The all-important policy meeting of the Federal Reserve this week will influence where investors put their money to work.
The Fed could maintain its tepid stance on inflation, ignoring the recent increase in price pressures reflected in economic data. If the central bank says it is not time to end accommodative policies and is not concerned about inflation, investors should stick with commodities and stocks with high pricing power as hedges against rising prices, according to investment banks.
Bank of America screened S&P500 companies for pricing power and the ability to expand margins in times of rising prices, according to its analysts. Among the stocks are a few chipmakers, such as Nvidia, Texas Instruments, and Broadcom, as well as consumer staples such as Home Depot, Nike, and PepsiCo. Exxon Mobil, a dividend payer in the energy sector, is also on the list.
UBS also created a framework for assessing corporate pricing agility, which takes pricing power, margin momentum, and input cost exposure into account. UBS calculated pricing power as the extent to which a company can raise prices above and beyond costs. UBS tracked corporate pricing trends for margin momentum using its proprietary pricing mapping.
UBS looked for companies with negative sentiment on commodity and transportation costs during earnings calls for input cost exposure.
Billionaire hedge fund manager Paul Tudor Jones said earlier this week that if the Fed continues to ignore rising prices, investors should “go all in on the inflation trades.”
“If they treat these numbers — which were material events, very material — with nonchalance, I think it’s just a green light to bet heavily on every inflation trade,” Tudor Jones said on Analysts’s “Squawk Box” on Monday.
“If they say, ‘We’re on track, things are looking up,’ I’ll go all in on the inflation trades. “I’d probably buy commodities, cryptocurrency, and gold,” added Tudor Jones, who predicted the 1987 stock market crash.
Cryptocurrencies and other commodities, according to the legendary investor, are good inflation hedges. Investors could bet on related exchange-traded funds, such as gold miner ETFs, in addition to purchasing the commodities outright.
So far this year, the VanEck Vectors Gold Miners ETF (GDX), the largest gold miner ETF with more than $14 billion in assets under management, has outperformed the popular gold ETF GLD.
If the Fed indicates that it is time to begin removing easy policies.
Another widely anticipated scenario is for the Fed to signal that it is nearing the end of its easy policy, stating that it will begin tapering soon and raising its forecast for a rate increase. In such a case, where the central bank is not sufficiently dovish, bond yields are expected to rise.
“It could easily push longer yields higher,” said Kristina Hooper, chief global market strategist at Invesco. “If it shows the anticipation of earlier or more aggressive rate hikes, a revised dot plot could be one way to do that. And Fed Chair Jay Powell could easily raise rates if he says the Fed has begun discussing tapering or that tapering could begin in the next few months.”
Tudor Jones warned that this scenario could lead to another taper tantrum, causing a stock market correction.
“If they course correct, if they say, ‘We’ve got incoming data, we’ve accomplished our mission, or we’re very quickly on our way to accomplishing our mission on employment,’ then you’re going to get a taper tantrum,” Tudor Jones said Monday. “There will be a sell-off in fixed income. There will be a stock market correction.”
Analysts examined the performance of all S&P 500 stocks during the last five significant increases in the 10-year Treasury yield. These five periods of sharp rate movement occurred between 2003 and 2006, 2008 and 2009, 2012 and 2013, 2016 and 2018, and 2020 to the present.
After identifying the stocks that consistently outperform the market, we looked for names that are well-liked by Wall Street analysts. The average gains in the stocks during those rising interest rate periods are shown below, along with the percentage of analysts who currently have a buy rating.
Savita Subramanian, Bank of America’s head of U.S. equity and quantitative strategy, advises clients to buy high-quality stocks as tapering approaches. Stocks with an S&P quality rating of “B+” or higher are considered high-quality.
During the 2013 taper tantrum, high-quality names outperformed their low-quality counterparts by 1.3 percentage points from peak to trough in May and June, according to Subramanian.
A hint of removing stimulus could also harm stocks that are most sensitive to economic recovery, such as cyclicals such as financials, energy, and materials.
“More pessimistic = lower growth.” Evercore ISI macro research analyst Dennis DeBusschere wrote in a note that cyclicals should underperform. “The fact that hawkish concerns are being raised at the same time that people believe the reflation trade is in trouble, and you have a poor cyclical backdrop.”
The energy sector has outperformed the other 11 S&P500 sector groups this year, rising 46 percent. This year, both financials and real estate have gained more than 20%.
If the Fed appeases both camps.
A third possibility is that the Fed signals that it is concerned about inflation but is not yet ready to begin tapering.
According to The Sevens Report founder Tom Essaye, if Fed Chair Jerome Powell admits that tapering has been discussed but nothing has been decided, the market will likely see a modest rally, led by tech stocks.
“This is essentially the outcome that Powell and the Fed have been telegraphing for several weeks,” Essaye said. “This would be a continuation of the Goldilocks market outlook from the previous two weeks. This outcome would assist the S&P500 in extending its breakout from last week.”
With bond yields falling, investors have been returning to technology. The Nasdaq Composite, which is heavily weighted in technology, has gained about 2.5 percent this month, reaching a record close on Monday, its first all-time high since April 26. Meanwhile, the S&P500 is up slightly less than 1% in June.
“This is what the Fed has been doing for the last several months — warning that an inflation surge is coming but that it will be temporary, so there is no need to taper,” Leuthold Group chief investment strategist Jim Paulsen told Analysts. “Moreover, this is most likely the most anticipated outcome of the Fed meeting.”
“Yes, there may be comments from members that the time to start talking about tapering is here,” Paulsen added. “However, I believe Powell will continue to suggest that inflation is up as expected but is not yet acting any differently than expected.”
According to Bernstein’s top-rated technology analyst Toni Sacconaghi, this year’s pullback in tech stocks has created some opportunities in high-quality names that are now trading at a discount.
The Wall Street firm discovered several high-quality technology stocks with low valuations. Bernstein looked for the cheapest technology stocks based on their forward price-to-earnings ratio. The firm also assigned a quality score to each stock.