The Fed sets the pace of cyclicality

01/14/2022 | 11:23am

With rising interest rates and inflation, investors could have expected a shift in their agenda from growth to value portfolios. Between successive waves of COVID, rising interest rates and galloping inflation, players still have very little visibility on the market. One day value, one day growth, one day value, one day growth, all at the pace of the Federal Reserve.

Here we are talking about two fundamental investment strategies: growth and value. Growth investors look for companies with strong earnings growth, while value investors look for stocks that appear to be undervalued in the market. Until recently, the consensus was fairly clear on how to overcome rates and inflation: a shift of funds from growth to value stocks.

Historically, value companies outperform when inflation and interest rates rise. This is because discounted cash flows are less accommodating for growth stocks, for which market participants expect a bright future. Value stocks generally have a lower valuation (by definition) compared to their tangible assets and their current situation. In these moments of doubt about rising interest rates, investors are refocusing on what is concrete, palpable, tangible. Logically, the tech sector should suffer from rising rates and inflation rising to historic levels. And this is even more true for companies that are not very profitable or do not have pricing power. In other words, a rotation from highly valued growth stocks, such as tech, to companies that trade at a discount to their financial fundamentals, such as banking and energy, should occur.

The tech-rich Nasdaq-100 suffered a sharp decline in that first week of 2022, confirming the previously cited strategy. But it has recently rebounded, then went down again. A loss of visibility for investors which plays on the "usual" sector rotation in times of rising inflation and interest rates. The FED is at the helm and is being followed like milk on the fire by investors, in order to avoid being rinsed out of the market.

Drawing by Amandine Victor

 

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