Piazza Affari – small caps: return of confidence in the real economy needed

Since the beginning of the year, all the major equity indices have performed positively. As of 20 April, in the Italian market, the FTSE MIB stood at +3.0% (+18.5% YTD), the FTSE Mid Cap at +0.6% (+11.7% YTD) and the FTSE Small Cap at -0.1% (vs +8.1% YTD). Globally, the Stoxx Europe 600 is gaining +2.5% (+11.3% YTD), the S&P 500 is at +1.2% (+8.7% YTD) and the Nasdaq is at -0.5% (vs +16.5% YTD) in local currency.

The scenario for banks has been very positive to date, because although the big rates hike of recent months has led to a repricing of bank assets, there has been no corresponding increase in return on deposits. The failure of two US regional banks (Silicon Valley Bank and Signature Bank) and the UBS rescue of Credit Suisse is a reminder to look again at the financial sector more selectively and with due caution. In the short term, the banking sector’s momentum will be borne up by the still positive quarterly results forecast. In fact, as mentioned by some large U.S. banks that have already reported their quarterly earnings, it is reasonable for Italian banks to still expect sky-high profits for the first quarter of the year in the wake of very solid interest margins and low default rates.

However, in the medium and long terms, this wave of banking crises is sure to lead to a credit squeeze and the inevitable increased risk of recession. Although the major central banks have already signalled their readiness to step in if necessary to avert systemic risks and to support the economy, as managers, right now we prefer to position ourselves with large banks that finance large companies (i.e. firms that are “too big to fail”, that is so large that, if they became financially stressed, the government would almost certainly intervene with a national bailout).

The banks’ interest in big transactions inevitably penalises SMEs, which are more closely correlated with the business cycle and therefore perceived as riskier in this stage. In fact, mid and small caps have been underperforming compared to large caps since the beginning of the year, a factor already priced in by the market. So, a return of confidence in the real economy – not evident so far – is necessary for SMEs to recover and start performing again.

In addition, this renewed macroeconomic uncertainty means that investors are once again eyeing up rate-sensitive sectors, such as utilities or technology, which have been penalised by the too-abrupt hike in rates. This upward trend may now be coming to a close, especially in light of the banking developments mentioned above.

Now and for the next few weeks, investors’ attention will be on the Q1 reporting season. At this time, the market will be looking to pick up any signs of weakness or slowdown in end consumer demand and in the resilience of corporate margins. The latter should, in fact, benefit from the recent retracement of the cost of energy (which is still, however, far from normalised) and the easing of global supply chain bottlenecks (following China’s reopening), whereas the cost of many raw materials still remains very high.

Given these circumstances, we reiterate the importance of careful stock selection and analysis of fundamentals when targeting companies for investment. This way, we prioritise solid businesses with healthy balance sheets and business models that can weather volatile periods in the business cycle.

Commentary by Massimo Trabattoni, Head of Italian Equity.