Market Rotation: Magnificent Seven

The Magnificent Seven rallied in early July, carrying the market to new highs, but reversed course with a violent selloff in early August for over $3T of total market value lost. While some of the Magnificent Seven’s lower prices offer a more attractive valuation, recession fears have driven the CBOE Volatility Index “fear gauge” to pandemic-era levels amid economic uncertainty. The deepening tech sell-off prompted the Nasdaq to enter correction territory, down over 10% from its record high. The S&P 500 and Dow were 5.7% and 3.9% below their all-time highs, respectively, driven by concerns over slower job growth, anxiety over the November U.S. Presidential election, and the timing and impact of emergency interest rate cuts. The sell-off impacted every major stock exchange across the globe, every sector, and asset class, including safe havens like gold. The benchmark, Nasdaq, and Dow Jones all fell for three consecutive sessions, with the S&P 500 having its worst session since 2022 on Monday, August 5, 2024, falling 3% with only 20 index constituents posting a positive gain.

Market Meltdown: Monday, August 5, 2024

Although concerns of a recession have escalated, the U.S. economy’s estimated 2.8% GDP growth in the second quarter was significantly higher than 1.4% in Q1. Fears escalated Friday, on economic data showing non-farm payrolls increased by only 114K. The unemployment rate hit 4.3%, triggering the “Sahm rule,” which suggests a recession is imminent when the 3-month average unemployment rate rises 0.5 percentage points or more above the previous year’s low. With this in mind and according to the Labor Department, on August 8th, first-time filings for jobless benefits came to a seasonally adjusted 233,000 for the week, a decline of 17,000 from the previous week’s upwardly revised level and lower than the Dow Jones estimate for 240,000. The market rallied on the back of the report.

Recession Fears

As global panic sweeps the globe, nearly $6.4T was wiped out amid the market panic, with Japan’s Nikkei 225 falling over 12%. Assets are falling, and attempts at timing the market are like catching a falling knife. “It’s the great unwind, [and] there are falling knives everywhere,” said Vishnu Varathan, head of economics and strategy at Mizuho Bank in Singapore.

Economist Claudia Sahm, who developed the Sahm Rule, said the U.S. is not in a recession but is getting “uncomfortably close.” Some analysts argue that Treasury yield curve disinversion is the best recession indicator. On Monday, the 10-year Treasury yield (US10Y) and US 2-year (US2Y) uninverted for the first time since July 5, 2022, with the 10-year falling to its lowest since December 2023, as investors flooded to bonds for safety.

According to the CME FedWatch tool, the probability of a half-percent rate cut in September increased following Fed chief Jerome Powell signaling that rate-easing could begin at the central bank’s next meeting. According to Strategas’ historical review of the nine previous First Rate Cuts, over an average of 276 days following the first cut, the S&P 500 has fallen 20.5%. What’s positive is that on average, six months after the first cut, the market was up an average of 3.4%.

Stock Market Valuation And Performance After The Fed’s 1st Rate Cut

Fed officials have tried to refute the notion that the U.S. economy is headed toward a cliff. “Jobs numbers came in weaker than expected, but [are] not looking yet like recession… We’re going to take all the measures, we shouldn’t react to one number,” said Austan Goolsbee, Chicago Fed President. Goolsbee added that jobs data is not an indicator of a recession and warned against overreacting and that the central bank will act if conditions deteriorate. Investor expectations and broader market sentiment will influence the market reaction to Fed rate cuts. As the Jackson Hole 2024 Economic Policy Symposium approaches, all investor eyes will be on Powell’s rate cut forward guidance.

Jackson Hole Conference: August Fed Meeting

The Fed’s Jackson Hole Economic Symposium, which will be held August 22-24 this year, offers vital insights into global central bank policies and potential impacts on the markets and economy. The response to Fed chair Jerome Powell’s speech at the 2023 summit led markets higher and the 10-year Treasury to experience a one-basis-point slide. Larger impacts followed the 2022 symposium, which triggered a surge in interest rates, a 15% selloff in the S&P 500 over the following six weeks, and the Fed raised its policy rate to 300bps, including 100bps in the seven months leading up to the 2023 symposium.

Will the Fed lower interest rates in 2024?

The bigger question is what the Federal Reserve will do with interest rates going forward. In June, although CPI fell to its lowest point in three years (3%), concerns over a real or imagined 2024 recession are looming and could lead to sector rotations and a transition from high-growth to income-focused investments. Although rates remain at a 23-year high of 5.3%, with a cooler job market and progress toward lower inflation, Powell said, “a reduction in our policy rate could be on the table…we’re getting closer to the point at which it’ll be appropriate to reduce our policy rate, but we’re not quite at that point.” Amid market turbulence and economic uncertainty, it’s key for investors to steer clear of speculative holdings and focus on stocks with solid fundamentals that are more likely to rally quickly. One option to prepare for a potential recession is to look at defensive or recession-resilient stocks.

