May was a good month for the markets after several months of hesitation. The performance of global equities was close to 2,5%. Indeed, the year started strongly: global markets enjoyed a robust performance of more than 5% in January, and then suffered from several months of sluggish performances. In May, they picked up again, driven in particular by technology in the United States, which rode the wave of innovation and productivity gains promised by the gradual adoption of artificial intelligence (AI).
Of course, there are reasons behind this market euphoria, but it is diametrically opposed to the trend shown by economic indicators: it is clear that the rate hikes seen since 2022 are slowly but surely taking the global economy into a recession phase.
Needless to say, we are in the presence of an extremely polarised market with a very small number of stocks outperforming the index (particularly in the US), and an economy mainly driven by the sectors that suffered most in 2022: Technology, Communications Services (Meta, Alphabet, etc.) and Discretionary Consumers (Amazon, Tesla, etc.). Of course, indices are climbing, but they are almost exclusively driven by these happy few, and the broader participation of different sectors and industries is still limited.
The number of stocks outperforming the index is minimal and the disparity also lies in the different investment styles. For example, small-cap indices are far behind large-cap indices. The Value style has been flat year-to-date and emerging markets are the worst performers behind developed markets. In such a narrow market, the question of the sustainability of this increase is legitimate. It is mainly the underperformance of small caps and emerging markets, two very cyclical segments, that is sending warning signals.
In economic terms, growth estimates for the first quarter were updated, generating a surprise in the economic sphere. According to the latest data, the German economy went through a recession with two quarters of negative growth, between the fourth quarter of 2022 and the first quarter of 2023. Consumption has fallen sharply in the first three months of the year and has pushed the economy into recession. This situation is somewhat in contrast to the relief effect resulting from a minimised energy crisis thanks to successful diversification in terms of supply. However, Europe posted positive but sluggish growth of just 0,1% at the end of the quarter.
On the bond front, rates rose in the second half of the month after a flat trajectory for several weeks. An onslaught of negative news around the debt ceiling crisis in the United States, a rather cautious stance on inflation by US central bankers and resilient short-term economic figures, particularly on employment, pushed US 10-year yields up from 3,65% to end the month at 3,80%. Europe also experienced volatility: German yields increased, particularly the 10-year yield, which rose to more than 2,50% for the first time since March, but the month ended below 2,30%. In terms of rates, the rigidity of inflation, especially that of the core segment, continues to be cause for worry, while weak growth is expected to stoke optimism. That said, we welcome the return to the normalisation of the correlation between equities and bonds: this is the key positive point after a very complicated 2022 where bonds have not played their role as a cushioner. As such, if stress on equities intensifies, bonds should provide diversification this time, given that inflation concerns are falling and the majority of the rate hikes seem to be a thing of the past.
The macroeconomic environment therefore remains unfavourable for risk-taking. For this reason, we continue to recommend a slight underweight in equities. Geographically, neutrality remains in place between a US market driven by technology and euphoria around AI and the European markets favoured by investors, as they are still much cheaper and benefit from a more balanced sector dynamic than in the United States. Only two sectors, Energy and Real Estate, posted a negative year-to-date performance in Europe, while in the US, only four sectors posted a positive performance.
The corollary of an underweight position in equities is a positive view on bonds. As rates have risen, the income they offer has become more attractive compared to previous years. Low growth combined with falling inflation are two positive factors for the asset class, particularly via US Treasuries. In the fixed income bucket, Investment Grade credit moved from a positive to a neutral view, with yield spreads likely to widen in the event of a recession. For the riskiest sub-segments, such as high-yield and emerging debt, we remain underweight.
In terms of sectors, we favour technology, which benefits from a very strong trend in the AI theme, as well as utilities, known for their defensive side and stable revenues.
Disclaimer
The recommendations contained in this document are, unless otherwise expressly stated, those of Spuerkeess Asset Management and are produced by Carlo Stronck, Managing Director & Conducting Officer, Aykut Efe, Economist & Strategist, Guillaume Gehant, Portfolio Manager et Loïc Chaulacel, Portfolio Manager, acting under an employment contract with Spuerkeess Asset Management.
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