Steering Through Rough Waters  

Geopolitics – Bipolarity Defining Our Age

The defining geopolitical confrontation of our age is the strategic rivalry between the US and China. Geopolitics remain complex, ambiguous and to varying degrees confrontational, in a world characterized by the growing bipolarity between the global West led by the US and the global South spearheaded by China.

We keep watching both sides drawing new members into their respective clubs and various associations. Finland just joined NATO and Saudi Arabia the Shanghai Cooperation Organization (SCO – the China/Russia-led bloc to counterbalance Western influence). Importantly, relevant powers and developing economies will be eager to participate and try to benefit from both sides – Turkey is the prime example.

Xi Jinping’s recent visit to Moscow and Ursula von der Leyen’s visit to Beijing alongside Emmanuel Macron removed any remaining doubts in regards China’s one sided support of Russia and its illegal military attack on independent and sovereign Ukraine. China, as a result, lost any aspiration as potential peace broker.

Xi Jinping’s Miscalculations on the European Security Order

Xi Jinping keeps miscalculating the European security order – as Vladimir Putin before him. Clearly they are unaware of the strengthening effect on Europe. There is no more room for ‘divide and rule’ power-play politics in regards to the integrity of the European post-WW ll security order – the very founding ‘raison d’être’ of the EU.

Any relevant increase in China’s economic and military support for Russia’s war in Europe is likely the single biggest geoeconomic risk, potentially leading to a fast and profound deterioration in EU-China political, economic and business relationships.

China’s President is asking for a painful wake up call as Russia is inevitably facing military defeat against Ukrainian forces backed up by vastly superior and resourceful Western powers.

Economic Policy – High Interest Rates Crack Weakest Links

The global economic situation is characterized by significantly higher interest rates working their way through the system and leading to bank casualties, kicked-off by Silicon Valley Bank and Credit Suisse. Remember, monetary tightening cycles invariably end in some sort of crisis. This time it is the banking sectors on both sides of the Atlantic.

The ongoing difficult macro environment and tightening of credit conditions will result in aftershocks and negative second round effects causing more distress and defaults in the financials, corporate and property space. However, we remain in cyclical territory and there is little reason to expect an escalation into another systemic crisis. The casualties will be specific and can be expected where illiquidity and leverage meet with management and policy failures.

Desynchronized Global Growth Provides Resilience

The FED’s stance is guided by regaining inflation fighting credentials and will move into relative softening particularly as US labor market and final demand keep cooling and the yield curve inversion pointing to an economic downturn.

Russia has lost the energy war against Europe thanks to an extraordinary mild winter and a resolutely unified response from the West. Yet, the ECB will lag the FED in easing rates dealing with sticky core inflation as a result of higher wages and supply disruptions.

China on the other hand, has left its disastrous no-COVID policy behind and will continue to recover by increased consumer demand and capital investment thus supporting overall global growth.

Asset Allocation – Brightening Outlook for Equities

The asset allocation consequences of our geopolitical and economic scenario driven by a cyclical downturn and disinflation are to be increasingly long risk assets with high quality equities, marked by top leadership, dominant international market positions and strong financials.

Depending on one’s risk profile and performance objectives we would focus on a customized portfolio mix including sovereign fixed income, international and early cycle equities, selected emerging markets, EUR and gold. Gold might even break out from a longtime consolidation, anticipating easing by the Fed and a weaker USD.

Geographically speaking Europe and selected emerging markets are much cheaper than respective US markets, not only providing a margin of safety but also a significantly higher upside.

Banking Crisis – Look Beyond Financial
Ratios!

The extent to which bank executives and policymakers conveniently rely on, believe in and hide behind standard financial ratios is shocking. The data is crucial, necessary but by no means sufficient as criteria to judge the viability and sustainability of banks’ businesses and risk taking.

In consequence, when crisis hits policymakers are either caught sleeping at the steering wheel or looking in the rear view mirror and are then forced to re-act adhoc and arbitrarily instead of acting with timely and well calibrated crisis management strategies.

European Banks – Persisting Fragmentation

ECB President Christine Lagarde recently told EU leaders that the Eurozone banking sector is resilient due to strong capital and liquidity positions and thanks to post 2008 reforms.

The reality, however, is quite different as many Eurozone banks lack viable business models and sustainable profitability, yet suffer from poor leadership – fundamentally they never restructured and have delayed responses to new technologies and changed consumer behavior.

Lagarde told the 27 EU leaders: ‘we need to progress on completing the banking union; further work is also necessary to create a truly European capital markets.’

The next major financial institution casualty, however, might have a silver lining, by propelling the overdue pan European bank industry consolidation and finalization of European banking and capital market union a decisive step forward – a chance to finally capitalize on the scale of the EU and European market.

Article by Beat Wittmann, Chief Investment Strategist at Key Family Partners SA