Staying the Course in the Face of Volatility

The biggest X factor for the stock market right now is not one that we can forecast or predict.

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Armed conflict like we are seeing in Ukraine pushes most stock prices lower because there isn’t any way to accurately price the potential impact. However, the exception to this rule is that investors tend to favor oil and gold stocks (and the commodities themselves) when a crisis hits.

The flight into commodity stocks and treasury bonds is to take advantage of the potential for supply constraints or to hedge against the conflict escalating. Because Russia and Ukraine are so central to energy supplies, it makes sense why prices have been skyrocketing since last March when the Russian military buildup began.

So when planning for the week ahead, we have to deal with the fact that the normal news flow is not likely to move the stock market the way it usually does. For example, the Personal Consumption Expenditures (PCE) last Friday didn’t show the rate of inflation slowing from prior months, yet stocks ignored this critical report and skyrocketed on Friday.

The issue here is that developments in Ukraine will likely overshadow the Fed chairman’s testimony to both houses of Congress this coming Wednesday and Thursday and the BLS report of unemployment and job gains on Friday.

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Although Friday’s rally was a welcome relief, we recommend that you set your expectations for continued volatility for the next two weeks at least. Although the S&P 500 held at the support level we expected, it seems unlikely that we will see a big move higher in the short term.

The term traders use to describe the kind of trading we expect this week is a “whipsaw.” If you have ever seen an old movie or cartoon with two men sawing a log into boards by holding two ends of a saw, you know what a whipsaw is. The quick back and forth of the saw gives you a good idea of what to expect from stock prices.

So the bottom line for this week is if you are a low-risk investor, keep your powder (capital) dry for when prices settle down. However, to paraphrase Warren Buffett, if you are a high-risk investor, this is a good time to be “greedy when others are fearful.”

For investors willing to take a risk, we think this week is a unique opportunity to take some calculated risks in exchange for the possibility of some big profits.

Retail stocks have been in the tank for a couple of months. Investors are fearful that inflation will slow spending and the economy and the Ukraine crisis have dragged consumer discretionary stocks like Costco Wholesale (NASDAQ:COST), Target Corp (NYSE:TGT) and Nike (NYSE:NKE) well below fair value.

If we assume the Ukraine crisis resolves in one way or the other like it did in 2014, then this is the time to add consumer stocks to the portfolio.

Energy prices will drop quickly once some progress is made towards ending the conflict. You already saw how a few words from President Biden on Thursday and Friday last week brought oil prices down 9% over 24 hours.

If energy continues to decline, that removes a lot of the pressure on consumer wallets. In our view, consumer discretionary stocks have been wildly undervalued while investors overpriced short-term issues and underpriced the long-term trends of job and wage growth.

Speaking of energy:

Over the past few months, we have repeatedly recommended stocks in the energy sector. That has played out very well for us, and the recent spikes have done a lot to offset the damage done to other sectors. However, we recommend investors start looking at the energy sector as a source of profits to take off the table.

We can’t predict the future, but it still seems in everyone’s interest (Russia, Ukraine, EU, US, etc.) to find some way to de-escalate the conflict. In our view, that means traders are going to start pricing in a return to “normal” in the energy market, and oil prices will drop. If the commodity’s price drops, stocks in the energy sector will come down as well — and they will likely do it fast.

Bottom Line

The stock market can be frustrating sometimes, and right now, we are in an extreme situation where normal fundamentals will be overshadowed by the external issue in Ukraine. We think this is a good week to increase positions in consumer discretionary stocks and take profits from energy, but otherwise, we recommend holding back before making any big changes.

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