So goes January, so goes the year, it is sometimes said. If so, Mr Market has decided that the Covid-19 pandemic is behind us. This has investment implications: the long duration narrative will fade into the background, and “real economy” stocks will outperform again.
The conglomerate of conglomerates, Berkshire Hathaway, has been staging a strong rally in recent weeks. Warren Buffett’s vehicle has risen sharply on the back of its substantial position in Apple, which recently passed the $3 trillion mark. But there is more to it.
After all, Berkshire is the poster child for corporate America: a motley collection of companies that keep their finger on the pulse of the real economy. And it is doing just fine.
Mr Market is apparently convinced that the Covid pandemic is behind us. In a way, the rise of the Omicron variant can be seen as a blessing. If many people contract this highly infectious but less pathogenic variant, group immunity may finally emerge. And so the pandemic can become endemic and, over time, very mild.
You would not know it from looking at the daily images of doom sent out by health professionals and virologists, but it is a real possibility. In any case, it is discounted in share prices.
Peloton
At the other end of the spectrum we find a company like Peloton. During the height of the lockdown, this company caused a furore with its treadmills and home fitness solutions, which are connected via devices. It seemed like everyone wanted a Peloton by March 2020.
Today, Peloton is faring a lot less well if we look at its share price. The share has fallen back to pre-crisis levels.
Cathie Wood is also having a particularly hard time. She was the “goddess of growth stocks” during the lockdown and achieved an outrageous 150 per cent performance with her ARK Innovation ETF, which invests in disruptive companies that are changing the face of the world. Today, stocks such as Roku (-59 per cent below its peak), Zoom (-69 per cent) and Palantir (-57 per cent) are trading much lower than they were a few months ago. Why is this?
Real interest rates
The markets feel that the Fed wants to remove the “punchbowl”. After all, much of the increase over the past 18 months can be attributed to the continued decline in interest rates. Also, the very negative real interest rate encouraged the taking of positions in risky assets of all kinds.
The long duration party therefore seems to be coming to an end. The graph below clearly shows that real interest rates are on the rise.
The inflation-adjusted interest rate on 5-year US Treasuries is now minus 1.46 per cent, which is the least negative figure since the end of 2020. This trend is significant because many investors had taken advantage of the heavily negative real interest rates to buy risky growth stocks.
Peter Garny, head of equity research at Saxo Bank, put it as follows in a recent paper: “Travel stocks (up around 4 per cent month to date) are rising on good omicron news and a faster path to normalisation, and the broader commodities sector is still in demand as investors add protection against inflation to their portfolios. The flip side is a bloodbath in speculative bubble stocks and themes such as NextGen Medicine and E-commerce.”
Garny refers to the divergence in just two trading sessions: a staggering 9.1 percentage points between baskets of travel stocks and baskets of bubble stocks.
Conclusion
Currently, markets are trending towards a return to outperforming the real economy in the medium term. The tide may turn again if economic growth falls below trend and the market corrects heavily, causing the Fed to forego rate hikes. At that point, the adage “when growth becomes rare, growth becomes expensive” may resurface.