A Volatile Flight X 1,000Wed, 02/16/2022 - 15:00
- Spaceship 1 get ready for landing
- What the f..!? Houston, we are not, I repeat, we are not ready for landing!
Although it might be more complex than a spaceship flight, let's think for a second about the current accommodative monetary policy as a rocket ship launched by the US Federal Reserve (investors’ NASA, Houston) at the start of the COVID-19 pandemic as a way to keep credit flowing and limit the economic damage that was caused from lockdown measures all around the globe.
The Federal Reserve took several actions to mitigate this damage, such as purchasing debt securities, increasing its balance sheet from $4.7 trillion in March 2020 to $8.5 trillion as of November 2021. The Fed also reduced the federal funds rate, the rate banks pay to borrow from each other overnight, to a range of 0 percent-0.25 percent.
These measures were taken to promote spending and provide a lower cost of borrowing for households and businesses. For the stock markets, the support helped not only to recover the backdrop seen in early March 2020, but also boosted market prices as a result of increasing economic activity and booming earnings growth, a really pleasant honeymoon with above-average returns for investors.
After a two-year pandemic, a lot has changed. Although new COVID-19 variants have emerged, it seems like omicron has passed its peak and is losing its strength. Economic activity not only looks strong but everyone expects GDP to continue growing.
Now, the bad news: inflation rates have climbed to levels we have not seen over the last 40 years, which is a big concern for the Federal Reserve. It seems like the Fed is now trying to bring back the spaceship, with a hawkish message that has led to a spike in market volatility since the start of 2022. There are likely several scenarios of how this landing might occur but I do believe the Federal Reserve will act in investors’ best interest and guide us through this landing.
That being said, all asset managers are threatened (especially in the world of startups) with losing our way, buying into fear and not seeing the big picture, making us biased toward cash or low-volatile strategies in an attempt to protect our portfolios. There is nothing wrong in building a conservative strategy. We just need to remember that buying into fear can lead us to the wrong decision.
A defensive strategy can change depending on economic growth expectations. If we were looking into a recession, minimum volatility or defensive sectors such as consumer staples or utilities might be the way to go. Economic growth is now solid, so it makes sense to look for companies with high returns on equity, earnings growth and robust balance sheets.
In other words: it is important to get quality exposure, which can be described as companies that are proven to keep growing and maintain a healthy balance sheet even in a noncyclical environment. Personally, I believe these are characteristics that can be found especially in sectors such as technology and healthcare.
These two sectors tend to have a higher beta and underperform a highly volatile market, so many investors might think it is a good idea to cash out given the uncertainty. But let's look at two facts:
- Revenues are not linked to economic activity and both healthcare solutions and technology will continue to be in demand.
- Earnings growth has been strong, so valuations are still attractive for investors.
Now, why do I believe these decisions are harder for a startup? First of all, I don't come from a startup background. I have over 15 years of experience and over the course of my career, I have worked in long-established corporations until recently, when I decided to join Fintual. I can tell you that this volatility we are going through is part of the game and not particularly uncommon. Making decisions as a portfolio manager wasn’t that hard, so why is it this time?
When I interviewed for Fintual, I was told that aside from being a portfolio manager, I would be a jack of all trades, involved in all aspects of the business, including asset retention and growth. So, this time, I am not only focusing on the market; I am aware of different challenges that Fintual as a startup faces every day. These challenges certainly increase with high volatility in the financial markets.
Fintual is an investment platform where people can invest in an optimized portfolio that matches their risk profile. They can start with just MXN$1.00 (US$0.05). Quality investments are available for everyone. Considering that when markets aren’t doing so well, you have two additional problems to address: retaining assets under management and calming people’s fear of losing their money, especially with all the noise that we hear on the news.
Over the last month or so, some questions have repeatedly come to my mind: Are we actually doing the right thing? How long until the market turns around? Should we increase cash or set aside a percentage in a safe haven strategy (defensive stocks)? Even though I know the answers to all those questions (don’t listen to the noise, focus on fundamentals!) these thoughts are always there.
So yes: it seems like the Federal Reserve will remove its economic stimulus earlier than we expected and it might be a bumpy ride for a while, so buckle up and stick to your course.
Some people think it’s too early to eliminate financial stimulus and that stock markets will be dealt a heavy blow as a result. Even without this support, the US has a solid economic growth perspective and earnings are still expected to grow faster than inflation (in the range of 12 percent-15 percent) in 2022. Even with up to five interest rate hikes, real yields will be negative, so I believe there is still a positive outlook for the stock market this year.
Investing in the stock market while developing our business in the Latin American startup ecosystem could certainly generate extra volatility for our firm. We all prefer smooth rides, but honestly, what success story has not been choppy?
And yes! Houston, we are ready to go home.