RBC Market Update - Week ending February 4th, 2022

February 04, 2022 | Vito Finucci


We discuss the tug of war taking place between rising rates and earnings and the mixed bag of results from the tech sector.

The year is still young but is already shaping up to be quite the tug of war. More specifically, a standoff between two forces: pressure on asset valuations as investors anticipate higher interest rates versus the prospects of above average earnings growth.

In early January, investors began to reprice the odds of central banks becoming more aggressive in their approach to combat elevated inflation, which led to a rather weak start to the year. Thereafter, the earnings season began, and positively, investors were reminded that corporate profits remain solid and have the potential to grow at a reasonable clip this year, driven by the services and more cyclical sides of the global economy. More recently, a number of global technology juggernauts reported results. Not to be outdone, central banks provided updates that have forced investors to reassess the outlook for interest rates once more. We address both of these recent developments.

The Bank of England and European Central Bank made policy announcements over the past week. In the case of the former, it announced a quarter point increase in its Bank Rate, which adds to the first hike it made late last year. This was widely anticipated by investors. It also revealed that it will begin to reduce the size of its balance sheet in the near future, and that a number of its members were in favour of an even larger rate increase. Meanwhile, the European Central Bank, which was widely expected to remain stagnant this year, delivered a similarly hawkish message. It left its policy rate and balance sheet plans unchanged, but its comments suggest it is growing increasingly uncomfortable with the inflation backdrop. Investors now believe the door is open to some potential rate action from the ECB as soon as this year, instead of 2023, as was previously expected.

Meanwhile, the technology sector, the world’s largest and one of its most important, has been a poor performer to start the year. Much of the weakness can be attributed to the dynamic explained above: the potential for higher interest rates is putting pressure on a sector with elevated valuations. In addition, the past few weeks have delivered a mixed bag on the earnings front. Among the large cap companies, some have provided very good results and guidance that reassured investors that growth prospects remain robust. Others missed expectations for one reason or another. It is no surprise to see the stocks of companies who miss expectations get punished as we have transitioned to a climate where investors are more closely scrutinizing valuations than they have in the recent past.

On the whole, the technology sector still possesses some enviable growth prospects and exposure to powerful secular trends that are not going away any time soon. But, the sector may remain vulnerable until the broader market can get comfortable with the degree of monetary policy tightening that may take place. Ultimately, central banks will need more time to assess inflationary pressures and recalibrate policy, leaving investors to ponder the pace and extent to which central banks may raise rates. With this in mind, our investment approach will remain patient with high conviction holdings and nimble should new opportunities arise, while also ensuring portfolios are adequately diversified in the face of a new interest rate cycle that is getting underway.

Should you have any questions, please feel free to reach out.