Stocks fell 2% last week after the US Federal Reserve and the European Central Bank sent hawkish messages to the markets.
The ECB said that interest rates need to increase “significantly” next year. “Anybody who thinks that this is a pivot for the ECB is wrong,” noted ECB chief Lagarde, referencing the slowdown in the pace of rate hikes. This was a very hawkish message.
In principle, increases in interest rates are beneficial for our bank-heavy portfolio because banks can earn more interest income when interest rates are high.
But if rates are taken too high, they will tip the economy into recession. The benefit from rates for banks then disappears, as they lose more money from people defaulting on their loans compared to what they make in extra interest.
At the moment, we consider that the tipping point has not been reached. Energy prices have fallen, helping the consumer,
while copper prices, a good indicator of global economic activity, have increased.
Despite current economic resilience, investors are fairly pessimistic about next year. Most investment banks expect markets to drop or go nowhere in 2023. The typical bank expects stocks to fall in H1 before recovering in H2, with little overall change for the year.
This is important because the best times to buy tend to occur when expectations are low. If we had to hazard a guess, it would be that the markets will confound expectations by rising in H1 but falling in H2, as it is only in H2 that consumers run out of their pandemic excess savings and a recession ensues.
Our portfolio is therefore positioned for a better-than-expected economy. The risk is that the economy deteriorates quickly in H1 23, especially if this is accompanied by rapidly increasing interest rates that would raise doubts about Italy’s debt sustainability. We take this risk because if the economy does not deteriorate, 50% upside is available from many of the banks in the portfolio.
We wish you a Merry Christmas! Weekly Update will return in the new year.
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A position was opened in $BAC (Bank of America Corp) .