Since the beginning of the year, all the major equity indices have performed positively. At the time of writing, in the Italian market the FTSE MIB is gaining +3.1% in February (+16.2% YTD), the FTSE Mid Cap +2.7% (+12.8% YTD) and the FTSE Small Cap +1.5% (+8.2% YTD). Globally, in February, the Stoxx Europe 600 is gaining +2.4% (+9.3% YTD), the S&P 500 -1.3% (+4.8% YTD) and the Nasdaq -0.3% (+10.5% YTD).
The FTSE MIB outperforming expectations since the start of the year can be attributed to its overweighted proportion of financial stocks, which have recorded very strong annual results due to the positive impact of rising rates on their interest margins at this early stage of the economic cycle. In addition to this trend, inevitably set to normalise over the coming months, the banking sector has also been able to provide a credible outlook for 2023 in terms of cost management and renewed capital strength. What we see, in particular, are good prospects in the asset gatherer segment (i.e. asset management operators), which is benefiting not only from rising rates in terms of net interest margins, but also from the recent market recovery, which is boosting managed assets and consequently the commission part of revenues.
Italian mid and small caps continue to underperform compared to large caps mainly because the they are still feeling the effects of the heavy outflows of 2022. Interest from foreign institutional investors could be revived, especially with a clearer picture of the medium/long-term resilience of the business cycle, given that small and mid caps tend to be closely aligned with the performance of the macroeconomic environment. An encouraging early sign comes from the apparently more stable political scenario, as confirmed by recent regional election results.
For the next few weeks, the financial community’s attention will turn to the end of the earnings season, when companies report on their 2022 results and give their forecasts for 2023. The significant downward revision of consensus estimates for all sectors (except financials) last year-end makes it more likely that companies will beat revenue and margin estimates.
Investors are weighing the credibility of companies’ revenue growth trajectories in order to detect any signs of consumer demand slowdown in their target markets and territories. But the main focus is on the outlook for the resilience or possible growth of profit margins in 2023. On one side, we have witnessed a recent retracement of energy costs and an easing of supply chain/logistics flows (critical for semiconductors and cross-sector components) since the Chinese borders reopened. On the other side, the ongoing conflict in Ukraine muddies the waters of macroeconomic visibility and also keeps the costs of many commodities above the averages of recent years.
A further theme that will be relevant in the annual reports and of continuing close interest to firms is significantly higher interest rates also in 2023, introduced to combat inflation that has proven to be particularly persistent, but which is decelerating, at least in the United States. In recent weeks, the bond market has further downgraded the likelihood of the rate hike cycle ending before 2024, which is why the U.S. 2Y/10Y yield curve inversion is at its sharpest in 50 years. This phenomenon has often been interpreted as a harbinger of recession in the short term.
This development has further sharpened differing expectations between the bond sector, which is already predicting an imminent economic slowdown, and the equity sector, which possibly expects the convincing reporting season to further boost the multiples appreciation we have witnessed since the beginning of the year, combined with monetary policy now seen as less aggressive, at least in America.
Against this background, our stock picking of Italian equities focuses increasingly on stocks that underwent heavy correction in 2022 due mainly to macroeconomic trends. Those securities are now positioned to benefit from the rerating of multiples that looks set to occur in the coming months. They are quality companies with good fundamentals and pricing power and leaders in their sectors. The Italian market is ideally structured for such a thorough and incisive analysis, since the country’s entrepreneurial fabric is richly endowed with companies of undisputed (and even global) leadership within their respective market niches.
Commentary by Massimo Trabattoni, Head of Italian Equity.