The past week has marked the official start of the interest rate hiking cycle, with the US Federal reserve (the “Fed”) joining the Bank of Canada in raising benchmarks rates; the Fed doing so on the 16th of March following the Bank of Canada’s announcement earlier in the month.
That the cycle has officially started is noteworthy, but the key issue is how protracted and deep the cycle will be. In other words, for how long, and to what degree, will central banks haveto raise rates.
The emphasis we have placed on the word “have” is by design. Increasing rates in an economic sense is analogous to taking medicine in a therapeutic sense; unpleasant in the near term, but necessary to prevent even more severe long-term outcomes. The economic ‘disease’ the Fed is mandated to ‘cure’, or ideally prevent, is persistent and structurally high increases in prices (i.e., inflation).
The magnitude of last week’s Fed rate increase was 25 basis points (or ¼ of a percent). This was in line with market expectations, though it is worth highlighting that these expectations had shifted dramatically over the course of the weeks leading up to the Fed meeting. In financial markets, it is often difficult to pinpoint underlying rationale for changes in expectations; this is not one of those instances. The heightened geopolitical risk arising from the Russian invasion of Ukraine, constrained Powell, the Fed Chairman, from taking the more decisive action that was required.
Walking this tight rope is not easy. Raise too quickly, and you risk ‘killing’ the patient (i.e. negatively impacting economic growth), too slowly and you risk the disease (i.e. inflation) gaining a stronger footing.
The challenge of this balancing act is evident when we look at the larger picture. Despite the rate hike of 25bp versus the 50bp expected in early Feb 2022, market expectations for rate increases through the cycle have continued to increase. The market is pricing in a further 8 hikes totalling ~200bp, which equates to a hiking cycle of ~225bp (~200bp plus last week’s 25bp).
Our view, articulated over prior commentaries (see table below for a brief recap), is that the Fed was playing catch up; if anything, recent events, and actions, place the Fed further behind the curve!
At a high level, we believe its important to understand the current dynamics of the market environment in which we find ourselves. We continue to view inflation, and the necessary policy response to contain it as a key element of concern for markets.
In our most recent “Market Forces 003” we highlighted the potential for stock selection to add value in more difficult markets; we now broaden that focus to categories or styles of equities, specifically value vs. growth stocks.
The terms value and growth when referring to stocks are widely used, and whilst there is some nuance (something to be explored in a future commentary), we will simplify growth/value stocks to be those with high/low valuations and high/low growth rates. See this link for a more comprehensive overview.
Recall that a company’s value today is the sum of all its future cash flow discounted to the present at the appropriate rate. All else equal, the farther out any cash flows (the very definition of growth), the greater the degree to which they are impacted by a given change in the discount rate.
From a theoretical perspective we would expect relative outperformance from value (vs. growth) equities when rates increase and have seen that play out so far in 2022; year to date the S&P 500 value index is essentially flat versus a near 10% decline in the S&P 500 growth index.
At McIver Capital Management, we believe that having a process that involves undertaking robust fundamental analysis on matters such as value versus growth positioning within asset classes, augmented by in-depth analysis on individual securities, is one that best serves clients’ long-term interests.
McIver Capital Management Paul, Katie, Neil, Warren, Matt, Mark
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The comments and opinions expressed in this newsletter are solely the work of McIver Capital Management, not an official publication of Canaccord Genuity Corp., and may differ from the opinion of Canaccord Genuity Corp’s. Research Department. Accordingly, they should not be considered as representative of Canaccord Genuity Corp’s. beliefs, opinions or recommendations. All information is given as of the date appearing in this newsletter, is for general information only, does not constitute legal or tax advice, and the author McIver Capital Management does not assume any obligation to update it or to advise on further developments related. All information included herein has been compiled from sources believed to be reliable, but its accuracy and completeness is not guaranteed, nor in providing it do the author or Canaccord Genuity Corp. assume any liability.
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