MAY 2023 | NO 5



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

A month of April on a tightrope…but no fall

The economic and financial news was plentiful in April. The start of the earnings season, the cheap takeover of First Republic Bank by JP Morgan, a glimmer of hope for possible peace talks in Ukraine (under the «benevolence» of the Chinese president) and of course a whole battery of indicators to gauge economic activity and progress in the fight against inflation. All these elements (among others) have been scrutinized by the financial markets.  Paradoxically, this newsflow rich in potential clues on the direction of the economy had little effect on the stock markets, which on the whole remained flat or slightly positive over the month, not without offering a few bursts of volatility to which we have become accustomed over the last three years since the onset of the Covid pandemic.

After a positive first quarter on the financial markets and despite some concerns already mentioned last month, April did not offer much more visibility. That said, there are some new tangible facts to take into account when assessing our economic and financial scenario for the coming quarters. First of all, even though the corporate earnings season is underway, we can already rule out the idea of highly disappointing releases that would have come as a negative surprise to traders. Indeed, disregarding the sometimes overly optimistic announcements of certain media, we can say that the overall quality of corporate results in Q1 , while not exceptional, is so far satisfactory and does not indicate a sharp economic slowdown in progress.

The same can be said at the macroeconomic level, where the various indicators published in April leave little doubt as to the current shape of the global economy. There is nothing to get excited about in terms of future growth, but there is also nothing to panic about in terms of a marked slowdown or «hard landing».

It is true that the manufacturing PMI indices are now far from their pre-Covid levels and are indicating a certain slowdown. On the other hand, the «services» component of these same indices remains robust and offers an overall picture that is not that of economies heading straight for a severe recession.

Nothing to get excited about in terms of future growth, but also nothing to panic about in terms of a marked slowdown or «hard landing»

On the inflation front, one would almost believe that everything is going smoothly and that the problem is beginning to be put behind us… However, the «core inflation» index, dear to the FED, is not weakening as quickly as expected. Let’s be wary of this conclusion which seems a bit hasty at this stage. The downward trend is actually underway, no doubt about it. But the base effect contained in the inflation figures that are  being published now is important. It is indeed the indicator that includes food and energy that benefits from a positive base effect (CPI), notably because of the very high level of energy prices a year ago, following the start of the war between Russia and Ukraine.

The term «greedflation» has recently been coined to describe companies that have managed to pass on large price increases to their customers but have no plans at this stage to lower them, as their sales have not deteriorated. While the drop in energy costs, especially oil and gas, is significant (after a peak in 2022), it must be noted that the price-setting mechanism is not working downwards for the moment. A certain greed seems to have taken precedence over a possible decrease in prices made possible by a lower energy bill.

Finally, on the geopolitical side, we remain humble about our ability to predict the future on issues as complex as the conflict in Ukraine or the evolution of tensions between China and Taiwan. Let’s bear in mind that, overall, current geopolitics is not a factor supporting financial markets and that, while we won’t speculate on the advent of a new world order, we cannot decently bet on it as a «catalyst» for stock market indices for the coming quarters.

The elements reported so far have not prompted us to change our allocations in April. They remain close to the «neutral» weightings of our benchmarks and we have chosen to maintain a slight underweight in equities.

Our reading of the economic indicators released in April, as well as the company results published during the month, did not give us any more certainty as to the direction of the stock market indices, particularly equities, in the near future. This observation seems to have been widely shared by market participants, as the past month’s performances were balanced or slightly positive, with no clear trend, unlike those of January or February.

Far from being seen as negative, this weak stock market trend may actually be rather reassuring and appears to be in line with the contradictory signals about business activity and the phase of the economic cycle we are in.

It is tempting, however, to see the glass as half full and to bet on a «no landing» scenario in which the dreaded recession is neither small nor large, but simply does not happen. In this hypothesis, elements such as the likely imminent end of the Fed’s monetary tightening process, the bearish evolution of the dollar in recent months, which has been positive for emerging equities and historically rather favorable for U.S. stocks, or the Q1 results published by most of the mega-caps in the technology sector, together with the dizzying figures for the luxury goods segment, are all arguments that are regularly put forward to justify a continuation of the rally in equities this year.

We remain cautiously optimistic for the coming months and our asset allocation reflects this

However, to be so optimistic would be to overlook other facts that we do not wish to ignore. The first of these is obviously the situation of the American banking sector which, after two bankruptcies, has just witnessed the takeover (or rescue…) of First Republic Bank, whose recent earnings release revealed the extent of the withdrawals of the last few weeks, driving the share price close to 3 dollars, compared with nearly 150 dollars a year ago. The denouement is certainly a relief, but not really an encouraging sign as to the health of the sector.

Even if the threat of contagion to the major American banks, known as «systemic», does not seem to be on the agenda, the speed with which the loss of confidence can occur must make us cautious.

A second reason to see the glass as half empty lies in the future evolution of inflation, whose decline in recent months does not guarantee that the process will continue. There is a broad consensus, which we share, that central bankers have completed the «easiest» part of their mission to bring the annual rate of general price increases back towards the 2% target and that the coming quarters will not necessarily be as successful should rate hikes be put on hold at the beginning of the summer.

Finally, we cannot totally ignore a scenario in which the very rapid monetary tightening of the last few quarters ends up causing a marked contraction in economic activity and the first signals of this are already appearing through certain indicators (manufacturing PMI, prices of certain commodities or inflation-adjusted retail sales). In such a configuration, the «ketchup bottle» effect would have finally happened, with the FED tapping the back of the bottle with repeated rate hikes and eventually causing a sudden and excessive slowdown in economic activity. While this hypothesis is not part of our central scenario, it does not prevent us from considering it.

To conclude, our analysis for April is only slightly different from last month’s as the markets have not really found direction in recent weeks. We remain cautiously optimistic for the coming months and our asset allocation reflects this. Keeping our exposure to different asset classes unchanged should not prevent us from adjusting the internal composition of our portfolios. Thus, as part of the substitution of two investments held for several quarters, we have decided to introduce an actively-managed, short-duration fund on dollar-denominated emerging corporate bonds. In addition, we are incorporating an ETF on the global consumer staples sector, whose main players should continue to benefit from the price increases imposed on their customers in recent quarters without seeing their sales volume decrease.

More than ever, it is our tactical skill and a certain amount of cool-headedness that will determine how well our allocations hold up in the coming weeks. The nervousness of market participants reflects a certain vulnerability of our economies, but we do not perceive this as a promise of a severe economic slowdown or a plunge in current valuations.