VIDEO: The Great Stock Rotation Gets Underway
Welcome to my latest video presentation. If you’d prefer to read a condensed transcript of my remarks, see the article below.
The first trading week of 2022 was rough on equities, especially growth sectors such as technology and communication services. Value-oriented sectors such as energy, financials and industrials got a boost.
The catalyst for the rotation: rising yields and tighter monetary policy. I expect this stock rotation to have legs as 2022 unfolds.
According to minutes released last Tuesday of the Federal Reserve’s December 14-15 policy meeting, the U.S. central bank is considering raising interest rates this year sooner than expected to fight inflation. The Fed also is contemplating a faster taper of its asset purchases, to wind down its balance sheet.
The 10-year Treasury yield has risen from 1.34% in early December 2021 to 1.77% by the end of last week. The major stock indices in the U.S. and overseas closed lower last week. The tech-heavy NASDAQ composite got clobbered (see chart).
Cloud-related stocks and other pandemic era outperformers slumped the worst last week. There is, roughly speaking, an inverse relationship between yields and the growth-oriented NASDAQ (see my video for details).
The December jobs report released last week provided a good news/bad news scenario. The headline number of 199,000 nonfarm jobs added was a disappointment versus consensus expectations of 400,000 new jobs, but the average hourly earnings figure surpassed estimates, hitting 4.7% year-over-year, compared to projections of 4.1%.
The unemployment rate dropped to 3.9%, as labor participation held steady at 61.9%. Higher wage growth indicates a tightening labor market in the U.S.
The Fed’s calculation in 2021 was that it could have kept inflation lower only at the cost of a slower employment recovery. This balancing act appears to have paid off. The U.S. economy has regained nearly 19 million of the 20 million jobs that were lost during the worst of the pandemic in April 2020. Now, with the jobs market on the mend, the Fed is pivoting to fight inflation.
I continue to recommend value equity plays in the first half of 2022. Reasonably priced companies in cyclical sectors are poised to take off this year. However, rising rates and slower corporate earnings growth are wild cards that suggest greater volatility ahead for both growth and value.
For the fourth quarter of 2021, the estimated earnings per share (EPS) growth rate for the S&P 500 is 21.3%. The estimated year-over-year EPS growth rate for calendar year (CY) 2021 is 45.1%. The estimated year-over-year EPS growth rate for CY 2022 is a more modest 9.2%.
After outperforming for the past two years, technology’s winning streak may be coming to an end. The growing pessimism of analysts regarding technology largely derives from the dynamic I’ve just discussed, to wit: rising yields and the Fed’s intention to hike rates at least three times this year.
When interest rates are rising, growth sectors like tech must produce much higher growth rates to justify the risks shouldered by investors for a higher return. Rising rates also diminish the value of future cash flows, reducing the value of current share prices. Conversely, value stocks are less vulnerable to rising rates because they tend to be more mature companies with stronger existing cash flows.
The pandemic and rising inflation have derailed economic and financial forecasts that seemed assured just a few weeks ago. The economic recovery remains intact, but we’re witnessing a rotation from growth to value. Calibrate your portfolio, accordingly.
In the meantime, if you’re looking for a trading methodology that makes money despite the risks I’ve just described, click here for details.