Last week, the Federal Reserve told us what we all expected: Rate hikes are coming.
That exacerbated a sell-off in equity and debt markets, with technology stocks getting hit the worst.
But there are a few industries I'm a bit concerned about, including the automotive and appliance industries.
You see, higher rates mean consumers pay more interest when they take on debt from purchases. Typically, this happens with big-ticket items.
However, the picture is a bit more nuanced than just “sell auto and appliance stocks,” because consumer debt levels are at some of their lowest levels in decades.
I want to take you through my analysis and highlight the key data points that will tell me when and where to expect a potential sell-off.
The dealer gives you two options to purchase a $30,000 vehicle.
Put $3,500 down and get 0% interest for 72 months.
Put no money down and get 4% interest for 72 months.
With a typical amortization schedule, you'd pay $3,793.60 in interest on the second option. So the two are pretty close.
Now imagine you get that same deal, except instead of 4%, you are charged 10%. You'd end up spending $10,015.81 on interest. Given those kinds of rates, you'd probably be willing to cough up as much as $8,000 for a down payment.
If you're someone who only has $3,500 to put toward a car at the moment, you would have to go with the second option. But that also means your monthly payment jumps from $469.36 to $555.78. Now you have $86.42 less to spend on other purchases each month.
This example illustrates how interest rates influence customer behavior and decision-making.
Higher interest rates generate one of three behaviors:
You put more cash down to lower interest payments.
You pay for more purchases in cash.
You take on higher interest payments and have less disposable income.
All this seems pretty straightforward, and it makes sense why big-ticket items like autos and appliances would see demand dwindle with higher rates.
But there's another piece of information you need.
Current State of Consumers
Despite record inflation, American consumers have more wealth and less debt than at any time in the last decade.
The following graph shows us the assets, liabilities, and net worth for the American household as a percentage of disposable income over the last 15 years.
Source: Federal Reserve
Our disposable income is the money we have left over after paying all our essential bills.
Creating a ratio between disposable income and our assets, liabilities, and net worth allows us to see our personal balance sheets relative to the amount of excess money we have.
Right now, American households have more total assets and fewer liabilities (debt), leading to higher overall net worth.
How did this happen when the economy was at a standstill for so long?
A big chunk of it came from the federal government's payments sent to households and other types of assistance.
In fact, researchers at the University of Michigan found that financial instability and food shortages actually declined as a direct impact of those payments.
On top of that, The Conference Board found that wages have increased at some of their fastest levels in decades, with more pay raises planned for 2022.
However, inflation has outpaced wage gains, which will start to eat away at the household wealth generated over the last year.
Why do I bother explaining all this?
Go back to the three outcomes of higher interest rates.
With so much wealth, a significant chunk of which is in cash, Americans can forestall the impact of interest rates for a while, possibly even months, creating a lag before demand for capital goods begins to decline.
Where We Spend Our Money
I pick on autos in particular because the two largest purchases for most households are homes themselves and cars.
Homes will see demand decline. However, there's such a shortage of inventory with no substitution, I don't see interest rates having much of an impact in 2022.
On the other hand, you can fix up an old car or extend the life of your current vehicle, take public transportation, carpool, or like many of us these days, work from home.
That's why I expect durable goods to be the first casualties of rate hikes from the consumer side. This includes furniture, washing machines, televisions, and the like.
Manufacturers that rely heavily on semiconductors are particularly susceptible because they already struggle to meet demand as is.
Should interest rates curtail demand below the manufacturers' supply capacity, those same semiconductors are likely to find their way into other industries.
Think about it like this.
Let's say a car costs $20,000 to make, $2,000 of which is the cost of semiconductors. The car itself sells for $24,000.
The Fed comes along and cranks up interest rates, pushing demand below supply.
So the carmaker can either make fewer cars or reduce its price.
If it reduces price but still spends the same amount to make each car, its margins decline. So the automaker decides to pay less for its materials, including semiconductors. Given the high demand and massive shortage of semiconductors, the chip manufacturers will simply sell their wares to another industry willing to pay more.
This same logic applies to any input costs where demand far outstrips supply, including aluminum, steel, and other commodities.
Just before his death in 2011, the founder of Apple said that the biggest innovations of the 21st century will be at the intersection of biology and technology. Exactly a decade later, one little-known company is doing just that. The company already has million-dollar deals with fortune 500 companies. And Steve Jobs' biggest rival, Bill Gates, has already invested millions in this company, which has the potential to become “America's Next Big Monopoly”.
What to Watch for
While we've seen the sell-off hit technology hard, it hasn't filtered into consumer cyclical stocks quite yet.
I believe those will start to lose their footing several months after the Fed raises rates, if they haven't already.
To give you an idea of where things stand, here's a quick snapshot of some major durable goods companies and the health of their stock charts:
Ford Motor Company (F) — Yellow
Whirlpool (WHR) — Yellow
Wayfair (W) — Red
Tempur Sealy International (TPX) — Yellow
General Motors (GM) — Yellow
I'm not saying I expect these stocks to fall out of bed tomorrow.
However, I believe that some investors underestimate the risk in these names relative to other consumer products companies.
Now, there are some companies that make products we can't live without, like smartphones.
Which consumer cyclical companies or what themes do you expect to outperform the broader market?
P.S. Our tools can analyze the risk and health of consumer cyclical stocks — and sound the alarm when they start wilting under the heat of rising interest rates.
These insights can make the difference between simply preserving your capital and watching it multiply.
To see how they can help you weather any type of market decline, click here.
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