Febuary 2022 - The Value of Growth
Markets in the first month of the year were like a roller coaster. They were hard to follow and tricky to understand.
It ended up being the worst month for US equity markets since March 2020, led by a strong sell off in tech stocks. So far, almost each day of 2022 has been rocky, starting in the green and ending in the red or vice versa. Also, the selloff didn’t spare any asset, and bonds traded at record yields not seen since the end of 2020. In fact, they had their worst yearly start in decades. The US 10-year Treasury Note was itself very volatile, ending the month with a yield of 1.78%, its pre-pandemic level and almost 30 bps above where it started the year.
The main triggers of this correction were on the one hand, inflation and the anticipated rate hikes, and on the other hand, a reassessment of growth companies’ stocks. Of course, the threat of a Russian invasion in Ukraine didn’t help to enhance the general feeling and only the energy sector seems to benefit from such news so far, with oil prices back to 2014’s levels.
During its first meeting of the year, the Fed adopted a particularly hawkish tone, hinting that there will be as many rate hikes this year as needed in order to assure price stability. Indeed, Chairman Powell left the door open to any possible change in policy, given the inflationary environment. When asked about asset bubbles, he simply replied that companies are strong financially, banks are well capitalized, and he doesn’t see any vulnerability that is not manageable. Encouraging.
The issue is, using rate hikes to fight inflation caused by supply / demand imbalances could prove to be quite useless. Even Jerome Powell noted that these imbalances could start resolving themselves only during the second half of the year and regarding semiconductor shortages, it could even last until 2023. Moreover, a too aggressive use of this monetary tool could make the debt burden unbearable for those households or companies who took advantage of cheap credit and are, at this point, highly leveraged. Therefore, it’s possible that rate increases won’t fix the inflation issue and on top of that may cause a real credit mess.
Concerning the correction of the tech sector: the upcoming rate hikes could not possibly be the only reason for that strong pullback. We rather see a reevaluation of the future growth for some companies / sectors. Indeed, until now investors were ready to tolerate high ratios if expected future growth was worth it. But when the growth appears to be capped, or slowing, like the growth of value companies, they may not want to pay such elevated prices anymore. Therefore, there is a general reassessment of growth companies’ stocks. Only when the market experiences a serious correction, and both overvalued and well valued assets are sold, then, it’s the moment opportunities emerge, and in our opinion, some companies with strong growth ahead (like in the semiconductor sector, to name only one example) suddenly appear relatively cheap.
January also marked the kickoff of the earnings season. At this point, slightly more than one third of S&P companies have reported, and more are beating EPS estimates than the historic average, but by a smaller margin (4% vs 8%). So, it matches what we said above: there is still growth, but it is starting to flatten.
As for China, Chinese markets (Hong Kong and Mainland) are closed this week for Lunar New Year celebrations, but there is not much to celebrate when we look closer. China is still dealing with a real estate crisis and the zero covid policy is hurting both consumption and production.
From our side, although it’s tempting to buy the dip at these levels, we must be very selective. Also, we don’t know if the correction will continue further or the rebound will be similar to that of April 2020, therefore, we prefer, in doubt, to stay on the safe side and continue to overweight Value vs Growth. So, to conclude, alongside a defensive approach, don’t miss the real opportunities!
As always, risk-management combined with rigorous sector and geographical diversification will remain key factors for investment performance.
You are more than welcome to contact us to discuss our investment views or financial markets generally.