What can we expect from the securities markets as summer comes to an end?
Ismael García Puente, head of investments and funds selector MAPFRE Gestión Profesional
There is a quotation attributed to the Chinese philosopher Lao Tzu, who lived during the 4th century B.C.: “Those who have knowledge, don’t predict. Those who predict, don’t have knowledge.” Although there are plenty of investors who are able to operate in the securities markets with skill, knowledge, and intelligence, many of them still see the end of the summer vacation period as an opportunity to reassess their portfolios for the final part of the year, which inherently requires an exercise in prediction.
On the other hand, the people who do seem to be following Lao Tzu’s advice are those in charge of monetary policy, judging by the statements made by the heads of the central banks at the Jackson Hole conference. The most commonly heard message was about the need to make decisions on interest rates based on ongoing publication of macroeconomic data, in view of the current difficulties with determining exactly where we are in the economic cycle. This change of focus should not be too surprising to anyone, given the scarcity of accurate predictions made by the United States Federal Reserve (Fed) and European Central Bank (ECB) regarding the future course of inflation, and the inaccurate forecasts presented in recent years by Jerome Powell and Christine Lagarde regarding the evolution of interest rates.
For example, just one year ago the Fed was predicting interest rates of 3.25% to 3.5% for December 2022, and 4.5% to 4.75% for December of this year. However, at the end of last year interest rates were in the range of 4.25% to 4.5%, and right now those rates are at 5.25% to 5.5%, with ongoing uncertainty about whether additional interest rate hikes will occur during the next few months. The conclusion we can therefore take from the year’s most important monetary policy event is that interest rates will remain high for longer, while those in charge wait for clear signs of price stabilization and inflation data showing a secure return back towards 2%.
And this is linked directly to what has been happening in the securities markets during the month, until the chip manufacturer Nvidia released its earnings report last Wednesday, August 23rd. Without a doubt, the most significant catalyst behind the cumulative series of revaluations seen in the main stock market indexes in 2023 has been anticipation of an interest rate cut by the central banks sometime during the year, in view of the year-on-year decline seen in corporate earnings. However, as economies continue to demonstrate their resilience, with support from a job market that is now in a state of full employment, and with salaries rising faster than inflation for the first time in a decade, hopes for lower interest rates based on fears of a recession have been fading away, and this has affected the securities markets in August.
The current situation now calls for plenty of caution, because in addition to interest rates, macroeconomic conditions are also a source of volatility. Some companies are trading with rather unattractive multiples, and equities are now offering a risk premium that, for the first time in quite a long while, is lower than what we are seeing with fixed-income investments. It is certain that the securities markets will gain some support from corporate earnings in the third and fourth quarters. This is what analysts are expecting, and they are predicting a recovery of these profit figures based on a job market that is showing no signs of slowing down, along with the improved productivity brought by a major expansion in the use of artificial intelligence. But there is much need for improvement, in order to compensate for the demanding valuations of the indexes in general, and monetary policy (with the exception of the securities markets in emerging economies) that should continue to put the brakes on the expansion of multiples in the securities markets, as well as on consumption in the real economy. In addition, a paradox could emerge, where higher levels of corporate earnings and demand (something positive for the securities markets in the short term) would only increase the need to maintain tighter monetary policy, with the corresponding risk of causing a more severe recession (something negative for the markets over the medium term).
In view of all the above, it would be better to wait for a drop in the markets that could arrive in the form of a “financial accident” that puts an end to this economic cycle. However, only occasionally has the future we were expecting actually come to pass, and instead, it is the things we don’t know that are creating the best opportunities. Given the lack of ability to anticipate events of this type, and the difficulties associated with trying to predict the short-term performance of the securities markets (remember the words of Lao Tzu), the only thing we can do is try to find the right risk/return balance that represents the best way to achieve the pertinent financial objectives. This is no easy task, but then again, it never has been. This is something that financial advisors know perfectly well, and in fact, this is one type of knowledge they have in abundance.