Inflation in the US is playing a spoilsport with the equity market investors. Rising yield is sending disturbing signals to the stock market investors and the ongoing war in Ukraine is also putting pressure on the economy. How the dynamics of the US economy changes and how the US market responds in the coming weeks and months will be largely dependent on the planned series of rate hikes by the US Federal Reserve. Asheesh Chanda, Founder and CEO, Kristal.AI shares his view on the expected impact of the series of rate hikes on the US stock market and the tech-heavy Nasdaq 100 in particular. Read on to find out what investors with exposure to US stocks do in the present environment.

Rate hikes by the US Fed in 2022 will be a keenly watched event. What is the market expecting the Fed to do?

Fed has only delivered one 0.25% rate hike at their March meeting, but they have signalled a more aggressive stance in the months to come. Central bank policy is always data dependent, so if we see a sharp slowdown in growth, expectations might change again rather quickly. For now, market expectations are that by June we will reach a level of around 1.5% and 3% by March 2023.

How big is the expected impact of the series of rate hikes on the US stock market and the markets worldwide?

Empirically, equity markets have a tendency to continue their rally anywhere between 2- 6months until after the first rate hikes. It will only become an issue, if the Fed in their mandate to fight inflation are risking a severe slowdown or even recession, when equity markets would start to react negatively.

Right now, the forward growth expectations are still positive despite the expected changes in rates policy. But we caution that investors should be very careful and expect much lower rates of return in the coming quarters if not years ahead.

While many have become used to annual growth rates of 12-20% in US Equity markets, we expect a normalization of that rate back to medium to high single digits.

European markets are also pricing in a bigger drop in growth expectations, mainly driven by the high cost of energy imports post Russia’s aggression against the Ukraine.

What should investors with exposure to US stocks do in the present environment?

It is important to look out for changes in overall economic growth expectations. We are closely monitoring this quarter’s earnings season to see if companies are revising downward their growth expectations sharply.

We also think that in this environment it is important to focus on good businesses at a good price, as revenue growth itself for highly geared companies might not be enough to increase profitability.

It is important to have a good balance between value and growth, and also to closely look at holdings in the portfolio. Even if some positions might be down 25-50% from the highs already, don’t fear to cut losses, as a recovery might never come for some.

What could be the impact of Fed rate hikes on the tech-heavy Nasdaq 100 index and other tech stocks?

Most companies should be able to handle higher rates up to 3-4%, but there will even be some victims who relied on ultra cheap money over the last 10 years.

Our team is wary of companies with high leverage and no or low profitability. Companies who achieve a return on invested capital in the 3-4% region and are 4-5x levered over ebitda will struggle or resort to equity financing, which will lead to lower prices.

Also companies who raised debt to buy back stocks should be avoided, as the tide will turn its direction. But even within the tech sector, our team sees great value opportunities, and with a long term investment horizon in mind, we continue to believe that technology will continue to play an important role in the fight out of inflation through productivity gains.

What is the likely impact on equity markets during the Fed rate hikes

The biggest change for us is that the Fed has abandoned their implied asset volatility management through substantial changes in the narrative. First signals emerged in November last year, but since the March meeting minutes it is more evident that the Fed put might have been diminished, if not even abandoned at all.

It does seem that the Fed is determined to bring long term inflation expectations back under control and with a trajectory back towards the 2% target rate, even if it means risking a 20% equity market sell off.