Outlook H2 2023 – Navigating Through Tricky Transitions

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

Geopolitics – The West Prevails

Russia’s unlawful and unacceptable overthrow of Europe’s post WW ll security order and the strategic confrontation between China and the US are permanently changing the geopolitical landscape and the economic globalization as we knew it.

The West has displayed not only unanimous political and security unity but also a high degree of economic, energy and capital market resilience in the face of adversity. Global affairs, politics and security are ranking above trade and business, marking the dawn of a new era – we must acknowledge and accept this. This paradigm shift directly leads to the decoupling of the West from Russia and an ongoing de-risking from China.

Accelerated by the mutiny of the Russian mercenary Wagner Group the regime in Moscow suffers ongoing political, security and economic fragmentation and destabilization. The ripple effects are felt all the way to China, adding to economic troubles at the home front.

De-risking and Rapprochement with China

Unlike Russia, China is a player too big to fail in the global economy. On the positive side there has been a rapprochement between China with the US and Europe in recent weeks in search for a new equilibrium of relationships. As China keeps facing economic challenges on the domestic front, it remains prisoner to its ideology preventing it from implementing the necessary measures to achieve its economic growth objectives.

Our outlook remains muted as China is still behind its long term structural policy objective to shift from property and infrastructure capital spending to deploy its savings surplus towards the consumption side of the economy. Unfortunately, the respective stagnation and deflationary similarities to post bubble Japan in the 1990s are only too obvious and worrisome.

Russia – Decoupling and Containment

Regarding Russia one should not underestimate the unwavering determination of the West to restore Ukraine’s territorial and economic integrity. History teaches us time and again that resourceful and inclusive democratic and capitalistic societies prevail over any types of autocratic regimes.

The respective outlook for Russia remains particularly bad. The problem, however, is not only Russia’s President facing elections in the spring of 2024 but, sadly, also a fundamental problem within Russian society, as it never showed nor experienced throughout history any prolonged and sustainable development to general civil rights and a broader economic inclusion and prosperity.

Global Economy – Slow-motion Credit Crunch

The decade of plentiful money and ultra-low interest rates is over. The lagging effects of a 12months continuously restrictive monetary tightening cycle, the steepest in history, are painfully hitting home. Sovereign, corporate, property and consumer borrowers are confronted with massively rising refinancing charges, while credit standards and loan demands are tightening.

We stick to our stance that central banks, led by the FED and ECB, keep tightening and are willing to overshoot. Their priority is to anchor inflation expectations, manage tight labour markets pushing up wages and prices, slowing the pace of credit creation and regaining credibility (cementing their political independence). As a result, in H2 2023 expect a significantly tougher refinancing environment and related casualties in selected developing economy sovereigns, corporates, property and consumers.

Financing Overdue Structural Reforms

Any solution to the unsustainably high sovereign debt levels and infrastructure investment needs, aging populations and pressures on public budgets has three dimensions:

• implement reforms to facilitate growth and increase productivity by attracting investment, businesses and qualified immigration
  
  
• cut economically harmful subsidies and reduce social spending
  
  
• increase indirect taxes on consumption and tax negative externalities
  
  

To implement any overdue and painful structural reforms is politically and socially problematic as the situation in France is showing. Typically, upcoming elections such as this summer in Spain or in 2024 in the US lead to short-term fixes and populist promises rather than sustainably prudent fiscal solutions.

Investment Outlook – Resilience, Flexibility and Focus

In H1 2023 Western economies and capital markets have proven resilient facing adversity. Selected equity markets, sectors (NASDAQ) and yield-on-cash holdings have been quite rewarding.

Clearly, the political, security, economic, business and investment road ahead to a new global multipolar equilibrium will be fractious and hazardous. Policymakers and businesses need to keep an open mind. To increase exposure to risk assets in H2 2023 monitor final demand trends and, most importantly, demand-side inflation.

The focus in global equity markets should be on financially strong, well managed multinationals with leading product and services propositions – as they tend to gain market share in downturns. Key risks include firms across nearly all sectors that have been riding the wave of cheap money for too long and have failed to built sustainably profitable businesses.

In the quarters to come expect economic weakness and persistently sticky and painful borrowing cost – any refinancing will not only be more expensive but also more difficult to access. As a result, expect cheaper corporate valuations and a growing number of forced sellers, creating unprecedented opportunities.

And yet again, cash has become an attractive asset class benefitting from high yields and the full war-chest optionality to act on special opportunities.