It’s All about the Fed
There is not an investor on Earth who is not aware of the market volatility that has hit global markets through January/February. It has not been a ‘Happy New Year’ for the market. Why has this happened? Because the most powerful influence over the US stockmarket (the world’s largest equities market) has told the world that it intends to combat inflation with rate rises throughout 2022. Combine the rate rises with talk of allowing the Fed’s ~$9tr balance sheet to runoff and the cries of ‘Don’t Fight the Fed’ will start to ring around the world.
There’s no doubt though that the Fed has pivoted from ‘transitory’ inflation to ‘real’ inflation that has to be addressed. Equities shed close to 10% in January and the curve has backed up ~55bps as a result. When will it all end? Chances are not until the Fed gets out of the bond purchases and supplies more information on when balance sheet reductions will commence. Expect more volatility as it is difficult to discount cashflows to value all equities and impossible to value long dated equities until the curve is known. With unemployment below 4% in the US and CPI 7% yoy, it is no mystery as to where the Fed’s problems lie. The question becomes – Can inflation be fought successfully which will allow an economic soft landing without triggering a recession? With the curve so flat it will be a difficult task!
The good news is that investors will likely have more clarity as to the shape of the curve in March. While volatility may still exist for most 1H22, it’s likely that 2H22 sees more stability and possibly a return to the secular bull market investors are used to – especially if China alleviates supply chain disruptions and eases monetary policies.
Australian investors are unlikely to see central bank action like the US because (a) we aren’t experiencing large CPI increases to the extent seen in the US, and (b) the RBA hasn’t accumulated treasuries on the balance sheet to the magnitude that the Fed has done. Australian households are however more levered to rate rises and it wouldn’t take much to see rate rises bite aggregate demand in Australia. Geopolitical risks to one side, high quality names are at prices that have not been seen for some time. It may make sense to buy quality shares in companies that exhibit strong pricing power on the dips while keeping some dry powder for when the term structure of rates becomes clearer. For investors with money on the sidelines, it is worth looking to put some (but not all) money to work now on quality stocks that will show solid long term financial gains for your portfolio.
COVID– Out… Inflation– In
Commodities have been in focus as tensions in eastern Europe push oil prices back toward the USD100 per barrel mark. Iron ore rallied strongly for the first part of 2022, almost back to USD150/t before selling off in February after China intervened once again in the hope of slowing input price inflation. Nickel, Cobalt and Lithium used in batteries that power EV’s and other devices, continued their upward trend, most trading at or near multi year highs.
As we move into the third week of reporting season, it was pleasing to notice that COVID-19 was less of a talking point in the half-year reports, replaced instead with cost pressures from wage and shipping inflation. The standout performers so far for the FY21-22 year are those that are well established as leaders in their markets and have pricing power to effectively pass on cost rises to their customers.
Tech stocks broadly have been heavily sold off as rising interest rates causes large tech valuations in the US to compress, forcing others down in kind. While no company in the sector has been immune, the well-established Australian tech firms have found buyers as investors see value after the pullback.
In terms of the big four banks, the general theme was margin pressure but still better results than the markets expected. NAB and Westpac the strongest performers post result with CBA taking home the wooden spoon, after an outlook undeserving of the valuation premium normally enjoyed. Macquarie, as it generally does, continued to impress the market as the only real Australian investment bank with its sticky earnings profile and quality investment portfolio.
With roughly half the market still yet to report I’m sure that like us, many investors will be looking closely at which companies have been able to adapt to the inflationary environment and continue to grow their revenues without sacrificing margin and earnings.
