The InvestSense Podcast

Markets slid again last week but the selling was concentrated in US tech, most of which is down 10% or so this year. Much of last week’s selling occurred in the last 2 sessions of the week. However, it was the pattern of trading that was just as worrying for many observers with some fairly pronounced intra-day swings on Thursday and Friday that ended with the market selling off dramatically into the close. On Friday the proximate cause was Netflix which reported weaker subscriber numbers and a pessimistic outlook which was seen by some as a potential crack in the pristine earnings and cash flow credentials of the broader US tech sector. In a winner takes all, platform driven digital economy, these have been seen as safe havens while many smaller, less profitable tech and biotech stocks have already halved in value during 2021. 15-20 of these tech titans represent a 1/3rd of the US market and over 2/3rds of the Nasdaq, so this reversal has happened very much below the surface, until this year. Investors appreciate and pay a hefty multiple for the ‘bird in the hand’ of massive current cash flows plus strong growth prospects. Higher interest rate expectations are turning from a tailwind into a headwind and now cracks in the growth story are adding to the markets doubts. Regulatory curbs, although not on the scale of those in China, have also been gaining bipartisan and cross-country support in recent weeks.

That left the Nasdaq down another 7% and the broader S&P down almost 6% while Europe and especially the UK were much more resilient, down around 1.5% and 0.7% respectively. Asia also fared better, and the Chinese and Hong Kong markets were actually up on the prospect of fiscal, monetary and even regulatory easing by the Chinese Government. Even Latin American and Eastern European markets did relatively well, making this look like a quite US centric correction, for now at least.

The Australian market was down almost 3% and it had its own interesting internal dynamics. With not much of a tech sector to speak of (at least in market capitalisation terms) Australian national champions, market darlings and export hopefuls tend to take much of the flows from investors with an eye on growth. Many of these stocks like Cochlear, ResMed and Goodman Group were on the back foot last week while the two dominant sectors, banks and resources were also in negative territory. On the other hand, many of the less well known mid-cap names in sectors like Consumer Staples and, ironically, some of the less well-hyped IT stocks (in more administrative and operational areas) were notably resilient. Some like Appen, which had previously fallen from grace, were actually up maybe indicating a degree of rotation into less highly rated or expensive stocks as AfterPay exits the index (having been bought by Block, formerly known as Square).

Near the end of the week bond markets rebounded slightly indicating again that the inflation debate could still have 2 sides, but commodity markets remained resolutely inflationary with pretty much every type of commodity in the green, including gold. Energy stocks were also strong performers here and abroad and it is likely that what now looks like more than Russian posturing has also bolstered energy prices.

Fixed income government bond yields came down slightly at the end of the week and ended more or less where they started, while rises in implied inflation expectations started to moderate meaning that real rates remained firm, even if still negative. Credit spreads eased again, and high yield bonds indices were down. In the context of that asset class, it was a fairly slight move but maybe something to keep an eye on as volatility in credit markets and drying up of liquidity is something that could change the Fed’s rhetoric. For now, though the bond markets appear to remain very much open for business and we hear that debt issuance continues unabated.

Markets were more settled last week, but interest rate expectations continued to set the tone with the US market proving especially sensitive. Markets were at first buoyed by Fed Chair Jerome Powell’s insistence that inflationary pressures would abate later in the year but the next day an annual US inflation print of 7% put markets on the back foot again and long-term interest rates spiked again on Friday. This is the fourth week in a row that long-term rates have been on the rise and the third week the Nasdaq tech index has ended in the red.

In Australia long-term rates are now just below 2% which at least makes them at least roughly equivalent to long-term inflation expectations. At a sector level, the inflationary theme continued with energy stocks again being the stand-out performers (up by 6% overseas and 4% in Australia), followed by materials which was of particular benefit to the local market (BHP, Rio, Fortescue and Woodside were all up between 5% and 10% last week). As signs of easing in China became more tangible, Chinese tech and healthcare stocks also rebounded strongly. Elsewhere performance was mixed as the market switched focus from weak December consumption data to the upcoming US earnings season. Expectations remain quite high but some weaker than expected bank results on Friday was an ominous sign. Either way it is likely to be a noisy earnings season as the strong rebound of 2021 is juxtaposed with an uncertain but potentially improving post-Omicron outlook. Wesfarmers is a case in point. It was one of many Australian Consumer Discretionary and Consumer Staple stocks that fell sharply last week amid concerns over supply chain disruptions and Omicron induced labour shortages, only to rebound today when the trading update confirmed the market’s fears. ‘Sell the rumor, buy the news’ as they say. That left the local market down almost 1% alongside Japan and Europe and behind the UK and US (both flat for the week) and emerging markets (up more than 2%).

Most commodity markets were up again, apart from precious metals and copper which were flat. This could be due to an increasing sense that, as COVID numbers seem be peaking the market is looking through the current disruptions and seeing buoyant production activity, or it could also be due to expectations of persistent supply chain disruption. The broad based and steady rises we have seen recently perhaps imply the former explanation and bond markets may be supporting this thesis. The last half of 2021 was characterised by significant volatility in short-term rates while the last four weeks has seen steadier rises in both nominal and real rates of interest across the interest rate maturity spectrum and perhaps especially at the long end. Corporate bond spreads eased again very slightly and certainly didn’t display any signs of distress at the prospect of higher funding rates. If the Chinese authorities, the Fed and smaller central banks like the RBA have a playbook for quietly exiting the post-COVID regime of extreme monetary stimulus this is probably what they were hoping for. So far so good.