Where optimists invest, company profit forecasts for 2024, escalation in the Middle East and the impact on inflation.

Chart of the week

Bank of America conducts a monthly survey of major institutional investors. Here they were asked if and when they expect a recession.
Why this is important
Is the glass half full or half empty? The chart above gives both the optimists and the pessimists their reasons.

The optimists say that the largest group of investors does not expect a recession this year. This group has grown considerably since December.

The pessimists say that 52% of investors still expect a recession, they just disagree on when it will come. We are still among the pessimists and expect a recession in the second half of the year.

In the same Bank of America survey, optimistic investors were asked where they would invest. It is surprising that the Magnificent Seven (Apple AAPL, Microsoft MSFT, Alphabet GOOGL, Amazon AMZN, Nvidia NVDA, Tesla TSLA and Meta Platforms META), which performed so brilliantly last year, are no longer the big favorites.

The favorites are biotech, sustainable energy, real estate, banks and small caps. Investors who are pessimistic therefore prefer to avoid stocks from these sectors.

Here, the major institutional investors were asked where they see the "most crowded trade". In other words, the biggest overvaluation that should soon correct itself. This is seen in the Magnificent Seven and in bets on further declines in the Chinese stock markets.  This means that less money is likely to flow into these two areas, which could result in a trend reversal.

Institutional investors were asked where they see the greatest risks for the coming months. Not surprisingly, concerns about geopolitical risks have increased. On the other hand, the risks of a major recession or rising inflation are considered to be lower than in the previous month, even though they are still among the biggest concerns.
The current market positioning of the largest institutional investors is also always interesting:

The major institutional investors are maintaining their overweighting of bonds. The US equity market is also still favored. Europe and the UK are at the bottom of the list, where investors have the largest underweighting.
The chart should be interpreted more as a contrarian indicator. The overweighting of bonds and US equities is already very high and is unlikely to increase any further. A weaker US dollar could very quickly lead to money flowing out of the US equity market and back into the European equity market.

Companies' earnings forecasts for 2024
Over the next few days, companies will start to announce their earnings for 2023 and will also talk about their expectations for 2024 at their press conferences.

The chart shows the historical earnings per share for the US market on the S&P 500. The earnings statements and expectations are well above the historical average (yellow line). The expectations for 2024 (red line) are very optimistic, probably a little too optimistic in our view.

The chart shows the average margins reported by US companies. These are expected to be quite low. In the earnings season, which starts this week, special attention will therefore be paid to the development of margins. Even if profits continue to grow, falling margins could be a harbinger of an approaching recession.

Escalation in the Middle East and the impact on inflation.
The situation in the Middle East appears to have destabilized further in recent weeks and days. Iran has fired directly at targets abroad, Israel has killed representatives of the Iranian Revolutionary Guard.
For the time being, this has not yet had any major impact on the markets in Europe and the USA. What is very dangerous, however, is that the Houthi militia in Yemen are effectively paralyzing the sea route from Asia to Europe via the Suez Canal. The USA and UK have also attacked Houthi militia targets in Yemen.

The chart shows the impact of the conflict on sea routes. The slump is almost as high as during the COVID crisis. Back then, the reason was that it was not possible to produce or ship in China. The current impact is less dramatic, with ships being forced to take a longer route. Tesla therefore has to close its plant in Germany, among other places, for 2-3 weeks until the supply chains are up and running again.

The longer sea route will increase costs. This will lead to falling margins for companies or price increases. Costs are also likely to increase for companies that rely on short-term deliveries.

The chart comes from the same Bank of America survey of the largest institutional investors mentioned above. The question was whether they expect inflation to rise or fall. Almost everyone agrees on this. Expectations of rising inflation are at an all-time low.
The conflict with the Houthi militia could therefore catch many on the wrong foot and inflation could fall less or even rise in the next 1-2 months. This is unlikely to leave the stock markets unscathed.