EMR March 2023

Dear Reader

Industrial transformation, i.e., the change in the growth pattern of the last 20 to 30 years, is once again taking place at a rapid pace. Well, our search for evidence on the position of the global economy, and by extension the financial markets, led us to the Inflation Reduction Act of 2022 (IRA), passed by the U.S. Congress and signed into law by President Biden on August 16, 2022. Astonishingly enough, it goes almost unnoticed in the media. Now, one may ask what the scope of this act may be? Well, it is a law primarily aimed at curbing inflation by reducing the deficit and investing in domestic energy production while promoting clean energy. Among other things, the enacted legislation is expected to raise $738 billion and authorize $391 billion in energy and climate change spending and $238 billion in deficit reduction. Although the expected impact on inflation is somewhat controversial, it still indicates some economic progress. Indeed, the goal is to make substantial public investments in social, infrastructure and environmental programs throughout the country.

From this ambitious program, one can infer the implicit intention to promote domestic economic activity. In other words, this legislative text favors domestic investment, which in due course will also mean a reduction in certain imports. Certainly, it will take some time for this to become apparent in practice, but it nevertheless requires careful and continuous analysis of foreign trade.

The said act implies “regulation” with the specific aim of balancing/protecting the local competitiveness of the national market from the oligopolistic aggressiveness of mainly multinational technology corporations and especially nations like China. The “act” presupposes an initial reaction by the governments of democratic states and thus a clear response to the Russian invasion of Ukraine. At this juncture, it is worth mentioning that the EU faces similar difficulties as the US, namely rising import prices. A key difference between the U.S. and Europe, especially the EU, is the lack of “decision-making power,” which is still based on the authority of the respective national authorities. In addition, it should not be forgotten that the EU also decided to suspend state aid regulation with the Temporary State Aid Framework of March 2022. Strangely enough, the focus was mainly on Germany.

In the table and graph we show e.g., the SECO’s (State Secretariat for Economic Affairs) outlook in order to illustrate the specific interrelationships.


The annual data and forecasts tell us that the U.K. and U.S. real GDP growth rates were the highest in 2021 and 2022, while the other countries’ data were significantly more modest. The Brexit decision is somewhat visible in the UK GDP data. The Covid-19 years and recent actions on interest rates by central banks to reduce inflationary pressures are visible in the GDP data of the countries shown.

Recent weeks have witnessed a certain revival of optimism, albeit accompanied by understandable caution, especially in financial circles. This seems to be supported by an increasing number of macroeconomic signals, as evidenced by the recent “modest” increase in the benchmark interest rate by just 0.25 percent, which is a clear sign of the approaching end of the rate hike cycle.

The risk of recession is slightly decreasing, mainly due to the explicit willingness to give extensive support to fixed investment by local enterprises. In the context, there is talk of “repatriation” of production of technological goods, to reduce dependence on imports, from the Far East. The Seco data are really telling. We are often told that the rise in the consumer price index must be controlled by raising interest rates. The U.S. Federal Reserve took the lead and raised interest rates significantly. Other industrialized countries have followed suit. At this point, we would like to point out the potential impact of rising prices on asset allocation.

Nominal interest rate increases—such as those recently induced by central bank measures—argue in favor of exposure to fixed-income securities. This, due to the fact that increases in interest rates usually open up opportunities to earning money on fixed-income securities. However, there is also the risk of loss in times of rising inflation. It is necessary to check whether future real interest income is higher than the cost of inflation. If this is not the case, the risk of loss would have to be assessed. At this stage, we continue to favor investing in equities. Particular attention needs to be paid to various sectors such as technology and chemicals, with volatility to be closely monitored.

The fact is that the financial markets play an important role in the fluctuations of business cycles. Given that the current tightening policy could continue for some time, we think it is quite difficult to predict exactly which sector of the economy should be overexposed or underexposed and in which time frame. However, we consider the Russian invasion and war on Ukraine to be the most specific determinant of a worthwhile asset allocation. Geopolitical tensions aside, the impact on international trade and thus consumption and investment will need to be carefully monitored. In terms of international diversification, one should seriously consider the possible divergencies (STDEV) of the leading currencies in the following chart.


The Seco data on the primary sectors of the Swiss economy—see following chart—are telling indeed. Often, we are told, that the increase in the Consumer Price Index must be controlled via higher interest rates. The Federal Reserve Board has taken the lead in strongly pushing interest rates up. Other industrialized countries followed in a similar manner. Here, we would like to point to some other factors responsible for the increases in prices.


Undoubtedly, the Russian invasion of Ukraine will force the economies of the free world to reduce their dependence on autocratic, pro-communist countries as quickly as possible. This is bound to entail a return to local production of many goods and services and an orientation toward other producers of oil, gas, etc. First signs of this change are visible in the U.S. technology industry. See: Chips Act , in which special attention is given to short-term inflationary pressures and thus to the specific responses of central banks.

