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27 June 2022 - Commodities feel the heat (at last).

Commodities fell precipitously, as recession fears could not leave them untouched. Copper was the worst performer with a 10% drop for the week, while US Natural Gas has already fallen 33% from its early June high. Oil prices fell further, last week, by 5% and they are now about 15% lower from their recent high. This was temporarily "good" news for stocks, as lower commodity prices point to lower inflation down the road, but one has to look also to the reason commodities are rolling over : slowdown of demand, hence an increased probability for a recession.

Hence, equity markets had a relief rally, for the "wrong reason", but we like it anyway. The stock markets reacted in a strong positive way from the recent lows, as investors saw commodity prices moving significantly down, which means that inflation might have peaked and the FED might finally be less agressive with raising interest rates. What they chose to ignore for now was that the risk of recession is now spilling into commodity prices and the bond market. Bear markets always enjoy big rallies throughout their duration. These rallies can also last long (several months) before the next leg down to a new low. Of course, were we not to go into a recession, we might as well have seen the lows. No forecast can be made.

Defensive sectors (Healthcare, Technology) outperformed the rest of the market, while the Swiss market finished the week on a very strong note (+3.5% on Frdiay). We repeat our preference for the above mentioned sectors and region at this stage. However, there are parts of the market which are recession-sensitive, but have already corrected a lot (european discretionary, such as luxury, clothes and autos) and we would "dip our toes again" in high quality names. Energy and Materials fell during this big rally of US markets, as commodities sold-off. German stocks fell for the week, aginst the positive mood, as the country is the most impacted in case of a possible blockage of Russian gas flowing to Europe.

The FED's Chairman, J. Powell, himself spoke about the risk of a recession for the first time. During his semi-annual testimony to Congress he stated that the central bank is laser-focused on bringing inflation down and that engineering a soft-landing for the economy would be a challenge. When asked if he is willing to be a new Volcker (who in the late 70s became known for his aggressive hikes of interest rates to bring down inflation and brought down the economy too) his answer was basically "yes". He added that "a recession is possible, but not a desired outcome of our policy".

The Eurozone PMIs (Purchasing Managers Index) for June fell more than expected. In particular, the manufacturing index fell to 52.0 from 54.6 and vs expectations for a small drop to 54.0 The Services index fell to 52.8 from 56.1 and vs. expectations for 55.5. France was the worst performer both in manufacturing, where its PMI fell close to the 50 level (51.0) and in services where the index fell to 54.4 from 58.3. The elections which did not provide President Macron with an outright majority complicates matters even more for the French economy in the coming months.

Germany is considering a rationing of natural gas to corporations, if Russia cuts off the supply. This basically means that German companies will have to reduce production, in order to meet the requirement of the government for a maximum allowed amount of energy consumed, at a time when they were trying to recover from the supply chain issues affecting their sales. At the same time, President Biden is trying to pass legislation for a "tax-holiday" on consumer gasoline prices for 3 months. This could shave off about 20 cents per gallon, but there is strong resistance even with his own party members. He is also continuing to push publicly the refining companies to act in order to bring prices down.

Government Bond yields dropped like a stone (prices rallied). As the market is focusing on a possible recession, it suddenly realized what we have been saying for some time now. That a recession will mean that interest rates will not move up as high as the market was pricing and that high quality bonds/government bonds of the US and Germany will have to rally, as they have always been the perfect hedge for a recession. The 10-year US yield moved to 3.05%, down from 3.45%, while the drop in yield of the 2-year has been even more impressive, falling below 3%, after touching 3.60% just ten days ago.

US banks passed the Federal Reserve Board's stress tests. All banks remained above their minimum capital requirements, despite total projected losses of $612 billion under a severe scenario. Under such stress, the aggregate common equity capital ratio—which provides a cushion against losses—is projected to decline by 2.7 percentage points to a minimum of 9.7 percent, which is still more than double the minimum requirement. With bank stocks down more than 30% from their peaks, valuations close to (mild) recession lows and dividends set to increase following the stress tests, bank stocks look increasingly attractive.

In other corporate news, the Porsche IPO in the last quarter of this year was confirmed by the Volkswagen Group. The listing of the Porsche brand in the stock exchange will be very positive for Volkswagen shareholders. On one hand the valuation of the group company will have to increase significantly, as Porsche will get a much higher multiple on earnings than the Group (similar to the Ferrari case, which has a much higher multiple than the rest of the automakers). And also VW shareholders will receive a special dividend which is estimated at about 12%, at current prices, as VW will sell about 20-25% of Porsche into the market, receiving 20-25bn EUR, about 50% of which will be distributed.

Equities: Weekly Performances


Charts of the Week

Eurozone's PMI point to weak growth ahead

The June Purchasing Managers Index for Manufacturing and Services in the Eurozone fell to a new cycle low, just a little over the 50 level, which signals expansion or recession. Both indices were closer to 60 last year, but they are falling since then as the rise in interest rates, the high consumer prices as well as the uncertainty of the war in Ukraine is taking a toll on consumer confidence and on their potential spending power. The PMIs are a leading indicator for growth in the next 2-3 months. This means that GDP growth in the Eurozone in the third quarter will probably disappoint, bringing the scenario of a recession even closer. In this environment, as we have been saying for some time, it is very difficult to envisage that the ECB will be as aggressive with raising interest rates as the market had priced in, until just one week ago. The market's expectations for 1% at year's end, and 2% by the end of 2023 look overly ambitious, although this year one should expect that the rate will become slightly positive again after almost a decade.

The software sector's risk/reward is compelling again.

This is the chart of the price of the ETF iShares Expanded Technology/Software (IGV) in blue line and its valuation as measured in Price-to-Earnings (green dotted line) for the last 5 years. After the big rally in 2020/2021, which was primarily caused by investor greed, chasing the best performing sector higher, the ETF is down about 30% this year and more than 40% from its high in November of last year. Even more importantly its valuation has come down to more "normal" levels, albeit at 28x earnings. However, this is a sector that includes high growth companies in the cloud and in the software business, which are industries that can offer some protection during a recession and are expected to keep growing significantly above GDP levels. We had cautioned for a bubble last year. But now that this bubble has burst, the risk/reward owning these stocks, at these levels, is again favorable for the investor with a 3-5 year horizon.



• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

• This document is strictly confidential and should not be distributed further without the explicit consent of Kendra Securities House SA.

• Sources: Equity performace: Factshet, Chart 1: UBS, Chart 2: Facstet


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