MARKET INSIGHT – November 2023

MARKET INSIGHT

Prime Partners’ monthly analysis of global economic and financial market news.

Soft landing but damaged aircraft?

The autumn months are one and the same for financial markets this year. After a rather tough September for investors, October brought little respite – far from it.

The reasons for the downward trend in the past month are not to be found in the chorus of more or less realistic fears regularly put forward since the beginning of the year. The first results of the earnings season once again demonstrate the resilience of major US corporations, even if, as might be expected, CEOs’ statements on the outlook for 2024 are tinged with a cautiousness that tends to be poorly received by traders.

Similarly, the main economic indicators surprised few people in recent weeks, and do not explain the overall downturn in equities that we are witnessing.

Unfortunately, it was once again the geopolitical situation and the October 7 attack on Israel by Hamas that reminded investors of the fragility of today’s world, and of the fact that the days of the so-called “peace dividend” are now over for our economies, and therefore for the financial markets as well.

In the life of a portfolio, there are many things that can be predicted, modelled and, increasingly, even entrusted to artificial intelligence, and others against which only diversification provides at least partial protection. Such is the case with a global pandemic like Covid 19, the Russian invasion of Ukraine or the October attacks on Israel.  In all three cases, the cards have been reshuffled and new market dynamics have emerged, naturally bringing fresh risks for investors.

While no one seems to be calling for an escalation of the conflict beyond the Gaza Strip at present, market participants have had to come to terms with the fact that a widening of the fighting could have a definite impact on the price of oil. This adds to the uncertainty surrounding the continuation of disinflation and the timing of any change in central bankers’ attitude.

When it comes to monetary policy, it is probably politics that will count the most in the months ahead. Indeed, in addition to the current instability, 2024 will also mark the end of Joe Biden’s term in office and the likely return of Donald Trump to the electoral arena. The recent dithering over the appointment of a Speaker of the House of Representatives and the potential future shutdown of the US government are concrete illustrations of what Jerome Powell and his team will have to consider when assessing the health of the US economy.

There is something fascinating about the spiral of fear in the financial markets and, amid the dark clouds hovering over our heads, it is easy to point to a few indicators or observations suggesting that the alleged resilience of the world’s leading economy may be in doubt.

First of all, the decline in inflation, as calculated in the US CPI index, as well as in the Core CPI, is regularly called into question, and some argue that it does not accurately reflect the actual everyday situation of consumers.

Indeed, in the US, the average Joe is much more strapped than the figures suggest, and the low unemployment rate is partly due to the fact that many Americans have been forced to take on a second job to make ends meet. In the same vein, credit card delinquencies are at a record high, supporting the theory that the financial health of consumers is an illusion. This is also clearly reflected in the index of Consumer Discretionary shares.

When it comes to monetary policy, it is probably politics that will count the most in the months ahead

Likewise, it would be hard to ignore the evolution of the Russell 2000 index of small and mid-cap stocks over the past few months, which reflects the state of the US economic fabric. This index has virtually fallen back to its 2018 levels, thus erasing the entire performance of the last four years, which was largely achieved during a period of exceptionally accommodative monetary conditions.

Very high refinancing rates, a mountain of outstanding debt to be rolled over as early as 2024/2025, and fears that the “economic engine” will be more damaged than expected next year have had a particularly negative impact on the Russell 2000, as well as on some of the big American cyclical names such as 3M, Dow and Deere.

And what about Europe in all that? The economies of the Old Continent offer fewer paradoxes than their American counterpart. The slowdown in activity has been felt for some months now, particularly in countries with a strong industrial base, Germany first and foremost. Christine Lagarde’s recent statements suggest that the ECB will now emulate the attitude of the US Federal Reserve and maintain interest rates at high levels, in order to assess their disinflationary impact. A soft landing, yes, but only relatively speaking.

While economic conditions remain acceptable (low unemployment, corporate bankruptcies contained), the widening credit spreads between good and bad performers (Germany vs. Italy) and the underperformance of cyclical sectors on both sides of the Atlantic confirm that investors are somewhat uneasy about the economic outlook for 2024. 

Lastly, European equity indices continue to suffer from the lack of major technology leaders listed on the Old Continent’s stock exchanges, which have been the cornerstone of risk asset performance this year.

Despite this picture of a slightly less rosy global environment than the one we painted a few months ago, we do not wish to modify our allocations, whose rather defensive profile, notably through our underweight in equities, seems well suited to us.

Traders have added an additional risk premium to current markets

The earnings season did not deliver any major negative surprises and, as we had anticipated, the volatility stemming from the cautious outlook eventually materialized in share prices.

Two months of successive declines in equity indices is never a pleasant experience, but the environment we have been living in for the past three years, filled with exogenous shocks, reminds us that abrupt shifts in allocation often lead to accidents rather than to their prevention.

The further deterioration in the global geopolitical situation has been quickly priced in. Traders have added an additional risk premium to current markets, with the price of the barrel of crude threatening to rise sharply in the event of a major escalation of the situation in the Middle East.  

Barring a major year-end rally, 2023 should prove to be a year of passable performance, driven once again by technology. The impressive rise in equities, particularly US shares, during the Covid period, part of which was wiped out in 2022, will therefore not have resumed its forward march.

We see this primarily as a sign of moderation on the part of market participants and the normalization of activity. A soft landing is still in the cards, but the aircraft may need maintenance.