In Europe, too, there are proposals that go in the same direction, although there are still differences from country to country. There is no doubt that the invasion of Ukraine is a sign of an increasingly inevitable “de-globalization.”

Geopolitical tensions aside, the impact on international trade, and thus on consumption and investment, needs to be carefully monitored. The dreaded volatility of energy and gas prices will remain a source of confusion, both in terms of economic growth as a function of inflation, and in terms of the ups and downs of international trade, which currently speaks of continued volatility, and not just in the financial markets.

There is a further serious difficulty: the increasing and high indebtedness of countries, companies and the general public. Fortunately, the current situation does not resemble that of the late 1970s, when Paul Volcker, chairman of the FED, was forced to intervene aggressively to fight inflation.

In terms of international diversification, one should seriously consider the possible developments of the leading currencies.


The above-outlined environment clearly indicates a dramatic change in the environment. Until recently, the focus was on fighting inflation; now the focus is much more on “repatriating” production. This is evident, for example, in the stimulus proposals [Inflation reduction ACT (IRA), Chips and Science Act, and Bipartisan Infrastructure Law]. Thus, the focus is clearly on renewable energy, semiconductors, and infrastructure, i.e., promoting local economic growth while reducing dependence on foreign manufacturers.

In both the United States and Europe, economic policy is no longer primarily focused on fighting inflation, but rather on rapidly renewing the domestic manufacturing sector to reduce dependence on imports from foreign manufacturers. This, if implemented coherently, would lead to a significant increase in local employment and economic activity. The specific objective is, among other things, to reduce dependence on China.

At this stage, our forecasts can be considered somewhat more optimistic than those currently circulating in the press. To some extent, our assessment is confirmed by a contradictory political attitude that is no longer so much determined by “cheaper producers” as much as by the “free market” or, at best, by an egalitarian mixture of both approaches.


Assuming that investment growth will replace government spending as the main determinant of future economic activity, one needs to look beyond infla-tion expectations and trends to define a successful investment approach. Therefore, we argue as follows:

  • The era of runaway inflation is almost over; more attention needs to be paid to price stability.
  • If the assumption is correct that inflation will not rise as strongly as it has recently, fixed-income investments should become somewhat more attrac-tive, at least in the short to medium term.
  • A reduction in dependence on autocratic countries, combined with a not in-significant increase in domestic production, would stimulate optimism in fi-nancial markets.
  • We continue to believe that the CHF remains promising, as does the USD.

Comments are welcome.


Turning Points in 2023?

EMR January 2023

Dear Reader


At the beginning of the new year, we may ask ourselves which of the following statements may be considered correct and thus a valid indicator of the most likely future developments:

  1. Is significant inflation acceleration, plus 4% or more, a negative for the equity markets?
  2. Is significant decrease, minus 2% or more, a positive for the equity markets?

Bevor answering the two above posed questions let us portray the historic developments of the leading economy, the USA, as shown in the chart.

What does the historic representation of the yearly average changes of the DJIA and the yearly rate of change of the US Consumer Price Index tell us? Our interpretation of the graph shows several interesting things:

  1. The analysis of the annual rate of change indicates that changes in the DJIA are much more volatile than for the consumer price index.
  2. Both the development of the inflation rate and that of the DJIA, before 1945 and since 1945, differ considerably from those of the preceding period. This makes predicting future developments – for both indicators – somewhat more difficult than generally assumed.
  3. The rather contained inflation rate swings since 1980 do not point to a significant growth in the equity index.

After a thorough analysis of the diagram, we come to the following conclusions:

First, we note that the actual annual changes in the inflation rate are less volatile than those in the DJIA index. This suggests, in our view, a deterministic distinction between the two categories under consideration. In other words, the respective trends are not primarily determined by the same factors for the DJIA and the CPI-Index.

So far into the current cycle, inflation has not (yet) risen as in the late 70’s nor in the previous cycle. The real question at this time is which of the two series used here will be the deterministic factor: the DJIA or the CPI? Any suggestions?


Recalling the various expectations and taking into account the available hard facts as compared to the known developments in 2022 as a starting point, we firmly believe that the outlook for 2023 remains characterized by known and also imponderable features. The challenging question to answer at this time concerns, first of all, the hoped-for end of the disastrous Russian invasion of the Ukraine. This “hoped-for return to normalcy” would undoubtedly lead to lower crude oil and gas prices and, as a result, would also lead to a reduction in fears of persistently high inflation and would consequently encourage the inflow of much-needed technological inputs. The result would be a significant pickup in economic activity, instead of the recessionary outcome currently feared.

For Central Banks, this would imply a deterministic reduction in recession fears and the abandonment of restrictive monetary policy. This, in turn, would promote an economic recovery that should boost stock markets and, to some extent, fixed-income investment as well. High inflation rates historically have been associated with financial losses, as they have also been in the recent past. History teaches us also, that patience is a promising attitude, especially when the causes of inflation are due mainly to factors that are not so much monetary as economic or even worse political.


