Illiquidity and renewed recession fears

Summer is here and markets are tanking.

That's pretty common: many operators outside of the office, pockets of illiquidity, a disappointing (vs expectations) round of Q2 company earnings just published.

Plus, unique for this summer 2024:

• we have crazy expensive valuations in the tech sector justified by the hope of an even more exciting AI boom to come soon
• we have a dis-inversion of the US yield curve, justified by a softening of inflation (good), that normally indicates a recession coming now (more insights here)

This is a classic if perfect storm for markets to initiate an aggressive sell-off. We do not know if it will last or not.

What we know is that the economy remains in good order:

• leading indicators of growth point out to more growth in US and soft landing in Europe

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• Inflation is convincingly softer in US and Europe (good!)
• Unemployment numbers point out to a soft landing but are far from jumping towards recession fears (for now at least)

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• Markets see a US Fed rate cut coming closer: now priced-in for October

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• In parallel, recession indicators continue to point out to possible issues ahead, but that has been the case since late 2021

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• Volatility is picking up slightly in both US and EU markets

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• Bonds are finally rallying

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• Equity markets are close to being oversold

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Defensive sectors are back in fashion in Europe, not yet fully in US.

All equity styles are moving lower. All equity sectors (but healthcare) are moving lower.

What are we doing in our fund?

Our investment strategy does not react swiftly to market-driven fears when not backed-up by factual data (in fact, it is one of its strengths over the long term not to over-react to noise).

But this time is different somehow. While there are no signs of macro stress, markets are reacting pretty badly on their won emotions: earnings have moved to post-peak status, sentiment is deteriorating quickly with a pick up in vol and markets are clearly re-routing (bonds upward, stocks downward).

So our AI-run engine picked up an excess in market noise and thus shifted its asset allocation to a more defensive stance with more bonds and less stocks.

Here's the current asset allocation preferences for our investment strategy

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You can appreciate the change of posture in our asset allocation - see the right end side of the chart below: lower equities (in blue), higher fixed income (in green). Inside this broad movement, we have reduced exposure to the Nasdaq and both US and EU indices, and to cyclical sectors. The fixed income portion has increased allocation to long duration bonds.

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As closing remark: the economy is softening from a very overheated, toppy state.  We should enjoy the normalization before we go into full recession mode.  Plenty of time for that next year (eventually).