This week brought a pullback in the market like we haven’t seen in a while. The past two years has really brought strong market returns that many investors have enjoyed. So after a few days where the market has moved lower, analysts start to ask “why?” and how long will this continue?
What we have really seen is strong MOMENTUM stocks being sold off, which could simply be investors taking profits and reinvesting in quality names rather than high growth names like technology. Last week Jerome Powell, the Fed Chair reminded the market that they plan to continue increasing interest rates in an effort to return to “normal” rates. It was almost as if he was saying if you think this bull market will continue because rates are going to stay low, then I’m reminding you we aren’t planning to keep rates low.
Many argue that rates have to move higher, quickly, because they were held too low, for too long. Whether this is or isn’t correct doesn’t matter. It’s a matter of when will we return to normal rates so the economy and market can get back to feeling like this factor isn’t a fear that affects investors.
So, what does it mean to sell a momentum stock and buy a value or quality name instead?
As an example, companies like the FAANG stocks: Facebook, Amazon, Apple, Netflix, Google, have seen a large momentous growth of their stock price in the past several years. So we are starting to ask questions like which companies are good to hold when the momentum slows.
I’ll pick out Apple as an example. We ask ourselves if this is a stock we should still hold as interest rates rise.
To consider the interest rate affect we remember that companies with high debt will be affected as rates rise. Having high debt means that they borrow to finance new products and services or borrow to finance the purchase of a company. This can put them at a higher risk in the coming months and years because the cost to borrow money is getting higher. That is what happens when interest rates rise and this is why investors are a bit nervous. They fear that less borrowing could lead to lower growth ahead and less momentum.
So back to our example of Apple being a high growth stock, this company keeps large amounts of cash and low levels of debt. So this allows us to maintain a positive outlook for this stock given that the company can weather the worry about interest rates rising.
Of course there are other concerns that loom such as the global trade concern. Many hoped that since the US came to an agreement with Canada and Mexico that we could quickly work with China next. But that isn’t happening according to what we’ve heard in the media recently.
As we always say be sure to know your investing time horizon and appetite for risk. This will help as we move toward JUST growth rather than momentous high growth of the markets like we’ve become accustomed to.
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Will 2023 be better for investors? They just suffered one of the worst investment years ever in 2022. There are reasons for hope in certain parts of the stock and bond market. We give our thoughts on the chances of a recession and path of interest rates in this opening post of 2023.
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