Co-Heads of Investments Jeff Klingelhofer and Ben Kirby discuss market resiliency through the banking tremors and where valuations appear attractive.
Global Markets Observations: Risk Assets Ride Out the Banking Scare
I’m Adam Sparkman, a client portfolio manager with Thornburg Investment Management. Today, we’re continuing our observations in fixed income and global equities series. I’m joined by Ben Kirby and Jeff Klinghofer, co-heads of investment firm Thornburg Investment Management. Ben, Jeff, thanks so much for joining us today. So, the first quarter was ended on a particularly volatile note with the impact of rising rates spurring the closure of two U.S. banks, as well as the takeover of Credit Suisse Ben, from your perspective, what do you think this has on the outlook of equities through the rest of the year?
Thanks, Adam. Great question. So surprisingly, risk assets are actually up since the banks failed. I think that’s mostly because rates are lower, which has been a tailwind for equity valuations. I think the longer-term implication of the banking scare, you know, we might get a few more banks that they go out of business. It’s probably not going to be a broad-based banking contagion.
The broader implication, I think, is going to be tighter credit conditions. So, banks are going to be much more likely to raise their lending standards. So, I think even though rates are lower, tighter lending standards will tend to reduce money supply in the economy, and that should be a headwind for stocks going forward.
So, Jeff, from your perspective, where does Chairman Powell and the Fed go from here?
My view is it’s business as normal at the Fed. I think the Federal Reserve has stated very clearly their intention is to create a classic credit cycle. Right? They’re trying to raise rates. They’re trying to raise rates to bring inflation down part of the transmission mechanism. And the reason why the economy has been so incredibly strong, looking backward, is the advent of lower rates and an easy credit conditions. So, look, I’ve joked before that when the Federal Reserve came in on Saturday morning to solve the banking contagion crisis, which they ultimately did by insuring and backstopping depositors, the first thing they did was toast each other with mimosas and say mission accomplished. Right? Not that they wanted Silicon Valley bank or signature bank to fail, but what they did want to see is the effect of higher rates actually exerting itself in the real economy.
And the reality is, is that after these bank failures, what we’ve seen is a pretty significant pullback and a tightening in credit conditions. What we’re seeing is ultimately that the tightening of credit conditions work in a very normalized way. And the Federal Reserve is it’s business as normal.
So, Ben, you know, to the point that you made, equities have broadly shrugged off the turmoil, looked through at indices, kind of across geographies, put up really strong returns in Q1. And the S&P is now trading at north of 18 times forward looking earnings. From your perspective, do you think equities are getting ahead of themselves kind of looking past all of the turmoil?
Sure. So, it’s always hard to say. Look, stocks go up seven years out of ten. And valuation is notoriously difficult short term timing indicator. On the long term, though, valuation is actually really important. And so, starting at this level is not very auspicious for long-term equity returns and essentially above average. That said, when you look at stocks outside the U.S., valuations are a lot lower.
Europe is normally a 50% discount to the US. That is a 30% discount to the U.S. There’s also some sectors that we think are still pretty interesting. So, as you think about the economy, slowing, you want to be probably positioning in some of those sectors, there are going to be a bit more defensive. So, I would think something like, like telecoms or health care that we own in a lot of our portfolios, especially if you can find those stocks that aren’t highly valued. So, something is sort of at market multiple or lower, then you get protection on the multiple front and also a protection on the earnings front. We think that’s a good place to be positioned as you as you look for the rest of the year.
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