Despite a first quarter growth rate of 1.6%, much lower than anticipated by the market (2.5%), on the back of weak inventories and exports, Lionel De Broux, chief investment officer at Banque Internationale à Luxembourg, is confident that a US recession is not in the cards. He sees the economy as relatively robust and supported by the all too important and “resilient US consumers, the engine of the US economy.”
A distant possibility, he thinks that we may see one “marginally negative quarter,” but overall, De Broux expects a relatively good performance for the year as a whole.
US Fed rates to go up or down?
“When the economy runs smoothly with an inflation not yet under control, there is no urgency for a central bank to cut rates,” commented De Broux during an interview in late April. Despite being on the right path, he considers that the last mile in taming inflation toward the 2% target as the most difficult. He thinks that the upcoming inflation figures will determine whether the current one-cut expectation by the market will hold for early autumn (September).
“There are no rationale today justifying a rate hike… unless the economy strongly rebounds toward 5%,” said De Broux. He is not aware of any broker-dealers or asset managers expecting a hike by the Fed. Consequently, a rate hike nowadays would be a “major shock for the world markets.”
A rapid rise of energy prices as seen during Russia’s invasion of Crimea in 2014–when Brent almost reached $120–on the back of exogenous factors may result in an “inflation shock.” Yet he believes central banks would hold rates steady as their currently elevated level, coupled with higher inflation, would put downward pressure on the economy. “The objective of raising rates is always, always, always to dampen an overheating economy.” Therefore, this condition would not be fulfilled.
ECB: Cut rates at your peril
“Rates have been higher for longer with the markets continuously pushing back the rate cuts for the last 12 months,” observed De Broux. Contrary to the US, the European economy is in worse shape. “Not much is needed for it to fall in recession.” He thinks that we in Europe cannot afford to maintain elevated rates for too long.
De Broux admitted that nothing is easy, as a rate cut would increase the rate differential between the Fed and the ECB. The euro may then weaken, an adverse outcome on inflation as Europe is a net importer of energy, which is priced in dollars. The timing for rate cuts is therefore crucial.
The size and the speed of the rate cut(s) in Europe will depend on the coming moves from the Fed. “Our inflation outcome is not independent of what will decide the Fed.”
Tech bubble to burst?
Asked about a tech bubble, De Broux replied: “Is it a bubble?” When comparing the internet bubble of the late 1990s to today, several factors make him believe that “we have not reached this [bubble state], at least for now.” The sector is rather “blooming but not bowing.”
First, he thinks that “the markets are quite discerning” by separating the wheat from the chaff in terms of financial profile. He commented that the market is serious about in-depth due diligence in the artificial intelligence sector, for instance.
Second, the current market does not display the turn of the century IPO madness when business plans were written on the back of an envelope. He noted that the number of IPOs so far this year has been very limited. De Broux could recall only one company in artificial intelligence, Databricks, planning an IPO in March which was postponed as the market was seen as “pretty shut” by its CEO.
De Broux also noted that differentiation also applies to the Magnificent Seven with Meta’s stock hit hard after it published its 1Q24 earnings. The market grew concerned about its ability to monetise the firm’s plans with AI. In short, the market does not appear ready to give a blank cheque to anyone, including Mark Zuckerberg, Meta’s CEO.
De Broux noted that AI is in an infrastructure building phase. That benefits Nvidia, which has very few competitors, enabling it to dictate prices. He thinks that the growth of the sector will depend on the economic cycle to evolve beyond Microsoft, Amazon and Meta.
Any concerns on major defaults or credit events?
“None in the short term.” De Broux noted that spreads have declined so much that the “cost of risk is near zero.” Therefore, the market signals little risk of default rates to climb despite the high refinancing cost for several companies in the current cycle and the expectation by the credit ratings agency Fitch that “default rates for European high-yield bonds and leveraged loans to rise to 4% in 2024 and 2025 from 2.5% and 3% respectively in 2023.”
Some like to claim that the worst is in front of us. All the options are well known, the probabilities are just wrong
Moreover, he thinks that the pressure on large debtors is limited as the demand for credit and debt products remains high. “At this point in the cycle, whatever the rating of a debtor, the risk of default reflected by the spread is much lower than what has been observed historically.”
Idiosyncratic risks
De Broux is concerned about the return of large pandemics given the high mobility of people. Whether it is about pandemics or geopolitics, he thinks that low probabilities should not prevent investing but rather prompt an investor to assess what should be their next action upon the occurrence of such events. Yet he does not think that an investor should mobilise capital to protect against an event with an unknown timing.
Climate: included in intrinsic valuation?
“It is highly difficult to foresee adverse climatic events, but we see a trend.” Yet De Broux knows that there is a high risk that these events will impact some sectors more than others. Therefore, he explained that Bil is accounting for ESG factors in addition to financial projections when pricing financial assets.
“Some like to claim that the worst is in front of us. All the options are well known, the probabilities are just wrong.” For instance, De Broux thinks that ESG factors considered in financial asset valuations are understated. He believes that the performance of financial assets will take significant hits as the timeline of climate events will likely occur sooner than companies and society expect. Consequently, the repricing of financial assets will likely be violent if not gauged early enough.
Trump: policies may be floppy
“The last time around was not that bad for investors… as Trump is perceived as business friendly,” stated De Broux. Besides, such a victory would not be such a surprise anymore.
He considers that a Trump administration will be negative for the export sector targeting Asia and Europe, in particular given the adverse consequences of raising tariffs to 10% across the board. Elsewhere, he thinks that the oil and gas sectors should be net beneficiaries whereas his policies will likely be negative for the cleantech industry “as observed in [his] first mandate.”
Confronting Russia without love
De Broux noted that the additional expenditures on defence may result in the making of new industrial champions in Europe. However, the redirection of expenses will most likely come at the cost of weaker economies, weaker budgetary positions, higher taxes and cutbacks on investment commitments to counter climate change effects. Not surprisingly, he is unclear on the extent and the timing of additional European expenses given the inherent war uncertainties.
This article first appeared in the of Delano magazine.
