Weekly Brief: Surviving inside the turmoil of inflation and interest rate hikes

The Plunge of S&P 500

Until January 4th, 2022, most of the investors believed that the US stock market is showing a decent start. Despite the outbreak of COVID-19, S&P 500 made 16.26% of return in 2020, and 26.89% of return in 2021 was a true ‘liquidity party’. It was hard to accept opinions such as ‘Now it is time for correction’, or some aggressive voices such as ‘We should short the market’. However, since the record high of S&P 500 of 4,793.54 points on January 4th, S&P 500 plunged 7.54%, by closing 4,431.85 on the last trading day (2022-01-28).

Since investors around the world experienced a liquidity party for the last two years, the current S&P 500 of 4431.85 is truly embarrassing.

Why is this happening?

Then why is the S&P 500 underperforming? There is no doubt that the fear of high inflation generated this fluctuation. As mentioned in the previous weekly briefs, the last CPI announcement (2021-12) was 7%, the highest Consumer Price Index (monthly, year changes) since 1982. High inflation means that the US Fed would stop injecting liquidity to the market, and conduct high-level bond tapering & interest rate hikes. Goldman Sachs, one of the most prestigious market makers, predicted that Fed would hike interest rates four times in 2022, while most of the other brokers predicted three times.

Following is a line from Thomas Barrabi from New York Post, in the article ‘Inflation could lead Fed to hike rates more than 4 times in 2022: Goldman Sachs’

Goldman’s current projections call for four rate hikes in 2022, with hikes coming in March, June, September and December. But with inflation at a four-decade high, the central bank could adopt an even more hawkish policy stance, analysts said in a note to clients over the weekend.

“We see a risk that the will want to take some tightening action at every meeting until that picture changes,” the Goldman Sachs analysts said. “This raises the possibility of a hike, or an earlier balance sheet announcement in May, and of more than four hikes this year.”

The Fed is set to tighten monetary policy in the coming months, with efforts to include rate hikes and trimming of the central bank’s nearly $9 trillion in bond holdings. The central bank’s last rate hike occurred in December 2019, months before the COVID-19 pandemic began.

Sectors that might survive inside the turmoil of inflation & interest rate hikes

However, there are some sectors that can survive inside the turmoil of inflation and interest rate hikes. Let’s take a look at the sector that traditionally performed strongly while CPI went up, and while interest rates hiked. This is not just the view of the professionals in the market, but also the view of the members of the WEFF 1 Fund as well.

3-1. Energy Sector Stocks & Commodities

The Energy sector is one of the most popular sectors while the fear of inflation overwhelms the global markets. When inflation rates get high, energy prices get higher. When energy prices get higher, the fundamentals (earnings) of the companies that have a business model relying on energy can be improved.

For example, XOM, one of the world’s biggest oil refining & distribution companies, performed extremely strong, while S&P 500 was fluctuating.

Under the same logic, oil futures & commodities might perform strongly for the next few months. Above is the chart of the WTI Crude Oil index, performing the opposite way while S&P 500 was fluctuating.

3-2. Financials

Buying stocks in the financial sector is one of the most popular & solid ideas to hedge the risk of the portfolio. When the interest rate goes up due to the Fed’s policy, financial companies that highly relies on ‘commercial banking’ can improve their balance sheet. Especially, Wells Fargo & Company (WFC) was one of the best stocks in 2022 so far. Wells Fargo has one of the strongest commercial banks in the United States, ranking third place, followed by J.P. Morgan (Chase Bank), and Bank of America.

US Commercial Banking Ranking

Rank	Name	Total Assets
1	JPMorgan Chase Bank	$3,025,285,000
2	Bank of America	$2,258,832,000
3	Wells Fargo Bank	$1,767,808,000
4	Citibank	$1,661,507,000
5	U.S. Bank National Association	$544,774,160
6	Truist Bank	$498,944,0007
7	PNC Bank	$463,097,309
8	TD Bank	$401,511,800
9	The Bank of New York Mellon	$386,515,000
10	Capital One	$363,521,558
11	Charles Schwab Bank	$342,023,000
12	State Street Bank and Trust Company	$311,181,000
13	Goldman Sachs Bank USA	$271,652,000
14	Fifth Third Bank	$203,174,120
15	HSBC Bank USA	$197,980,343
16	Citizens Bank	$183,365,970
17	Morgan Stanley Bank	$175,627,000

As Wells Fargo highly relies on commercial banking than investment banking (while Goldman Sachs, Morgan Stanley highly relies on investment banking), they were able to announce decent earnings, adding value to their equity.

Therefore, we, the members of WEFF 1 Fund focus more on sourcing & screening a ‘good sector’, than finding a ‘good stock’, as it is extremely difficult to win the market. By finding a decent sector that can perform well inside the turmoil of inflation, we aim to provide returns to our investors.

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References

Thomas Barrabi. (2022, January 24). Inflation could lead Fed to hike rates more than 4 times in 2022: Goldman Sachs. [Website]. Retrieved from https://nypost.com/2022/01/24/inflation-could-lead-fed-to-hike-rates-more-than-4-times/

Lewis Krauskpf. (2022, January 14). Analysis: U.S. energy shares on fire again to start 2022, stoked by inflation. [Website]. Retrieved from https://www.reuters.com/business/energy/us-energy-shares-fire-again-start-2022-stoked-by-inflation-2022-01-13/

Simon Kennedy. (2022, January 29). Goldman Sachs Predicts Fed Will Raise Rates Five Times This Year. https://www.bloomberg.com/news/articles/2022-01-29/goldman-sachs-predicts-fed-will-raise-rates-five-times-this-year

Enda Curran. (2022, January 30). Quantitative Tightening Looms For Markets on Hawkish Fed

.https://www.bloomberg.com/news/articles/2022-01-29/quantitative-tightening-looms-for-markets-as-fed-turns-hawkish