Tightening monetary policy is one of the main concerns for the stock market right now.
The Fed has kept its benchmark interest rates historically low since the COVID-19 pandemic. But with inflation now at 40-year highs, investors expect the Fed the raise interest rates this year (maybe even multiple times) to help ease rising consumer prices.
But the big question is whether the economy and, in turn, the stock market can handle a higher rate environment.
“The market can handle higher interest rates, but not a lot higher,” Farr says.
He points out that the Nasdaq is already in correction territory despite the Fed not having increased rates yet.
Farr suggests that two to three rate hikes may be enough to tame inflation without killing the growth momentum in our economy. The danger is that the Fed may overdo it.
“Historically, the Fed gets it wrong,” Farr cautions. “It is because it is so terribly hard to do. And we end up over 80% of the time in recession after the Fed starts a hiking cycle.”
The stock market
When interest rates go up, high-priced growth stocks, which have lofty earnings expectations built into them, tend to get hit the hardest.
That’s why Farr believes now might be the time for value stocks — “discounted” securities trading at below-average price multiples — to shine.
“We’ve been through more than a decade where value has underperformed growth,” Farr says, “and those companies with really good balance sheets and cash flow and a limited if not, you know, a reasonable amount of debt, I think have started already to perform.”
Farr notes that this “style shift” typically happens over multiple years. But what specific areas should investors look to?
“I certainly like healthcare, I continue to like industrials, I like the financial stocks. And I continue to think that there are opportunities in the large-cap tech, solid balance sheet companies.”
“This feels like a blue-chip environment in almost any sector.”
Decent tailwind for energy, but no autopilot
In 2021, energy was by far the best performing sector of the S&P 500. And with momentum in oil prices going strong, the sector continues to attract investor attention in 2022 even as the broad market slips.
The Energy Select Sector SPDR ETF is up nearly 19% year to date, substantially outperforming the S&P 500.
Farr acknowledges the strength in commodity prices, adding that disruptions from Ukraine and other parts of the world could keep oil and gas prices at elevated levels.
But he also points out the volatile nature of cyclicals like oil: Investors usually get three or four good years in the cycle and then have to deal with several bad years.
Careful monitoring is required if you want to invest successfully in the space.
“A cyclical stock requires a buy and a sell decision that you really do need to get right. The sector has a tailwind, but it’s not a set and forget it kind of sector.”
The bottom line
Stocks are volatile. We all want to buy low and sell high, but no one can time the market perfectly.
For long-term investors, it might be better to simply ignore the ups and downs of the stock market.
“My partner John Washington used to say the best time to buy stocks is when you have money, and the best time to sell stocks is when you need money,” Farr says. “Otherwise, don't worry about where the stock market is.”
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