Last month, all eyes were on US politics being able to reach an agreement on the debt ceiling. A deal was reached under the wire, which brought back investors’ positive sentiment. Recession fears have been pushed out towards 2024. Even the most bearish economists are now turning less negative on the US and European economies.

Tech replaced safe havens like Consumer Staples and Utilities, as they hold large cash positions and are responsible for most of the performance of the main indices like the S&P 500. Is “AI” a hype or a complete reshaping of the use of technology in many fields of our daily lives?

We are now entering summer, which is historically known for storms and stress in the markets, caused by less liquidity and little appetite from investors to enter new positions. The focus will remain on economic numbers and especially on how much positive or negative surprises are already priced in. The US consumer data have shown resilience, is it going to last? Are current valuations sustainable going into H2 of 2023? We are climbing the Wall of Worry …

China will also play a central role in the second act of 2023. Everyone is waiting for the great recovery that is playing hard to get, and that will be the main driver for commodity prices such as copper, steel and oil. The Middle Kingdom needs a stimulus package in order to return back to growth and achieve the growth target set by its government.

Credit Spreads still seem too low, as the refinancing of debt has become much more expensive, and usually the effects of higher financing costs are lagging. Watch out for High Yield with low quality.

The legendary investor Peter Lynch once said, “Although it’s easy to forget sometimes, a share is not a lottery ticket…it’s part-ownership of a business.”

This quote emphasizes the importance of focusing on the underlying fundamentals of a company. Last month, we saw mixed equity markets, with some sectors and companies experiencing significant gains (US Consumer Staples +2.94%, US Healthcare +2.12% and EU Luxury +3.09%), while others struggled (US Industrials -1.22% and EU Auto -2.55%).

The quote of Peter Lynch also illustrates the importance of companies’ earnings. Since last month, all eyes are on the Q1 reporting season in the US. Q1 is expected to register a decline in YoY earnings growth for the second consecutive quarter, fulfilling the conditions for an earnings recession.

Another parameter of current stress in the markets is the US debt limit which is being reached faster than expected. Weak tax collections in April suggest an increased probability that the limit will be reached in the first half of June. This would raise the possibility of a short-term ceiling extension, but it all comes down to the US Congress being able to reach an agreement – which is not very likely. The 1yr CDS on the USA reached an all-time high of 176 basis points higher than some HY corporates!

Most global central banks may be either close to a peak or already done with interest-rate hiking. May could cement a turn in what has been the most aggressive global tightening cycle seen in decades. A soft March CPI YoY (down from 6% to 5%) and PPI YoY (down from 4.6% to 2.7%), coupled with weak retail sales (-1.0%), is reviving talks that the inflation battle has been won.

The commodities complex has started to price in a weaker economic activity with industrial metals and energy prices softening during the month of April. The war in the Ukraine and supply constraints seem to be less of drivers for higher prices as well as the slower than expected reopening of the Chinese economy. This is partially helping inflation prices to continue its decline and should be supportive for the FED to achieve a soft landing and avoid a severe US recession.

However, the fight between Bulls and Bears is still ongoing and investors expectations continue to be divided about the outcome of the current slowdown.

Many bad things can happen to banks. Its customers can pull their money out (a liquidity crisis). Their borrowers can fail to repay their loans (a solvency crisis). Their shareholders can sell their stock, sending their shares down (a confidence crisis, making it far harder for them to raise money). And beyond true crises, changes in economic and financial conditions can attack their profits — which is bad for shareholders and ultimately might tend to imperil everyone connected to the bank. All of these things are conceptually separate, although in practice they will often affect each other.
The collapse of Silicon Valley Bank, Signature Bank and Silvergate Capital Corp were all triggered by a liquidity crisis caused by poor diversification of its depositors and lamentable risk management. Those banks are important for the US economy as they feed many young companies with the capital needed to realize their projects. The network between small and/or new companies with their regional banks has a crucial role for the ongoing economic heartbeat of United States. Germany has a similar setting – small industries, famously known as Mittelstand, are connected with their local regional banks, Both models relied heavily on the regional banks albeit with completely different client profiles. The success lies in the proximity with the clients, Know Your Client, in the traditional manner and the quick and smooth response to credit access. We could argue what makes an Economy successful? I will argue it is Energy and Banking services!

