August 2024

“Suddenly the world began to wither and blacken, rapidly secreting from itself a hallucinatory dusk that infected all things.”  Bruno Schulz

If we do indeed enter a period of definitively slower/negative economic growth, then we can look back to August as the moment when the notion first entered the market’s collective consciousness.  Early on, the July employment report in the US showed a much slower pace of job creation and virtually no growth in private sector employment.  Later, annual revisions showed that 818,000 fewer jobs had been added than previously reported.  The sentiment was enhanced by general softness in the larger European economies and a consumer that is showing signs of depleted savings, and several forecasters raising their probability of a recession.  Tellingly, the USD had its weakest month in several years and bond yields dropped.  To be sure, Pavlovian calls for an emergency Fed rate cut in response to a stock market wobble, induced by the weak jobs data, were risible and underscored just how far from rationality sensibilities have drifted in the twenty-five plus years of the “Fed Put” era.  But, given softer CPI in most economies, it is a certainty that we will see a more sustained move to ease rates by central banks.  The obvious questions are how much will they cut and how will the markets react?

For the past few years the market seems happy to continue with the theme that good news for the bond market is also good news for risk markets, but an early month rout of equity prices following the weak jobs report served as a timely reminder that while stock markets hate rising rates, they also don’t like the falling rates if they are harbingers of economic slowdown and earnings compression.  Markets steadied themselves for the balance of the month, but all eyes will be on September’s releases, especially employment.

The market will undoubtedly be concerned about the impact of lower rates on bank earnings, having seen NIMs greatly expand in recent years, as well as looking for any signs of deteriorating asset quality.  On the former, it should be noted that there is only a remote possibility that rates will fall to crisis levels and that given cost structures the fall in top-line revenue should be manageable.  On the latter concern, a significant downturn would lead to higher provisions, especially for banks with concentrated exposures to problem sectors (e.g. CRE).  But it’s worth remembering both the absolute levels of capital that most European institutions are now sitting on as well as the extensive balance sheet reduction that has taken place over the past ten years.   To be sure, bank equities, and likely AT1s will not be immune to market pressures in the face of a deteriorating economy, even if other sectors bear the brunt of the pain.  But the banking system will not be ground zero in the next recession as in 2008, and any significant selloff will represent an opportunity for those capable of sorting through the winners and the losers within the sector.  We cannot be sure of the scale of any downturn at this stage, but the fourth quarter is likely to be eventful.

Apart from the chaos of the first few days of the month European financials traded constructively throughout the month, with our action focused primarily on “story names” with CRE exposure and southern European names which continued to outperform driven by strong results, albeit on thin volume.  For the month the fund’s A shares rose +87bps with fixed income contributing +116bps gross and equities -13bps.  We retain strong conviction in the composition of the portfolio and will look to take advantage of any opportunities that emerge in the coming month.