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Uncertainty around hawkish central banks has led to volatility

Harbour sails 5
Harbour Team | Posted on Feb 1, 2022
  • Global equity markets were strong in 2021 benefiting from accommodative central banks and record earnings growth to spur on returns
  • Loose monetary and fiscal policy, implemented in response to the COVID-19 pandemic, has led to an increase in inflation, which central banks now need to combat
  • Uncertainty around the exact extent of future interest rate changes has led to a volatile start to 2022 in markets

Global equity markets were strong in 2021 benefiting from accommodative central banks and record earnings growth to spur on returns. While companies are continuing to deliver strong earnings growth (a key driver of long-term returns), loose monetary and fiscal policy, implemented in response to the COVID-19 pandemic, has led to an increase in inflation. Central banks around the world have generally turned hawkish, tightening monetary policy through increasing interest rates and, as New Zealand did in the middle of last year, ending or signalling an end to quantitative easing.

The uncertainty around the exact extent of future interest rate changes has led to a volatile start to 2022 in markets. For example, the main US stock index, the S&P 500, which returned 27% in 2021 fell over 5% in January, after at one stage being down more than 10%. That drop in January was larger than any fall we had in 2021.

Putting 2021 and our experience so far this year in context, a study by JP Morgan found that, since 1980, the average intra-year drop in equities was 14%. Equities, despite this yo-yoing up and down, returned an average of 9.3% p.a. over that time period.

These numbers reinforce that, in the short term, investing in equities may “feel” risky due to the volatility of returns that can be seen over periods like one month. Investors in equites should always have the capacity to look at longer time frames where rising earnings and the compounding of dividends can provide a large cushion and impetus for real investor returns.

Over the short term, share markets may focus on a range of things like changes in interest rates and bond yields (as they are now). Additionally, sentiment may be impacted by geopolitics. Over the long term, company earnings should be the key driver of performance. Building real wealth means focusing on identifying companies that can both grow earnings faster than the market expects and maintain that growth through market cycles.

Why are equity markets so concerned about interest rates?

To cut to the chase, when interest rates rise, valuations generally fall. Typically, equity investors are looking to invest for longer periods of time and consider the interaction of potential future earnings and dividends balanced against the cost of money in the medium to long term.

For instance, the 10-year interest rate (or bond yield) is classically used to anchor equity valuation. The multi-decade low in the 10-year interest rates of less than a 0.5% yield was a boon for valuing long-dated equities – especially technology stocks and companies with stable and more certain dividends, such as utilities.

In New Zealand, 10-year bond yields are now 2.6%, up more than 2% on the lows struck in 2020. The market in New Zealand is anticipating six to seven interest rate rises this year and another two in 2023. A tightening cycle of nine interest rate rises seems well baked into New Zealand’s bond and equity market.

This interest rate rise is likely to have been a dominant factor in the under-performance of the New Zealand equity market through 2021 and the further fall in January 2022, although a high initial relative valuation and compositional factors, such as a low exposure to well-performing banks and resources, is another factor.

This under-performance hasn’t been exclusive to New Zealand though. Globally, over December and January, higher bond yields triggered a rotation from growth and information technology to cyclical stocks. Omicron hit re-opening stocks, particularly travel stocks. Chinese policy easing supported commodity prices and materials stocks. 

Light at the end of the tunnel?

It's important to remember that many investors have benefited from very strong equity returns in the last 10 years. Staying invested has been a simple strategy for investors to beat more conservative strategies. A large chunk of investor returns has been backed by solid earnings and revenue growth. However, some of the rise in equity prices has also been generated by higher valuations. Markets have started to see a wash-out of some of the excesses in valuations

The cheapening of stock prices could mean investors begin to think that the major risks for higher interest rates have been recently factored into valuations and that, from here, the corporate earnings outlook could take over as the principal influence on equity returns.

Long-term investors might increasingly find bargains in the next few months but, rather than rely on a bounce in valuations, it seems more likely that equity returns will be more closely marked to revenue and profit growth trends. Within our equity growth portfolios, we have taken the opportunity to increase exposure to companies caught up in the sell-off, some of which are trading at below COVID levels despite delivering double digit earnings growth in the ensuing period.

History teaches us that volatile periods, while unsettling, may also give rise to opportunities. We only need to cast our minds back to March 2020 and look at where key portfolio holdings Summerset, Mainfreight and Pacific Edge traded in order to remind ourselves that long-term growth companies can be influenced by short-term sentiment. Looking at key holdings such as Alphabet, Microsoft and Charles Schwab within T. Rowe Price’s Fund yields a similar lesson. These results were achieved despite the headlines, which tend to already be reflected in share market pricing. This shows the high level of uncertainty that existed in markets at the time which led many investors (particularly in KiwiSaver Funds) to alter their investment strategy in response to the uncertainty.

In our view, the best investment results are achieved through considering carefully whether investment portfolios are aligned with both goals and investor appetite for risk.

Harbour Asset Management Limited is the issuer and manager of the Harbour Investment Funds. Investors must receive and should read carefully the Product Disclosure Statement, available at We are required to publish quarterly Fund updates showing returns and total fees during the previous year, also available at  Harbour Asset Management Limited also manages wholesale unit trusts. To invest as a Wholesale Investor, investors must fit the criteria as set out in the Financial Markets Conduct Act 2013. This publication is provided in good faith for general information purposes only. Information has been prepared from sources believed to be reliable and accurate at the time of publication, but this is not guaranteed. Information, analysis or views contained herein reflect a judgement at the date of publication and are subject to change without notice. This is not intended to constitute advice to any person.  To the extent that any such information, analysis, opinions or views constitutes advice, it does not take into account any person’s particular financial situation or goals and, accordingly, does not constitute financial advice under the Financial Markets Conduct Act 2013. This does not constitute advice of a legal, accounting, tax or other nature to any persons.  You should consult your tax adviser in order to understand the impact of investment decisions on your tax position. The price, value and income derived from investments may fluctuate and investors may get back less than originally invested.  Where an investment is denominated in a foreign currency, changes in rates of exchange may have an adverse effect on the value, price or income of the investment. Actual performance will be affected by fund charges as well as the timing of an investor’s cash flows into or out of the Fund.. Past performance is not indicative of future results, and no representation or warranty, express or implied, is made regarding future performance. Neither Harbour Asset Management Limited nor any other person guarantees repayment of any capital or any returns on capital invested in the investments. To the maximum extent permitted by law, no liability or responsibility is accepted for any loss or damage, direct or consequential, arising from or in connection with this or its contents.