Assuming that the Russian invasion of the Ukraine is unsuccessful, it can be assumed that Russian oil and gas supplies will slowly increase, which should tend to reduce the inflation rate. This makes it unlikely that domestic banks will continue to push interest rates up, as they have done recently. In other words, the appeal of fixed-income securities may be limited to the next few months of 2023. However, we believe that the appeal of fixed income is likely to be limited to the coming quarters, limiting the appeal of equities in the first quarters of 2023.

Our assessment depends largely on the size and length of the expected economic slowdown, which, in turn ought to bring inflation down. The necessary and sufficient condition for this to happen, is that inflation begins to fall in line with the decline in energy costs. In any case, special attention should be paid to currency fluctuations when diversifying internationally. Highly indebted companies should be avoided. As Swiss investors, we continue to prefer the local market, at least until the end of the cyclical interest rate increase will manifest itself. In any case, in the international diversification process, special attention should be paid to currency fluctuations. Highly indebted companies should be avoided. As Swiss investors, we continue to prefer the local market, at least as long as the end of the interest rate cycle is in sight.

We wish you all A HAPPY NEW YEAR

Comments are welcome.



EMR November 2022

Dear Reader


Both the Covid-19 pandemic and Putin’s war against Ukraine are increasingly determining economic analysis, both in the short and long term. Also going almost unnoticed by the public debate are the consequences of “digital nomadism” and, in particular, the tax consequences of the migration of highly qualified professionals who take advantage of the opportunity to work at a computer in places where taxes are low.


As a result of both the Covid 19 pandemic and the war against Ukraine, two specific and deterministic aspects can be found regarding the short- to medium-term economic outlook. Monetary authorities have emphasized a policy of “extraordinary” monetary tightening to combat inflation, i.e., unprecedented increases in interest rates, as evidenced by the recent trend in the federal funds rate relative to developments since 1955. See table and chart.

FOMC Meeting DateRate of Change (bps)Federal Funds Rate
Sept 21, 2022+ 753.00% – 3.25%
July 27, 2022+ 752.25% – 2.50%
June 16, 2022+ 751.50% – 1.75%
May 5, 2022+ 500.75% – 1.00%
March 17, 2022+ 250.25% – 0.50%

Indeed, it is instructive to elicit the logic behind policy responses. As far as policy adjustments are concerned, we face a real dilemma. Are the actions and reactions in curbing inflationary conditions more supply or more demand-driven?

By even superficially reading newspapers, listening to the radio or watching television, we find that the focus is on “demand.” Why is that? Well, Central banks are pushing interest rates sharply up to contain rising inflation. Thus, when interest rates are raised quickly and sharply, one must assume that the goal of containing rising inflation is to reduce demand, especially of business investment (i.e., fixed investment, construction activity, and net exports). At this point, it is worth recalling that the recent rise in prices in all major economies is not primarily due to an increase in demand, but to a sharp reduction in the supply of essential economic goods. More specifically, prices are being driven up by “policy-induced” cuts in crude oil and gas exports, primarily by Russia. Recently, there has also been a significant decline in imports of engineering components from China. It is a fact that the countermeasures taken by the EU and the U.S. should also be taken seriously.

We are currently facing a new phase in the economic cycle. The positive trends of the period prior to the advent of the Covid-19 pandemic and the invasion of Ukraine have turned into a restrictive phase, particularly in the area of procurement of vital goods and production components. In our view, this emerging change requires a radical rethinking of the economic behavior. This should entail a rethinking of the interdependencies between the economy, finance and monetary policy. In other words, it is not about inflation per se, as much as on rapidly improving the supply of key intermediate goods and products.

However, if we assume that policy should focus on supply-side rather than demand-side constraints, as has been the case recently, then we can assume a dramatic policy-driven shift away from rising interest rates toward improving domestic supply, with more emphasis on the local investment sector. What we can envision is a shift back in the production of intermediate goods and change in energy supply. This readaptation would require a shift away from “cheaper” imports to increasing domestic production. The focus should (and will) be on improvements for the local investment sector to the detriment of imports.


A closer look at the current environment shows that the focus is on raising interest rates to coun-ter inflationary pressures. The actual determinants of current inflation are almost ignored. As-suming that the rise in inflation is mainly due to factors (such as Covid-19 and especially the in-vasion of Ukraine and China’s threat to invade Taiwan), the rise in crude oil, gas and food prices would increase dramatically beyond the normal supply and demand trends. Therefore, the focus should rather be on how to solve the bottlenecks in the supply.

In October 2022, there were increasing calls from international institutions to slow the pace of monetary tightening because of the unexpected impact on exchange rates, as shown in the charts on currency and NYMEX.

It should be considered that the U.S. dollar increasingly tends to mimic crude oil and gas price trends. These similarities portend an imminent reversal in the fight against inflation. Thus, one may wonder whether the phase of interest rate hikes by central banks is coming to an end. Re-markably, so far, calls for moderation of the pace of monetary policy have not increased. An im-portant reason for a probable reversal of interest rates is given by the voices of international in-stitutions, speaking of an impending recessionary phase.

