Source: ODDO BHF AM
Despite strong earnings releases, recession fears continue to dominate the markets
European companies have once again beaten the most pessimistic forecasts. Activity and margins remained solid despite a still high level of inflation. While the energy sector was obviously favored in a context of persistently high oil prices, other cyclical sectors also benefited from positive revisions, such as industrial stocks, consumer cyclicals and financials. However, these releases did not alleviate fears of recession.
The possibility of a negative event materializing in the coming months is not in itself a reason to reduce risk and change our portfolios.
Inflation, monetary tightening decisions around the world to control it and uncertainties about energy supply in Europe as winter approaches have dominated discussions. These discussions are largely concerned with guessing when inflation will peak, when the Fed will "pivot", when the recession will begin, and how deep it will be. A common feature of these questions is their short-term focus. The return of inflation that we have been witnessing for several months is not a transitory phenomenon. Although exacerbated by recent health and geopolitical events, there are many arguments for considering that the level of inflation will probably be higher in the next decade than in previous ones: reversal of the major trends in globalization and demographics, the energy transition, etc. Assessing the impact that this change of regime could have on the level of a company's normative margin is more important than determining the peak of inflation, since it constitutes the essential determinant of a company's industrial value.
Similarly, the possibility of a negative event materializing in the next few months is not in itself a reason to reduce risk and change our portfolios. This could be justified if the event is not properly reflected in the valuation of the companies or if the materialization of the event would lead them to an extremely difficult financial situation. Assessing the risk of a recession materializing, whether in this case caused by aggressive monetary policies or by the occurrence of a major energy crisis, seems almost secondary. Economic cycles are by nature a succession of growth and recession periods. Our job, as value managers, is to ensure that the companies we hold in our portfolios can weather the toughest of times and adapt to long-term changes. We are investors, not traders. We do not base our investment decisions on macroeconomic forecasts, short-term events or momentum.
Value management regularly results in doing the opposite of what most investors think, especially in extreme periods. Establishing and maintaining a Value investment process requires defending idiosyncratic portfolios that might be considered, in times of great uncertainty and in the eyes of conventional wisdom, to be totally unwise. While adopting contrarian behavior can be difficult, we know from experience that it is an indispensable quality for building long-term performance.
