Looking for Value
Through the back half of January, markets have grown increasingly choppy. After briefly entering correction territory (-10%) early in the week, the index fought through a series of wild swings to settle roughly 7.75% below its all-time high. Each of the past five days saw an intra-day movement greater than 2.5%, with a tendency to close in the opposite direction of the open. Computerized trading is the likely culprit behind the recent noise, but the general anxiety among participants is more a reflection of concern over Fed policy. With inflation showing no signs of abating, the Fed has begun to take a notably hawkish position. Corporate earnings reports are also starting to show the stress of higher input costs. In addition, geopolitical tensions are adding to market turbulence. Russia continues to build up forces on the border of Ukraine. Further escalation of conflict in the region could have a meaningful impact on already soaring energy prices. Anxiety is certainly warranted, but pockets of the market are starting to look flushed at current levels.
Inflation continues to be the primary concern on the minds of market participants. Corporate earnings reports have begun to shed light on some truly astonishing increases in labor and material costs. Many of the country's largest banks cautioned that compensation expenses are sharply on the rise across their operations. Restaurants are getting hit on both fronts. On their calls, many pointed to soaring food and packaging costs alongside a growing difficulty to attract and retain quality workers. Such increases have companies across several industries softening their guidance into 2022. If inflation persists, we could see a top-line hit from sagging consumer confidence combine with a bottom-line hit from inputs. The earnings environment has certainly gotten tougher compared to 21. Still, we think improvements in productivity can play a key role in offsetting some of these costs.
The Fed now clearly understands that inflation is a problem that it must quickly rein in. In the coming months, monetary policy is set to tighten. The committee plans on raising the Fed Funds rate as soon as March and has begun plans for balance sheet reduction. The quick shift from accommodation to tightening has left the highest multiple stocks hanging out to dry. The threat of higher long-term rates has increased the discount rate for such stocks, and the looming clampdown on growth could make future earnings more difficult to come by. For the pockets of the market with relatively little in current earnings but lofty future expectations, the Fed's pivot is a problem. As an example, the often-touted ARK Innovation ETF is now down roughly 54% from its euphoric covid high.
However, it is important to draw a distinction between high growth now and high growth in the future. The average stock in the S&P 500 is down over 15% from its high. For companies that have a mixture of recent earnings growth and projected earnings growth, a pullback like this could prove opportune. As an example, Accenture plc (ACN) has fallen over 18% from the start of the year. With a quick look at its earnings trajectory, we see that earnings grew 18% last year and are expected to grow another 20% this year. We believe this type of consistent growth in the fundamentals will ultimately be rewarded. ACN is a growth company, but it has real earnings growth today vs. a mere promise of it tomorrow. We think money on the sidelines should find such opportunities attractive around these levels.
Preston May, CBE®
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S&P 500: Standard & Poor’s (S&P) 500 Index. The S&P 500 Index is an unmanaged, capitalization-weighted index designed to measure the performance of the broad U.S. economy through changes in the aggregate market value of 500 stocks representing all major industries.