After what seemed (to me) to be an interminably long stateside earnings season, Wall Street closed the first quarter of ’23 in surprisingly decent style.
“Solid gains,” was as effusive a description as could be mustered by the anxious investment bank Morgan Stanley.
And that’s probably the most upbeat MS could get about what’s happened in 2023 thus far.
Across the board the US majors did well.
The tech-heavy Nasdaq lurched off it’s arse, up 17% in one of its best quarters since 2020. The S&P 500 Index rose 7%.
Both those US indices are up about 15% and 20%, respectively, from their 2022 lows, according to some observations made late last week out of MS and which I believe are worth sharing.
The Nasdaq has stolen into a bull market as of last week. And – myopic at the best of times – all sorts of Wall St investors are starting to declare the angst, fear, pain and trauma of the 2022 bear market over.
Morgan Stanley: We believe that such a call is premature.
Here’s a short, but sharp wake up call on where we’re at – because to MS a lot of what’s happening smacks of the crazy-brave.
“This stock-market resilience, even in the face of extreme bond-market volatility, demonstrates that investors continue to ignore genuine risks to the economy and corporate earnings.
“Investors appear to be operating rather single-mindedly, focused only on a potential decline in long-term interest rates back to pre-COVID levels, since lower rates would mean higher stock valuations.
Adding to the bank’s worries – and therefore, I’d reckon yours and mine – are emerging stresses in other asset classes, particularly those vulnerable to higher rates and tightening lending standards.
“Cracks in those markets could add new headwinds to the investing environment and the broader economy.”
So what are the assets our asses need to look out for?
Well, according to MS, 2 x asset classes can take down the US in familiar style.
Commercial real estate (CRE)
We touched on this a few weeks back.
So investors have woken up a little on this sector in the US, especially after the latest banking screw ups and regional US banks’ very large and significant share in CRE lending.
“Even before the banking-industry turmoil, however, CRE was facing risks from long-term trends, with remote work threatening the office sub-sector.
“What’s more, the sector is now facing a huge “refinancing wall”: More than half of the US$2.9 trillion in commercial mortgages will be up for refinancing in the next couple of years. Even if current rates stay where they are, new lending rates are likely to be 3.5 to 4.5 percentage points higher than they are for many of CRE’s existing mortgages.
Commercial property prices have already turned down, and Morgan Stanley analysts forecast prices could fall as much as 40%, rivalling the decline during the 2008 financial crisis. These kinds of challenges can hurt not only the real estate industry, but also entire business communities related to it.
Private markets across venture capital (VC) and private equity (PE)
The collapse of Silicon Valley Bank placed an albatross around the neck of an already victimised US venture capital sector.I mean it had to be a bank actually called Silicon Valley, right?
VC-backed American businesses must soon be done with all their wee cash reserves, and any further cash infusions will cost and arm and a leg even if they are forthcoming.
VC firms and the businesses they back are dead in the water amid suddenly higher capital costs and restricted access to funding.
These challenges will likely have knock-on effects for the broader economy and markets: VC-funded companies employ more than 5 million people and generate revenues for many companies with publicly traded shares, says MS
“In private equity, opportunities do exist, given that the industry sits on roughly US$2.3 trillion of available capital that it can deploy opportunistically.
However, the overall market is likely to see a multi-year slowdown in new fundraising as investors rethink their capital commitments amid market and economic uncertainty.
A wholly uncertain and ever diminishing economic outlook shows that the punts many PE firms have made in portfolio companies over the past couple of years “face markdown risks and those companies, themselves, may need capital injections.”
Not ideal.
Equities are not invulnerable
It’s important to remember that few sectors and asset classes exist in a vacuum, MS adds as a last little slap before breakfast.
“Price declines and markdowns in valuations in these more-illiquid strategies ultimately impact the broader market. U.S. stocks, even high-flying tech and consumer discretionary companies, are unlikely to be immune.
“Consider rebalancing your portfolio with a keen eye to the likelihood of markdowns on illiquid asset classes. If you’re thinking about alternative investments, remember that CRE, VC and recent-vintage PE investments are especially vulnerable. Private credit remains our preference among private-market strategies over the next 12 months.”