Breaking Point – Geopolitics, Economies & Markets
Article by Beat Wittmann, Chief Investment Strategist at Key Family Partners SA
Having entered Q4 2023 the signs indicating more capital market turmoil are written all over the wall – interest rates are up, equities are down, credit spreads are widening and the US Dollar is up.
The recent pressures on weak links in the economic system keep piling up – something is going to give, sooner rather than later. Primarily at risk, once more, are the banks. Their underlying problems since the collapse of Silicon Valley Bank and Credit Suisse have not gone away, but gotten worse.
Red Flags Ahead
’Huge US borrowing extends pain for Treasuries investors’ (Financial Times); ‘US restricts trade with 42 Chinese entities over support of Russia’s military’ (Reuters); ‘Israel’s Netanyahu ‘We are at war’’ (CNN); ‘’Knee-jerk surge’’: Oil experts predict market impact of Israel-Hamas conflict’ (CNBC).
This weekend’s news point to major red flags and breaking points, as policymakers have been kicking the can down the road too often and for too long.
Needless to say, unresolved political conflicts (Middle East) and economic imbalances (inflation; sovereign debt; consumption and subsidies instead of investment) have a nasty and untimely way to hit back, forcing policymakers into overdue and painful corrective actions.
System Dynamics – What Goes Around Comes Around
Current problems and challenges have been well known for quite a while. Let us pause and acknowledge – studying system dynamics is key to analyse and manage complex, non-linear and dynamic problems in politics, economics, industries and capital markets.
Respective key elements include policies, decisions, structure, and time-delays – they are interrelated to influence growth and stability (‘Industrial Dynamics’, Jay W. Forrester).
From a political economy point of view, autocratic as well as democratic systems have their flaws to address structural challenges. Autocracies typically get politically more repressive and economically less responsible, whereas democracies with an average – four year terms, are more driven by voter polls than pursuing long-term economic policies, responsible fiscal policies and investing in infrastructure.
Damaging Geopolitics still Dominating
In an ideal geopolitical world, the top five surprises for 2024 would be:
- neither Joe Biden nor Donald Trump will be US president but a forceful and responsible bi-partisan candidate
- China prioritizing economics and business instead of leader cult and politics
- multilateral organizations deal with global challenges such as migration, trade and climate change more effectively
- Russia retreating from Ukrainian territory
- long-term solution for the conflict(s) in the MidEast
Unfortunately, that is not very likely. Muddling through will more likely prevail.
For the foreseeable future and the run up to the 2024 US presidential elections, ever more polarizing domestic politics in the US are to be expected. In China, the president will stay on course with party control and power politics, ahead of economic growth and private business. And in Europe, the Russia Ukraine war, sadly, is heading for a stalemate.
A number of geopolitical developments, however, are heading for inflection points and are largely known and discounted by capital markets, forcing overdue changes, that could finally bring hope and have the potential for lasting peace and sustainable prosperity.
National Politics Dominate Economics
We are heading for major elections until 2024. Ever stronger fragmentation and polarization in Western democracies are alarming, as political centre parties failed to secure sustainable economic growth and structural reforms.
Tragically, they wasted the post 1989 Cold War peace dividend with consumption, subsidies and social spending, failing to invest in critical infrastructure in all areas from digitization to energy transition, education, health, transportation and national security.
At the same time, these mainstream centre-right and centre-left parties piled up unsustainable debt burdens and left the field wide open to protectionist national-conservative populists (MAGA US republicans; UK Brexiteers; Germany’s AFD; France’s Rassemblement National; Poland’s PiS; Hungar’s Fidesz; Switzerland’s SVP). They, unfortunately, have proven to master largely fact-free and emotionally charged identity politics.
It’s the Interest Rates….Stupid!
We have consistently maintained our view that central banks will no-doubt over-tighten monetary policy, resulting in rapidly rising interest rates and tightening lending conditions, rippling through economic systems eventually.
As a result, we expect casualties and distress in sovereigns, corporates and households pressuring overall financial stability.
The catalyst to any broader market sell-off, violent spikes in volatility and system destabilization will be the cracking of any weak link particularly in economic and capital market areas where illiquidity meets leverage.
Recently we experienced the fastest and steepest interest rate hikes, however, we only reached long term averages in absolute levels. Remember, the aberration was the post 2008 GFC (Global Financial Crisis) ultra-low and negative rates environment providing unlimited liquidity.
Cash is King and Quality is Queen
Cash yields have reached peaks in absolute and relative levels in relation to risk assets to such a point that latter are becoming attractive. Cash not only offers yield and safety but optionality to tap into emerging investment opportunities.
US Government bonds have clearly reached oversold levels exacerbated by ongoing strength and resilience in the US labour market. Remarkably, US treasuries are on track for a third consecutive year of negative total returns – that has never happened before.
Equity investors should focus on holding and accumulating on weakness of quality stocks with healthy financials, proven management, competitive products & services and attractive valuations.
The fallouts of higher interest rates are imminent, with major casualties likely leading to potential financial stability crises. Policy makers led by central banks, however, will ‘blink’ and do whatever it takes to secure stability, liquidity and functioning capital markets.