7 Minutes on Markets - Q3 2023 Market Update

Host: Welcome to 7 Minutes on Markets. Today, I have been joined by Ben Kumar, Head of Equity Strategy;

Ben Kumar: Hello!

Host: And Fiammetta Valentini, Investment Manager.

Fiammetta Valentini: Hello.

Host: Welcome both and thank you for joining us. So we're halfway through 2023 and there's been a lot of mixed messages out there. Equity markets are up; economic confidence seems very fragile. Ben, what's going on?

Ben: So you're right, equity markets are higher and that is something that people have been talking about as kind of a strange thing, but mostly equity markets have been driven by one sector — the technology sector, and the excitement over AI, which has driven companies like Nvidia or Microsoft or anything that even might be related to maybe having a robot do something; all of those shares have risen and dragged the market up with it. But I do mean drag because outside of that technology sector and those big companies, things aren't quite so rosy.

Fiammetta: Yes, Ben. As you said, if we look at the global sector performance year to date, we experienced a complete reversal with respect to last year. Energy was the best performing sector last year and the only one finishing on a positive territory; and nowadays, it's a complete laggard. So if we think about it, the reason behind it is linked to a potential recession; of course, oil consumption is linked to global real GDP growth, and if we foresee a slowdown, oil is going to be impacted. Another sector that is struggling year-to-date has been the financial sector. The domino effect started with the Silicon Valley Bank lapse, was quickly followed by Credit Suisse and also the First Republic failure. Stock in financial sectors, especially regional and small cap stock in the financial sectors, have underperformed, and also we have seen quite a differential and a divergence in performance across Europe and the US; Europe tends to be more regulated as a market, has strong capital and liquidity buffers and these should allow and protect European large banks. When we look at the retail sector — as well as being pretty weak year-to-date, part of the reason is linked to the banking crisis, given that real estate is a capital-intensive sector, but also to the lower demand for office space.

Ben: Yeah, I mean, I think it's really interesting when I think of office space; as everyone decides how hybrid working is going to go for them, who's moving into larger offices? Everyone's downsizing as far as I can see, and that will feed through into how those real estate companies do over the next few years.

Host: Thank you very much, both. But then what about the economy at a broader level? What is happening there?

Ben: Yeah, all of the things Fiammetta has just talked about are being affected, I think, by one key thing: the rise in interest rates. As interest rates go up, they are causing pain through various sectors. It takes different times to feed through, but you've seen it; interest rates go up, and suddenly those small regional banks start struggling. Interest rates go up and suddenly some property companies aren't quite as profitable as they thought they were. Interest rates go up and people start having less money to spend. That is the whole point. You want to suck the money out of the economy in order to contain inflation, but unfortunately it hits growth as well. So it's why I think you're seeing this... I think economic lack of confidence. People are being told by the central bank, by interest rates, to be less confident, to spend less money in the real world.

Host: That's a bold statement, Ben. You know, you talk about higher interest rates causing pain, you talk about sucking money out of the economy, so it seems like positioning appropriately is the name of the game. How are we doing that?

Fiammetta: Yes, to face a potential recession, we want to be conservative; so we tend to prefer cheaper parts of the market with respect to the expensive one. And we also have a preference for defensive sectors like, for example, healthcare. The real question nowadays for investors is like, do bonds offer compelling opportunities? With rising interest rates and slowing economic growth, for sure equities are going to be vulnerable. But the bond market offers compelling opportunities, rising interest rate boosted the income offer by bonds, and if confidence grows, that interest rate expectation has peaked; investors buying now could benefit from capital gains as well.

Ben: And I think that's important, right? Bonds do well in recessions. We also don't want to hold things that do badly in recessions, and the main thing that we see on that — I mentioned it briefly earlier — is big US tech companies. Some of them are trading on ludicrous valuations; they're really, really expensive. For those companies to meet even the barest expectations to keep their prices where they are, they would have to grow at phenomenal rates, unprecedented rates. I'm talking about Nvidia, I'm talking about companies like Meta. So we think it's safest to avoid those companies where we can. Doesn't mean exiting the equity market, but it means holding different companies, like Fiammetta said, in healthcare, or in the UK — holding some of those energy companies, which are still really big, make a lot of money; hold them instead of those tech companies, which, if we face a recession, what happens to the demand for iPhones? I don't expect it's going to be as high as it was in the good years when interest rates were low; if you have to pay £100 or £200 a month for your iPhone because interest rates are higher, I think Apple's going to be selling less iPhones, right?

Host: It was great to hear your thoughts, Fiammetta and Ben, thank you very much for sharing them. This is all from us here at 7IM.