Economy is the transformation of energy with the cheapest resources!

The move from bank accounts to money funds and other instruments is likely to put more cash in the pockets of longsuffering savers, but there is concern that a dearth of deposits will leave the US with a smaller number of community and regional banks that have less money to lend — and that in turn could hold back growth and worsen inequality. Bank loans are a crucial source of funding for small businesses, which employ about 46% of Americans who work in the private sector and have generated nearly two-thirds of jobs created since 1995, according to the US Small Business Administration.
The forthcoming regulations and commercial real estate mayhem will, for sure, dampen small and midsize activities damaging the economic activities.as they will deprive firms of capital. Since 2022 the cost of money has already made its way through the credit activities, whether loan, leasing, or short-term credit lines. The inverted yield curve does not provide high incentive for banks to offer for long-term credit and now with the mistrust and new regulations the credit will be restrained. 

Small and Mid-cap companies will be the first in line to suffer. Credit spread widening will accelerate, in the first instance, for lower quality bonds – CCC bond spread is already under pain and it will soon contaminate the other ratings! Stay away long duration High yield bonds, stay away small/mid cap companies with weak balance sheets.

In section VII of Psychopathology of everyday life (1905), entitled “The forgetting of impressions and intentions”, Sigmund Freud, the founder of psychoanalysis describes the mental process by which a person can sometimes reject the reality of a perception, on account of its potentially traumatic associations, despite overwhelming evidence. In that specific section, he recalls how he became angry with his wife during a visit to a restaurant. She was listening to a gentleman’s conversation with his neighbors and asking him (Freud) questions that took up the thread of their discussion. A few weeks after the incident, Freud complains to a relative about this behavior, but he is not able to recall even a single word of the conversation of the gentleman – an amnesia undoubtedly determined by respect for his wife. Sometimes, we, investors, have to endure too much. We prefer to forget. Forgetfulness of lingering price pressures, erasure of painful market drawdowns, dismissal of central bankers’ warnings. If Sigmund Freud had seen January’s “everything rally” (S&P 500 +6.2%, Nasdaq-100 +10.6%, Stoxx Europe 600 +6.7%, Xover/CDX 5yr -60bp/-54bp), he would have screamed Verleugnung! Denial! U.S. inflation is admittedly moderating, but the January CPI showed that the disinflationary process is far from being smooth. The gauge rose 0.5% in January after posting smaller 0.1% and 0.2% gains in December and November, respectively. On a year-over-year basis, headline/core CPI advanced 6.4%/5.6% (consensus +6.2%/+5.5%). Besides energy, several components showed some unexpected strength lately, such as prescription drugs (+2.1% month-over-month) or apparel (+0.8%), in addition to labor-reliant categories like nursing homes (+1.4%) or car repair (+1.3%). Inflation also rebounded at the wholesale level, with the PPI rising 0.7% in January, higher than the 0.4% estimate. The January core PCE price index came as a confirmation of the overall rebound, advancing by 0.6% month-overmonth on both the headline and core (consensus +0.5%/+0.4%, respectively).

In ancient Roman religion and mythology, Janus was the god of gates and doors, the god of beginnings and transitions, both in literal and abstract ways As we know, the month of January is named for him. Portrayed with two faces one facing the past, and one facing the future Janus was proudly venerated as a uniquely Roman god (rather than one adopted from the Greek pantheon) One way to honor Janus was essentially to exchange New Year’s gifts such as dates, figs, honey and even coins with your friends These gifts, strenæ in Latin, became étrennes in French, strenne in Italian (and Neujahrsgeschenk in German, for some reason).

We, the neo Romans, had to deal with the ugliest face of Janus last year, and gave up a large chunk of our portfolios to honor him (as a reminder, 2022 performances: S&P 500 -19.4%, Nasdaq-100 -33.0%, Stoxx Europe 600 -12.9%, Nikkei 225 -9.4%, HSCEI -18.6%). Pleased with our generosity, Janus in January decided to offer us better prospects on the macro, monetary and performance fronts.

