It is Darkest before Dawn – Recession and Recovery 2023
Geopolitics – Complexities and Confrontations
Geopolitical complexities increase and economic confrontations between the West and Russia and China keep escalating, yet no relief nor resolution is in sight any time soon.
Sadly, many countries continue to prioritize nationalist politics over economic and business interests, leading to dire consequences for the social fabric and the well-being of populations at large.
As a result, investors are faced with intended and unintended consequences in regards to economic and capital market risks as well as opportunities.
The US in an Enviable Geo-economic Position
The global economy remains exposed to supply chain frictions, declining final demand, record high inflation, rising interest rates and contracting corporate earnings. However, the balance between economic winners and losers diverges massively between geographic regions and sectors.
In this global turmoil, the US is reinforcing its position as an economic winner profiting from an enviable geo-economics position as the only superpower with almost full strategic autonomy.
While China has put politics ahead of economics and now suffers from the consequences of its failed COVID policy, Russia faces economic mayhem exacerbated by the exodus of Russian human capital, the loss of Western businesses and competitiveness, even in the energy sector and its industrial-military complex.
Europe – Heading into a Winter of Discontent
Europe has been too short sighted for its own good and failed to plan and invest long term. The culprits are not mainly the European institutions but rather national governments protecting their national champions across critical sectors such as energy and banking. This crisis, however, should not be wasted and I remain convinced that Europe will emerge strengthened.
Russia keeps exploiting Europe’s weakness ruthlessly. Germany, in particular, had embarked on an irresponsible dependence on Russian energy, exacerbated by the inexcusable mistake to quit nuclear and fossil energy before establishing adequate alternative and renewable energy sources. The unavoidable transition to a sustainable future without Russian energy will be costly, lengthy and painful but overdue and necessary.
For the time being the European economic and capital market outlook remains negative and continues to suffer from the growing risk of fragmentation and contagion in the Euro area, as well as rising interest rates, persistent inflation, energy bottlenecks and falling business and consumer confidence.
Central Banks and Credibility
Monetary policy and liquidity conditions have been to loose for decades, largely because elected politicians have left the heavy lifting of structural adjustments and the occasional financial crisis management to the central banks.
FED Chair Jay Powell was right to deliver a hawkish message at the Central Bankers’ annual Jackson Hole retreat – now, he has to walk the talk. Somehow logically, bond markets reacted favorably, while equities sold off in fear of a recession.
Central banks, led by the FED, are determined to restore lost credibility and have made relevant progress in recent months. The normalization of monetary and interest rates policy is a much needed and welcome development in the medium- to long-run.
Inflation Rates Peaked
The trouble with inflation rates is that events such as war-induced shocks in Europe or the rising wage spiral of the past months have pushed levels excessively above interest rates. The force of the recently slowing upward momentum and favorable base effects, however, will lead to lower levels in 2023.
No matter what, central banks will have to regain credibility in regards to their policy mandates. On the bright side, longer term inflation expectations remain rather well anchored looking at the performance of gold, long duration sovereigns and inflation protected securities.
Corporate Deal Making in the Balance
The corporate sector remains on a downward trajectory. For the foreseeable future, the days of rampant deal making in IPOs, M&A, LBOs and the mania in cryptos and SPACS are gone.
The combination of restrictive monetary conditions, tightening lending standards, slowing economic activity and growing investors’ risk aversion will lead to lower valuations, widening credit spreads and rising corporate defaults.
The Danger of a Financial Accident
The worst macro environment for any one country, sector or firm is the combination of negative global forces, high inflation, reduced economic growth, political infighting and inconsistent monetary and fiscal economic policies. Italy and the UK with their domestic political and stagflationary situations are such examples.
Risk assets move in cycles from overshooting to undershooting in prices and valuations. Investable bottoms in markets are only reached once weak links break and investors capitulate.
The list of most vulnerable candidates is rather long and includes zombie-type European universal banks, LBO financed corporates, over-leveraged shadow banking players and over-indebted emerging market sovereigns.
Brighter Outlook into 2023
Let us remember – equity markets look ahead and are discounting future developments. Only new and unexpected news move markets.
Looking ahead, the US equity market is clearly best positioned in terms of geopolitical, energy security, economic resilience and growth, as well as monetary policy leading perspective. Our current investment focus is to stick to slower growth yet stable, financially healthy companies and as well as profit from this autumn’s weakness by adding cyclicals and financials.
And lastly – times of emotional, intellectual and financial dislocations or distress are the ideal breeding ground for extraordinary investments and entrepreneurial opportunities.
Article by Beat Wittmann, Chief Investment Strategist at Key Family Partners SA
