Jacob Sonenshine
If everything goes smoothly in the economy, the market will see a "risk-on" trade. That would benefit a broad group of usually volatile stocks.
Ideally for stocks, the economy would continue to grow, but only moderately, in which case the rate of inflation won't surge and the Federal Reserve can continue to cut interest rates. In such a scenario, companies' earnings would continue to grow, and investors wouldn't have to worry about a recession on account of rising rates.
This scenario has arguably already played out. The rate of economic growth was recently more than 2%, but below its postpandemic peak, while inflation has edged down close to 2%. Markets expect a Fed rate cut in December. But this narrative comes with its risks: Trump's second term will likely include fiscal spending, which would boost inflation and could lift rates. Separately, before any such policy materializes, the market still has to monitor how much growth will slow down.
The good news is that there are plenty of events on the horizon that could fully ignite the "just right" narrative for the economy. One would be a rate cut this month, which would bolster investor confidence that the U.S. can sustain its current economic expansion for a while. Another key factor is for economic data to continue to show healthy but moderate growth.
If those events unfold, the market will see a risk-on trade that could see the most volatile stocks perform the best.
Specifically, there's a broad group of risky names that 22V Research's Dennis DeBusschere calls "earnings turbulence" stocks. These companies' earnings are the most volatile. Some examples on DeBusschere's list have unstable profits because of company-specific issues, such as Boeing. But many are in the basket because their earnings are simply the most sensitive to economic growth. Swings in demand for goods and services cause swings in sales -- up and down -- for these companies. Their profits therefore see even larger swings because margins go up and down as certain expenses such as depreciation and interest remain fairly constant.
These stocks are a good group to own when the "just right" economic narrative plays out, and the market exhibits a risk-on trade. We looked at DeBusschere's screen of earnings turbulence names, and picked out the ones that are at least several percent below their record highs and may have more room to rally.
These included Take-Two Interactive Software, First Solar, Enphase Energy, DuPont, Micron Technology, Qorvo, Truist Financial, and American International Group.
Another one is Albemarle, a $12.4 billion leader in lithium mining. At just over $100, the company is valued at less than a third of the value of its $325 peak in 2021. Prices of lithium, a component in batteries of electric vehicles, had collapsed as economic growth in China, a major lithium buyer, has slowed down. EV demand has slipped, and so has demand for the EV batteries. Now with both the Fed and the People's Bank of China reducing rates, however, both economies should recover, and bolster EVs.
If the price of lithium shoots higher, so would Albemarle's sales. The company's margins should increase, since it has many fixed costs. Earnings would soar.
There's also Southwest Airlines, with a $20.1 billion market cap. The stock, after rising 16% so far this year to $33, is still about half the late 2021 peak. Southwest has many fixed costs, and if investors anticipate better sales than current estimates, there will be a big bump up in earnings expectations. In that scenario, it would have to join the broader airline rally, which continued Tuesday after Alaska Air Group increased guidance, and saw its stock soar 15%.
These names look like intriguing buys, and investors who already own these stocks should hold on. Risk-on events for the market could easily be on the way.
Write to Jacob Sonenshine at jacob.sonenshine@barrons.com
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(END) Dow Jones Newswires
December 10, 2024 15:08 ET (20:08 GMT)
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