In the current economic policy environment, it is tricky to draw conclusions about a promising asset allocation. We believe that the Swiss investor should continue to focus primarily on the do-mestic currency market (and also the US dollar), as a positive development can be expected here. Secondly, we believe that it is premature to invest in money markets and/or fixed income instruments, at least as long as the high interest rate phase persists. Thirdly, it is necessary to quantify, as precisely as possible, the depth and duration of the much-touted recessionary phase. For our clients in particular, it seems advisable and necessary to assess the impact on the real estate market. An undoubtedly arduous task not only for the experts at Swisschange.

Comments are welcome.


Inflation vs. interest rate?

EMR July 2022

Dear Reader


The current controversy is once again focused on the strategic role of interest rates and economic activity. Why, you might ask? Both variables provide a link between the financial environment and economic performance. They provide information about the interaction between the supply of savings and the demand for investment. Theoretically, there is broad agreement on the factors that influence interest rates. There is disagreement about the relative importance of the various instruments.


We have no doubt that recent actions by, for example, the Federal Reserve Board to raise the fed funds rate (defined here as “i = interest rate” on banking sector deposits) should be seen as indicative of a tightening of monetary policy. How does this interplay work is the key question at this point?

A simplified demand for money (Md) can be formulated as follows:

In other words: We speak of the “cost of holding cash” and, in particular in this context, of the cost of holding cash at the central bank. Both within the framework of economic theory and in ongoing, publicly available reporting, three deterministic effects can be derived:

  • Price Expectations Effect (also known as the “Fisher Effect”),
  • liquidity effect, and
  • income effect.

We would like to emphasize that the function presented above is a highly simplified demand function. Nevertheless, it helps us to assess the current situation. We do not doubt that the Fisher or price expectations effect is particularly useful in the context of recent extraordinary central bank interventions. It explains the interdependence between interest rates and expected inflation. The two recent 0.75 % increases in the key interest rate were intended to reduce commercial banks’ overnight borrowing. When the central bank raises the key interest rate, it makes borrowing more expensive for both businesses and consumers by spending more on interest payments. An important effect of higher interest rates should be that they tend to lower inflation and prevent the economy from overheating. On the other hand, higher interest rates should also affect the stock market, while the price of existing bonds should fall. Consequently, new bond issues tend to offer investors higher interest income.

The liquidity effect is widely recognized in the context of monetary policy. In other words, it refers to the benefits that can be obtained by shifting money to assets.

Contextual changes in the money supply and interest rates can balance the actual and expected money supply. In the real world, however, one is confronted with the interactions of all the above determinants.


When we look at the current environment, we see that the focus is on raising interest rates to counter inflationary pressures. The factual determinants of current inflation go almost unnoticed. If we assume that the rise in inflation is mainly due to factors (Covid-19 and the invasion of Ukraine) that have put dramatic downward pressure on crude oil and food prices above and beyond normal supply and demand trends, we should rather focus on how supply chain bottlenecks can be resolved. At this point, we believe that “extraordinary monetary tightening” could constrain demand without rapidly improving supply! Supply disruptions are expected to ease in coming quarters, while “financing costs” could rise.

We agree with Fed Chairman Powell that monetary authorities can manage demand, but not supply. Therefore, it would be worthwhile to distinguish companies whose prices move due to changes in demand from those that move due to changes in supply. In this context, we argue that the most promising investment approach would be the one that focuses on increasing supply while prices are falling.

The expected trigger is the quantification of the change in quantities and prices. We believe it is deterministic to focus on technological improvements as well as the adjustment of wages to the cost of living.

We advise investors to quantify the “expected turnaround” in global and local supply constraints, as we expect these to continue to be key determinants of the inflation trend and hopefully reverse it.

Comments are welcome.


Focus on Switzerland

EMR June 2022

Dear Reader


Recently, the global economy has started losing momentum due to the unacceptable Russian invasion of Ukraine as well as the sharp increase in inflation and also interest rates. We take these developments, along with currency adjustments, as confirmation of our preference for investing in the Swiss market. Therefore, here we will focus on the Swiss mortgage market.


The chart of mortgage rates shows that there was a somewhat steep, choppy decline between 2007 and 2011/2013, followed by relatively stable, low interest rates until early 2021 and a fairly steep rise until 2022! It is striking that the 10- and 15-year interest rates have risen significantly more than the short-term interest rates.

The thorny question implicit in the graph on mortgage rates currently relates to the main drivers of the recent price increase. Following the argument made in the May 2022 EMR, we would argue that “aggregate supply disruptions” are the key determinant of the short- to medium-term outlook. Determinants of crude oil price increases include both the impact of the Covid 19 pandemic and the Russian invasion of Ukraine. However, one should also take into account the recent monetary policy interventions by central banks, the interactions of which will ensure continued volatility in the financial markets.


