While there was no rate hike this month, US central bank chief Jerome Powell (pictured above) said in a news conference that “the committee is of a mind to raise the federal funds rate at the March meeting, assuming that the conditions are appropriate for doing so”.
Powell went on to say that further interest rate rises and a reduction in the Fed’s asset holdings would follow as required.
But with inflation soaring well above the bank’s 2% target, Powell was clear on one point: inflation is high and the Fed will gradually reduce and end the credit and support it has offered the US economy during the Covid-19 pandemic.
The Fed’s hawkish tone has left many investors wondering how many rates hikes could happen this year.
What do investors expect now?
The Fed’s recent comments on tightening policy and taming inflation surprised investors, who were already expecting as many as four interest rate hikes in 2022. But the recent hawkish shift has left some revising their views.
“The market’s reaction has been to increase its expectation to four or more rate hikes over the coming year, but the reality is that the policy path will be highly dependent on how growth and inflation pan out”, said Rupert Thompson chief investment officer at Kingswood.
Strategists at Deutsche Bank now expect the committee to increase interest rates at each meeting from March to June, and then from September revert to a quarterly tightening cycle, giving a total of five rate hikes in 2022.
BNP Paribas expects as many as six hikes of 25 basis points in 2022, an increase from the previous estimate of four. It expects the Fed funds target range to be at 2.25–2.50% at the end of 2023, 25 basis points higher than an earlier forecast.
“Our new base case for six hikes this year poses challenges to our bullish outlook for US equities,” the French bank’s strategists said in a note on 27 January.
‘Growth’ versus ‘value’ stocks
Growth stocks such as tech companies generally fared well since the outbreak of Covid-19, as people increased their reliance on technology and interest rates and inflation were low. Since the beginning of 2022, however, there has been a shift to value stocks that generally pay out a dividend, like financial and energy companies.
“After a recession like what we had in 2020, what typically works is value, inflation-linked strategies [and] cyclicals,” John Davi, chief investment officer at Astoria Portfolio Advisors, told CNBC. He expects this to continue, and thinks that “tech stocks are going to be challenged”.
ARK Invest founder Cathie Wood published a note in December highlighting that “innovation stocks are not in a bubble”, but that they “are in deep value territory”. Her flagship ARK Innovation exchange traded fund, also known by the ticker ARKK, is down 27% year-to-date, while the tech dominant Nasdaq 100 and broad S&P 500 indices have fallen 11.1% and 6.1%, respectively, over the same period.
Wood believes that “the bigger surprise to the markets will be price deflation — both cyclical and secular”. And despite her poor performance in 2022 so far, her high growth positions in companies such as Tesla “could turn around dramatically during the next year”.
Which sectors could benefit from interest rate hikes?
With US earnings season currently under way, this could push value stocks to outperform their growth counterparts.
James Davolos, portfolio manager at Horizon Kinetics, argues that the winners in an inflationary environment will be companies that have capital-light business models and can pass additional costs to consumers. In last week’s Opto Sessions podcast, Davolos identified sectors like shipping, real estate and insurance as potential beneficiaries.
“The entire world is going through a strong underwriting cycle for insurance. Shipping has gone through a very volatile cycle, kind of bouncing back and coming back in. Commercial real estate, even if prices have been choppy there, the leasing and sales cycles are picking up,” he said.
“It’s totally skewed with about 20% of the market — the cyclical sectors, energy, materials, industrials, discretionary — together expected to grow 95% to 100%,” said Jonathan Golub, chief US equity strategist at Credit Suisse. “Everyone is expected to do better than tech.”
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The investment universe is changing beyond all recognition, and with a thematic focus, investors can capitalise on this wholesale disruption. From Genomics to Artificial Intelligence, disruptive innovation empowers companies to displace industry incumbents, and secure majority market share. Opto exists to identify those businesses, and help investors to invest in the next big idea.