Markets continued to take a beating this week as investors appeared to be pricing in even more hawkish Federal Reserve action throughout the year than originally feared. Fortunately, we will get an update next week, when Fed Chairman Jerome Powell hosts the FOMC press conference on Wednesday, at 2:30 p.m. ET, a half hour after the central bank’s policy statement for its two-day January meeting.
Taking a quick peek at the CME Fed Watch Tool, the market is currently factoring in four quarter-point interest rate hikes as the most likely outcome by the end of the year. However, more telling is how those expectations have changed over the past month. Expectations for three hikes this year declined from 30.2% to 22.7% over the past month, while expectations for four hikes jumped from 20.5% to 32% and expectations for five hikes jumped from 8.2% a month ago to 24.3% on Friday.
With that in mind, it’s also worth remembering that nothing has actually happened yet other than the Fed striking a more hawkish tone. That change in tone has achieved two things.
So, once the 10-year yield starts moving to the upside, those other securities tend to rise as well and can therefore serve as a natural “pumping of the breaks” on the economy. Take home prices for example, when rates are rock bottom, home prices are free to rise to the sky. However, with the 10-year yield advancing, mortgage rates start to advance; when mortgage rates advance, the monthly payments (a combination of the interest rate and the amount of money borrowed, the latter of which rises with list prices) become more expensive (think less affordable) and serves to slow the rate of home price appreciation.
Finally, now that we have covered discounted cash flow analysis, price-to-earnings multiples, and the importance of rate expectations over the past three weeks, lets remember the single most important thing as longer-term investors, the one thing we have to fall back on when markets want go down seemingly endlessly: company fundamentals.
While interest rates and valuation multiples fluctuate and investors have a tendency to overshoot on both the upside and the downside when attempting to price in future market environments, the one thing we can do when the “Wall Street fashion show” turns against us is dig in and re-analyze the underlying fundamentals. We do this with industry checks and by listening to investor presentations and earnings calls from both the companies we own and their peers.
This is what we are doing now as we put money to work, we are looking for stocks of company’s where the price has come down (the numerator in a P/E valuation model) but the underlying fundamentals and therefore earnings power (the denominator) remain intact. When you find a company like this it means the stock actually is getting cheaper. So just as you do when your favorite store has a sale, you should be looking to buy, not sell because the item you are getting is just as good as it was a month ago but it’s selling at a lower valuation — i.e, you are paying less per dollar of earnings.
This is not the case when the fundamentals are deteriorating, in that case the price may come down but if the earnings power declines the stock doesn’t get any cheaper. If anything, it may actually be getting more expensive. That is why we are so focused on the stocks of companies that “do things and make stuff” because the companies with real earnings power become more attractive as the stocks decline and that provides us the conviction we need to stick with our discipline, even if it means holding our nose to buy.
Here’s a quick look at some of the broader market measures we like to keep an eye on: The U.S. dollar index was holding as the mid-95 level. Gold was about flat on the week, trading at around the $1,800 level. WTI crude prices were holding in the mid-$80s per barrel. The yield on the 10-year Treasury yield was holding at around 1.75% level.
Within the portfolio, we received earnings from Morgan Stanley (MS) and Union Pacific (UNP). While earnings season and Fed rate hike expectations are certainly what shaped this week’s action, we also got a few key macroeconomic updates to consider.
Wednesday
Thursday
Fourth-quarter earnings will really ramp up next week. Within the portfolio, we will hear from Microsoft (MSFT) will report Tuesday after the closing bell; from Boeing (BA) and Abbott Labs (ABT) on Wednesday before the opening bell; from Mastercard (MA), Nucor (NUE) and Danaher (DHR) on Thursday before the opening bell; from Apple (AAPL) on Thursday after the closing bell; and from Chevron (CVX) on Friday before the opening bell. As a reminder, we will provide our full analysis of every earnings report for the companies held in the portfolio.
Here are some other reports we will be watching.
Monday
Tuesday
Wednesday
Thursday
Friday
On the macroeconomic front, we’ll be keeping an eye on the geopolitical sphere as well as for the following releases (all times ET).
Monday
Tuesday
Wednesday
Thursday
Friday
(Jim Cramer’s Charitable Trust is long MS, UNP, MSFT, BA, ABT, MA, NUE, DHR, AAPL and CVX. See here for a full list of the stocks.)
As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade.
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