As far as the development of inflation is concerned, we would like to point to the similarly strong increase in consumer prices in the United States and the EU, while the Swiss CPI is still lagging well behind. The U.S. CPI rose to 8.6% in May 2022, after reaching a low of 0.24% in May 2020. A similar increase can be seen in the Eurozone consumer prices, which reached 8.1% in May 2022. Swiss consumer prices are dancing on a different planet, rising to 2.94% in May 2022. These intrinsic developments have led us for some time to focus our allocation on the domestic market in order to reduce volatility and significant losses.


Assuming that the leading central banks (e.g., FED, ECB and BoE) will continue to push up interest rates, while the SNB is likely to continue to lag behind, we ask ourselves what these developments should mean for the Swiss mortgage market?

Our macroeconomic framework assumes that the rise in interest rates in Switzerland will obviously be much more moderate than in the markets of our trading partners. The decisive factor is and remains a moderate increase in the cost of accessing credit. In addition, the CHF is likely to appreciate or at least not depreciate significantly.

At this juncture we suggest clients to contact Swisschange in order to discuss the best policy for your specific portfolio. We believe that a 5 to 7 year horizon could be appropriate.

Comments are welcome.


Demand Pull vs. Supply Push

EMR May 2022


Dear Reader On the one hand, optimism reigns due to the economic growth of the leading nation, the United States, currently characterized by a consumer boom and near full employment. On the other hand, there is the language of the future, in which pessimism gives way to a spiral of geopolitical crises, a sharp rise in inflation and interest rate increases needed to combat inflation without hindering growth. Contained optimism in the United States, while in Europe and other industrialized economies pessimism prevails mostly due to Russian senseless ongoing aggression in the Ukraine.

In light of the recent rise in inflation and its impact on central bank interest rate policies, we are interested in what the best environment might be for equity markets. In this context, we will paraphrase causes, effects, and historical developments that should allow us to draw appropriate conclusions.

There are three promising approaches: the demand-pull, the supply-push and the most promising – the joint approach. Our deterministic assumption is that the overall political, social and economic environment remains marked by a high level of uncertainty. The world economy faces difficulties, beyond the war in Easter Europe, which concern the availability of resources both at the local level as well as internationally. The chart on the Dow Jones Index (DJIA), US Inflation and 3 months as well as 10-Y government bond yields since 1872 begs questions like what can be inferred form past developments by means of quantitative facts? From the chart – of yearly data – we might deduce the following:

  • Volatility is significantly higher for stock indices than for inflation and interest rates.
  • The longer-term ups and downs of short-term interest rates are more pronounced than for 10-year bond yields. Is it fair to assume that the period we are currently experiencing will resemble the post-World War II period?
  • The short-term “stability” of the inflation rate is indeed astonishing.
  • What is pronounced, however, is the dichotomy between the short-term information that emerges from the hard data in relation to the longer-term assessment. We consider this dichotomy an important aspect in the current forecast because it implies possible differences in outcomes when focusing on the demand-pull approach versus the supply-push inflation assessments.

The longer-term ups and downs of short-term interest rates are more pronounced than for 10-year bond yields. Can we assume that the period we are facing currently will resemble the period post the Second World War?

Let’s ask ourselves which factors are currently more deterministic: cost push or demand-pull factors. The correct answer is that there are many explanations why prices are currently rising. In other words, we could argue that rising prices are not simply due to the expansion of money supply. Indeed, the following chart of the annual change in M2 money supply for Switzerland and the United States is interesting. The volatility of the Swiss data is much larger for the period between December 1985 and 2008 than in the U.S. for the period from December 1985 to the end of 2019. The two astonishing swings and corresponding corrections occurred in Switzerland from the end of 2008 to early 2011 and in the U.S. since the end of 2019. What are the factual implications of these developments? We believe that “other factors” were and are much more deterministic than money supply.

Sources: Swiss National Bank and fred.stlouisfed.org


Here we do not subscribe to the widely expressed opinion that inflation is primarily due to monetary fine-tuning. No doubt the policy of Central Banks matter, and this not just as “moral suasion”. In the last decades we have encountered many reasons why prices rise and/or fall beyond movements of money supply. Currently we see that e.g., the price of crude oil increased due both as a consequence of strong supply and transportation restrictions as well as due to demand resurgence. The real question at this time refers more to supply restrictions than to demand revival. The environment is intrinsically determined by “politics” i.e., the war. The cost of labor, another source of price volatility is due to the ability of producers to arbitrarily compensate rising prices. At this juncture we find it highly difficult to quantify the interplay of “Cost-push and Demand-pull” factors, beyond and or depending of the expected or feared monetary actions. As we all known in almost all periods of history inflation has been a combination of several factors. The current specificity is due to synchronous worldwide repercussions, on the real economy as well as prices, interest rates and currencies. It must be factored in that the governmental “printing press” of recent quarters and years – in order to combat particularly the COVID-19 pandemic – must now be controlled, hopefully by means of subtle interest rate increases.