Top Defensive Stocks

Businesses in defensive sectors are less sensitive to economic fluctuations because they provide products and services consumers will buy despite downturns. Food, health services, and electricity are necessities that offer recession-resilient qualities and tend to outperform during recessionary periods. Consumer staples, utilities, and health care outperformed the market by an average of 10% in six of the last seven recessions since 1960, excluding the two-month COVID downturn in 2020, when the S&P 500 plummeted over 30% but rebounded to finish the year +15%.

U.S. Market Recession Performance by Sector Since 1960

The market’s reaction to initial rate cuts can be influenced by many factors, including the upcoming Jackson Hole Economic Symposium, economic conditions, investor expectations, and broader market sentiment. As a result, the Quant team has identified four stocks in defensive sectors with strong investment fundamentals for weathering a recession, showcasing strong collective valuation, growth, profitability, and earnings growth potential, including two food stocks and a healthcare stock.

1. Pilgrim’s Pride Corporation (PPC)

• Market Capitalization: $10.42B

• Quant Rating: Strong Buy

• Quant Sector Ranking (as of 8/13/24): 3 out of 185

• Quant Industry Ranking (as of 8/13/24): 2 out of 53

A multinational food company and one of the biggest chicken producers in the United States, Pilgrim’s Pride has rallied +70% over the last year and is the #2 quant-rated Packaged Foods and Meats Stocks. Year-to-date, the stock is up 60%. It is +15% over the last month despite the overall market meltdown, beating Q2 earnings expectations that include an adjusted EBITDA +164% YoY and EBITDA margin rising from 5.8% to 14.4%. PPC’s Q2 results reflect the structure of its portfolio, and strategy to capture market upsides. Pilgrim’s Pride invests in its business throughout cycles and market volatility, strengthening its competitive advantage and creating opportunities to drive profitable growth as market conditions change. In the U.S., Big Bird (commodity chicken) benefitted from enhanced cutout values, production efficiencies, and lower input costs. PPC’s Case Ready and Small Bird business units delivered above-market growth with key customers via differentiated offerings, while the Prepared Foods segment increased presence, brand innovation, and value-added items across retail and food service.

“Our global portfolio delivered significant year-over-year profitability growth. We remained disciplined in the execution of our strategies, focusing on what we can control and continuing to expand our relationships with Key Customers, elevating our performance as market fundamentals became increasingly attractive,” said Fabio Sandri, President and Chief Executive Officer, in a press release.

PPC is trading at a mere 10x earnings and has a forward PEG of 0.26x, which indicates an 88% discount to the sector. The valuation framework of the stock is better than it was 6 months ago with an ‘A’ factor grade vs. a ‘C’ grade and the forward P/E is at a 35% discount. EPS long-term growth forward (3-5Y CAGR) is +42%, and EPS is estimated to grow +142% in FY24, according to consensus estimates. Analysts are positive about PPC, which has had 5 upward revisions in the last 90 days. But it’s not the only consumer staple they’re revising up.

2. Tyson Foods, Inc. (TSN)

• Market Capitalization: $21.47B

• Quant Rating: Strong Buy

• Quant Sector Ranking (as of 8/13/24): 8 out of 185

• Quant Industry Ranking (as of 8/13/24): 4 out of 53

Tyson Foods defied the selloff and was among the top gainers during manic Monday as investors searched for solid ground. Reporting a double earnings beat in Q3 of its fiscal year 2024. The #4 quant-rated Packaged Foods and Meats Stocks has benefitted from a spike in pork prices during the quarter, offsetting weakness in chicken and international segments. Tyson revenue grew 1.6% YoY to $13.35B, topping Wall Street expectations by $140M. Adjusted EPS of $0.87 beat the consensus target of $0.67, and crushed last year’s EPS of $0.15. In addition to sales and EPS, Tyson reported solid year-over-year growth in adjusted operating income (AOI), which rose from $179M to $491M or +175%.

“Q3 not only dramatically improved versus last year but also marked the highest profitability in the last seven quarters. What’s even more impressive is that we delivered these results despite well-known headwind in the cattle cycle as we benefited from our diverse portfolio,” President and CEO Donnie King said in an earnings call.

Tyson’s offers an attractive dividend with a forward yield of 3.25% and a 5Y growth rate of 6.47%. Delivering shareholder value, Tyson has paid its dividend for 34 consecutive years, including 12 years of growth.

Maintaining an uptrend, Tyson’s momentum has significantly outperformed sector peers quarterly, with the largest difference over nine- and 12-months. Tyson trades at a discount, as showcased in a forward PEG of 0.42x, which suggests the stock is currently undervalued by over 80%. Tyson’s EPS long-term forward (3-5Y CAGR) is a whopping +50%, and the company has eight upward revisions in the last 90 days, with EPS projected to grow a staggering +111% in FY2024. Up more than 10% over the last few weeks, this stock may be primed for more upside, along with The Southern Company (SO), a top utility stock.

