In light of the recent news and announcements from the Fed, we have discussed the potential ramifications with some of our managers. We asked what the latest update will mean for the equity markets.
Ludovic Labal, co-manager of the Strategic Europe Quality Fund explained that Powell did little to counter the view that a more aggressive rate hiking cycle might be on the cards, adding that this is obviously negative for equities and risk assets.
David Haynal, Deputy Portfolio Manager (Equity) from the Sturdza Family Fund commented that contrary to Chairman Powell’s assertion yesterday, the team would argue the communication with the Fed is not working properly. To be clear, the process of normalising monetary policy is, of course, more than legitimate.
That being said, after months of supporting a transitory inflation narrative and the need for nothing more than gradual normalisation to protect economic lift-off – to the point of seeming “behind the curve” – Powell’s hawkish pivot in December, followed by yesterday’s press conference, seems to suggest an unexpected shift. This shift was specifically towards reigning in current inflation numbers; even as commodity base effects; shortages and fiscal stimulus should contribute to contain upcoming readings.
David went on to say: eagerly contrasting the current rate cycle from previous ones effectively lowers the strike on the “Fed put”, and some will even question whether it has completely vanished. In the Team’s view, the January meeting was more akin to a cold shoulder than a warm embrace for bulls, and we expect the volatility to remain generally, and more acutely in the highly valued corners of the market where discount rates and sentiment/flows carry outsized importance.
The Teams also provided guidance as to how there saw these adjustments influencing their management of the portfolios.
From Ludovic’s perspective, he indicated that at this point they would be favouring affordably priced defensive stocks. He stated though: “we remain wary of high growth stocks due to their long duration but acknowledge that a large part of the repricing has probably already been done. Hence a selective approach on beaten-down names of very high-quality trading at decent valuation levels seem warranted.”
The Team are reluctant to allocate more of the Strategic Europe Quality Fund’s capital to cyclicals; believing that although some of the stocks might seem insulated from the rising rates by a moderate P/E, they are certainly not insulated from a growth slowdown in a tough pricing environment.
David’s preferred approach was to focus on fundamental bottom-up fundamental assessments, ideally with some diversification in businesses benefiting from higher rates and robust GDP growth, with the caveat that a perceived policy error by the Fed could dampen GDP growth expectations. He continued to state “European equities have a meaningful opportunity for rare outperformance, should the combination of cyclical momentum; a weaker Euro; milder inflationary pressures; and lower inflation isn’t broken by a potential European hawkish pivot.”
The selection of quality names that have de-rated, benefit from ample cash reserves and continue to deliver on secular growth opportunities; such as Microsoft could start attracting investors post-earnings, and put option sellers could potentially do well by harnessing volatility and fixing lower entry points on such specific quality names.
David concluded by suggesting a more hawkish backdrop places the onus on companies to deliver strong (and real) fundamentals to earn stock price stability. In that sense, a strong opportunity for fundamentals-based active management including long-short strategies.
On the subject of the Fed’s news affecting corporate earnings, Ludovic believed the Fed’s announcement will have little impact on corporate earnings, except for highly levered companies that will face steepening refinancing costs.
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The views and statements contained herein are those of Banque Eric Sturdza SA and Phileas Asset Management in their capacities as Investment Advisers to the Funds as of 27/01/2022 and are based on internal research and modelling. Please click on Disclaimer Page to view full disclaimers.