My portfolio strategy for 2022: Earnings outpace the Fed

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How often does the Fed “get it right?”

The Federal Reserve Act was passed and signed into law by President Woodrow Wilson on December 23, 1913. This Act created the “Federal Reserve System” by creating twelve regional Federal Reserve Banks which were jointly responsible for the management of the nation’s money supply, lending, overseeing all banks, and serving as a lender of last resort.

The Banking Act of 1933 created the Federal Open Market Committee, which oversees the Federal Reserve’s open market operations. A more recent amendment requires the Federal Reserve”effectively promote the objectives of maximum employment, price stability and moderation of long-term interest rates.“That’s the definition we’ve come to think of, as citizens and investors, as the Fed’s most important mission.

It’s not always easy work. If the Fed and the various administrations that have relied on their advice would accept the fact that no one knows what curveballs are coming and temper their ensuing projections, predictions, SWAGs and actions, we would rely less on old maxims to make our investment decisions.

The Fed’s forecasts, comments and public testimony on rates, core inflation, GDP growth and unemployment are all part of the essential form that leads the Fed to predict what its next move will be. Do you imagine that they are close to accurate most of the time? To be useful in helping you with your investment decisions, this august organ must be quite good at calculating numbers and guessing the future, right?

50% is what we would get just by flipping a coin.

Rosenberg Research chief economist David Rosenberg has been crunching the numbers since 2012:

Dating back to 2012, the Fed’s rate forecasts have been correct 37% of the time.

The Fed’s projections for core inflation are not as good. They were only accurate 29% of the time.

By making decisions based on their best estimates of the evolution of unemployment? 24% of the time.

Finally, to discern the gross domestic product growth trajectory, 17% of the time.

Please note that the period from 2012 to 2021 has been a period of low interest rates and overall exceptional corporate earnings

You’re not fighting the Fed? Which Fed are we fighting and why would we give them such credit? Sure if the Fed decides to raise rates by 4, 5, 6% or more, borrowing will become prohibitive, many will be denied credit and the economy will go into recession. Entering a recession is not the ideal time to enter new positions.

Ah, but there’s a set of circumstances that suggest the Fed’s planned rate hikes shouldn’t cause you to sell your investments and put the money under your mattress. This benevolent event occurs when:

  1. Rates are coming from such a low point that three or even four quarter-point hikes don’t make loans too expensive, and
  2. When earnings are likely to be robust for most stocks you may want to own.

Fed rate hike, Earnings and the markets

Four Fed hikes over the next year “could” take rates close to 3%. Over the past 50 years, since 1971, the Fed has raised the target federal funds rate 103 times. And, short-term panic, during those months when it was lifted, the S&P 500 rose on average annualized rate of only +1.3%. (This compares to +9.2% annualized return for “every” month.

However, we are indebted to James Paulsen of the Leuthold Group for digging into these numbers. It seems that the negative effect on the stock market caused by Fed tightening was only a concern if real earnings decreases.

As Mr. Paulsen succinctly puts it, “For 50 years, rising profits have neutralized Fed rate hikes!” annualized monthly decline of nearly -10% and posted a monthly loss 57% of the time.” But “of the 61 months in which the Fed raised the funds rate as real S&P 500 EPS rose, the S&P 500 posted an average annualized price gain of +9.7% and only suffered a monthly loss 43% of the time.”

Of course, investor reaction is not limited to a single month. However, the biggest problem we face as investors is risk management, not performance management. With this historical context, we have an anchor that public opinion and media alarmism cannot take away from us.

I am convinced that the Fed will raise rates and many will panic because of it. I’m also confident that corporate earnings will grow across the board in 2022. Some won’t make it, some will at a reasonable pace, and some will knock the ball out of the park. I don’t believe a 1% or 2% increase in the Fed will disrupt the 9% to 11% rise I’m seeing in corporate earnings this year.

As I have said so often in letters and articles from my clients and Investor’s Edge subscribers, “It’s all about winnings.” With omicron and its successors fairly transmissible but, if history is any guide, less and less virulent, more and more people around the world will return to work, manufacturing plants will reopen, goods will be produced and inflation current demand-driven world (too much money chasing too few goods) will give way to a flood of goods as global supply chains run amok.

This is the most likely scenario I see for 2022 and is why I am using the current pullback to fill in some positions and initiate new ones in anticipation of rising corporate earnings on the immediate horizon.

How I will invest in 2022

In the short term, and only in the short term, I opportunistically seek out companies that benefit from a sluggish and clogged supply chain. This led me to purchase and suggest to SA readers the due diligence of companies such as ZIM Integrated Shipping Services Ltd. (ZIM). That article is here: Put some ZIP in your wallet with the ZIM shipping shipper.

For your information, myself and many of my clients also own CMRE, DAC and MPZZF in the world of global shipping. We also own a number of commodity companies in the energy and materials sectors that are benefiting from the fear of inflation.

But these are mostly short-term investments, some of which I have already started placing trailing stops on. What I’m filling my portfolio with on the current pullback are more traditional businesses. My bias is to focus on the asset classes that perform best in boom times:

US Large Cap Growth

Large cap American core and, to a lesser extent,

US Large Cap Value

Certain types of real estate (mainly American) and

SMID Growth / SMID Core.

There are times when an ETF, which typically holds the good, the bad, and the ugly, remains the best way to gain quick or immediate access to an entire industry, sector, or asset class. But once I have that input, I like to find the creme de la creme of the companies themselves. This keeps me on the hunt for individual innovators who I believe will be the titans of tomorrow.

For your information, I don’t see anything on the horizon that would indicate that I should increase my cash position, buy fixed income securities of any type, or buy precious metals (although I could add to our holdings of industrial metals and in raw materials) – or do more than try my hand at developed and developing countries beyond the North American continent.

I think the US is the place to be in 2022 and earnings from all the asset classes I suggested above will outperform anything the Fed could do this year.

Good investment,

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Author – JL Shaefer


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Don F. Davis