Should we expect a deadly summer on the markets? For many investors, this week of decline does not bode well. The successive crashes (vague notion which generally designates a 10% drop in asset prices) that have followed one another since last fall, on technology or growth stocks, on alternative assets such as cryptocurrencies, but also on the bond market , had so far had an almost reassuring explanation: they had their origin in the sudden shift in monetary policies in the face of inflation and were ultimately part of a kind of normalization, a fair return of things to “normal”, after the extravaganza of 2021.
Strong growth (7% in France last year) and zero rates, in other words, butter and butter’s money, could not last forever. The end of free money would bring investors back to their senses and valuations back to historical averages, if not attractive entry points. Some market strategists even developed the idea that inflation was a support factor for equities. The good results of companies in the first quarter and the absence of a downward revision of earnings growth forecasts confirmed this cautious optimism.
Awareness
This was before the outbreak of war in Ukraine. This was especially before the stock market carnage on Wall Street last Wednesday. The publication in the United States of poor activity figures for two major retail heavyweights, Walmart and Target, caused a sharp drop in American indices, including “value” stocks, and reminded the markets that inflation could weigh on consumption and corporate profitability. As a result, fears of a recession have never been higher than since 2008, according to Bank of America.
“We are seeing a real realization that inflation is not good for stocks because the pattern is always the same, after inflation comes recession. Markets are now clearly anticipating a recession. We are even already in recession in the United States, with a negative first quarter and a second quarter which does not look any better. We’ve been in kind of denial so far as the turn signals have been red for months,” warns Eric Galiègue, president of Valquant Expertyse.
From then on, the darkest scenarios began to flourish in the United States. Scott Minerd, head of investments at Guggenheim, warns on US channel CNBC that the Nasdaq could plunge 75% from its fall 2021 peak and that the S&P 500 could slide 45%, still from its peak. . Eric Galiègue is hardly more optimistic: “The market decline that began on February 24 could take us towards 5,700/5,800 points on the CAC 40, with technical rebounds of course, but more likely towards 4,400 points at the start of 2023”.
An aggressive Fed
The configuration of the markets combines both problems in the real sphere and in the financial sphere. Companies will not be able to structurally maintain the stratospheric level of their net margins while they are subject to pressure on wages, rising prices of raw materials and inputs but also, in the medium and long term. , to a “deglobalization” of the world economy.
It’s not so much the shares that will fall as the value of the companies themselves. The downward movement in profits will be all the more harmful for US equities as one-third of the growth in EPS (earnings per share) in the United States results from share buyback programs for cancellation. Less profit, less stock buybacks.
In the financial sphere, the picture is not more reassuring. The Federal Reserve (Fed) has made it clear that it intends to continue raising interest rates, even if it risks ruining the stock and bond markets. And the European Central Bank (ECB) may well follow suit sooner than expected. So far, since the 2000s, the markets have operated on the belief that the Fed will do anything to save the markets. This “put” (sell option) from the Fed clearly expired today.
For Fed Chairman Jerome Powell, restoring price stability has become the top priority. The market anticipates a further increase in key rates by 50 basis points next June, while US inflation exceeded 8% in April. The only hope: that the recession will decide the Fed to slow down its tempo of rate hikes and balance sheet reductions. In the meantime, there may be damage to the markets.
Orderly decline
Behind this rather gloomy picture, a positive note. The decline in the markets seems to be taking place in an orderly fashion. Clearly, there is no panic movement, no generalized “sell off”. It’s a tactical withdrawal, in search of cash. According to a very recent survey by Bank of America, the level of liquidity of fund managers has peaked since September 2001.
“The consensus has become very pessimistic, which is generating phases of redemption on simply less alarming news”tempers Jean-Jacques Friedman, CIO at Vega Investments Managers. “Eventually the Nasdaq has normalized in terms of valuation multiples and in Europe we are at 12 times the multiples with rates still remaining relatively low”he adds.
This cash can thus fuel technical recoveries in the event of market declines deemed to be excessive. Especially since investors remain extremely cautious on the bond markets, which have also fallen sharply since the start of the year. Only sovereign debt recovered in a “flight to quality” movement. This somewhat caps the rise in long-term rates.
This absence of “market capitulation” – even if it could look like it in the middle of the week – should however encourage the Fed to continue to tighten its policy while the markets are still hoping that it moderates its speech.
In the meantime, the US indices are close to reaching the level of a true bear market, generally defined as a pullback of 20% from the most recent peak. The Nasdaq has largely crossed this threshold (-30% compared to November) and the S&P 500 has just reached it. The fall is less severe in Paris: the CAC 40 has lost 15% compared to its high of last January.