A strong start to the year of cyclics

The first week of 2022 progress Decrease in cyclical sector and growth stocks. There are several factors behind this move, including rising interest rates associated with the Fed’s outlook for monetary tightening.

This is one of the strongest numbers earlier this year. In the United States, inflation reached 7% in 12 months. By disrupting supply chains and encouraging unprecedented government and central bank inspiration, the Covid-19 pandemic is a source of a strong surge in global inflation.

Rising interest rates unfavorable for growth stocks

It’s time for the Fed to act. After supporting the recovery with low interest rates and asset purchase policies, the central bank of the United States is about to make a strategic shift. The purchase of the asset will end in March 2022 and the first increase in the key rate should also be recorded. Therefore, some increase in key rates is expected in 2022.

This outlook will have a significant impact on the fixed income market. Since the beginning of this year, US yields have risen to match higher inflation and more stringent monetary policy scenarios. Therefore, the US 10-year borrowing rate has returned to its highest level in two years, approaching 2%. The US 10-year real interest rate remains negative, below pre-crisis levels, but rising for weeks. However, there is a strong correlation between this real interest rate and the relative performance of circulating stocks to growth stocks, including the European market.

Keep in mind that for all intents and purposes, so-called “circulating” stocks, their activities depend on economic conditions. There are banks, insurance companies, real estate companies, industries, automobiles and even energy. It also discusses the “value” sector in relation to multiples of medium valuations. Conversely, so-called “growth” stocks are strong developing sectors, especially technology and luxury.

Of course, the impact of pricing on these two major categories of companies is not a coincidence. This phenomenon is based on two clearly distinguishable pillars.

In traditional valuation models, a company’s future revenue is mathematically discounted for long-term rates. Therefore, the lower the rate, the higher your future income will be. Therefore, it is understandable that growth stocks, such as 2020 and 2021, will benefit during periods of low interest rates with a strong visualization of future outcomes. Conversely, as interest rates rise, the model lowers the reputation of these companies. ..

From a more operational perspective, the credit margin and investment-based banking and insurance sectors are structurally profitable in high interest rate situations. This effect can only be observed in the long term. The rise in interest rates observed from the beginning of the year does not make it possible to revise the current sector outlook. Nonetheless, rising interest rates have contributed to its revaluation by permanently alienating the outlook for low interest rates.

Multiple factors beneficial to circulating stocks

In parallel with rising interest rates, which are particularly beneficial to financial stocks, other factors underpin a “circulatory” world.

First of all, the Covid-19 epidemic has benefited “at home” stocks, especially technology stocks.

Conversely, the value of “going out”, which groups landowners, especially in the transportation, hotel industry, and even shopping centers, was severely sanctioned. This dissatisfaction often spread to all non-technical stocks from the circular sector.

In the future, this trend will tend to reverse. The epidemic of low-risk Omicron variants associated with less stringent hygiene measures suggests a return to normal. Therefore, cyclical companies are finding a more stable outlook.

At the same time, the economic recovery observed in 2021 was accompanied by various shortages, the most prominent of which was semiconductors. Production of these components suffered from supply chain disruptions and failed to meet demand. The automotive sector is one of the most affected. Last year, it was discovered that most manufacturers were unable to meet their production targets because they had not received the components needed to assemble the vehicle. These shortages are now being resolved, which is great news for the automotive sector. Sales in the automotive sector could only recover after two difficult years.

Finally, the recovery in inflation caused commodity prices to skyrocket at the end of 2021. Oil has returned above $ 85 / barrel, reaching its highest level since 2014. Gas and electricity prices have reached historic records in Europe for the reasons already mentioned.

Therefore, this situation has proven to be beneficial to certain companies in the energy sector, without constructing generality. The French case perfectly illustrates this. Rising electricity prices may seem like good news for EDF, but on the contrary, the group issued an important “profit warning” in January related to the 2022 forecast. Shutdown of certain reactors for maintenance, in addition to the loss caused by the price limit of electricity in France. Within the energy sector, prove that the situation can turn out to be the exact opposite, from one company to another.

In short, sector rotation in favor of circulating stocks constitutes a market opportunity to be exploited, but stock selection requires great care. Also, the recent outperformance of these stocks, which we have long expected, especially by pointing out the profits of the banking sector, does not limit the profits of any particular growth stock, especially for growth. Certain ability. ‘innovation. Therefore, the latter can provide additional performance drivers, but in the current period, it will prioritize periodic, high quality stocks that are often undervalued.

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An article written on January 28, 2022. This document has no pre-contract or contractual value. It is given to its recipient for information. The analysis and / or description contained in this document may not be construed as advice or recommendations from Lazard Frères Gestion SAS. This document does not constitute a buy or sell recommendation or investment solicitation. This document is the intellectual property of Lazard Frères Gestion SAS.

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