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Fed policymakers surprised a lot of investors on Wednesday by signaling that tapering and interest-rate hikes are finally on the way.
Investors sat up and noticed because “taking away the punch bowl” has doomed many a growth cycle. That’s not probably not likely any time soon. But this was a key turning point for the Fed — with clear implications for investors.
Here are the five key takeaways.
1. You should now favor quality
The Fed policy shift confirms we are moving toward the middle of the economic cycle from the early stage where rip-roaring growth is the norm – which benefits more speculative stocks. This means it’s time to favor quality in the stock market, says Emily Roland, the co-chief investment strategist at John Hancock Investment Management.
What does “quality” mean? Companies with characteristics like better profit margins, strong balance sheets, good free cash flow and higher returns on equity, she says.
You could set up a screen for all these qualities. But here’s a shortcut. “The sector that has highest overlap with quality is technology,” says Roland. “Technology can weather a more modest growth climate.”
Roland declined to suggest individual names, but here are a few ideas. One is Asana
ASAN,
which offers software that helps workers compartmentalize all the time vampires at work – like email and other communications — and better define and understand complex issues in the workplace like descriptions of who is responsible for what, the details of tasks on hand, and overarching missions and goals. The stock is up 123% from where I first highlighted it in my stock letter Brush Up on Stocks (link in my bio below) in November 2020, and 13% from where I just reiterated it on June 15.
I suggested and bought this as a multiyear position, and it has more room to run from here, given the growth trends. Sales grew 61% in the first quarter, and company raised full-year guidance.
Next, I recently reiterated Microsoft
MSFT,
in my stock letter because of some insider buying and exposure to the cloud computing transition mega trend. You can see more on Microsoft in my overview here.
2. Stay with reopening plays
For Brian Barish, a portfolio manager at Cambiar Investors, the biggest takeaway on the Fed this week was its acknowledgement that extreme monetary accommodation needs to come to an end relatively soon. That’s good news.
“There is a perception among a lot of people that the Fed has had a somewhat reckless posture,” says Barish. “It has had a policy consistent with another Great Financial Crisis type recession. In a very positive surprise, that is not what happened.”
But while it’s due time to cut back stimulus, a more aggressive Fed also makes investors nervous because of the possibility for policy errors that create the next recession. Barish is not concerned about that just yet. So he’s sticking with reopening plays, like the casino company Penn National Gaming
PENN,
Besides picking up business as people come out of hiding and visit casinos again, Penn National Gaming has solid exposure to online gaming through its ownership of Barstool Sports.
“Online gaming is a big, long-term market. We are literally in the first inning,” he says. Only one of the big four states in the country — New York — has approved online gaming. Barish thinks California, Texas and Florida will also go along; the tax revenue is just too tempting.
Barish is worth listening to because the Cambiar Opportunity Fund
CAMOX,
he helps manage beats its Morningstar large value category and Russell 1000 Value
RLV,
benchmark by 3.5 percentage points annualized over the past five years.
Next, Barish likes Uber
UBER,
the ride-hailing software company. It has the advantage of size over competitor Lyft
LYFT,
New management has cut back on more speculative investment projects like flying taxis. “As we get to other side of the pandemic, Uber will be an indispensable service,” says Barish. You can see my overview of Uber and Lyft here.
Barish likes Sysco
SYY,
as a reopening play because it supplies food and equipment to restaurants. He also cites Bed Bath & Beyond
BBBY,
in retail, a turnaround led by Anu Gupta who brings experience from Target. The home-goods chain is improving the business by reducing the number of products on offer, cutting back on coupons and introducing store brands.
Sandy Villere, portfolio manager with Villere & Co. in New Orleans, also thinks it makes sense to stay with reopening plays — because the projected Fed rate hikes are in the distant future. “If rates are going to stay low until the end of 2023, that is still a long time to have low rates. I am not going to cash any time soon.”
He likes the casino company Caesars Entertainment
CZR,
in part because it, too, has exposure to online gaming through its recent acquisition of William Hill. He also owns the bank First Hawaiian
FHB,
which should benefit from a lift to the Hawaiian economy as tourists come back.
3. Be careful with meme stocks and cryptocurrencies
The Fed sent a confusing mixed signal on Wednesday, points out Roland, the John Hancock Investment Management strategist. On the one hand, it clearly stated it thinks the recent inflation spike is transitory. This makes sense because a lot of the inflation spike is linked to supply-chain issues and shortages. The recent sharp rise in inflation is also a bit of a mirage since the comparison is to temporarily suppressed prices during the depths of the pandemic a year ago.
But on the other hand, the Fed pulled forward the timeline for rate hikes. “If they believe inflation is transitory, why are they stepping up rate-hike expectations? One theory is the Fed is concerned about excesses in the market in meme stocks and cryptocurrencies,” says Roland.
Excess liquidity created by the Fed and spending by politicians in Washington have clearly contributed to these pockets of speculative excess. The Fed may be interesting in curtailing the excesses contributing to huge spikes in bitcoin
BTCUSD,
and stocks like GameStop
GME,
and AMC Entertainment
AMC,
4. Trim real estate, energy and materials stocks
For Tim Murray a capital market strategist in the multi-asset division of T. Rowe Price, the big takeaway on the Fed this week is that it is getting more vigilant about inflation. “The Fed is no longer on autopilot,” he says.
That’s bad news for areas of the market that benefit the most from inflation. This means companies with exposure to real assets that go up in value with inflation — like real estate, energy and materials. But Murray doesn’t think the Fed will be so vigilant that it stamps out economic growth. So, there’s life left in other cyclical stocks in sectors like industrials.
5. Don’t lose sleep worrying about a taper tantrum
Tapering is on the table now, and it is likely to start by the end of the year. In the past, this has created big selloffs in the S&P 500
SPX,
Nasdaq Composite
COMP,
and the Dow Jones Industrial Average
DJIA,
– known as taper tantrums. Will we get a repeat?
“Probably not,” says Murray. “In 2013 investors were not expecting it, whereas this time the Fed has been preparing everyone for it.”
Michael Brush is a columnist for MarketWatch. At the time of publication, he owned ASAN and PENN. Brush has suggested MSFT, ASAN, PENN, UBER, LYFT, TGT, CZR and AMC in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.
