The highest inflation in four decades and the prospect of rising interest rates has jolted stocks. Julian Emanuel of Evercore says investors can expect elevated volatility, but eventual gains. Emanuel says investors should pick healthcare stocks that don’t track US rates. One reason the stock market is so nervous about high inflation and rising interest rates, according to Julian Emanuel at Evercore ISI, is that they’re rarely seen these days.
“There have only been four such regimes” since the early 1980’s, Emanuel wrote in a recent note to clients. That’s when Federal Reserve Chair Paul Volcker broke a cycle of high inflation, and the resulting low-inflation and low-rate environment has been great for stocks.
Today inflation is the highest it’s been in 40 years, and investors and experts alike are certain that interest rates will start to rise when the Fed meets next month — if not even sooner. Even though cycles of interest rate hikes have become rare, Emanuel says investors should learn some lessons from what has happened in the past.
“While each cycle is unique, there is consistency: SPX is down each time 1 and 3 months after the first hike, but always higher 12 months later; the VIX rises during the first month post hike, and Consumer Discretionary underperforms in every 12 month period following ‘liftoff,'” he wrote.
Emanuel says it’s likely that stocks will drop back to their late-January lows both before and after that first rate hike. He doesn’t think that turbulence will spell doom for this bull market , but says investors have to be prepared for a bumpy ride.
“A balanced attitude toward risk, favoring Value over Growth (the end of negative German 10 year yields is a psychological “game changer” for this relationship) and alpha over beta (1/9, The Three V’s) makes sense,” he wrote.
Specifically, he says investors should rely on healthcare and underweight discretionary names — especially through the next couple of months, when he expects volatility to stay high.
His comments might be that much more pertinent because investors are getting worried about geopolitical issues.
“Health Care (Outperform), immune to geopolitical instability but convex to D.C. legislative stalling, with above peer group mean expected earnings growth (“Healthy Health Care”) could outperform in the medium term,” he wrote
While overweighting healthcare as a sector can be done with ETFs, Emanuel suggests investors can be choosier and look for companies with strong earnings, better-than-average earnings growth, and a history of stock performance uncorrelated with interest rates as measured by their correlation with the yield on the two-year US Treasury note between March 16, 2021 and February 6, 2022 — that is, he wants to find stocks that didn’t move in tandem with that bond at all.
The 17 stocks below are Emanuel’s top picks in the healthcare sector right now, ranked from lowest to highest based on their expected earnings growth in 2022.