What we are watching next week, including Wells Fargo earnings

Published Fri, Jan 7 20224:57 PM ESTUpdated Fri, Jan 14 20221:52 PM EST

(This article was sent first to members of the CNBC Investing Club with Jim Cramer. To get the real-time updates in your inbox, subscribe here .) Markets got off to a shaky start to kick off the new year. While the major indexes posted weekly losses, the economically sensitive Dow Jones Industrial Average was the relative outperformer, as investors positioned themselves for a year in which the Federal Reserve is expected to raise rates and reduce the size of its balance sheet. In line with the increased focus on rising rates, the tech-heavy Nasdaq Composite was the relative laggard, now more than 7% off the all-time high reached in November. Ultimately, we are not that surprised by the action and believe it to be in line with our view that in 2022 you want to own the stocks of companies that "do stuff and make things" while avoiding the "story stocks," i.e., the high-flying, longer-duration, concept names with little-to-no earnings power. Remember, stocks are valued on future earnings and cash flows. We generate a present value for companies by estimating these outyear numbers and then discounting them to the present day using a discounted cash flow (DCF) model. When rates are at essentially zero, the discount rate (the denominator in a DCF model) is minimal and as a result, investors can speculate and look out into the future as far as they want — because the value in the future is essentially the same as today's. But when rates rise, the discount rate (or the rate of return investors require for the risk they are taking on by owning equities) must increase. That increased denominator means that the present value of future earnings and cash flows declines. The further out those earnings are, the less they are worth today with every tick higher in rates. An example of how rising rates impact valuations: To better illustrate this, let's consider an example of how a higher discount rate impacts future earnings. Company A is a high-flying tech stock (think something in the EV space that came public via SPAC or an enterprise software company) with a promise about the future but no earnings power today, making it a longer duration asset in the context of stocks. Company B is a value cyclical name, like a large-cap financial or industrial. These companies are traditionally thought of as short-duration assets. Company A is expected to generate $10 of earnings per share in 2027 (five years from now), while Com