Where optimists are investing, companies’ 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 large institutional investors. In this survey, they were asked whether and when they expect a recession.

Why This Matters

Is the glass half full or half empty? The chart above provides arguments for both optimists and pessimists.

The optimists point out that the largest group of investors does not expect a recession this year. This group has grown significantly compared to December.

The pessimists argue that 52% of investors still expect a recession—it is only a matter of timing. We remain in the pessimistic camp and anticipate a recession in the second half of the year.

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

Instead, the preferred sectors are biotech, renewable energy, real estate, banks, and small-cap stocks. Investors with a more pessimistic outlook therefore tend to avoid equities in these areas.

Here, large institutional investors were asked where they see the “most crowded trade”—in other words, the most overvalued positions that may soon correct. These are identified as the “Magnificent Seven” and bets on further declines in Chinese equity markets.

As a result, less capital is likely to flow into these two areas, which could lead to a potential trend reversal.

Here, institutional investors were asked where they see the biggest risks over the coming months. Unsurprisingly, concerns about geopolitical risks have increased. At the same time, the risks of a severe recession or rising inflation are assessed as lower than in the previous month, although they still rank among the top concerns.

It is also always insightful to look at the current market positioning of the largest institutional investors:

Large institutional investors continue to maintain an overweight position in bonds. The U.S. equity market also remains favored. Europe and the UK are at the very bottom of the list, where investors show the strongest underweight positions.

This chart should be interpreted more as a contrarian indicator. The overweight positions in bonds and U.S. equities are already very elevated and are unlikely to increase much further. A weaker U.S. dollar could quickly lead to capital flowing out of the U.S. equity market and back into European equities.

Corporate Earnings Forecasts for 2024
In the coming days, companies will begin reporting their 2023 earnings, and during their press conferences they will also provide guidance and expectations for 2024.

The chart shows historical earnings per share (EPS) for the U.S. market, represented by the S&P 500. Both reported earnings and expectations are well above the historical average (yellow line). The forecasts for 2024 (red line) are very optimistic—likely somewhat too optimistic from our perspective.

The chart shows the average margins reported by U.S. companies. These are expected to be relatively low. As the earnings season begins this week, particular attention will therefore be paid to margin developments. Even if profits continue to grow, declining margins could be an early warning sign of an approaching recession.

Escalation in the Middle East and Its Impact on Inflation
The situation in the Middle East appears to have become increasingly unstable in recent weeks and days. Iran has directly targeted locations abroad, while Israel has killed members of the Iranian Revolutionary Guard. So far, this has had limited direct impact on markets in Europe and the U.S.

However, a significant risk lies in the actions of the Houthi movement in Yemen, which has effectively disrupted the key shipping route from Asia to Europe via the Suez Canal. In response, the United States and United Kingdom have carried out strikes against Houthi targets in Yemen.

The chart shows the impact of the conflict on shipping routes. The decline is almost as severe as during the COVID-19 pandemic. At that time, the disruption was caused by halted production and shipping in China.

Currently, the situation is less dramatic—ships are still moving, but they are forced to take longer routes. As a result, Tesla, among others, has had to shut down its factory in Germany for 2–3 weeks until supply chains stabilize.

The longer shipping routes will increase costs. This will either lead to declining corporate margins or higher prices. Companies that rely on short-term or just-in-time deliveries are particularly likely to see rising costs.

The chart comes from the same Bank of America survey of large institutional investors mentioned above. Participants were asked whether they expect inflation to rise or fall. There is near-unanimous agreement: expectations for rising inflation are at a historic low.

The conflict involving the Houthi movement could therefore catch many investors off guard. Inflation may not decline as much as expected—or could even increase over the next 1–2 months. This is unlikely to pass without impact on equity markets.