As we predicted, last week the Federal Reserve hiked rates by 75 basis points. This brought the federal funds rate to 1.5%-1.75%. The markets reacted positively on the back of that news, as they were delighted with the fact that the Fed is making moves to seriously tackle inflation. However, the next day the markets gave up those gains as they had concerns about inflation.
The market buying up one day and selling off the next based on the same pool of information shows how emotional the market can be. We highly suggest you not to invest like how the market has been reacting. Following the herd mentality is likely to lead to unfavourable outcomes. You could be selling low and buying high.
That is not to say that you shouldn’t be flexible in adjusting your investment views to new information. It is important to back your investments as long as the fundamentals don’t change. If there is news that does significantly fundamentals positively or negatively, then it may be the time to reassess your thesis, in which you may end up topping up your investment, holding, trimming or selling.
The market volatility has resulted in some opportunities, although it does require some good stock picking. What we have been avoiding are long duration and concept stocks. These are companies with great ideas and high revenue growth, but the bulk of their earnings are a long way off. Ultimately, earnings drive share price growth, and these types of companies are being penalised as higher government bond yields discount them more heavily.
A big theme in the US has been the tight labour market. So what’s some of the other evidence that’s recently been released?
The print for initial jobless claims in the US last week was 229,000. This was above forecasts of 215,000 and well above the low in March of 166,000 claims. To avoid using one or two data points, the four-week moving average of jobless claims is now at 215,000, above the April low point of 171,000. From our perspective, the string of data indicates that initial jobless claims may have bottomed, and that the tightness in the labour market may have reached its peak. We do note that by historical standards, 215,000 claims are still very low.
If the labour market loosens, this will ease wage cost pressures in due course. Higher wage pressures either hit the bottom line of companies or are passed on to consumers in the form of higher prices, which further contributes to inflation.
The rise in jobless claims coincides with some companies announcing hiring freezes and even laying off staff as demand starts to fall. This moderation in demand is pointing to an economy which is slowing down, which is a positive in containing inflation. Slowing growth for containing inflation is a trade-off that anyone would take to the bank. Due to this, we have downsized our allocation in the consumer discretionary sector. Instead, we are upweighting companies in which the bulk of their revenue are non-discretionary, giving more stable earnings.
Back in Australia, the biggest news was that the unemployment rate stayed flat at 3.9%. 60,600 Australians became employed, well above the forecasted figure of 25,000. Although you’d think this would push the unemployment rate down, this was offset by the participation rate increasing to 66.7%. These are all good signs that the Australian economy is in good enough health to withstand rate rises.
That brings us into what’s happening this week. The RBA meeting minutes will be released, in which we will be deconstructing every change in wording the statement has. Governor Phillip Lowe has recently indicated that inflation will peak over 7% in Australia this year, to justify the hawkish pivot in monetary policy. The markets are pricing in a cash rate of 3.15% by the end of this tightening cycle.
However, we did pick up some indications of a softer tone by Lowe, as he made references towards the uncertainty of consumer spending in the future, as well as the expected decline of the currently high global commodity prices. This is on the back of consumer surveys showing lower consumer confidence.
Although the rate hike path is not guaranteed, the RBA will take in and respond accordingly to data of the economic conditions as they flow through during this cycle.
The Fed will also release the results of their bank stress tests. For 34 of the largest banks and financial institutions in the US, the Fed will assess if they are meeting new capital requirements and whether these banks will be able to increase dividends and continue share buybacks.
Interesting Finance Fact
The value of global mergers and acquisitions was US$5.9 trillion in 2021, with over 63,000 transactions
This eclipsed the previous record in 2015 by almost US$1.5 trillion. The M&A bonanza was fuelled by easy money conditions and soaring stock market valuations which gave companies access to cheap financing, as well as buyout funds sitting on a lot of dry powder.
Have a great week,
Sam Waldron - Research Analyst