US Interest rates and inflation
For those of you who don’t have the time or interest to follow financial markets, in summary, over the past 18 months, markets have gone from a bear market last year to a bull market this year. For the broad global stock market index, that’s (down) -18.24% last year to 11.92% this year. The technology sell-off of 2022 has reversed with big-tech shares making a solid recovery, up 38% year-to-date.
Another feature of markets since 2022, has been a tremendous amount of volatility as markets attempt to factor-in interest rate hikes and the possibility of a recession in the US. The first quarter of 2023 has however seen volatility revert to more normal levels.
Perhaps one of the more consistent features of the past 18 months, is that almost without exception, value investors trumped growth last year, while in 2023 growth managers are on-top once again:
Other than technology sector shares, the Japanese stock market has also delivered high returns this year and over the longer term too, up over 20% this year.
I have been surprised that there is so much liquidity still around, to drive technology shares up to this extent. I say this, because interest rates have gone up significantly from 1% to 5% in the U.S. and similarly in Europe. This would normally suck money out of stock markets and into cash deposits and bonds, but the recent rally serves as a reminder that businesses and by extension stocks markets, are ultimately driven by entrepreneurs and businesspeople who are inherently risk-takers and positive in their outlook.
The key lesson and core investing principle is not to time markets. Why? Firstly, they are mostly unpredictable and secondly recoveries happen fast; if you’re not invested, you forfeit big gains.
Inflation and interest rates remain a big topic at the moment. My assessment is that both are likely to remain high as western countries grapple with setting up new supply chains to be less dependent on China. The prices of goods in the US, like memory chips and green technologies that rely on establishing sufficient new supplies of the raw materials is likely keep many prices elevated. Through monetary policy, central banks are therefore likely to keep interest rates higher for longer to dampen demand and keep prices in check. Lower demand is already squeezing company profits and this environment is likely to continue to be a headwind for share valuations to rise more broadly, in other words across more sectors.
So, I still think that over the next couple of years it is probably going to be better to have a leaning towards value stocks as markets muddle through a more restrictive high interest rate environment. Investors need to carefully consider the risks of chasing the recent strong returns from growth stocks. The rally might be less sustainable than we hope for, as ratios are once more suggesting high valuations for many of these stocks.