The mid-year quarter reports offer a snapshot of the economy’s health

This July, all the major global equity indices are showing neutral or positive performances: on the Italian market, the FTSE MIB recorded +2.2% (+25.0% YTD), the Stoxx Europe 600 +0.8% (+11.8% YTD), the S&P 500 +2.0% (+19.2% YTD) and the Nasdaq +1.7% (+41.7% YTD) in local currency (total return).

Initial remarks on the second-quarter reporting season, which has just begun in the United States and is about to begin in Europe, currently confirm the positive momentum that the banking sector has benefited from for several months. As a matter of fact, the main American commercial banks have reported good profits and in some cases even raised expectations for the remainder of 2023, especially thanks to the renewed solidity of their interest margin, which continues to benefit from the repricing of their assets and the delay in the accompanying increase in the return on deposits.

These data, alongside the knowledge that the United States is at a later stage of the current economic cycle than Europe (since the Fed is much further on in its process of raising rates compared to the ECB) give rise to predictions that the second quarter might also see healthy figures for the European banks. Therefore, we are entering the mid-year reporting season while maintaining exposure to the banking world especially through large commercial banks. These are names that, on the one hand, are able to benefit from the continued positive growth in the interest margin and, on the other, are less exposed to the risk of higher allocations to address any increase in defaults should the recession feared by the markets materialise.

Of course, as we move through each quarter, the approach to adopt towards the banking world has been gradually more selective and is destined to become even more cautious and strict, in light of a series of elements for precaution. Indeed, investors will use the mid-year reporting to understand whether banking stocks could still have positive surprises in store for profits or whether the profits we will see in the second quarter will peak: the decisive factors in this sense will be the timing with which the banks increase the return on deposits (especially retail ones) and the evolution of the cost of risk, namely the capital that banks must use to hedge any asset losses recorded (or in the case of an increase in defaults of companies with whom they carry out lending).

We ought to note the strong divergence in performance that has continued since the start of year among large capitalisation companies and small/medium-sized enterprises: since the start of 2023, the PIR, AIM and Star have achieved +9.0%, -1.1% and +1.5% respectively. On the one hand, the overperformance of large caps is mostly attributable to the significant weighting of banking stocks within the index. On the other, the underperformance of mid and small caps is due to the strong correlation between this asset class and the economic cycle, which implies that the scarcity of new incoming flows is destined to last at least until there is greater clarity on the current macroeconomic context.

A positive element in this direction is the news of the lifting of restrictions on negotiations between the EU and the Italian government for the disbursement of the third tranche of NRRP funds (€ 18.5 billion), even if the sluggish time frames and often intricate procedures risk being problematic and obstructing.

At this stage, therefore, it is best to continue to focus on the fundamental analysis intended above all to identify stocks with a positive earnings momentum, namely with prospects of an upward revision of future profit estimates.

Furthermore, the mid-year reporting season will be an important opportunity for companies to update investors on the financial results achieved until now and on the outlook for the remainder of the year. The market will seize this opportunity to consolidate the endurance of consumer demand (and therefore the top line of companies) and the resilience of the margins.

Commentary by Massimo Trabattoni, Head of Italian Equity.