January was one of the more difficult months as the thematics that persisted at the end of last year became exacerbated, and there were few places to hide.

Investors sold off stocks, especially faster-growing technology companies, as concerns about central bank liquidity withdrawals and increasing interest rates impacted valuations.

There was widespread selling in many sectors with the NZX50 off -8.8% despite containing more defensive-type stocks as interest rates increased. The ASX All Technology index was off 15% too.

The sectors which were relative outperformers were oil and interest rate-sensitive sectors like financials – sectors which we traditionally have little exposure to the poor returns on capital these industries typically generate.

Investors are also becoming more cautious about potentially over-earning companies due to pandemic tailwinds. We have seen some large-cap companies like Facebook, Paypal and Netflix fall more than 20% on their earnings reports as they reported an outlook of slowing growth in FY22. If the US large-cap stocks falter this year, it may be difficult for global markets to rally, given the significant weighting in indexes to them.

Currently, the market volatility is likely a valuation reset. Massive central bank economic stimulus pushed risk premiums down and asset prices up. Now this is potentially overflowing into the real world economy through higher inflation, exaggerated by disruptions caused to supply chains and labour movements from the pandemic. If inflation is persistent, further tightening may be necessary to prevent stable economic conditions from overheating. However, for a bear market to eventuate, it is most likely a recession would be required, and central banks would be closely monitoring to ensure interest rates are not hiked if economic conditions deteriorate.

Predicting markets is difficult, if not impossible, to do consistently. We prefer to spend most of our attention analysing companies and management teams to invest with over the long term, knowing growth in earnings per share is what drive stock prices. In the short term though, it pays to be mindful of what the market tells you about industries or particular companies. I think the falling share prices of many companies are symbolic that investors were capitalising over-optimistic scenarios about their future growth, while paying a high valuation for those earnings. Our mistake has been slow to realise this about some companies in our portfolio where we should have reduced exposure earlier. The positive is for the long-term investor lower prices mean higher future returns and in this environment, the high volatility is creating much more opportunity than would normally exist.

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