Cathie Wood and Warren Buffet see eye-to-eye again

Chart of the week

This chart shows the performance of two investment vehicles that couldn't be more different.

The Ark Innovation ETF is managed by Cathie Wood. She has made a name for herself investing in new growth stocks and innovative business models. She focuses on companies that are changing entire industries with new approaches. She was one of the first managers to bet on Tesla and Palantir.

Berkshire Hathaway is the investment vehicle of Warren Buffet. The best-known representative of the deep-value approach. He invests in stable companies with continuously growing earnings for years, such as Coca-Cola. Warren Buffet was long considered the best investor in the world and worked his way up from the middle class to the richest American. In recent years, however, he has been overtaken by Jeff Bezos, Elon Musk, Bill Gates and Mark Zuckerberg.

Why this matters:

The chart highlights the huge shifts taking place in the markets. The broad market index in the U.S. was up over 15% in 2021. Yet some stocks were down as much as 50%. The broad indexes do not show what is really taking place.

Since the Federal Reserve, first verbally and now with tangible actions, has turned monetary policy from expansionary to restrictive, a change in style is taking place in stocks. The long-forgotten value stocks are fighting their way back, and the highly touted growth stocks are correcting, in some cases massively.

Many young growth companies are not yet profitable and have financed their growth with short-term loans. This is now becoming much more expensive:

The chart shows the yield on the 2-year US Treasury bond. Interest rates have increased fivefold since September 2021! We therefore think that the shift from growth to substance stocks will continue.

Stock markets in a rising interest rate environment

Traditionally, stock markets are considered safe during periods of inflation and rising interest rates. This is due to the fact that central banks raise interest rates when the economy is doing well and companies can cope with the higher interest rates.

The chart shows 12 phases since 1947, from times when the Federal Reserve changed strategy. The chart shows stock market returns two years before the first rate hike and three years after. The broad market expects the first Fed rate hike in March 2022.

In 3 of the 12 periods, rates were raised too soon or too quickly and the economy failed to recover. In the vast majority of cases, equity markets continued to rise. However, a sideways movement of the markets in the first 6 months after the first rate hike occurred relatively often.

The chart also shows that the stock markets could increase in phases of rising interest rates (blue bar). However, no large increase is expected in the first 6 months after the first increase (light blue and orange bars).

American mid-term election year

Due to Corona, it was somewhat forgotten that the mid-term elections are taking place in the USA this fall. One-third of the senators and all members of the House of Representatives are newly elected. Traditionally, the party that did not win the presidency in the last election wins the midterm elections.

Currently, there is a fairly high probability that this tradition will be continued. Biden is currently in a polling slump. His ill-advised statements on Ukraine, which in effect invite Russia to a partial invasion, will put him under further pressure.

The chart shows how, on average, the return of the broad U.S. stock market moves when midterm elections are coming up.

Until after the elections, a sideways movement can be expected and only by the end of the year the market continues to move upwards.

Both observations, the behavior of the markets when interest rates are first raised as in a mid-term election year are remarkably consistent. So, everything points to a first half of the year with high fluctuations and a sideways phase.