There was talk of ‘volatile market conditions’. That is why WeTransfer, the originally Dutch service for sending large data files, canceled its IPO on Thursday. The tech company and its investors are not much to blame. These are wild times in the financial markets, with technology stocks in particular having a hard time.
Last Monday, the US Nasdaq index, which contains many tech stocks, made a huge turn. First the index fell as much as 5 percent that day, then trading completely reversed around noon (US) and ended with a small gain. Such a goodbye within one day, that does not happen often with such a large index.
Nerves everywhere. The US VIX index, which reflects the volatility of the shares, rose above 30 points this week, a level that was reached, among other things, just after the outbreak of the pandemic, in March 2020.
Unless something crazy happens on Monday – the last day of the month – January 2022 will go down in history as a bad stock market month. The AEX index lost 7 percent, the American S&P 500 9 percent and the Nasdaq index even lost more than 13 percent.
Where do these sharp price drops come from? Fear of heights. Shares have risen sharply during the pandemic, due to the enormous economic support that Western governments have provided, and due to the extremely loose money policy pursued by central banks. Together, they have been able to wear off the sharpest edges of the pandemic.
Investors have benefited immensely from this. Take a look: 2020 started with an AEX index of slightly above 600 points. It collapsed by a third to 404 points in March, when the pandemic panic hit. But then there was a spectacular recovery, more than doubling to 830 points in November last year.
Technology stocks, which nowadays weigh heavily in the Amsterdam index, played the leading role in this stock market boom. The US Nasdaq index rose like a rocket. While it had fallen to 6,860 points in March 2020, the Nasdaq stood at 16,057 points at the end of last year.
Economy is doing well
At the beginning of 2022, the economy will be in good shape. The International Monetary Fund lowered its expectations for economic growth in the world on Tuesday because the Omikron variant is still circulating in the current first quarter.
But expectations for the full year remain good: 4 percent growth in the US, 3.9 percent in the eurozone, 4.7 percent in the UK and even 3.3 percent in Japan – very high for that country.
But favorable economic prospects also have drawbacks. The broad support given by central banks, with their ultra-low interest rates and government bond purchases, has had its day. Especially now that inflation has risen everywhere. This could mean that those extremely stock-friendly, ultra-low interest rates will come to an end.
Why are stocks so sensitive to this? The market for government bonds is particularly attractive in the US, which now offer an effective interest rate of 1.85 percent. Shares then become relatively less attractive for the investor. But more importantly, there are many stocks that are themselves sensitive to rising interest rates.
ASML delivers, but declines
Take the tech sector. It does not only contain companies that mainly rely on distant promises. The share in the chip machine manufacturer ASML is precisely an example of the opposite. It is a technology fund that does not promise, but delivers: it makes substantial profits with unique products that are in huge demand worldwide, and even pays dividends. It is in the AEX and in the Nasdaq.
In style with the rest of the market, ASML fell to 184 euros in March 2020, after which it more than quadrupled in a year and a half to 777 euros in November last year. At the time, ASML had a stock market value of no less than 323 billion euros – double that of oil giant Shell.
Investors then offered as much as 46 times expected earnings per share in 2022 to buy ASML. And such a high ‘price/earnings ratio’ is important to indicate the current nervousness in the stock markets. Investors who pay that much for a stock apparently expect a substantial, steady increase in earnings into the future.
This makes such a ‘highly valued’ stock very sensitive to future conditions. And the interest rate environment is one of the most important. To put it simply: if the expected interest rate rises, the value of all those future profits that are already priced into the stock decreases. And that is exactly what is happening now. The higher the P/E ratio, the more important the future, and the greater the sensitivity to interest rate increases.
Stocks with a high P/E ratio, in particular, have fallen the fastest since the beginning of this year. This includes many tech companies: Adyen, ASM International and therefore ASML itself. In their wake also publishers such as RELX and Wolters Kluwer. DSM and IMCD, both chemistry and therefore no tech. But with high P/E ratios.
No wonder that last Wednesday the stock markets were nervously waiting for the outcome of the interest rate meeting of the Federal Reserve, the US central bank that sets the tone worldwide.
Powell’s Interest Rate Path
Fed chief Jerome Powell surprised investors with his determination to raise interest rates sharply this year. Powell hinted at a first post-pandemic rate hike in March. The main interest rate, currently still at the historically low level of between 0 and 0.25 percent, will then rise a quarter of a percentage point.
