CCA 40, Nasdaq, S&P 500, Euro Stoxx 50… The equity market is off to a strong start in 2023, following a difficult year in 2022 marked by the “roller coaster” following the Russian invasion of Ukraine and as central banks have clearly tightened their monetary policies in the face of rising inflation. A renewed optimism in Exchange Socks which can be explained by inflationary expectations (fall in energy prices, slowdown in wages in the United States, etc.) and growth expectations (the scenario of a very deep recession, particularly in Europe, is considered much less probable).
Earnings estimates for listed companies remain high. Corporate results “are expected to grow by 3% in the next 12 months, estimates that are too optimistic in view of the expected deterioration of the global economy”, judges however the private bank Neuflize OBC (ABN Amro group), which remains quite cautious on equities (particularly in Europe), as the impact of the recession still seems not to be sufficiently integrated into stock prices. Earnings of listed companies could fall 10 to 15% in 12 months amid an unfavorable backdrop for the economy in the first quarters of 2023, she said.
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For the equity investor, however, there is reason for hope. First, Neuflize OBC notes that “the bubbles emblematic of the Covid-19 crisis”, in particular that of the Spac (Special Purpose Acquisition Companyor acquiring companies with a specific vocation, with no operating business) and that of hypergrowth stocks (but not very profitable), have already exploded.
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Furthermore, on Wall Street, the S&P 500 (barometer of American stocks and the most popular stock index on the planet) has already fallen by 25% (to its lowest in October, over 9 months). These numbers compare to 9 bear markets tracked since WWII (average S&P 500 decline of 38% from main peak, over an average duration of 18 months), suggesting that the bear market could potentially have a long way to go. , but also that the bulk of the price drop would already be behind us.
In addition, since 1945, after a 25% decline, the S&P 500 has averaged a 1-year performance of 7.3% and a 3-year performance of 29%. Better, for 5 years, “the performance is always positive”, with an average gain of 54% over 5 years and 142% over 10 years, argues Neuflize OBC. Encouraging statistics, for a long-term investor, who will still be able to monitor a certain number of risks and problems this year 2023, after a 2022 that causes anxiety.
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Inflation could hold up, remaining structurally higher
In the short term, inflation is marking time, between the slowdown in demand (pressure on the economy and on household consumption), the easing of supply tensions (the cost of sea freight from China has collapsed) and the drop in energy prices. However, we do not yet know whether inflation will be able to return to pre-crisis low levels or whether a permanently higher inflation regime can be expected, due to the slowdown in globalization (China in world exports has been stagnant for several years, after having recorded an increase until 2015-2016), the cost of the ecological transition (the price of a ton of CO2 remains high despite the economic slowdown) and energy prices consistently high.
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The trajectory of the key rates of the Fed and the ECB is another considerable risk. Notably, the Fed could raise its key rate to at least 5%, while the ECB could still hike its rate significantly amid inflation, equity investors predict. However, faced with the recession that is expected to develop in the major Western powers, Neuflize OBC is betting that the Fed and the ECB could significantly lower their key rates in the second half.
The energy price shock may persist
Furthermore, beyond the decline observed in recent months in energy prices (oil, gas, etc.), Neuflize OBC fears that the energy shock will remain “significant in the coming quarters”. On the supply side, the bank notes “multiple constraints” (exclusion of Russia from Western markets, OPEC+ quota on oil supply, constraint on French nuclear power). And on the demand side, “the slowdown in Western countries, energy savings in Europe (facilitated by the mild temperatures) and the recovery of the Chinese economy are opposed”.
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Economic recession expected in the first half of the year
On the economic growth front, Neuflize is currently counting on a recession on both sides of the Atlantic (moderate in the United States and more marked in Europe), although the second half of the year could be more favorable, with an expected recovery in business . The first few quarters could prove challenging as household purchasing power is strained by inflation, while higher interest rates make it more difficult for households to access US real estate.
The US economy has been fairly resilient thus far, but the excess savings (the $2 trillion accumulated during the Covid-19 crisis) should dissipate by the end of the first half of the year. And banks are tightening their credit terms. Finally, the labor market could deteriorate. Already in the United States, “the first signs of a recession are appearing”, notes Neuflize OBC, which notes the collapse of the confidence of real estate developers and new business orders. Fortunately, corporate debt and household debt are not showing huge imbalances, which rather argues in favor of a moderate recession.
In Europe, where inflation has recently reached double digits, consumer confidence has fallen to historic lows. “Europe is heading towards a recession in the first half. The rate shock should produce its full effect this year, while the Old Continent should feel the effects of the future deterioration of the American economy”.
As for China, which has paid dearly for Beijing’s zero-Covid strategy, household consumption and investment are on the wrong track, but “excess savings and economic policy support should allow the economy to rebound in spring,” judges Neuflize OBC, who notes that the growth of new loans tends to accelerate. However, the bank expects only a moderate recovery of the Chinese economy. Indeed, corporate debt (almost 220% of GDP) is very high, which will structurally weigh on growth.
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Geopolitical and financial risks
The evolution of the war in Ukraine will be one to watch. Any de-escalation would allow for a reduction in the risk premium on European equities (and therefore a positive impact on stock prices). Conversely, renewed tensions could favor turbulence.
Furthermore, while the Fed’s key rate hike in 2022 has been historically abrupt, financial risks are clearly on the table. Analysis of the past 50 years shows that when the Fed tightens its monetary policy too much, shocks have often occurred in the financial sphere. In recent quarters, the Fed’s rate hike has fueled, among other things, tensions over UK debt and the bursting of bubbles in tech stocks and cryptocurrencies.