Staying Diversified in a Jittery Market
Despite all the bright spots, consumers, particularly those with lower income, face significant struggles paying for food and gasoline. In July, the all-items consumer price index rose 8.5% year on year, a smaller increase than the 9.1% for the previous month, but still way too high. We continue to watch the stickier parts of inflation such as rents, wages, education and health care costs.
And as expected, housing remains in a downturn if not a recession. Sales of new U.S. single-family homes plunged in July, falling 12.6% to the lowest level since January 2016. I expect to see continued softening of the housing market as potential buyers hold back due to higher mortgage rates. As housing softens, so too will demand for items such as appliances, home decorating supplies and all the goods people purchase when they move into a new home.
How I’m Investing Right Now
Despite the summer equities rally, as we’ve seen in the recent retracement, we are headed for choppy waters. September is typically the weakest month of the year, so I won’t be surprised if we see a pullback. For my portfolio, I remain data dependent and very selective, seeking pricing-power stories as well as companies with strong balance sheets and free cash flow.
S&P 500 earnings forecasts for Q3 call for just a 5.5% increase, with a rebound back to 8.5% in Q4. With many companies struggling with higher input costs and customer sensitivity to inflation, we continue to be selective and cautious when taking big sector bets.
I currently favor the energy sector, as companies are generating enormous free cash flow thanks to higher prices, and are using it for dividends and buybacks. Break-even for an oil company is $40-$50 per barrel, and current crude prices are over $90 per barrel right now. Aside from the Ukraine war, we are seeing tight supply in the U.S. because energy companies have prioritized renewables over building new refineries. Supply will only get tighter this fall as supply from the U.S. Strategic Petroleum Reserve runs out.
Another sector I like is materials, where companies are also benefiting from higher prices and greater free cash flows. Widely used commodities such as copper are hard to produce and are in demand for a range of uses, including homes and electric vehicles. Financials are also on my list, as banking revenue rises when rates rise; they are also rewarding shareholders with dividends and buybacks.
While the economy is slowing this year, we have yet to feel the effect of the recent rate increases, with more to come. We are still not out of the woods when it comes to recession, possibly in 2023.
Heading into September and what’s sure to be a volatile market, I am staying diversified in my portfolio, focusing on quality and emphasizing value with selective exposure to growth. The consumer has remained resilient so far, and since consumers represent 75% of the U.S. economy, we will be watching demand closely.
Stephanie Link is chief investment strategist and portfolio manager at the national wealth management firm Hightower Advisors LLC. She leads the firm’s Investment Solutions Group, which specializes in outsourced chief investment officer services, model portfolios, separately managed accounts, investment research and due diligence for Hightower Advisors LLC. Follow Stephanie on LinkedIn and Twitter @Stephanie_Link. Read her regular market insights here.