Once again, we would like to stress that we are unable to determine when and how the Russian invasion and dismemberment of Ukraine will end. In spite of the unacceptable human tragedy, we should seriously consider the implications not only on the energy front but also on the food front, mainly for Europe and the whole world. Although the media mainly focus on inflation “tout court”, i.e. without mentioning the specific causes, we believe that these are expected to have a decisive impact on the allocation process.

At this stage we do not see any specific isolated factors that could determine the course of inflation. We are thinking of bad weather or new epidemics. Inflation due to the war will continue to play an important role, especially – and we hope – only in the short term. Food prices must be taken into consideration at this point. They will continue to suffer as a function of the Russian invasion of Ukraine. The offer speaks of a possible increase in food prices in the medium to long term. Another reason for inflation will be the recovery of global economic activity. Inflation of the economic cycle should – at this juncture – only have a short-term deterministic value.


The recent ups and downs on a global scale remain difficult to permit a clear-cut formulation of a promising investment approach. In other words, the environment remains elusive. Therefore, we suggest the following approach. It is a known fact that almost all major wars have been a major cause of inflation. Should we expect that this time around it will be much different? Industrial production is not expected to yield much support to economic growth. Why? Because there are additional reasons like the Covid-19 pandemic and the national and international transportation of raw materials and intermediate goods and services.

A first consequence speaks of short-term trading. This approach suggests that daily, weekly and monthly volatility is expected to remain fashionable.

Second, sectoral rotation should not be underestimated, especially in the short to medium term. From a historical perspective, there seems to be no doubt that the current setting requires an adjustment of the profit or loss potential in constant currency.

Third, inflation at levels over 3 to 4%, together with the impending need to tighten the monetary environment to prevent inflation to increase even further, must be taken as an indicator that the equity markets ought not to be an inflation hedge instrument.

Fourth, we continue to believe that, at least over the short-to-medium term, Swiss investors should focus preponderantly on the domestic currency.

At this stage, given the recent markets´ correction we believe that investors should remain more focused on equities than on fixed income instruments.

Comments are welcome.


Follow the Money

EMR April 2022

In the Fokus

Dear Reader

Die derzeitigen geopolitischen Umwälzungen verändern die wirtschaftlichen Aussichten und deuten, zusammen mit der durch Preisschocks verursachten Stagflation, auf eine weithin befürchtete Konjunkturabschwächung hin. Die Entwicklung der amerikanischen und europäischen Aktienindizes, der Anstieg des Goldpreises und die rasante Verteuerung von Rohöl und Gütern deuten darauf hin, dass die Preise nicht nur kurzfristig steigen werden.

The current geopolitical upheaval is changing the economic outlook and together with stagflation, caused by price shocks, points to a widely feared economic slowdown. The developments in the American and European stock indices, the increase in the price of gold and the rapid increase in the price of crude oil and goods indicate that prices will rise not only short-term.

What can we learn from history? If we look to the stock market indices from February 23 to April 1, 2022 the strongest negative impact on equities relates to the German, British and Swiss indices, while the price of gold increased by 4%. Worthwhile recalling are the past swings. Swiss inflation rose first in the early 1970`s, while US inflation peaked in the early 1980`s. So far in 2022 the rate of growth of the US CPI is once again quickly on the way up.

Over the short-to-medium term, further price shocks can be expected as a consequence of the Russian invasion in the Ukraine. Prices for commodities (e.g., oil and gas) and for food (e.g., wheat, corn, and soybeans) will continue to increase. For forecasters, it would indeed be rewarding to compare and analyze the assumed similar downward corrections of consumer prices of 1950-51, 1975 (following the oil crisis) and especially in the early 1980`s (following the energy crisis) and more recently (following the financial crisis of 2007-2009)! See chart on CPI Index.

The effects of the recent and still ongoing Covid-19 pandemic make it considerably more difficult to quantify the return of price advances to more normal levels. The impact of international trade and various economic policy measures on prices should not be neglected either. The current conflict on the EU’s border is unlikely to remain attractive to consumers in Western countries, especially as wage increases could be significantly delayed. Moreover, it is very difficult to quantify the whereabouts over time of supply chains.

International comparisons are currently further complicated by the split at the currency level, with the surprisingly rapid rush to the traditional safety currencies: the Swiss franc and the US dollar. The consequences of the inhumane tragedy cannot be underestimated. There will be repercussions on both sides of the Atlantic regarding inflation, economic growth and interest rates, and thus for monetary policy. It is worthwhile recalling that on March 16, 2022, the Fed decided to raise the federal funds rate by 0.25 basis point. Chairman Powell indicated that the Fed plans six more rate hikes in 2022. It can therefore be assumed that the European and Japanese monetary authorities will sooner or later follow the U.S. example.

The chart points to two astonishing developments:
The gap between the Swiss and the US Indexes since 1975 is astounding.
The ups and downs of the Swiss inflation rate precedes those of the U.S. inflation!