Most analysts had already expected that. But Powell went further. He did not rule out the possibility that the Fed would raise interest rates further at every policy meeting in 2022. At the end of this year, the interest rate would then be between 1.75 and 2 percent. Market expectations for the Fed rate at the end of this year have so far been between 1 and 1.5 percent.
At least as important was a second message from Powell: The Fed is getting ready to wind down the huge portfolio of government bonds and state-backed mortgages it bought up during the pandemic. With this buy-up of government debt, which will last until March, the Fed is now pushing interest rates on the bond markets to support economic activity.
But in these times of economic boom and peak inflation, this crisis medicine now does exactly what is not needed: it increases inflation. Because the lower the interest rate, the cheaper it is to borrow, fueling consumption, investment, and speculation in the financial markets, resulting in wide-ranging price increases. Inflation in the US in December was 7 percent, the highest percentage since 1982. The recent stock price records can also be seen as a form of inflation.
Cheap Fed Money
The Fed’s balance sheet, the total assets or liabilities, has been as of March 2020 more than doubled: to $8.860 billion. Powell admitted in so many words that the Fed has gone too far in this. He called this balance “substantially larger than necessary”.
Whether the Fed will be actively selling bonds soon or simply letting them expire is not yet clear. But the message is clear: The flood of cheap Fed money in the financial markets, which helped drive the prices of (tech) stocks high during the pandemic, is slowly coming to an end. This is now starting to sink in among investors, although it takes some getting used to. During Powell’s press conference, the Nasdaq fell about 3 percent, only to bounce back on Thursday.
Even with the path of higher interest rates now initiated by the Fed, the central bank remains in good spirits for the economy, and therefore for the investor. The so-called ‘real interest rate’ – the interest rate adjusted for inflation – will remain largely negative in the coming year, the IMF noted. this week on. In the US, only the somewhat longer-term interest rate (with a term of eight years or longer) becomes positive.
In Europe (Eurozone and United Kingdom) the situation is even more extreme. Interest rates across the spectrum will be deeply negative next year. According to the IMF, this continues to encourage risky investment behaviour. In search of scarce returns, investors turn to riskier stocks that do offer returns. Or, in many cases, promise to do so in the future.
Raising (real) interest rates in this time of inflation is a very precarious operation for central banks. Stock market risks that are difficult to detect in times of extremely low interest rates may crop up if central bankers retreat. Small stress reactions were seen on the stock market last week. A major stress response in the financial markets can cause economic damage, or even a recession.
Partly for this reason, the European Central Bank, which will meet next Thursday, is even more cautious than the Fed. The ECB will continue to buy government and corporate bonds throughout the year, although the buying rate is gradually slowing down. A first rate hike in the eurozone does not appear to be in sight until next year, although analysts, for example from Deutsche Bank, think that interest rates will have to rise at the end of this year anyway. Inflation is also very high in the eurozone: 5 percent in December, a record. So far, the ECB has maintained that these are mainly temporary price increases, especially in energy, but seasoned ECB watchers have noticed that the word ‘temporary’ is slowly disappearing from the central bank’s vocabulary.
Crypto acts like tech
Also read: Inflation has risen again. Why does the ECB not dare to raise an interest rate?
Translated to the stock market this means: more chance of higher interest rates, more periods of nerves, and a greater chance of price corrections.
What is striking is that crypto coins are also starting to behave like tech stocks. Bitcoin, still by far the largest, peaked at $67,000 last year, almost simultaneously with the Nasdaq index. The coin now stands at just above $37,000. The same goes for Ether, the number two, which has been halved in value.
The motto of crypto investors in times of price declines has always been ‘HODL’: hold on for dear life. Hold on, don’t sell, you’ll be fine. Many equity investors have become accustomed to buy the dip: strike when prices have fallen enough. Until recently, that cut wood. It was a winning investment strategy. The question is whether the generation of new investors is able to keep a cool head. Shares (and cryptos) are still higher than they were at the start of 2021. But many newcomers who only joined in the course of last year are now looking at a loss. The nervousness test, especially for them, seems to have only just begun.
Also read: In 2022, the government debt monster will awaken
A version of this article also appeared in NRC Handelsblad on 29 January 2022
A version of this article also appeared in NRC on the morning of January 29, 2022
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