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Writer's pictureMichael Smith

Is the market too focused on rates and overlooking proven growth opportunities?

Some mega-tech companies are trading at pre-pandemic prices. Is it time to buy?


As we’ve become used to seeing throughout 2022, there is no bigger talking point for the stock market than elevated inflation and rising interest rates.


However, two of the biggest hurdles for the market thus far are also two potential catalysts that can potentially lead to a reset in stock market valuations.


Of course, in the midst of an uncertain economic environment, it’s easy to lose sight of the fact that the share market is well off its highs. And for individual stocks, including market leaders that have seen transformational growth, the losses have taken some names back to multi-year lows.


Why rate hikes may now be less concerning


The Federal Reserve recently made the decision to lift interest rates by 75 basis points, in a move that was widely telegraphed as inflation remains stubbornly high.


As yet, there is no clear indication that we are near a terminal interest rate level, with the central bank having said little to suggest it is prepared to wind back its rate hikes.

At the same time, the Fed’s current path is also supported by strong employment, which has provided the foundations to hike interest rates.


With that said, it is our view that we are a lot closer to the top than we are near the bottom.

In fact, we believe the Federal Reserve will soon begin to shift in adjusting the magnitude of its rate hikes, with a step down to 50 basis points, and/or 25 basis points on the cards.


Already, this level of speculation has provided some support for equities to bounce off their lows. It was one of the key factors for the stock market rally we witnessed throughout October.


We would anticipate that further confirmation of a dovish pivot would provide clarity for the market, while also allowing investors to recalibrate their valuations for stocks, particularly in the rate-sensitive tech sector.


This would align with what we saw when the Reserve Bank of Australia made a similar move in cutting the size of its interest rate hikes from 50 basis points to 25 basis points.

The obvious justifications for a winding-down, or even a pause in interest rate hikes would be signs of inflation decisively moving lower.


While that has not transpired, it is likely that central banks, including the Fed, will be reluctant to keep pushing rates up without at least taking the time to see the effect that said rate hikes have had.


It must be reiterated that interest rate hikes take time to flow through the economy, and while there are early signs suggesting the housing sector has come off the boil, we really need to see this filter through to the consumer.


Growth overlooked, valuations discounted


With all the above said and done, markets are still sitting well off their highs. There is a long list of stocks - once again, especially tech stocks - that have fallen more than 70% from their all-time highs.


More pertinently, it is the market leaders that we are taking great interest in, because this is where we feel there is great risk-reward upside.


Quality companies such as Microsoft (MSFT), Alphabet (GOOGL), and Amazon (AMZN) are still delivering blockbuster earnings reports, despite a number of headwinds being cited as either having an impact on their results, or looming on the horizon.


But in the grand scheme of things, we do not believe the market discount attributed to these factors is representative of the nature of the issues at hand.


On top of that, we also do not believe current prices reflect the level of growth that these companies have recorded over the last two years, and how moderating growth in the near-term is a function of the fact that we are growing from a markedly higher starting point.

Take for example, Amazon. Yes, the company’s outlook guidance for the final quarter of the year may look somewhat soft on paper, at just 2-8% revenue growth.


However, that outlook figure was always going to decelerate in the wake of skyrocketing growth recorded during the last two years of the pandemic.


What’s more, the stock is now trading at pre-pandemic levels, almost as if it hasn’t benefitted at all from the paradigm shift in the ecommerce sector, including the way we shop, as well as cloud computing.


Remaining patient in a tough market


Although it is difficult to witness market volatility play havoc with our returns at times, we must also recognise that this is the nature of the stock market.


It is also the reason why we maintain a focus on high-quality companies that have a proven ability to grow throughout the economic cycle.


We look for companies that offer diversified revenue streams, have core products or services that are highly regarded, and resilient business models playing a leading role in their industry or field.


With this in mind, it is important that we remain patient and manage our Portfolio with a long-term outlook. We must avoid any ‘reactionary’ type of responses to market events or company news.


Instead, we need to think in the context of what our holdings will be doing over the years to come. And given the trends that have taken place, there is good reason to believe plenty of growth lies ahead, once we pass any hiccups along the way.


It is our belief that the current market sell-off is not only overdone, but in many cases, has created a number of attractive long-term buying opportunities.


These opportunities may still entail some downside in the near-term, but they are also the sort of prospects that don’t come along very often.


On the contrary, the risk of missing out here means that we could forgo considerable opportunity cost once markets start to rally - something we feel is more likely as we get closer to the end of the Federal Reserve’s rate hike cycle.


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