Daily Voice | Equities may present more downside than upside potential at this time, says Sunil Garg of Lighthouse Canton

Despite monetary tightening at the fastest pace, over the last 12 months, economic indicators have been mixed at best with labour resilience the most remarkable. While demand appears to be slowing, it’s at a slower-than-expected pace. With the FED indicating a pause to their monetary tightening efforts, there appears to be optimism of a “soft landing”, supported by rate cuts.

We see this Goldilocks scenario as wishful thinking. No doubt, the much-awaited recession is not even on the horizon, but then, recessions never arrive by appointment. Sequentially, weaker corporate revenues and earnings (and these are already in evidence), drive job losses, which in turn impact consumption and economic growth.

While timing an (eventual) economic recession will always be tricky, we see complacency as the biggest risk in markets.

Moreover, the contrast between fixed-income and equity investors is striking as they exhibit vastly different approaches. While bond investors are pricing in a potential rate cut by the Fed in anticipation of an economic slowdown, stock pickers are displaying remarkable resilience. It's worth noting, however, that equities can be split into two categories: cyclical stocks, which have only partially recovered from their 2022 lows and are trading at their long-term P/E multiple of 15x, and tech stocks, which have rebounded sharply in 2023 and are once again trading at expensive multiples.

Are we at the beginning of the bull run, considering the current improved market sentiment?

Bull runs rarely begin with unemployment at record lows and valuations that are “average” at best (although factoring in expectations of earnings declines, probably expensive). As previously mentioned, the market’s belief in a robust economic outcome supported by FED easing is driving complacency/ positive sentiment. We do not see this as the start of a bull run and rather see this as a late-stage “bull trap”.

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To be precise, despite the strong performance of equities, particularly in the tech sector, in 2023, we have concerns that this trend may not last for long. This is due to the ongoing tightening of lending standards across the globe, which is expected to pose a headwind for global economies. As a result, we believe that equities may present more downside than upside potential at this time.

Is the realty sector looking attractive with 2-3 years’ perspective?

In the relatively short-term (over the course of the next year), we see opportunities in defensive sectors (healthcare, staples), especially after a prolonged and steep underperformance. On a more medium-term horizon, we are likely to see value emerging in the financial sector, especially after a substantial pullback led by the recent turmoil.

We also see opportunities in technology, especially AI, although much more on what that will do to drive innovation and productivity.

Which are the sectors that you are advising clients for the current financial year?

We are recommending healthcare and staples. In addition, we see selected opportunities in technology, although not broad-based.

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Do you see the possibility of another leg of crisis in the US banking space in coming months?

The current banking turmoil is significantly different from previous instances which were much more credit related. As such, comparisons with GFC (global financial crisis) appear misplaced, even though outcomes for individual institutions may appear similar. The distinction is important since the current crisis is one of depositor confidence and one bank’s loss is another’s gain – so less systemic (unless we make the assumption that savers will en-masse exit the banking sector – a view we do not subscribe to) and more individual bank specific.

Given a skittish environment, the possibility of more small bank failures cannot be ignored, but more importantly, we see cyclical stress rather than a systemic/ contagion problem.

From an investment perspective, the swoon in bank share prices has accelerated what would have been a cyclical downturn impact and as such, we are likely to see opportunities in bank/ financial stocks emerge sooner as a result, although we are not quite there yet.

Do you think the equity market has started focusing on expected interest rate cuts?

The positive performance of equities in 2023 has been partially driven by the expectation of lower interest rates. This trend is especially evident in "growth" stocks, which are perceived as "long-duration" investments due to their potential for generating positive cash flow in the future. Indeed, the bond market certainly is factoring in multiple rate cuts – starting as early as Q3-2023. This may prove to be an ambitious expectation.

Equity markets also appear to be benefiting from some of this optimism although much of the YTD gains were clocked in January 2023. We should also highlight that equity market performance, when the rate cycle reverses, has been negative in the early stage of the reversal cycle – as markets start focusing on the causality of rate cuts, being weaker economic conditions.

We are in the middle of corporate earnings season. What is your take on it and are these earnings on expected lines?

The current earnings season has certainly been better than previous expectations. While directionally the pressure on earnings has continued, expectations of a sharper retrenchment have not yet materialized. This is clearly a contributory factor to the better sentiment previously discussed.

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