International currency sanctions are causing tensions. The intention is to constrain the Russian economy and the immense wealth of the Russian oligarchs. However, it is clear that the measures will not only hit the aggressors, but also the investment policies of the Western world. The power of the financial world, hampered by the availability of hard data, clearly points to a financial blockade.

More and more politicians, central bankers, economists and the general public are pointing to rising inflation and inflationary pressures. At this stage, the chart of spot crude oil prices is instructive, as shown by the West Texas Intermediate (WTI) price. Will these developments lead to rising and sustained inflation? The chat indicates a renewed rapid rise in prices. The question that arises is: will the price of crude oil last as long as it did in the period after 2000?

The chart points to a renewed rapid rise in prices. The chart bets the question: How high and how long will the price of crude oil rise, resembling may be the period after 2000?

At this stage, we are much more concerned about the trend reversal of globalization and its impact on businesses and government policies. Recall that the recent rise in inflation has been and will continue to be caused primarily by increasing commodity prices and bottlenecks in industrial supply chains at the global level.

We expect that it will take some time before the impact of the continuing Russian ag-gression can be clearly assessed. The longer it lasts, the more it will undoubtedly con-tribute to raising the prices of energy and all other consumer goods, and even more so of capital goods, especially in the area of international trade. It would then be assumed that the economic situation would have consequences for the free world. It would lead to the reversal of globalization. Consumers, entrepreneurs and governments would suffer, also depending on the length of the financial and economic embargoes. It is likely that it would be difficult and expensive to repatriate some of the production. A difficult ques-tion, in the context of rising inflation, concerns the ability to bear the corresponding costs of “repatriating” production without further fueling protectionism.

Framework Considerations

At this point, it is worth remembering that forecasters face a particularly difficult quantification exercise given specific implications for the supply and demand sides of the equation. One can be more pessimistic or more optimistic depending on the weight given to the supply or demand side. We prefer to focus on the interdependencies and remain somewhat more constructive than the most vocal forecasters. The fact is, that the invasion of the Ukraine and the resulting liquidity tightening will continue to support inflation for some time. The associated liquidity squeeze, combined with the rise in commodity prices, suggests a slowdown in economic activity and rising interest rates. In this circumstance we assume that the most deterministic assumption concerns the expected reversal toward significantly higher domestic output. If it actually occurs, this would imply higher production costs at least in the short-to-medium term, thus arguing for persistently higher inflation rates compared with earlier comparable periods. Countries with significantly higher domestic production stand to benefit.

The second deterministic assumption relates to the efficiency and international independence of the financial environment. The U.S., with its much stronger domestic orientation, should benefit compared to, for example, Europe and Japan. Switzerland could “benefit” from a higher Swiss franc and rather sustained liquidity compared to the EUR and the pound sterling.

The third deterministic assumption relates to the attractiveness of the respective currencies. A concrete example is the impact of the trade deficit on the YEN/USD exchange rate since the start of the Russian invasion of Ukraine on February 23, 2022. The depreciation on April 1, 2022 amounts to 6.14%. These developments have and will continue to have an impact on the country allocation process. In other words, in a phase of high and prolonged volatility, be it in relation to economic growth, inflationary trends and the flight of capital in search of safety, as well as specific difficulties at sector and/or company level, require focused attention to a much more selective approach than the one used in recent times.

Findings for Investors

Given the rather unpredictable prospects of an early end of the Russian invasion of the Ukraine, we tend to take the following investment approach:

For the Swiss franc investor, an above-average exposure to the domestic market and currency looks promising indeed. International diversification should focus on those economies that are able and willing to increase domestic production, especially of intermediate goods and services.

Given the higher cost of money and below-inflation bond yields, investors should continue to focus on equities rather than fixed-income securities. Our view remains influenced by the statement of Fed Chairman Powell, of March 16, 2022, regarding six possible further interest rate hikes.

Comments are welcome.


Review 2021

EMR December 2021

Dear Reader

In this EMR, we take a look back at our forecasts and assumptions for 2021, and find that our preference for equities has been rewarded by an acceptable, differential rate of earnings growth. Taking the respective themes into account, we come to the following conclusions:

  1. The focus has been on Volatility, Virus and Vaccine and respective determinism on the asset allocation.
  2. Once again, we found that nothing is more deterministic than cyclical comparisons.
  3. We examined the repercussions on economic activity, inflation and interest rates.
  4. We clearly pointed out the various types of distortions, and
  5. We found that great upheavals create major opportunities.

ASSESSMENT 1: Yearly outperformance.

The following charts and table, based on the daily closing prices of selected stock indices, show the respective annual changes. It can clearly be seen that the stock indices performed better in 2021 than in the three previous years. The disparities can be summarized as follows:

One, there are sizeable differences between the indexes on a country-by-country basis, as well as between the technological content of the US indexes. The outperformance (as we repeatedly commented in various EMR`s) of the indexes heavy-weighted in technology is astonishing indeed. These developments underline the importance of sectorial selection.

