The idea that interest rates would remain low forever was ‘blue pill thinking’ by the market, according to Spheria, and lacked focus on the fundamentals.
Likening it to movie The Matrix, where the lead character can take a blue pill to remain in blissful ignorance or a red pill to understand the reality, Spheria co-founder and portfolio manager Marcus Burns, said this was the situation regarding interest rates.
Rates had remained so low, around 0.5% or lower, for so many years that it was expected this would be forever the case. In the UK, for example, there was no interest change for seven years between 2009 and 2016 and they still remained below 1% despite modest rises since 2016. However, rising inflation was forcing central banks to finally consider seriously raising rates again.
The Federal Reserve raised rates by 25 basis points to 0.5% earlier this month and the Reserve Bank of Australia was expected to make multiple rate rises later this year.
Burns said: “There was this belief, what I call iZirp, or infinite zero rate policy, that everyone thought that central banks would remain all powerful, they'd keep buying bonds forever, and that would keep interest rates incredibly low.
“That provided abundant liquidity for investors in the stock market broadly, and really there's a lot of what I call blue pill thinking. The market was very plugged into hot stories, hot ideas, momentum, and very little was focused on fundamentals.”
Expanding on what blue pill thinking looked like among investors, he said people were getting carried away by liquidity.
“The market goes through these incredible mood swings where you become very exhilarated by certain ideas and certain stories, disruptive stocks, FinTech and biotech were all very exciting, especially in smalls and micros. And people tend to get onto stories that sounded very compelling. There wasn't much red pill thinking going on. It was all very much what's the narrative of management teams, how big could this market be in five years' time? Very little application around what the business was today, what cashflow was today.”
A better solution regarding the ‘red pill’ would be central banks exiting buying bonds, a slowdown in the IPO market and excessive use of exchange traded funds (ETFs) and a more rational thinking about capital allocation by management teams.
“With rates rising, and a longer term lens being applied to the stock market, we think investors will question this idea that growth at all costs is where you should put your money. We think you'll see rotation out of sales growth companies with correctional business models, and back into things that look a little more fundamental.”