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Should we expect a deadly summer in the markets? For many investors, this week of decline does not bode well. The successive crashes (a vague notion that generally designates a 10% drop in asset prices) that have followed one another since last fall, in technology or growth stocks, in alternative assets such as cryptocurrencies, but also in the stock market bonds, had until now had an almost reassuring explanation: they had their origin in the sudden change in monetary policies in the face of inflation and, ultimately, were part of a kind of normalization, a fair return of things to “normal” “, after the 2021 extravaganza.
Strong growth (7% in France last year) and zero rates, that is, butter and butter money, could not last forever. The end of free money would bring investors 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 supportive factor for stocks. Strong corporate results in the first quarter and the absence of a downward revision to earnings growth forecasts confirmed this cautious optimism.
This was before the outbreak of the war in Ukraine. This was especially before the stock market carnage on Wall Street last Wednesday. The publication in the United States of the poor activity figures of two heavyweight retailers, Walmart and Target, caused a sharp drop in US indices, including “value” stocks, and reminded the markets that inflation could weigh on consumption and business profitability. As a result, fears of a recession have never been higher than they have been since 2008, according to Bank of America.
“We are realizing that inflation is not good for stocks because the pattern is always the same, after inflation comes recession. The markets are now clearly anticipating a recession. We are even already in a recession in the United States, with a negative first quarter and a second quarter that does not look any better. We’ve been in a kind of denial so far where 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, chief investment officer at Guggenheim, warns on CNBC that the Nasdaq could drop 75% from its fall 2021 peak and the S&P 500 could drop 45%, still from its peak. Eric Galiègue is hardly more optimistic: “The market crash that started on Feb 24 could take us towards 5,700/5,800 points in the CAC 40, with technical rebounds of course, but more likely towards 4,400 points in early 2023.”
An aggressive Federal Reserve
The configuration of the markets combines problems in both the real and financial spheres. Companies will not be able to structurally maintain the stratospheric level of their net margins as long as they are subject to pressures 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 is not so much the shares that will fall as the value of the companies themselves. The downward move in earnings will be even more damaging for US equities as a third of the growth in EPS (earnings per share) in the United States results from share buyback programs for cancellation. Fewer profits, fewer share buybacks.
In the financial sphere, the outlook is no more reassuring. The Federal Reserve (Fed) has made it clear that it intends to keep raising interest rates, even if it risks wrecking the stock and bond markets. And the European Central Bank (ECB) may well do the same sooner than expected. Until now, since the 2000s, the markets have operated in the belief that the Fed will do anything to save the markets. This Fed put option clearly expired today.
For Fed Chairman Jerome Powell, restoring price stability has become the top priority. The market is anticipating a further increase in key rates by 50 basis points next June, while US inflation topped 8% in April. The only hope: that the recession decides the Fed to slow down its pace of rate hikes and balance sheet reductions. Meanwhile, there is a risk of damage to the markets.
Behind this rather gloomy picture, a positive note. The fall of the markets seems to be happening in an orderly fashion. Clearly, there is no panic move, nor is there a general “sell-off”. It’s a tactical retreat, looking for cash. According to a very recent Bank of America survey, the level of liquidity of fund managers has reached its highest point since September 2001.
“The consensus has become very pessimistic, which is generating redemption phases on news that is simply less alarming”template Jean-Jacques Friedman, CIO of Vega Investments Managers. “Eventually the Nasdaq has normalized in terms of valuation multiples and in Europe we are at 12 times the multiples with still relatively low rates”he adds.
This cash can therefore fuel technical recoveries in the event of market declines that are deemed excessive. Not least because investors remain extremely cautious in bond markets, which have also fallen sharply since the beginning of the year. Only sovereign debt recovered in a “flight to quality” move. This somewhat limits the increase in long-term rates.
However, this absence of “market capitulation”, even if it might seem like it in the middle of the week, should encourage the Fed to continue to tighten while markets still wait for it to moderate its speech.
Meanwhile, US indices are close to reaching the level of a true bear market, generally defined as a 20% retracement from the most recent peak. The Nasdaq has largely crossed this threshold (-30% from November) and the S&P 500 has just reached it. The drop is less severe in Paris: the CAC 40 is down 15% from its peak last January.