Investment Newsletter – September 2023
The risks are still there for another banking crisis, but more significantly so are the risks of recession. According to the FDIC, the total of unrealised losses, including securities that are available for sale or held to maturity, was about $62bn at the end of 2022, prior to the March banking crisis. Interest rates have since been increased four times in 2023, while lending standards have tightened and real estate markets continue to deteriorate, and defaults are on the rise. In March, the FDIC said, ‘Unrealised losses on securities have meaningfully reduced the reported equity capital of the banking industry’. Falling Loans growth will have an impact on bank earnings, resulting in tighter lending standards, on top of the problems in March. Since the start of the year, Loans to the Private Sector have contracted from $3383bn in January, to $2763bn in August.
To Raphael Thuin, head of capital markets strategies at Tikehau Capital, the consensus is too optimistic. “People are estimating the economy will rebound and that we won’t have a recession. That’s too optimistic. You don’t need a crystal ball. There is a liquidity risk,” he said, referring to the decreasing money supply, or M2. “The consumer is exhausted. There is rising credit card debt.”
Even so, a recession, according to Tikehau’s Thuin, is still on the table as the lagged effects of the Fed’s aggressive monetary tightening finally trickle in. “The estimate is 12 to 24 months,” he said, referring to how long it usually takes for the rate hikes to hit the economy; the Fed started to raise the fed funds rate 18 months ago. “It’s exactly now. We are starting to see some effects.”
Markets are going to go through some trauma. That was the big takeaway from Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch Global Research, at a conference held by finance journal Grant’s Interest Rate Observer in New York. A concern, he said, is that government spending is high, while monetary policy is likely to become more accommodative. U.S. government spending is 44% of gross domestic product, he said, below the level during the Covid-19 pandemic but more or less in line with those seen during the 2008-2009 financial crisis. And spending is likely to remain elevated because 2024 is a critical election year, while the Federal Reserve will feel intense pressure to cut interest rates, he said. Taken together, it means “I want to be in real assets over financial assets,” he said. Real assets – investments such as precious metals, real estate, and infrastructure – tend to perform best when inflation picks up.
Goldman Sachs, which issued a study projecting that, by 2035, emerging markets’ equity valuations will overtake those of the U.S., which currently has 42% of stock capitalization, compared with 27% for the EMs. Come 2035, EMs and the U.S. will both have 35%, but the EMs will have a smidgen more. By 2050, the developing world, will command 47% of world market cap to the U.S.’s 27%, per Goldman. By 2075, EM stocks will reach 55%, and the U.S. will fall to 22%.
