Must Read Research

A smooth sea never made a skilled sailor. This week we help investors navigate cross currents in the market, interpret 4Q earnings to suggest a difficult environment for U.S. companies and present the bull case for European banks.

Whether it was COVID, inflation, or rate hikes, all that mattered for the past three years was the macro environment. Assuming central banks are successful in taming inflation, micro factors matter once more. However, U.S. Equity & Quantitative Strategist Savita Subramanian and Global Economist Ethan Harris warn of cross currents likely to complicate 2023, resulting in outcomes not found in a classic market cycle playbook. Unlike in a typical economic slowdown, we should see higher capex spending given underinvestment in infrastructure, peak globalization and tight labor driving automation spend. Similarly, consumer and corporate balance sheets look in far better shape than ahead of past recessions, with leverage still near record lows. Although the picture for government debt is much different. Also, layoffs haven’t been widespread with white collar workers (Wall St/Tech) disproportionately impacted compared to blue collar workers. And don’t be surprised if oil companies and renewables outperform this year, despite being negatively correlated in the past.

With half the S&P 500 having reported we have a good read on 4Q earnings. Investors have been more focused on 2023 company guidance. Savita highlights that Tech may be facing the biggest downturn since the financial crisis, and the reversal of easy money, globalization and the demand pull-forward during COVID suggests the sector is both cyclically and secularly challenged. Even after Tech layoff announcements, she calculates Tech has more costs to cut given 20% excess hiring over the past three years. Much like fiscal stimulus, layoffs also signal that “corporate stimulus” (employee assistance and firing freezes during COVID) is now behind us. Savita believes investments will rotate into old economy sectors like Industrials, Energy and Materials, which have been neglected for the past decade.

At its peak, the energy price shock threatened to hit Europe’s GDP (gross domestic product) by 300-400bp (basis points). The substantial reversal in energy prices since then means GDP tail outcomes have moved out over the horizon, a positive for European banks. Although inflation is no longer climbing higher, European Bank Strategist Alastair Ryan believes the rate picture is still quite promising as the UK has already seen evidence of a potential de-anchoring of inflation expectations, which could need higher rates over time.

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