- The past week’s global equity market bounce back has helped cut January’s losses by almost half. That is despite Facebook parent Meta’s 26% plunge on Thursday. Two fundamental factors explain the broader rebound, in our view: a) a stronger-than-expected US Q4 earnings season, led by significant earnings beats in the technology sector (a key driver of the January market pullback); and b) commentary from Fed officials pushing back against runaway Fed rate hike expectations. We believe the two factors serve as timely resets for the extreme pessimism that had dampened investor sentiment in January.
- The US technology sector bore the brunt of January’s market retrenchment, falling at one point c.17% since the start of the year. The past week’s recovery has cut the YTD loss to 8.8%. The main cause of the extreme pessimism was an increasingly hawkish Fed – at one point in January, markets were pricing in almost five rate hikes this year. Since the tech sector’s relatively higher current valuations (25x forecast FactSet 2022 earnings) are based on discounting their future earnings with hitherto rock-bottom interest rates, the concern was that a rapid rise in Fed interest rates would drive down the sector’s valuations.
- We see some misplaced concerns with this argument, which have been countered by data over the past week:
- First, we do not believe the Fed is about to embark on a runaway rate hiking cycle. We expect only three rate hikes this year, given our expectations of a moderation in growth and inflation by H2. This is based on easing demand for consumer goods, a significant tightening of fiscal policy and the negative impact of China’s slowdown and the USD’s strength since last year. Economic data over the past week support our US outlook. US private payrolls surprisingly shrunk in January as Omicron led the services sector to retrench (January’s non-farm payrolls due later on Friday are also likely to miss estimates of 125,000 job gains). The slowing jobs data follows weakening consumer sentiment, retail sales, new orders and wage growth. While the impact from Omicron is likely to be fleeting, the data shows exhaustion of excessive consumer demand as last year’s fiscal stimulus run out. Against this backdrop, we are not surprised to see Fed policymakers this week push back against expectations of runaway rate hikes this year. Indeed, we are likely to see a softening of the Fed’s tone in the coming months.
- Second, we believe a few Fed rate hikes, especially against the backdrop of above-trend economic growth, are unlikely to significantly dent the tech sector’s valuations as long as the sector continues to deliver revenue growth and earnings beats. The US sector’s performance is primarily driven by its strong structural growth outlook. The sector has beaten earnings estimates throughout the pandemic. For Q4 2021, the consensus now estimates a 23% rise in sector earnings, compared with a 16% expectation at the start of the year, on the back of 13% revenue growth. We are also seeing upgrades to the sector’s 2022 earnings estimates, which at 8% sets a low bar for beats in the coming quarters, in our view. Hence, we see January’s pullback as an opportunity to add to the sector. (Note: the tech sector is often confused with some members of the communications services or consumer discretionary sectors which missed Q4 earnings estimates – see table above.)
- More broadly, the US equity market volatility index’s (VIX) drop from close to 40 to around 25 is another sign of waning investor pessimism. This is an opportunity for medium-to-long-term investors to add exposure to US equities, one of our preferred equity markets. The Euro area, our other preferred equity market, faces near-term geopolitical risks from the Russia-Ukraine dispute that could potentially escalate. We see gold as a good hedge in the event of an all-out conflict. The ECB did not rule out a rate hike later this year, helping boost European bonds yields and the EUR. A sustained EUR rebound could confirm a peak in the USD and ease global financial conditions.
–Standard Chartered investment overview. It is not and does not constitute research material, independent research, an offer, recommendation or solicitation to enter into any transaction or adopt any hedging, trading or investment strategy, in relation to any securities or other financial instruments. This document is for general evaluation only. It does not take into account the specific investment objectives, financial situation or particular needs of any particular person or class of persons and it has not been prepared for any particular person or class of persons. You should not rely on any contents of this document in making any investment decisions.
