By Robert Ducker
Global equities rallied 6.1% (LCL) in June, the best month on a total return basis since January, taking total return generated during 2Q23 to 7.0%. In the first six months of 2023, global equities generated a total return of 15.4% despite the uncertain backdrop at the start of the year, which was made worse by the collapse of several US regional banks. Most regions we follow closed 2Q23 in the green, with China being the notable exception, as the re-opening boost disappeared quicker than the market had previously anticipated. The Nasdaq was the best performing index during the second quarter with a total return of 13.1%.
At the start of the year, our expectation was for equities to trade in a range. This seems inconsistent to actual equity market performance given that most regions are already in double-digit total return territory. Yet, returns over a 1-year period are quite low (Exhibit 1). Since late April, equity markets have rallied whilst volatility has fallen as risks started to fade, including: (1) the resolution of the debt ceiling; (2) less concern over the US regional bank sector; and (3) falling commodity prices implying less inflationary pressures. Additionally, the AI craze has fuelled investor interest in Tech/Growth stocks at a time when growth rates for the sector were converging with the broader index. Hence, the expectation is that AI will boost revenue/earnings growth making the sector attractive again for investors.
Exhibit 1 - Index performance (Total return in LCL, rebased Jun-22)
Equity market returns have been flat for most regions over the past year except for the Nasdaq
The resilience shown by the US economy has meant that recession expectations have been pushed back. Bloomberg consensus currently assigns a 65% probability of a recession in the US over the next 12 months, well above the median calculated since 2008 of 20%. The measure has only moved above the median in 2008/2009, 2011 and 2019 – 2021. In our opinion equities could continue to grind higher until the US economy enters a recession, or the likelihood of a recession increases significantly. It could be argued that the market-implied probability of a recession over the next 12-months is already high at 65% compared to the median calculated since 2008 of 20%. Yet, equity investors seem unmoved, with economic sensitive sectors and strategies still delivering double-digit returns so far in 2023.
We believe that the 2Q23 earnings season could set the tone for equity market performance in 2H23. Around 90% of the STOXX 600 constituents should have reported by the end of August. The third week of July (beginning 24th July) will be the busiest week in terms of earnings releases with around 50% of the constituents expected to report. In our opinion, investors will focus on the strength (or otherwise) of the earnings season, and this could have implications for equity market performance in the second half of the year. Of particular importance will be the guidance provided by companies. EPS expectations have been supported by stronger-than-expected Q1 earnings, though it remains to be seen if this can be carried forward in Q2. The disconnect between activity data and earnings growth expectations cannot continue forever.
European STOXX 600 FY23e EPS has been revised up by 1% since the start of 2Q23. Although the growth momentum has slowed, earnings estimates have remained surprisingly resilient. Generally, the current PMI levels in Europe would be consistent with negative EPS revisions, which is inconsistent with current consensus growth expectations. However, it should be noted that the SXXP constituents generate a large proportion of its earnings outside of the Bloc. Furthermore, the hawkish ECB should be beneficial for the earnings of Financials. Finally, lower commodity prices should have improved purchasing power, supporting earnings for exposed sectors.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.