Tuesday morning was one of those classic reversal days—beginning with a modest bull run that turned south by 11 a.m. and was accompanied with a spike in volatility. Tuesday morning was busy for journalists as well as traders; headlines included news of Russia troops advancing into Ukrainian territory beyond Crimea, Janet Yellen hinted at higher capital rules for big banks, consumer prices rose above expectations with food and rents leading the trend, and India saw consumer prices rise slightly above forecasts.
This is all big news, and none of it is good, so it’s no surprise that both the VIX (VXX, UVXY, TVIX) and S&P 500 (SPY) indicated a decline in stock prices was coming. At a time when the overall indices are struggling to get into green for 2014, none of this is welcomed.
The macro news is all easy enough to digest. While low inflation has given the Federal Reserve breathing room to expand the monetary base that would raise aggregate demand and in turn raise company revenues and earnings, rising inflation could limit the Fed’s ability to use monetary policy to increase aggregate demand. At an annualized 2.6%, inflation is still hardly a real concern for the Fed, and some pundits have said that rising inflation is a good sign, because it means we are avoiding a liquidity trap.
While that is true, the implications it has for the Fed easing its accommodative monetary policy is worrying investors who believe the overall U.S. market, particularly the declining real spending power of the average consumer, will have a dragging effect on top line and bottom line growth for companies. This has caused a real flight to safety for 2014—while speculative stocks like Tesla (TSLA) and Pandora (P) see steep declines, stocks like Johnson and Johnson (JNJ) and Coca-Cola (KO) handily outperform the market. The result is that many short-term traders are fretting that what is good for these consumer staple names is bad for the market as a whole.
This concern was fueled today by both companies’ strong earnings reports. At revenue growth of 3.5% on a year-over-year basis, JNJ proved that demand for its products remains robust; with EPS 6 cents above expectations, the company also proved fiscal discipline that yields value for shareholders.
The story with KO was a bit different; revenues declined over 4% on a year-over-year basis, but was above expectations at $10.57 billion while EPS remained at expectations. The revenue beat was thanks to a rise in overall volumes driven by demand in emerging markets. However, much more important for investors was KO’s assertion that they will continue to repurchase above $3 billion in stock by the end of the year.
There are many lessons to take here. The most important and most obvious is that you cannot invest based on one number; KO’s revenue declines sound bad on their own, but in the context of growing volumes and stock repurchases, it’s actually great news.
A subtler lesson is that the flight to safety trend has been paying off in 2014, and that these large-cap blue chip stocks will continue to provide above-average returns in an environment of higher volatility and greater uncertainty. While the dream of a huge win on a hypergrowth company gets a lot of return-hungry investors excited, that momentum does not last forever and needs to be indulged in only when it is available. When it isn’t, returns from more boring strategies are available elsewhere.