VIEWPOINT: Raising interest rates will help fight inflation
April was a volatile month, from the combination of interest rate expectations, persistent inflation and the continued escalation in Ukraine. The Federal Reserve has already raised interest rates, and we’re staring down more potential hikes coming with the upcoming meetings – some at even double the current pace.
While expectations are for inflation to peak soon, the Fed has seemed committed to reducing inflation at the expense of gross domestic product (GDP) growth. Given that GDP was negative for the first quarter, there is now a concern over GDP growth as rates rise. We don’t expect a recession in 2022, but concerns have certainly risen.
During the month of April, the 10-year Treasury bond yield rose from 2.32% up to 2.88%. For perspective, that yield was around 1.5% coming into the year and at 1.2% as recently as August of last year. The rapid change in expectations for interest rates has been a huge factor in markets as interest rates do influence asset prices.
Tech stocks have been trending lower – they were running high during the pandemic but in April we’ve seen traders shift away from big tech stocks into less risky ventures. April was the worst month for the NASDAQ, at -13%, since October 2008.
A lot of the reason comes down to the market’s concern over the Federal Reserve’s actions. Market prices indicate an expectation that interest rates will move up sizably in 2022 to fight inflation. Longer duration stocks, which are companies whose earnings are expected further into the future, are disproportionately hurt by this. Many technology companies, which come with higher growth expectations, fall into this category.
The market has rotated from high-growth sectors to more stable, defensive sectors like utilities and staples to go with energy (given the rise in energy prices). This makes sense given rising rates and volatility concerns, but one case for growth-oriented sectors like technology is that investors will search for growth as the economy slows. As these tech companies become more and more attractive from a valuation perspective, those arguments get even stronger.
Amazon also saw its first quarterly loss since 2015 with a decline of 14.2%, sparking some concerns of consumer spending decreasing. We also saw Netflix fall 49% in April, another indicator that the elevated valuations of tech stocks are looking less attractive in a rising rate environment.
These ups and downs in the market are expected as the market adjusts to the Fed increasing the interest rate. At Diversified we also recommend investing not for the short term but for the long term.
A lot of what we’ve seen has been a short-term repricing in markets and we need to keep our focus long-term. The market has priced in an aggressive Fed and a more pessimistic view, so we view the path forward in a more positive light. The concern is that risks have risen, as the Fed is now raising rates at a time when global growth is slowing, and assets are expensive. We still see respectable earnings reports and a strong labor market, but much will depend on inflation and how markets absorb rising rates.
Andrew Rosen is president of Diversified LLC, a Wilmington-based financial planning & investment management firm.