21 Apr 2023 4 min read

We’re holding the line on short risk positions

By Emiel van den Heiligenberg

No news has been read as good news, and equities have drifted higher following the banking crisis. That's been frustrating for our short equity risk position, but we see plenty of reason to stick with our cautious view.


Gladiator is one of my all-time favourite films, and early in the movie Roman general Maximus is readying his cavalry to charge. Maximus, played by Russell Crowe, tells his men:

“Three weeks from now, I will be harvesting my crops. Imagine where you will be, and it will be so. Hold the line! Stay with me!”

The debate in the market between soft landing or recession in the US in 2023 continues. Economic data readings have been generally inconclusive, which could remain the case for a while. Our take on the banking crisis in both the US and Europe is that the longer-term damage is done. This makes a soft landing less likely and a recession more likely in our view.

Deposits and the credit cycle

The latest data point to increasing weakness in the credit cycle: lending by US banks has sharply declined over the past two weeks, while the March National Federation of Independent Business survey showed the largest increase in two decades of US small businesses reporting that loans are harder to get. This adds to the risk implied by a sharp deterioration in the latest Senior Loan Officers Survey, which was published before the banking stress hit.

My teammate Ram Gulsin has written about bank stress and the impact on credit conditions. The credit squeeze has been driven by uncertainty about bank funding. Since the Federal Reserve (Fed) began raising rates a year ago, almost $1 trillion in deposits has left the banking system. In the past two weeks we have seen the biggest two-week decline in lending by banks on record to offset deposit flight.

The official bank lending data contain some lags and are distorted by recent bank failures, but the Beige Book released this week, which gives a summary of economic conditions across the 12 regional Fed districts, suggests tighter bank lending standards and that loan growth is cooling and perhaps abruptly in places.

This drop in deposits is concentrated in small banks. Why is this relevant? Banks with less than $250 billion in assets account for about 55% of outstanding loans and grew their loan books by about 2.4% of GDP over the last year. A move from deposits to money market funds reduces loans to the economy.

Larger banks allocate a much smaller proportion of their deposits towards lending. Moreover, to compete for deposits, interest on deposits is rising, impacting future bank profitability, which forms another channel for credit tightening.

Earnings are holding the line, but for how long?

We have been worried about declining earnings for the past six months. Estimates of future earnings have fallen, despite still-strong nominal GDP growth, but this warning sign has been largely ignored by investors. The market draws comfort from the fact that companies remain sanguine about their prospects. Should earnings find their trough it would potentially be a historical buy signal.

We are much more cautious on earnings. Falling inflation last week, especially for goods, is a sign of waning demand, and inflation is the one thing holding up revenue growth for many businesses. The gradual erosion of margins to date has mostly been a function of bloated cost structures. If/when revenues begin to disappoint, operational leverage causes margin degradation to be much more abrupt. This is likely to cause profit warnings and the usual kitchen sinking of companies.

That’s the moment when markets tend to move from sanguine to deeply pessimistic about the future earnings capacity of the market.  

Buybacks can’t hold the line

In recent years the equity market has been supported by companies buying back their own stocks, while the level of initial public offerings/equity offerings has been low. Recently, we have seen corporate net buying rise very strongly again.

But the incentive for corporates to buy back their stock is falling: according to data from Credit Suisse Research only around 23% of corporates now have an earnings yield above the corporate bond yield, and buybacks as a style are starting to underperform.

This is the market telling companies that it could be more rational for companies to start paying off debt or invest in capex instead of buying back their own equities.

Do we get to harvest our crops?

So, we believe now is the time to hold the line on our cautious position in equities in anticipation of a recession and subsequent earnings hit that have yet to materialise.

Spoiler alert for anyone who hasn’t seen the film, but Maximus does not end up harvesting his crops, though his men do stay with him. We make no promises of harvesting  alpha from the risk short in the short term, as it’s a medium-term view.

Much like Maximus’s men, investors must decide whether they have the stomach to hold the line.

Emiel van den Heiligenberg

Head of Asset Allocation

Emiel is responsible for the overall strategic direction of the team’s investment and business strategy. He claims to have been a promising lightweight rower at university until French fries got the better of him. Reflecting his love for rowing in a team, he firmly believes that excellence can only be achieved by a great team made up of motivated individuals that are also eager to work together. To this end he is the self-proclaimed inventor of the verb 'teaming' to acknowledge that shaping a top team and culture of excellence is an ongoing process. Outside of work-family obligations, Emiel’s spare time is filled by a passion for shark diving and skiing. Prior to dedicating his career to portfolio management in 1996, Emiel worked as a policy adviser in the Dutch Ministry of Finance and he graduated from Tilburg University in the Netherlands ages ago. When not glued to his Bloomberg screens, this Dutch man is hooked on computer games, peanut butter and his favourite dark beer made by Belgian monks.

Emiel van den Heiligenberg