Expect stocks to trough when fear peaks. Conversely, expect stocks to peak when fear troughs. This axiom speaks to why successful investing in stocks is difficult. It runs contrary to our instincts as humans. We are wired to raise our defenses under a threat of danger and drop those defenses when fear has subsided. Many investors currently feel the threat of danger in the form of armed conflict in Ukraine, inflation, pandemic, political turmoil, etc. It is therefore instinctual for many investors to get defensive right now and sell stocks. Here at KIG, we hold a different view.
A peak in fear, we believe, came on February 24th, when Russia launched its invasion of Ukraine. Stocks hit their lowest level of the year that day of 4,225 on the S&P 500® Index. Despite the continued conflict in Ukraine, a spike in oil prices and any other geo-political issues you want to add in, stocks closed Friday 2.5% higher than the February 24 low.
We continue to believe volatility will remain at elevated levels for a while longer, but not forever. Maybe through the summer, and into the Fall, the stock market will remain treacherous. However, we are growing convinced, by the day, that the stock market’s low for the year was set on February 24th. Time will tell if we are correct but we remain vigilant and will reduce exposure to stocks if our indicators change dramatically from our current readings.
For several months, we have emphasized that energy stocks, along with financials are the place to be. Energy stocks have exploded higher, while financial stocks have sagged. Our call on financials feels “early” but not necessarily wrong. Investors are fearful that economic growth is going to slow while the Fed pushes short interest rates higher. This combination would lead to a recession or even stagflation. We remain convinced that economic activity is not going to slow significantly despite the Fed raising rates and therefore recession will be avoided for now.
If we are correct, financials should turn higher as banks profitability expands. A normalized yield curve (lower short-term rates and higher long-term rates), along with solid economic activity, is a recipe for higher stock prices for banks. The recession we see coming is not for another year or so. In the meantime, we expect financials to turn higher and therefore are sticking with our positions.
Our call on energy stocks has more than offset the sagging bank stocks in our managed accounts. While headlines continue to be printed about soaring gasoline prices, we believe the peak in prices is close at hand. While West Texas Intermediate Crude (“WTI”) could spike to $150-170 a barrel in the near term, we do not expect this to last. It is important to remember that the best antidote to higher oil prices is…., higher oil prices. In other words, as oil prices move higher, supply starts to come online which then helps to push prices back down.
We do not believe that $170 oil prices are any less extreme than when prices temporarily went negative during the 2020 COVID scare. Somewhere in the $85-95 range seems more reasonable to us over the next year or so. This would be a healthy price to keep economic activity steady without threatening to tip the economy into recession.
That said, we have started to reduce our exposure to oil stocks in our managed accounts. Taking profits when prices spike like this is prudent portfolio management. The proceeds from the sale of oil stocks will likely be deployed into technology, metals, health care and consumer stocks. It is in these sectors that we see more opportunity than energy for now.
It is worth noting that Federal Reserve Chairman Powell removed a major question mark regarding interest rates. In his recent testimony in front of Congress, the Chairman stated clearly that interest rates would be raised by 25 basis points (1/4 of a percent) later this month. He went on to indicate that, while future hikes are likely, they will be measured and not on autopilot. This is in line with our view that the Fed will likely raise rates 3-4 times this year rather than the consensus of 7 times. This is positive for stocks and the economy. Too many hikes could dangerously slow the economy. From an increased supply of oil to a continued easing of the supply chain, there are forces that will moderate inflation coming that do not need any help from the Fed. So, the chairman’s comments that investors should expect a slow and steady Fed, will calm the nerves of markets.
A final observation on stocks. Market indicators suggest investors are following their instinct rather than their heads, as we said to kick off this commentary. From high levels of cash sitting on the sidelines, to high growth stocks getting pummeled, to options activity tilting toward “risk off” instead of “risk on”, the stage is set for a rally. The market tends to move in the direction that causes the most pain and for now we believe that direction is to the upside for stocks.
In conclusion, we feel sanguine about the near and intermediate term for stocks. Volatility will be with us for the next few months, but we believe stocks will end the year with a solid rally. Only fools and portfolio managers make year-end stock predictions. While maybe we are a little bit of both, we are certainly the latter. So, we are sticking with our prediction that the S&P 500® Index ends the year above 5,000. That suggests that stocks could rally by 16% or so from current levels and lead to a gain of 5% or so on the year. Regardless of whether we are right or wrong, we manage our client accounts every day with the information in front of us and not based on predictions. Until I get a perfect NCAA basketball bracket 100% correct, I will always hedge my predictions about the future.
Kessler Investment Group, LLC
All information in this presentation is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. All economic performance data is historical and not indicative of future results. The market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. Certain statements contained within are forward looking statements including, but not limited to, statements that are predictions of or indicate future events, trends, plans or objectives. Undue reliance should not be placed on such statements because, by their nature, they are subject to known and unknown risks and uncertainties. Please consult your adviser for further information.
Opinions shared in this presentation are not intended to provide specific advice and should not be construed as recommendations for any individual. Please remember that investment decisions should be based on an individual’s goals, time horizon, and tolerance for risk.