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U.S. Markets Move to Late Cycle
If you’ve never seen Japanese Kabuki theater, I’d certainly recommend it.
Not only is the performance style a treat to watch: Its slow-moving pace filled with exaggerated expressions and heavy foreshadowing capture exactly what Fed chair Jerome Powell has been tasked to perform today:
Giving crystal-clear notice of interest rate hikes.
Last Wednesday, the central bank tested their first act.
“Policymakers have spent weeks setting expectations for Wednesday’s rate hike,” noted the Washington Post. If investors had been paying attention, the Fed’s first 0.5% rate hike since 2000 should have come as zero surprise. The kabuki actors warned us this was coming.
Yet the markets reacted as if they had just seen an episode of the Twilight Zone. The S&P 500 index added 3% that day before tumbling 6% by the end of the week. For all of Mr. Powell’s pantomiming, investors still treated the rate rise like a surprise ending.
This isn’t the first time rate increases have startled investors. In 2015, stocks dropped 15% when the central bank began its long process of raising rates from zero. And the stronger the preceding bull market — as seen through 1991’s real estate, 2000’s tech bubble and 2008 banking stocks — the greater the effort investors seem to put into ignoring the signs.
Last October, I sounded the alarm bells when Mr. Powell first took to the Kabuki stage. At the time, his mention of “tapering” was enough to make me close out some crypto positions.
Now that Mr. Powell is starting the next act of the rate cycle, investors can’t afford to ignore the foreshadowing any longer.
The Big Winners of Late-Cycle Business Cycles
In May 2021, I published a chart explaining my investment timing philosophy.
It’s an insightful, if slightly imperfect, guide. Not only did it suggest the rise of tech stocks in 2021, as evidenced by the popularity of Cathie Wood’s ARKK Invest (NYSEARCA:ARKK), but it also foretold of an eventual shift into energy, basic materials, metals and mining.
In March, AMC Entertainment (NYSE:AMC) made a $28 million investment in Nevada gold miner Hycroft (NASDAQ:HYMC). And as InvestorPlace’s Luke Lango points out, investors today can’t seem to get enough of companies that dig rare rocks out of the ground.
Many of Moonshot’s top winners — including Enservco (NYSEAMERICAN:ENSV) and Volt Information Sciences (NYSEAMERICAN:VOLT) — likewise benefited from the economic cycle. These deep-value stocks ended up becoming Moonshots as investors shifted into more speculative, inflation-protected assets.
From Expansion to Contraction
With Wednesday’s 0.5% rate hike, investors are rightly asking, “what’s next?”
As the markets continue into a recessionary phase, winners tend to shift. According to data from Fidelity going back to 1962, the top performers during recessions include:
- Consumer Staples. +13%
- Utilities. +10%
- Telecom. +7%
- Health Care. +5%
And the under-performers? Well, the usual suspects:
- Info Tech. -8%
- Industrials. -7%
- Financials. -3%
- Materials. -2%
In other words, rising rates overwhelmingly benefit companies providing essential services. Someone might put off buying a new smartphone for a few years but they’ll willingly pay increasing prices to keep using the phones they already own.
Moonshot readers have already seen a shift to utilities and healthcare. Cheap pipeline and storage firms like Martin Midstream Partners (NASDAQ:MMLP) have heavily featured in the Moonshot Investor this year. And plenty of biotech firms have also taken up entire newsletters of late.
As the business cycle prepares for a recession, consumer staples and telecom will also enter the mix.
Two Potential Recession Moonshots
First, let’s be clear:
Consumer staples and telecom stocks are generally not Moonshot plays.
Unless you’re buying companies like AT&T (NYSE:T) with options or leverage, it’s hard to net a 2-5x return on a stable company with limited growth.
But for those who know where to look, some promising consumer staples and telecom stocks can emerge.
One such source is the Portfolio Grader, a quantitative system created by InvestorPlace’s Louis Navellier. When selecting the highest-growth, highest-quality stocks in his universe, we begin to come up with some potential Moonshots:
- Partner Communications (NASDAQ:PTNR). This Israeli telecom firm is a moderate-risk firm trading at a relatively fair value of 7.2x EV/EBITDA. In 2020, it acquired a major chunk of the 5G spectrum, putting it on a potential path to growth as 5G technology gains ground.
- SiTime (NASDAQ:SITM). This aggressive-risk firm creates silicon alternatives to quartz timing crystals. Analysts expect another 50% revenue growth in 2022 and 23% in the following year as demand for battery-operated devices continues to grow. Shares are pricey (so they don’t quite make it to the regular Moonshot list), but the firm’s exposure to the telecom industry still makes for a compelling “buy” case.
Investors can also look further afield. Foreign stock markets like Canada’s provide intriguing bets on offbeat consumer staples (read: cannabis). Elsewhere, emerging markets from Mexico to Kenya are home to monopolistic telecom providers that can pass 5G costs to customers.
As InvestorPlace CEO Brian Hunt says, “there’s always a bull market somewhere.”
When Should I Sell Stocks?
Recessions are a misunderstood part of an economic cycle.
We spend years worrying about a potential crash, but contractions are actually the shortest of the four economic cycle stages. Most only last between six and eighteen months. Recovery and expansionary phases last far longer.
That means fearful market timers usually take too little risk. By anticipating recessions too early, these investors tend to hold too much cash or gold over the long run.
But that doesn’t mean you can’t start playing defense.
For conservative investors, that means sheltering some of their Enservco and Volt gains in stocks with more stable outlooks like AT&T. These are the companies that will hold value during downturns.
Meanwhile, more aggressive Moonshot investors have two options. On the one hand, companies like Martin Midstream provide utility-like returns at deep-value prices. According to past economic cycles, these value plays tend to outperform growth ones during downturns.
On the other hand, investors with longer time horizons might care more about getting into promising companies like Desktop Metals (NYSE:DM) at reasonable prices. To these investors, suffering short-term losses is merely the price of admission to superior long-term gains.
Investors who bought Amazon (NASDAQ:AMZN) in January 2001 lost 50% of their investment by August. But with Jeff Bezos’ creation trading at $2,200 today, who really remembers whether they bought in at $15 or at $7?
P.S. Do you want to hear more about cryptocurrencies? Penny stocks? Options? Leave me a note at firstname.lastname@example.org or connect with me on LinkedIn and let me know what you’d like to see.
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On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.