Appetite for risk is back amongst investors and the riskier parts of the stock market ecosystem are performing – despite the Chairman of the Federal Reserve raising interest rates last week by 0.75 percentage points, the biggest jump since 1994.
Typically, markets get into a tailspin over interest rate hikes, especially the size of the Fed’s latest 75 bps. But investors have seemingly shrugged this off, maybe because it was largely priced-in, maybe because the Fed Chair suggested rate rises may now slow.
It is part of a wider picture. Investors appear to have rediscovered their appetite for risk, with global stock markets and high yield corporate bonds both making steady gains over the month so far.
Interestingly, it has been the riskier parts of the stock market universe that have performed best: global small cap stocks have outperformed global large cap stocks, while in the U.S the tech-heavy Nasdaq has outperformed the broader based S&P 500 Index.
The relatively defensive FTSE 100 has made more modest gains, but remains one of the few major stock market indices to record overall gains since January.
The gains in risk assets have come despite continuing high inflation and accelerating monetary tightening from central banks. So what is behind the rally?
First, investors believe that central banks will squeeze inflation out of the system. The higher interest rates go in the near-term, the sooner they can come down and help facilitate a new economic cycle.
Second, after a poor first half to the year, stock market valuations no longer look expensive.
Third, the ‘there is no alternative’ (TINA) argument persists. Although central banks are raising interest rates aggressively, they remain negative in real terms. Equities have the advantage of being linked to the real economy, with many companies able to raise their selling prices with inflation and so offer investors a level of protection from inflation that cash and bonds can’t.
Fourth, large companies are in a generally sound financial position. Big tech in the U.S. is cash rich. Global energy and mining companies are enjoying windfall earnings. Rising interest rates help financials’ boost profits. Meanwhile, many companies have used the rock-bottom borrowing rates of recent years to re-finance their debt at much cheaper rates.
Despite the bullish sentiment, investors must avoid complacency.
Economic data continues to weaken. Continental Europe appears particularly vulnerable to recession later this year, given its reliance on Russian gas, one of the factors behind the fall in the euro against the dollar.
Investors’ response should be to avoid panicking and stick to basic investment truisms.
You should look to allocate cash to risk assets, while remaining well diversified by asset type as well as sector and geography.
London-born Nigel Green is founder and CEO of deVere Group. Following in his father’s footstep, he entered the financial services industry as a young adult. After working in the sector for 15 years in London, he subsequently spent several years operating within the international space, before launching deVere in 2002 with a single office in Hong Kong. Today, deVere is one of the world’s largest independent financial advisory organizations, doing business in 100 countries and with more than $12bn under advisement. It specializes global financial solutions to international, local mass affluent, and high-net-worth clients. In early 2017, it was announced that deVere would launch its own private bank. In addition, deVere also confirmed it has received its own investment banking license.
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