In April, the market continued to move forward, pricing in the scenario of stagflation. With inflation figures rising quarter by quarter, driven by the prices of energy and food, the central banks are on course for the biggest interest rate hike in decades. On the other hand, consumer confidence indicators and prospective data on investment intentions show a worsening negative trend. This is beginning to make investors think that the chances of a recession caused by a fall in demand due to inflation is no longer that remote, especially in Europe. Indeed, the “Old Continent” is suffering under the pressure of energy prices much more than the United States due to its dependence on Russian fossil fuels.
In this environment, the very difficult choice regarding which countermeasures to undertake to defend the economy falls on governments and central banks. There is no way out of the dilemma that can make everybody happy. On one hand, it may be necessary to raise interest rates rigorously to curb inflation, but such a choice would penalise investments and could prove to be the final blow to the economic cycle. If, on the other hand, inflation were left to run unchecked with a less hawkish monetary policy and an expansionary fiscal intervention on the part of governments to support companies and consumers, the new aid package would increase the monetary base and reinvigorate demand, consequently causing further inflationary tension.
The Italian market investment themes for navigating these very macro-driven and volatile markets remain, in part, those associated with the NRRP spend, themes that have already been mentioned several times, such as digitalisation and the green transition, to which other themes which have flared up following Russia’s invasion of Ukraine will be added and superimposed. Among these themes, the four main ones we have identified are energy independence, food independence, the increase in military spending and pricing power/Made in Italy.
- Energy independence is clearly a theme that is already included in the European Union’s development plans, which, for quite some time now, has been rewarding investments for generating electricity from renewable sources (mainly wind and solar energy). With the war in Ukraine, the strategic importance of the energy sector has re-emerged, especially for countries that depend on Russian gas for most of their domestic consumption. Indeed, the RePowerEU plan foresees an even greater acceleration of issues, such as the production of green electricity, hydrogen, energy efficiency, technology related to batteries for electric vehicles and for storage in order to hasten the decarbonisation targets which have already been announced.
- Food independence is another investment driver for Europe, which has realised that it is far too dependent on Russian and Ukrainian wheat and grain imports. These agricultural commodities have a strategic value inasmuch as they guarantee a low price for basic necessities that are the basis of the diet for most of the population. Therefore, there is a need to invest in technologies that increase the productivity of agricultural land, starting from more efficient tractors, thereby helping even the Italian supply chain get to the biologics sector and the hydroponic crops sector.
- The rise in military spending is perhaps the most obvious repercussion of the crisis in Eastern Europe, given that never in the past thirty years has NATO been as close to conflict as it is now. In particular, France, Germany, Italy and Spain have realised that they must rely too heavily on their historical allies, the USA and the UK, having for years spent less than the NATO recommended minimum 2% of GDP, thus finding themselves with armies and military equipment that would be inadequate in the event of war with Russia. This error of judgement was promptly corrected by all four of the above-mentioned countries which declared a budgeted defence spend of around 2% for the immediate future, which translates into several hundred billion euros in contracts for large-cap European companies operating in this sector and small-cap companies operating in the field of cybersecurity.
- The fourth and last investment theme is related to sector leaders and companies that have pricing power, that is the ability to pass on increases in the prices of commodities, logistics and energy to customers. Usually, this type of capability is associated with businesses that have high marginality, providing added value to their customers with a high-quality service or product. These characteristics are by no means unavailable in Italy which, on the contrary, has a wealth of quality companies in many sectors such as, manufacturing, component production, the food industry, the medical sector, the automotive industry and high fashion.
In conclusion, even though the negative macroeconomic environment ,which is dominated by expectations of inflation, makes it very difficult to navigate the market, equities still express real growth, and we believe that at this moment in time they are preferable to fixed income. It becomes even more crucial, however, to be selective in stock picking by remaining anchored to the investment themes which, being based on structural trends, remain valid in different market scenarios.
Commentary by Massimo Trabattoni, Head of Italian Equity.