Good news has become bad news as markets see positive data raising the likelihood of interest rate hikes.
- Stock markets have slipped, with improving economic data making a pivot on interest rates less likely.
- This sets up an odd relationship, whereby ‘risk on’ growth stocks fare badly when there is good news.
- There is a point when this excessive sensitivity to interest rates is no longer rational.
Back in the good old days, stock markets used to like good news. Positive economic data tended to be greeted warmly as a sign that companies would enjoy a benign environment in which to grow their revenues and cash flows. However, over the past decade, that relationship has been derailed and persists even as interest rates have normalised.
Over the past week, stock markets have slipped, apparently because improving economic data makes a pivot on interest rates from the US Federal Reserve less likely. Ben Yearsley, director at Shore Financial Planning, said: “Better growth and jobs numbers from the US spooks equity markets into thinking that the Fed will hike rates further and for longer leading to losses in higher growth sectors.”
This sets up an odd relationship, whereby ‘risk on’ growth stocks fare badly when there is good news. This turns the traditional assumptions about the right time to invest in defensive and growth areas on their head.
Can this persist? There is a point when this excessive sensitivity to interest rates is no longer rational. The rising cost of borrowing is a factor for the corporate sector. However, other factors are equally – and often more – important for company earnings. It may be a problem for highly indebted companies who need to refinance, but this is not the majority.
Higher rates impact the risk free rate and therefore the way future growth is valued, but the heavy-lifting has already been done on interest rates and changes from here are likely to be tinkering at the edges rather than the movements seen in 2022. It is difficult to see why small changes in predicted future rates should affect sentiment so significantly.
There are understandable concerns that higher rates might deter investment, but this can go both ways. It may deter companies from pursuing value-destroying merger and acquisition activity, or encourage them to be more careful in how they spend money. This would be a long-term gain.
The past decade has left investors minutely focused on the path of interest rates and market liquidity. It is another uncomfortable legacy of the loose money era. It should not endure at a time when interest rates are more stable and have substantially normalised. There are signs that investors are starting to focus more on valuation and fundamentals, given the strength of UK and European equities for the year to date, but it remains early days.
