May 2023

“Regarding the Great Depression, …we did it.  We’re very sorry. … We won’t do it again.”  Ben Bernanke

In a month dominated by central bank actions and debate over future direction of interest rates it is timely to remember that markets have long been dealing with the consequences of policy mishaps.  While we don’t know at this stage how this current cycle will end, we have likely reached the first inflection point with a June pause expected after May’s .25% hike, a move that was followed by the ECB.  As we’ve previously noted economic data will drive the direction of rates from here, and on that front signals remain very mixed.  While credit conditions have tightened and inflation has moderated somewhat, employment conditions remain buoyant, which means that the pressures for a near term cut have not presented themselves.  And in the absence of a more pronounced credit crunch at this stage it is difficult to say whether the next move will be a cut or another hike.  Away from macro factors, the looming US debt ceiling triggered market anxiety (NB. This is the 75th time since the early 60’s that the debt ceiling has needed to be raised…).  That this anxiety still grips the markets every few years is testament to both the current polarized political environment and the goldfish-like memory of many traders.

Unsurprisingly, yield curves responded by backing up considerably, as prospects for rate cuts faded (see January Commentary).  Elsewhere markets treaded water in both the US and Europe as data and earnings often provided offsetting signals.  Artificial Intelligence (AI) formally emerged as “The Next Big Thing”, driving technology stocks and catalyzing thought pieces by futurists who’ve had little to write about since the dawn of the smartphone era.  The handwringing on display by many of the architects of AI (“we must not proceed from here!”) has been something to behold, as the ability to put this toothpaste back in the tube will be nigh on impossible.  Perhaps they should’ve thought of this before developing it.  What seems likely is that as with the internet, mobile, cloud and other advances we are likely to see both productivity gains and disruption, both of which have major implications for the financial services sector.

Against this backdrop financials’ securities continued to recover from the March selloff.  While larger bank equities were relatively stable there was considerable dispersion among smaller names, with Greek banks in particular outperforming.  This also applied to AT1s and credit markets with mid-tier names outperforming their larger counterparts.  Greek banks once again were the strongest performers as strong earnings and capital formation plus favourable domestic economic conditions led to a significant reduction in risk premium. The incumbent government’s strong showing in the first round of the parliamentary elections on 21 May in particular raised expectations of political continuity and drove a relief rally in Greek assets with renewed talks of a likely upgrade of the sovereign credit back to investment grade later this year.  Combined, this suited our portfolio with the fund’s A shares registering a 2.78% gain, with strong contributions from both credit and equity positions contributing +243bps and +40bps in gross performance respectively.  We expect current conditions to continue into the summer months and we will look to take advantage to trim holdings recently added to preserve flexibility ahead of expected future volatility as the macro situation reveals itself.