Equities selloff deepens after Fed’s hawkish shift
The hawkish turn by the US Federal Reserve is not being taken lightly by equity investors. Shares of cyclical sectors are feeling most of the pain with banks, materials, and energy firm leading the declines. Japan’s Nikkei 225 fell as much as 4% in early Monday trade while futures on US and European stocks pointing south. US long term Treasury yields resumed their decline with 10-year yields falling below 1.4% and 30-year yields dropping below 1.2% for the first-time since mid-February. The dollar remained hovering near 2-month high, but there is little action in currency markets today compared to other asset classes.
Investors are becoming more concerned of deeper corrections in equities as we head towards the middle of the economic cycle. We are likely to see forecasts for a decline of 10% or more in equities in the upcoming weeks and months. While we should not rule out steep corrections with such regime change, dumping out all risk positions in favor of cash is one of the biggest mistakes investors fall into. It might be a good idea to increase cash allocation but remain invested in the market. However, the approach needs to be a different mindset compared to the past 12-months.
The times of excesses liquidity created by the Fed and fiscal policies is closely approaching an end. Hence, the speculative parts of the market should be of most concern. The likes of cryptocurrencies and meme stocks will become less attractive as available inflows into them will begin to decline. This is the part of the market which is likely to receive the biggest hit.
Cyclical stocks or so-called value stocks as mentioned earlier declined the most after the Fed’s shift. They already had a great run since the first vaccine was announced in November last year and we are currently seeing some unwinding of these positions. However, from a valuation perspective, value continues to look more attractive compared to growth, and pullbacks may be an opportunity to increase allocation to the cyclical firms which should continue to benefit from the over trend economic growth over the next few quarters.
Whether you prefer growth or value, quality is the most important factor that needs to be considered going forward. The days of “everything rally” are likely to be over, and firms with robust business models, stable profit margins, and strong balance sheets will be the ones to outperform.