Stocks rose modestly last week, while interest rates surged.
Citigroup now expects the Federal Reserve to increase interest rates by 50 basis points in May, June, July and September. They see interest rates heading towards 3.5% next year.
Higher interest rates have hit rate-sensitive stocks such as house builders and retailers.
Even the Financials sector ($XLF), which usually benefits from higher rates, has not performed that well, as the market has started worrying that rates are becoming too high, raising recession risks.
In terms of what to expect going forward, we agree with the Bank of America, who think there may be a short-term rally over the next few weeks.
The rally could be driven by positive news about the war, as Russia’s invasion meets the “material reality of constraints”.
After the rally, we would expect the market to return to focus on inflation and rising interest rates.
During previous episodes when both inflation and interest rates surged, the S&P 500 fell 11% (1969), 30% (1974) and 12% (1977).
Due to the inflation situation, we expect 2022 to be a weak year for stocks. However, we believe our portfolio is better positioned than the index to deal with inflation, because Value stocks have historically outperformed Growth stocks when interest rates increased.
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“Will Value Outperform While Inflation Rises?”
– In this video, Rob Arnott says that Value stocks underperform if inflation is low, outperform slightly if inflation is moderate and outperform significantly if inflation is high.
– Value stocks are still cheap relative to Growth stocks and should outperform going forward.