To The Moon

Investors are trying to get through the end of the rate hike cycle in the most cautious way, waiting for the green light to take risks, but this may take time to materialize.

The stock market is extending the consolidation stage, which may continue. Volatility in the Euro Stoxx 50 was once again suppressed, with the Vstoxx index trading below 18 and back below its 10-year average. Investors are torn between expectations that the Fed will turn doves later this year and uncertain macroeconomic prospects.

After last week's economic report, the swap market already expects to cut interest rates by more than 75 basis points in 2023, although strategists warn it may be premature. Meanwhile, the European Central Bank has not yet completed its rate hike.

"There is a good chance that the market will move sharply in both directions, positive or negative," said Marcus Poppe, strategist at DWS. "It is also clearly reflected in the behaviour of market participants: many are upset and prefer to stay on the sidelines."

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Overall, investors are wary, with earnings season revealing their defenses. So far, about 68% of European companies have performed better than expected, according to Barclays strategists, and most of them are cyclical companies. However, the stock market reaction was flat. Despite strong profitability, cyclical stocks have been unable to reverse their poor performance over the past few months as investors continue to monitor deteriorating manufacturing data.

"Historically, European equities have edged sideways to slightly higher levels after the last Fed rate hike," said Beata Mantay, strategist at Citi. "Defensive stocks outperform cyclical stocks both in Europe and globally. In European markets, health care, utilities and technology performed best after the peak of US policy interest rates, while the commodity sector lagged behind."

Strategists noted that European stock markets could even outperform their US counterparts given differences in monetary policy, and warned that the Fed's turn could be later than market expectations, with the first rate cut set for early 2024. They recommend a defensive configuration in response to a shift to health care, essentials and technology.

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Arthur Van Sruten, strategist of Societe Generale Bank of France, said that it is certain that the current positions are very cautious and biased towards short positions, and investors should be alert to the possibility of upward breakthrough in the market. The number of net short positions in S&P 500 contracts is staggering, reaching the same extreme level as in 2011.

The strategist said positions were so extreme that a lack of confirmation of a recession scenario could lead to a swift and drastic reversal of positions that could help push stocks higher.

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At present, many asset allocators prefer bonds to stocks because they are better able to cope with the economic recession and the current interest rate environment.

Eileen Brown, portfolio manager at Pimco, said: "We are neutral on European stock markets because the slowdown in global economic growth, the uncut earnings per share and the lagging rate hike cycle behind the US may put pressure on cyclical and value-oriented European indexes." "We believe that the overall elasticity of the stock market will weaken during the economic downturn in 2023. Earnings expectations seem to be too high and overvalued."

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