Global equities bounced in January indeed (S&P 500 +6.2%, Nasdaq 100 +10.6%, Stoxx Europe 600 +6.7%), in a reflection of investors’ growing belief that central banks can now tame inflation without bringing a recession. Credit spreads tightened substantially (iTraxx XOVER 5 yr 414 bps i.e. -60 bps, CDX 5 yr 430 bps i.e. -54 bps). This soft landing notion has been reinforced by a flurry of economic indicators in the U.S., ranging from (i) a better-than-expected jobs report (US nonfarm payrolls +223,000 in December vs. consensus +200,000 ), (ii) reassuring inflation data (US headline/core CPI further decelerating to 6.5%/5.7% year-over-year – the lowest annual advances in over a year), (iii) University of Michigan 1-year inflation expectations falling to 4% from 4.4% and household confidence rising to 64.6 from 59.7 last month, (iv) stronger-than-expected economic activity (US Q 4 GDP expanding +2.9% annualized vs. consensus +2.6%).

After an exhausting year and two consecutive months in the green for global equities on the back, investors were probably expecting a visit from Santa Claus in December. They instead saw how a cat-like face, cantankerous, demented Grinch visited one last time their broken house. The curmudgeonly protagonist of Dr. Seuss’ “How The Grinch Stole Christmas!” (1957), unable to stand our risk-on attitude, decided to destroy once for all our portfolios. It all started well, though, and we were about to open our Christmas presents. China finally decided to relax its Covid-Zero policy. The U.S. CPI report showed that inflation was moderating further (headline +0.1% in November vs. +0.3% estimates, after a 0.4% jump in October). Several Fed officials (e.g., Evans, Barr, Bowman, Powell, Cook) signaled that the central bank’s pace of increases was likely to slow soon. Yet, several events excited our Grinch. The U.S. ISM Manufacturing PMI dropped into contraction territory for the first time in two and a half years to 49.0% in November, down from 50.2% in October, reflecting companies’ preparing for future lower output. U.S. PPIs surprised to the upside amid a jump in the costs of services (+0.3% in November vs. consensus +0.2%, and data for October revised up to +0.3% instead of +0.2%). The EU and G7 members implemented a price cap on Russian oil, sparking fears of retaliation. U.S. retail sales fell sharply at the start of the key holiday shopping season (-0.6% in November vs. -0.1% expectations, the biggest drop since December 2021), suggesting that higher borrowing costs and the threat of an imminent recession were starting to have an impact on household spending. The coup de grâce came from our central banks, with the FOMC, the ECB, and the BoE eventually, increasing their respective lending rates by 50bp, while emphasizing that their fight against inflation was far from being over, thereby suggesting additional rate hikes well into 2023. The Fed’s SEP Head showed significant negative revisions. The median projection for real GDP growth for 2023/2024 came in at 0.5%/1.6% (from 1.2% and 1.7%), respectively. The median unemployment rate forecast has been adjusted to 4.6% (4.4%) for 2023 and 4.6% (4.4%) in 2024. On inflation, the median estimate for core PCE was assumed to be 3.5% (3.1%) in 2023 and 2.5% (2.3%) in 2024. As a consequence, the median projection for the fed funds rate has been lifted to 5.1% (4.6%) in 2023 and 4.1% (3.9%) in 2024. The Grinch took notice. Global equities pulled back significantly on the last month of 2022 (S&P 500 -5.9%, Nasdaq-100 -9.1%, Stoxx Europe 600 -3.4%). Credit spreads widened again (iTraxx XOVER 5yr 474bps i.e. +15bps, CDX 5yr 484bps i.e. +31bps). WTI and Brent futures declined, too (-0.5% and -1.2% to $80.3/bbl and $85.9/bbl respectively). The only positive news is perhaps that we close, once for all, this turbulent year. Crippled by the war in Ukraine, runaway inflation and unprecedented monetary tightening policies compressing valuations, a weakening outlook for corporate earnings amid recessionary fears, as well as China’s failing Covid strategy, most gauges have finished deep in the red (S&P 500 -19.4%, Nasdaq-100 -33.0%, Stoxx Europe 600 -12.9%, Nikkei 225 -9.4%, HSCEI -18.6%). Wishing you a happy and (more) prosperous year.