3. The Southern Company (SO)

• Market Capitalization: $95.45B

• Quant Rating: Strong Buy

• Quant Sector Ranking (as of 8/13/24): 6 out of 105

• Quant Industry Ranking (as of 8/13/24): 6 out of 42

Recognized for its mission to sustainability, Atlanta-based Southern Company (SO), through its subsidiaries, develops, constructs, and manages electric utilities. Serving approximately 78,000 miles of natural gas pipelines and nearly 9 million customers, SO is focused on greenhouse gas emission reduction and expansion of renewable energy amid the rapid demand in the southern United States. Through a $48B capital investment plan over the next five years, SO has tremendous growth potential, as it shifted nearly 80% of its coal-generated electricity below 20% and showcases +45% ROE Growth (YoY), +32% EBIT Growth (YoY), and nearly 50% EPS Diluted Growth (YoY). As the 5th largest owner of renewable energy resources in the United States, SO maintains strong regulatory relationships for strong operational performance, and is tremendously profitable as showcased by its A+ Profitability Grade and balance sheet, allowing it to pay 34 consecutive years of dividends.

In addition to Q2 EPS of $1.10 beating by $0.17, and revenue of $6.46B (12.44% Y/Y) for six straight sessions of gains, YTD and over the last year the stock is +25%. As market volatility and recession fear have pushed investors to safe havens, utility stocks have surged to some of their best levels in over two years, including Southern Company. As a “greener future” becomes a popular topic during this election year, SO’s territory monopoly with efficient scale advantages and exclusive rights to charge customers for a solid return on capital gives this stock an economic moat and attractive opportunity with a quant ‘Strong Buy’ rating.

4. Exelixis, Inc. (EXEL)

• Market Capitalization: $7.68B

• Quant Rating: Strong Buy

• Quant Sector Ranking (as of 8/13/24): 22 out of 1036

• Quant Industry Ranking (as of 8/13/24): 15 out of 496

Exelixis, Inc. is a biotechnology company focused on oncology. Specializing in the discovery, development, and commercialization of difficult-to-treat cancers in the United States, its flagship product, CABOMETYX®, aka Cabo, is a prescription medicine used to help treat patients with advanced kidney cancer.

Focused on delivering higher-value and higher-priority treatments, EXEL is driven by allocating resources to support the best therapies and treatments. With evolving and diversified product offerings, the development of new therapies underscores the company’s opportunity to advance the patient standard of care.

“The Cabo lens sets a high bar for clinical differentiation and ultimate commercial success, and we’re mindful that investments in programs that are unlikely to improve standard-of-care does little to create value for patients or shareholders…we continue to advance our industry-leading pipeline with a focus on generating differentiating clinical data that will improve standard-of-care for patients with cancer. Our success in building the Cabo franchise provides a roadmap to maximize clinical and commercial success for molecules in our pipeline,” said Michael Morrissey, President & CEO of EXEL.

Although EXEL trades at a relative premium, based on its ‘D’ Valuation grade, underlying metrics like its forward P/E GAAP ratio is a 42% difference to the sector, and its trailing PEG ratio is more than an 80% difference.

Showcasing incredible growth and profitability metrics, Exelixis’ Q2 EPS of $0.77 beat by $0.46, and revenue of $637.18M (35.61% Y/Y) beat by $172.07M. Driven by the growth in demand for Cabo, CABOMETYX maintained its status as the leading Tyrosine kinase inhibitor (TKI), a first-line treatment option for renal cell cancer (RCC), the most common form of kidney cancer in the U.S. In Q2 2024, Cabo franchise net product revenues increased 16% quarter-over-quarter, and global Cabo revenues from Exelixis and partners increased $618M. For the fiscal period ending December 2024, consensus EPS anticipates +138% YoY growth and 12% revenue growth for the same period. Over the last 90 days, 13 analysts have revised estimates up, with zero downward revisions, a testament to Wall Street’s optimism regarding this stock.

Amid market and economic uncertainty, stocks in healthcare, utilities, and consumer staples can insulate portfolios from inflation and volatility. Consider PPC, TSN, SO, and EXEL as potential defenses amid the market turbulence.

Concluding Summary

Markets have plunged in a global selloff fueled by recession fears, leading to opportunities for recession-resilient stocks in industries where demand is constant and less sensitive to economic fluctuations. In six of the last seven major recessions, staples and healthcare are among the sectors that outperformed the market. SA Quant identified four stocks in defensive sectors, including consumer staples, utilities, and health care, with a strong track record of earnings growth and excellent momentum. We have many stocks with strong buy recommendations, and you can filter them using stock screens to suit your specific investment objectives. Consider using Seeking Alpha’s ‘Ratings Screener’ tool to help find stocks that achieve diversification into desired sectors you like. Or, if you’re seeking a limited number of monthly ideas, consider exploring Alpha Picks.