Economic data from the final quarter of last year published this fortnight has shown that the US economy grew by 5.7% being the strongest in 38 years. Growth last year was fuelled by massive fiscal stimulus and low interest rates.

In the US also jobless benefits dropped by 30,000 with employers desperate for workers with over 10 million jobs advertised in November 2021. Covid caused supply chain problems, and the economic recovery has pushed Inflation (the price of good and services/ rising prices) figures much higher rising to 7% in December a level unseen in decades. These inflation rates, similarly seen in Australia are being characterised as “transitory” phenomenon brought about by Covid supply chain issues. Inflation is generally much harder to control by Reserve Banks with interest rates being the major weapon. This has added to expectation that Central Banks will raise rates higher. In Australian we’re now moving to a mid 2022 interest rate rise. Markets are watching companies earnings reports closely as rising prices, rising costs, are expected to impact on their profitability.

Over the past few weeks, stocks have sold off as investors incorporate the following dynamics into their projections:

  • Slowing economic growth rate in the United States
  • Tightening monetary policy from the Federal Reserve
  • Rising inflation rate
  • Rising interest rates

Concerns fuelled by a new Omicron Variant and tensions in Ukraine added fuel to the fire.

The bulk of the sell-off has been a combination of pricing in slowing economic growth and rising interest rates. Growth and many technology stocks have been hit especially hard because of the long duration of their earnings. A significant part of the value of technology stocks is their future earnings profile, and as investors lower their growth expectations and/or discount those future earnings at a higher rate, the present value for these stocks falls further and faster than the broader market. In addition, market sentiment has turned negative on growth stocks, especially after Netflix (NFLX) fell off a cliff, dropping over 20% in one day following its earnings release last week.

Over the past 3-6 months, we have begun to observe the expectation of rising interest rates has been the catalyst for market participants to start shifting their preference away from concept and narrative investing and back to fundamental analysis. This has escalated over the past few weeks with a rapid sell off in growth / momentum names, particularly in profitless companies that are reliant on capital markets to fund future investment and growth. Perhaps the most high-profile example of this is the ARKK Innovation ETF which has fallen from a peak of $160 share in February 2021 to a recent low of $71/share

In this market environment, we prefer those companies with both stable cash flows and good near-term visibility into their earnings for this year, yet still have good prospects for long-term growth and large tangible addressable markets.

Yet, despite these challenges,  while the markets have been brutalised during the past few trading sessions, the outlook is not as dire as the market action portends. Even with the growth rate slowing, analysts are forecasting real US economic gross domestic product growth of 3.9% this year and 3.5% in 2023. Similarly, while inflation is running hot and will remain elevated for the next few months, it is  projected it will begin to moderate in the second half of this year and continue to decline in 2023. Finally, as interest rates are set to increase, it should be remembered that they are coming off levels that were not that far from historical lows.

Some parts of the world are now experiencing post Covid recovery’s.  India’s economy is expected to grow at a whopping 9%  in 2022 and ASIA similar high single digit returns.

But for the engine of the worlds economy such as the US and even for us, economic growth will continue to improve but at a slowing rate and central banks will finally start the removal of pandemic-driven policy settings. We don’t see either development as negative for the investment outlook but rather a return to more normal conditions of modest returns and greater volatility.

Please note: This is General Information Only, it’s not personal advice and does not take into account your personal situation. We recommend you talk to your Adviser.