Don’t Fight the Fed

This market is brutal. There’s no other way to put it.

Between inflation, Fed tightening, China’s covid lockdown and the war in Ukraine, the economic outlook is incredibly murky at best.

We all know markets hate uncertainty. Don’t Fight the Fed!

Growth stocks are lagging badly while less volatile, dividend paying stocks outperform. That’s bad news for the tech heavy S&P 500.

Today, I’ll show you how to tell when growth stocks have finally bottomed. Then, I’ll show you where to ride out the storm: in blue-chip, high yielders making new highs on big money buying.

Don’t Fight the Fed

The bull case for growth stocks hinges on an economic soft landing. Here’s what that means: growth slows just enough to cool inflation. This frees the Fed to slow its rate hiking campaign, helping the economy dodge a recession. Corporate earnings keep grinding higher and the tech heavy S&P 500 resumes its bull run.

Sounds pretty sweet right? Here’s the rub, history shows soft landings are hard to pull off. Since 1950, we’ve seen 13 Fed tightening cycles. All but 3 ended in recession. That’s why growth stocks continue struggling. Investors think the Fed will inevitably trigger a recession as they tighten to cool inflation.

The two-year Treasury yield is a great real-time market proxy for where the Fed funds rate is heading. As markets have priced in aggressive Fed tightening, two-year yields surged, pressuring growth stocks (chart). Growth stocks are unlikely to bottom out until two-year Treasury yields start trending lower. Falling yields are bullish because they signal the Fed won’t tighten more than what’s already priced in. That lowers recession risk. That’s your green light to buy growth stocks. Until then, don’t fight the Fed!

How to Play It?

My April 18 blog was titled, The Best Offense is a Good Defense. My message hasn’t changed.

• Until two-year yields fall, stick with high yielding stocks in safer sectors like consumer staples, utilities, and pharmaceuticals. Their all-weather profits help them outperform during downturns.
• High yielding, inflation fighting commodity stocks in the energy and materials sectors also make sense. But growing global recession worries mean you must pick your spots carefully.
• All these sectors have recently seen healthy profit taking from all-time highs. It’s best to buy momentum trades like these on weakness.
• And remember, keep a healthy cash reserve you can use to leg into cheap, blue-chip growth stocks in the tech, discretionary, communications, financials, and industrials sectors as they decline. Once Fed uncertainty eases, you’ll be glad you did!

Check out these high yielding, defensive stocks picked from the sectors with the highest map scores. They’ve all reported great Q1 earnings, are making all-time highs and are seeing big money buying. They’re an important reminder that if you target the right sectors and stocks, you can make money in any market.

JNJ is a high yielding, best of breed pharma stock – it’s a perfect example of what’s working right now.

Ditto for Coca-Cola. An all-weather, high yielder seeing buying from the big boys as it makes record highs.

Check out Dow Chemical, a best of breed, commodity chemical play with a 4.5% dividend yield that the big money can’t buy fast enough!

Look at the big buying in American Electric Power, a best of breed, utility with a 3.1% dividend yield.

Wrapping up, take a look at Kinder Morgan. It’s the leading oil and gas pipeline play with a 6% yield.

Bringing It All Together

Volatility could get worse if 8% inflation doesn’t cool down soon. The odds of European and Chinese recessions are up, and Fed rate hikes could tip the US economy into a contraction. All this could dent corporate earnings more than expected.

Don’t buy growth stocks until you see a persistent downward trend in two-year Treasury yields. That would imply recession risks are falling as it signals markets think the Fed won’t tighten more than what’s already been priced into the bond market. That’s your green light to buy growth stocks. Until then, tread carefully.

That doesn’t mean panicking out of stocks altogether. Instead, focus on high yielding, best of breed, defensive stocks with strong pricing power that are seeing big money buying. And remember, don’t fight the Fed!

Invest well,

-Alec