad. For the quarter, it rose by 2.7%. One problem is that the trade deficit knocked 3.2% off economic growth. A drop in defense spending took off another 0.3%. Also, a decline in inventory weighed on results.

The impact of the Fed’s interest rate hikes hasn’t been felt just yet, but that will soon change. We’ve already seen the dramatic increase in mortgage rates. The average 30-year fixed rate is up to 5.55%. This is the fastest increase in decades. Housing affordability is nearly the worst on record. In the last year, home prices are up 20%.

We’ll learn more about the economy this Friday when the government releases the April jobs report. The last jobs report showed unemployment at 3.6%. That was lower than the unemployment rate for every single month from 1970 to 2018.

On Tuesday, the Labor Department released its monthly report on job openings and labor turnover survey (the JOLTS report). The report showed that there’s an all-time record of 11.5 million job openings across the country. Businesses are desperate for workers. For the first time in many years, workers have the upper hand. During March, 4.5 million Americans quit their jobs. There are now 5.6 million more job openings than there are unemployed people.

Strong Earnings Season for our Buy List

This earnings season is going very well for our Buy List. We’ve had 16 earnings reports so far and 15 have topped Wall Street’s earnings forecasts. I mentioned Hershey (HSY) before. I was particularly pleased with Sherwin-Williams (SHW). The stock jumped 15% in four days.

We got another earnings beat this morning. Broadridge Financial Solutions (BR) said it made $1.93 per share for its fiscal Q3. That beat estimates of $1.78 per share. Revenues rose 10% to $1.53 billion and recurring fee revenue increased by 16%.

If you’re not familiar with Broadridge, the company is the dominant vendor for sending shareholder reports, prospectuses and proxy material to shareholders. Broadridge controls about 80% of the market. It’s a great business to be in, and all that recurring revenue underscores the stability of the business. Check out this long-term chart:

Broadridge now expects full-year recurring fee revenue growth to come in at the high end of its forecast of 12% to 15%. The company also increased the low end of its range for full-year earnings growth. The previous range was 11% to 15% and the new range is 13% to 15%.

Let’s do some math. Last year, Broadridge made $5.66 per share, so 13% to 15% growth on top of that works out to $6.40 to $6.51 per share. Wall Street had been expecting $6.38 per share.

Since Broadridge has already made $3.81 per share its first three quarters, that implies a Q4 range of $2.59 to $2.70 per share. The stock gained 2.2% in today’s trading. Broadridge remains a buy up to $160 per share.

If you want to know more about Hershey, Broadridge and other high-quality names on our Buy List, then please sign up for our premium newsletter.

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

– Eddy

Posted by on May 3rd, 2022 at 6:34 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.