This May, all the major global equity indices are showing neutral or positive performances: on the Italian market, the FTSE MIB (+16.5% YTD) and the Stoxx Europe 600 (+11.4% YTD) remain unchanged from the previous month, the S&P 500 is at +1.0% (+10.3% YTD) and the Nasdaq at +6.2% (+24.4% YTD) in local currency (total return).
The first-quarter reporting season confirmed widespread expectations of good results for European banks (along with their US counterparts), which reported higher-than-expected profits. Many of them even raised their guidance for 2023 thanks to a very solid interest margin and quite low provisions: such a situation has developed because the rate hike of recent months has so far only caused a repricing of banking assets, but not an accompanying increase in return on deposits.
From here on in, investors will inevitably take a more selective and opportunistic approach to banks, with the market wondering whether or not the profits seen in this first quarter have already peaked, and therefore whether banks can still offer pleasant surprises in the coming months. There are various factors that urge caution:
Therefore, we restate our preference for larger banks over smaller ones at this time: this of course penalises SMEs, whose closer ties with the business cycle will make them look riskier for the next few months. This also helps to explain this month’s underperformance of mid and small caps compared to large-cap stocks: in May, the FTSE Mid Cap returned -0.8% (+9.7% YTD), the Aim -0.7% (-0.6% YTD) and the Star -1.2% (+3.7% YTD). The essential ingredient to close this performance gap is greater confidence in the domestic macroeconomic scenario and consequently greater visibility on trends in key economic variables globally.
It can therefore be argued that if the rate hike cycle, in America at least, were to slow down (or even come to a halt) in the next few months, it would be an encouraging signal not only for the more rate-sensitive assets such as utilities and tech – since they have suffered greatly under recent restrictive monetary policies – but also for mid and small caps, which tend to be positively correlated with growth and quality factors, especially in the case of the Aim segment.
As regards the quarterly results of the non-banking sectors, most companies (especially in the more cyclical and consumer-sensitive sectors) show revenues still benefiting from a positive price effect (mostly still the effect of the 2022 price increases), while volumes have begun to point to a slowdown in US consumption (for firms exposed to the US). Margins, on the other hand, benefited from the strong retracement of commodity prices and the drop in gas prices, despite the latter remaining well above their long-term values and labour costs remaining higher than previously (especially in America where wage inflation is particularly sharp).
In a scenario such as this, the Team maintains an active approach supported by careful bottom-up, in-depth analysis. This way it is able to select companies with healthy balance sheets, strong pricing power and resilient margins that allow them not only to cope with further cost increases, but also to weather the various phases of the economic cycle.
Commentary by Massimo Trabattoni, Head of Italian Equity.