scenario that haunts investors

Should we expect a killer summer in the markets? For many investors, this week of decline does not bode well. The successive crashes (a vague concept that usually means a 10% drop in asset prices) that have followed one after the other since last fall, in technology or growth stocks, in alternative assets such as cryptocurrencies, as well as in the bond market, so far took place. an almost reassuring explanation: they arose from a sudden shift in monetary policy in the face of inflation and were ultimately part of a normalization of sorts, 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 money, couldn’t last forever. The end of free money will bring investors back to their senses and valuations back to historical averages, if not attractive entry points. Some market strategists have even developed the idea that inflation is a supportive factor for stocks. The companies’ solid first-quarter results and the absence of downward revisions to earnings growth forecasts confirmed this cautious optimism.

Awareness

This was before the start of the war in Ukraine. This was especially true before the stock market carnage on Wall Street last Wednesday. The publication in the US of poor performance by two major retailers, Walmart and Target, caused US indices, including value stocks, to plummet, and reminded markets that inflation could affect consumption and corporate profitability. As a result, recession fears 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 a recession. 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 looks no better. We’ve been kind of in denial as the turn signals have been red for months.” warns Eric Galleg, president of Valquant Expertyse.

Since then, the darkest scenarios have flourished in the United States. Scott Minerd, head of investment at the Guggenheim, warns on US CNBC that the Nasdaq could be down 75% from its fall 2021 peak and the S&P 500 could be down 45%, still off its peak. Eric Galleg is no more optimistic: “The market downturn starting Feb 24th could take us to 5700/5800 on CAC 40, with technical rebounds of course, but most likely to 4400 in early 2023.”

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 their sky-high net income levels while they are under pressure from wages, rising commodity and resource prices, and, in the medium and long term, from the “de-globalization” of the world. economy.

Not so much stocks will fall, but the value of the companies themselves. The decline in earnings will be all the more detrimental to US stocks as one-third of the growth in EPS (earnings per share) in the US is the result of share repurchase programs to cancel. Less profit, less share repurchase.

In the financial sector, the picture is no more encouraging. The Federal Reserve (Fed) has made it clear that it intends to keep raising interest rates even if it risks destroying the stock and bond markets. And the European Central Bank (ECB) may well follow suit sooner than expected. So far, since the 2000s, markets have relied on the Fed to do whatever it takes to save the markets. This “put” (put option) from the Fed has clearly expired today.

For Fed Chairman Jerome Powell, restoring price stability has become a top priority. The market expects a further increase in the key rate by 50 basis points next June, and inflation in the US in April exceeded 8%. The only hope is that a recession will force the Fed to slow down its rate hikes and balance sheet cuts. At the same time, there is a risk of damaging markets.

Ordered recession

Behind this rather gloomy picture lies a positive note. The decline in the markets seems to be in order. It is clear that there is neither a panic movement nor a general “sale”. This is a tactical retreat in search of money. According to a recent survey by Bank of America, fund managers’ liquidity levels have peaked since September 2001.

“Consensus has become very pessimistic, which gives rise to phases of redemption with just less disturbing news.”hardens Jean-Jacques Friedman, CIO of Vega Investments Managers. “Eventually the Nasdaq has normalized in terms of valuation multiples and in Europe we are 12 times the multiples, with rates still relatively low.”he adds.

Thus, this cash can fuel a technical recovery in the event of excessive market downturns. Moreover, investors remain extremely cautious in the bond markets, which have also fallen sharply since the beginning of the year. Only sovereign debt recovered during the flight to quality movement. This somewhat limits the growth of long-term rates.

This lack of “market capitulation” – even if it may look like this in the middle of the week – should nevertheless encourage the Fed to continue tightening its policy, while markets are still hoping that it will soften its speech.

Meanwhile, US indices are close to reaching true bear market levels, usually defined as a 20% retracement from their most recent peak. The Nasdaq has pretty much passed that threshold (-30% since November) and the S&P 500 has just hit it. The drop in Paris is less severe, with the CAC 40 down 15% from last January’s high.