Emmanuel Macron’s victory in the presidential election was not hailed by the stock market, in Paris or elsewhere. All European markets thus opened in the red on Monday, with a CAC 40 index down sharply by 2% at mid-session, towards 6,400 points, reducing the drop in the middle of the afternoon around -1, 40%. The electoral results were, it is true, already widely anticipated by the markets and integrated into prices. The Stock Exchange has never really taken into consideration the hypothesis of a majority for Marine Le Pen at the end of the ballot.
The markets remain reeling from the rise in rates and under the threat of the health situation in China which caused the Asian markets to fall at the close on Monday. Almost all of the economic capital of Shanghai has remained in lockdown for three weeks, again disrupting supply chains. In the opinion of many analysts, the Chinese government’s “zero Covid” policy, which persists and signs on this path, could ultimately jeopardize Chinese growth, and therefore global growth.
But it is indeed in the area of interest rates that concerns remain the most acute. What surprises the markets is not the rise itself, which can be justified by the strength of the recovery in recent months, but its accelerated pace.
The “hawks” set the tone
US 10-year rates, which give the the on the markets, have increased by 130 basis points since January to now tangent the symbolic threshold of 3%. More surprisingly, European rates have followed almost the same pace, while growth and inflation are at lower levels than across the Atlantic and the European Central Bank (ECB), unlike the Federal Reserve, does not has not yet started to raise its key rates.
The German 10-year rate, the benchmark rate for a risk-free asset in the euro zone, is approaching 0.9%, or more than 107 basis points since January, and the French 10-year rate (OAT) stands at 1.35% (after having exceeded 1.4%) today, against 0.2% at the start of the year. That is a multiplication by 7 in four months! This rapid rise in European rates also foreshadowed a lull. Alas, Christine Lagarde, President of the ECB, dashed these hopes last week by evoking, for the first time, the “high probability” a rise in key rates before the end of the year.
But it was Fed Chairman Jerome Powell who sounded the charge last week, deeming it “appropriate” to raise key rates by 50 basis points next May, a rate hike cycle the fastest for decades. In short, it is indeed the “hawks” (priority to the fight against inflation) who now set the tone compared to the “doves” (priority to growth).
Pressure on growth stocks
The rise in rates is not necessarily bad news for the stock market, provided that companies retain the ability to maintain the rate of growth in their profits. This is why investors prefer stocks that have pricing power, those that can pass on the price of their goods and services the increase in the cost of inputs, raw materials and wages.
On the other hand, there is mechanical pressure on growth stocks, which are generally valued by discounting their future cash flows. However, the higher the interest rate, the lower the discounted amount. But that rule doesn’t apply to growth stocks that manage to maintain their competitive edge, like Netflix. Still, the Nasdaq, the US benchmark index for growth stocks, fell 9% over one month and 18% since the start of the year.
On the other hand, sector rotation in favor of “value” stocks can be a support factor for the markets, especially in periods of high inflation. Certain sectors, such as commodities, listed real estate, banks and insurance, or more defensive stocks, such as telecoms, could benefit from this.
Another threat to equities: rising rates are making fixed income assets more attractive, especially risk-free sovereign debt, now in largely positive territory, and managers could arbitrate in favor of debt rather than equities. But this rotation movement does not yet seem clearly committed, even if equity funds are beginning, timidly, to outflow, after the massive inflows of last year.