What movement have you seen in the global equities market in the last week?
Throughout the first half of the year, market sentiment has shifted from bearish to greedy. Hedge funds and institutional investors were positioned too defensively and as the market’s momentum gather speed they had to adjust their positions accordingly, moving from short to long positions.
Retail traders have made a comeback and liquidity looks strong as we enter the summer season. Factors such as pension funds rebalancing and takeover blackout periods are changing the dynamics of fund flows, further impacting the market landscape.
Going forward, however, the path may become more difficult. Investors who were ready to enter the market may already have done so for the most part at this stage. Summer months are also characterised by lower liquidity and higher volatility, which could potentially force some commodity trading advisor (CTAs) and risk parity funds to de-risk.
Why is this happening now?
We remain in a very unusual market context. On one hand, investors want to go long on risk assets to protect the real value of their assets as inflation may stay high for a long period of time. On the other hand, investors are not compensated for the risk they take. For the first time ever, yield on cash, bonds and equities is the same in the US. The yield on three-month US Treasury bills was 5.3% last week after Fed held interest rates at between 5-5.25%. That is the same level as the expected 12-month forward earnings yield across the S&P 500, which has risen by >15% since January. This is also equivalent to the average yield of US corporate bonds.
How might this be impacting activity in other asset classes?
Our house view is that we live in a “new normal” with higher geopolitical uncertainty triggering higher macro volatility and thus higher market volatility. While the first half of the year could be seen as a “goldilocks” (i.e. no recession and declining inflation), the second half of 2023 might very well be characterised by a come-back of more challenging macro conditions, with developed economies flirting with recession and inflation proving to be stickier than expected. This could shift again the pendulum towards a more defensive positioning in which investors require higher valuation premium to get compensated on risk assets.
What needs to be done to boost equities in Europe?
European equities is a tale of two markets. On one hand, it is made of international exporting champions (think about the G.R.A.N.O.L.A.S which is the acronym of mega-caps GlaxoSmithKline, Roche, ASML, Novartis, L’Oréal, LVMH, AstraZeneca and Sanofi). These companies benefit from a wide economic moat, solid balance sheets, fat profit margins and solid revenue growth. They continue to be favoured by international asset allocators who are ready to pay a valuation premium for these stocks.
On the other hand, stocks exposed to domestic economies continue to fluctuate depending on the faith of local economies. While the Winter and Spring proved to be better than expected in terms of economic growth (mild recession only), Europe continues to face some structural headwinds which could affect again the domestic-led companies at some point.
Amid the many, which regulatory changes currently being proposed will be the most impactful on equities?
Member states of the European Union are pushing for a reversal of a significant legislation that mandated the segregation of investment research expenses from trading costs. These states are championing plans to revise Mifid II and are seeking a near complete reversal of the rules surrounding the practice of unbundling. The proposed changes would require investment firms to simply inform their clients whether they are paying for research and trading together, while also keeping a record of the charges associated with each service. This potential reversal has the potential to reshape the regulatory landscape, allowing for a more integrated approach where research and trading costs can be bundled together. This would be a very significant U-turn.