The start of a new year often triggers positioning for investment themes that strategists are predicting. One of the significant themes that many experts are focused on is higher inflation and interest rates. This issue has been developing for a while, but weakness in bonds coupled with the start of the New Year triggered some aggressive rotational action Tuesday.
The stocks that suffer the most from the perception of higher inflation and interest rates are high price-to-earnings (P/E) growth stocks that tend to be technology related. These stocks often won't have significant earnings until many years from now, and that future income stream is worth less when interest rates are high.
The money that rotated out of the high P/E growth names found its way into banks, financials, automobiles and more traditional growth names. A good illustration of what happened can be seen when comparing ARK Innovation ETF (ARKK) , which is made up mostly of high P/E growth names, and Warren Buffett's Berkshire Hathaway (BRK.B) , which holds financials and value names. Ark was down 4.4% which Berkshire was up 2.5% to a new high.
This rotational action does some collateral damage as stocks with solid fundamentals and reasonable valuations are included in the baskets of stocks that aggressively are bought and sold by the computer algorithms implementing the rotational action. If your favorite stocks are in the wrong sectors, they won't be safe even if they are good businesses.
The good news is that this rotational action is big and sloppy, which does create inefficiencies in pricing that eventually will be corrected. The bad news is that the rotational pressure can continue for a while, and there is no way to time when the overshoots in the market may reverse.
We have a very mild start here on Wednesday morning as market participants await the minutes of the last Fed meeting and contemplate to what degree the bond market is already pricing in inflationary concerns.