Will the first signs of improvement in industrial momentum be enough to restore optimism?

A quarter of a century has passed since the collapse of the giant LTCM. 
Halfway through, almost 15 years ago to the day, it was Lehman Brothers’ turn.
As Roger Lowenstein notes (When Genius Failed): “Those who suffer such cataclysms generally see themselves as the victims of an exceptional twist of fate. However, financial history is in fact made up of these statistically infrequent but intense events (wide distribution tails): unusual but extreme price fluctuations which, based solely on the study of past data, seemed unthinkable at the time”.
For more than three years, the markets have been looking to the lessons of past crises to help them cope with the new ones, to no avail. Stunned by the epidemic, they underestimated the strength of the recovery. Euphoric, they did not realise the extent of the latent logistical tensions until the images of the container ship Evergreen blocking the Suez Canal reached them. Frightened by the inflationary overheating that had led to the tightening of financial conditions, they ended up cursing the causes they had cherished just a few months earlier: the unconditional and total support for the economy by governments and central banks. 
From then on, they sought in the current episode of monetary restriction the markers of the recessions of 2000 and 2008, without success. China’s property crisis, epitomised by another ‘Ever’ (Evergrande), is hardly spreading beyond the region, for the time being. Thanks to an improved product mix, Western companies have generally managed to benefit from inflation over the past two years. In the absence of critical refinancing deadlines, financing conditions have not yet pushed them into massive redundancy programmes. This robustness in employment has enabled household confidence, although tested by the war in Ukraine and the rise in prices, to begin to recover in Europe. The result is robust underlying inflation, which nevertheless showed tangible signs of decelerating in September in the Eurozone.

However, in contrast to consumer sentiment, industrial business confidence remains depressed. Due to a lack of outlets, stocks of finished products, particularly those destined for China, have risen in recent months. The first signs of improvement are emerging. For gas market observers, after a very sharp fall in industrial demand again this year, a stabilisation seems to be underway. This, too, could herald a low point in European industrial production. Particularly as it is not gas prices but weak end demand that has been cited by companies like BASF, which is committed among others to structural production cuts. What’s more, in an environment of high interest rates, the longer it takes for inventories to run down and for demand to rebound, the greater the risk that production lines will be closed, thereby contradicting the preachers of the reindustrialisation of Europe. The first signs of stabilisation in Chinese industrial profits are a glimmer of hope. It remains to be seen, however, whether this is the result of a genuine revival in demand or the initial effects of the fiscal stimulus, or whether it is a short-term effect of a reduction in working capital requirements driven by destocking. 
It is not certain that a turnaround in industrial momentum in China and Europe will be enough to revive equity markets, which are coming to the end of a painful September. Faced with record oil consumption this year (mainly driven by Asia and the reopening of China), OPEC’s alignment around Saudi Arabia and Russia in favour of a more expensive barrel of oil is a further danger to the Western economic soft-landing scenario. In the United States, the rise in defaults, the fall in excess household savings and the eternal return of the risk of a government shutdown are adding to the worries. Far from succeeding in deflating rates, fears of a slowdown are coming up against the problem of the country’s indebtedness, which is pushing 30-year rates towards 4.7% and, with them, mortgage loans, above 7%.  Unenthusiastic about the presumed end to key rate hikes, the markets are above all bitter about an environment of higher rates for longer than expected… This bittersweet taste seems to be causing equity indices, which have fallen significantly since their highs for the year, to test major psychological thresholds… Will the adage ‘sell the last rate hike’ prove true? Or should we stop trying to compare the future with the past? 

Thomas Planell, Portfolio manager – analyst at DNCA. This article was finalised in September 29th, 2023.

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