Before The Bell - This morning, the equity futures, following yesterday’s whipsaw action in the U.S. stock market, are indicating a continuation of the rally that began during Tuesday’s session. This pre-market buying is being fueled by reports that Congress may be close to agreeing on a short-term resolution to the U.S. debt ceiling limit (moving the deadline from October 18th to December) along with yesterday’s strong private-sector payroll data from Automatic Data Processing (ADP), which market watchers think should be a sign that tomorrow’s report on September nonfarm payrolls from the Labor Department may surprise to the upside. On the labor market front, we also learned at 8:30 A.M. EDT that initial weekly unemployment claims came in at 326,000, which was down 38,000 from the previous week’s total. This report was another encouraging sign for the U.S. economy, and the futures held their gains following the release. That said…

The name of the game right now on Wall Street is volatility. The U.S. stock market has seesawed back and forth for an extended stretch. The price swings have been swift and at times pronounced, occurring both on a daily and intra-day basis. The spike in volatility has been fueled by a lot of uncertainty in the market right now, which has historically unnerved investors. In that regard, the months of September and October have thus far lived up to their reputations.

The recent uncertainty in the U.S. stock market has been created by a number of headline events, including continued worries about the coronavirus Delta variant, the aforementioned debt-ceiling negotiations, concerns about an emerging debt crisis in China’s property market and slowing growth for the nation’s second-largest economy, a natural gas shortage in Europe, the possibility of a more hawkish Federal Reserve later this year, and last, but certainly not least, fears about inflationary pressures and a resultant jump in Treasury yields. This confluence of events has raised the anxiety in the global equity markets and resulted in some noteworthy daily selloffs, especially with equity valuations quite frothy entering this September. 

But the recent selloffs have often been followed by some bargain hunting and notable rallies on Wall Street, including what looks to be another one this morning. That is because the U.S. financial system after years of accommodative monetary policies from the Federal Reserve is flooded with liquidity, and with a lot of cash waiting on the sidelines, investors use the selloffs either as opportunities to establish new equity positions or rotate into other sectors. Despite all of the recent volatility, the Dow Jones Industrial Average and the tech-heavy NASDAQ Composite will start today just 3% and 6%, respectively, below their all-time highs. There are very few attractive alternatives to stocks in this still highly accommodative era of monetary policy and low interest rates and this is keeping investors highly engaged in the equity markets.

So where should investors look in this environment? With Treasury yields starting to rise on both the short- and long-term ends of the yield curve and price increases now looking a bit more than temporary in nature, the inflation-trade sectors should be given a longer look. This includes the financial, energy, and material groups. Investors should note that the material stocks, which traded lower over the late summer months, as concerns about the Delta variant and its impact on the U.S. economy escalated, may now look more appealing, especially if Congressional lawmakers can push President Biden’s infrastructure plan across the finish line. Shares of the building materials suppliers, including Vulcan Materials (VMC) and Martin Marietta (MLM) have moved higher in recent sessions on these possibilities. Conversely, some of the REITs and homebuilding stocks have been under pressure recently, as borrowing costs have ticked up, which could impact demand for homes. 

We also think investors, even with the recent uptick in bond yields, which is historically not an ideal backdrop for the higher-growth stocks, should continue to look at the technology stocks, especially the mega-cap names. This group, which includes the FAANG stocks among other technology behemoths, has been out of favor recently, but these stocks do offer investors things that they typically value in companies, including strong operating leverage, healthy balance sheets, double-digit earnings growth, and a capital allocation strategy, including measures to enhance shareholders equity via stock buybacks, acquisitions, and more. It also is worth noting that some of the recent selling in these stocks may have been a bit overdone, as most of the companies are in blackout period with regard to share repurchases ahead of their earnings releases. They have not been able to step in recently to support their share prices through stock buybacks.

In view of the recent volatility, and for the reason why we think investors should not shy away from the mega-cap technology names, investors may want to give the stocks ranked 1 (Highest) and 2 (Above Average) for Safety by Value Line a close look. This group of high- and good-quality issues has historically fared better than the broader market during uncertain times. The stock-screening capabilities available to subscribers on the company’s website valueline.com makes the task of identifying these stocks quick and easy.  – William G. Ferguson               

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.