Two, “simili modo”, we might argue that 10-year bond yields confirm our assessments to underweight this investment category and to take currency expectations resp. corrections seriously into consideration. Looking back to the singly 2021 EMR´s we find confirmation of our positive assessment of equities vs. bonds and money market investments. The returns differences, excluding taxes and other costs, clearly confirm the recent attractiveness of equities over bonds, as shown in the following table and charts. The longer-term analysis of 10-year bond yields (see chart below) is telling indeed.

What does the chart tell us? Let`s remember that pessimism was widespread in 2021. Yet, we did not adopt the widespread negative assessment. The average performance of 2021 over 2020 has been significantly better than in the three years before. In the following we summarize our reporting as in the various EMR´s of 2021.

ASSESSMENT 2: The three V`s: Volatility, Virus and Vaccine.

At no time we took daily Volatility, the Virus and/or the Vaccine as trend setting. In view of the outperformance of equities versus fixed-income securities and money market instruments, we allow ourselves to solely assess the fate of the Swiss and U.S. equity markets. The following charts show the respective average monthly rates of change, revealing quite different patterns. Surprisingly for some, we did not find confirmation of the well-known statement: “The trend is your friend”. The charts simply speak of the difficulties while defining the own expectations. We deem ourselves lucky, in focusing on the right data, as implicitly visible in the differential developments of the monthly vs. the yearly rates of change.

ASSESSMENT 3: Deterministic is the cyclical comparison.

Usually, the daily closing values (of the stock indices) are shown. From the respective growth rates, one can in most cases deduce in which market one should be over- or under-invested. The developments of the SMI and the DJIA shown in the charts above are, as already mentioned, quite difficult to interpret. Nevertheless, one can deduce where the short-term trend might be headed as compared to the longer-term trend. What is easier to estimate is the time it might take for the index to return to its “normal” growth path.

ASSESSMENT 4: repercussions on economic activity, inflation and interest rates.

We all know, that this is an exercise that can go either way, i.e., as a driver of the economy or as an impediment. Depending on the context, there are a variety of possible interpretations. In other words: forecasting the future is a difficult exercise. It requires the most appropriate selection of the appropriate factors shaping the future environment. Even the knowledge of previous comparative periods is not always suitable as desired. The environment may appear to be quite similar, although important determinants remain indeterminable. Currently, these difficulties are evident in expectations, depending on the hoped-for end of the Covid 19 pandemic. Moreover, it can be argued that technological innovation, can and should provide much needed clarity. At present, many analysts remain rather skeptical about these deterministic factors of the fate of consumer attitudes. They hardly simplify entrepreneurial decision making regarding the much-needed adjustment of production lines.

ASSESSMENT 5: distortions.

TYPES OF DISTORTIONS: In the July EMR we focused on the marginal rate of transformation in production (TTP) as well as on marginal rate of substitution in consumption (TTC) and also, on the foreign terms of trade (FTT). We argued that these three factors were, are and will continue to be deterministic for some time. The transformation of production lines influences and distorts consumption goods to be exchanged in the world markets. Hardly a day goes by without a comment on one of these factors. Just think of the influence of the various Covid regulations as determinant of production and consumption. Specific repercussions are then visible in due time in the quarterly statistics of economic activity (GDP and components). At this juncture any quantification looks rather problematic and uncertain. As an expedient many analysts focus on prices, i.e. inflation as a promising determinant of future developments.

ASSESSMENT 6: great upheavals create major opportunities.

As known, in the past great upheavals did create major opportunities. As an example, we point to the growth revival following the great recession of 2007 – 2009, for Switzerland and the USA. This, in our opinion, could definitely be something to look into in the 2022 EMR`s, given vivid hopes of a U-Turn in the Pandemic, which in due time could lead to a sizeable economic recovery on a worldwide scale. We are aware of the fact that currently it is rather difficult to be optimistic, given the attitude of Central Banks, particularly of the US Federal Reserve, to start reducing the overall liquidity in order to contain feared inflation pressures. Fears of inflation are, a function of “politically induced” strong consumer`s support, and also to prevent further increases in the rate of inflation. According to Chairman Powell, the FED is no longer primarily fixated on encouraging a further recovery in the long-running labor market, but primarily on getting the potential for inflation under control. The risks of price increases have also to do with the strong demand for goods and services and also with the hope of getting the supply bottlenecks under control.


Comments are welcome.


Rythm of History

EMR November 2021

Main Lines of Change

Dear Reader

Studying the literature on economic change, while focusing on the post-World War I period, is very instructive, especially as a guide to the current turbulent environment. The available forecasts reveal major economic and social imbalances. We consider them quite significant, especially in the context of current uncertain developments.

Extrapolating the graph of the U.S. Consumer Price Index to September 2021 would result in a near doubling; the index would then rise to over 800! This further increase goes hand in hand with the various shocks. The sharp increases in the inflation rate began, as shown in the graph, in the late 1960s. What are the reasons for these developments?

Deterministic Facts

The above chart portrays two very disparate developments. On the one hand we find a rather volatile but smooth increase from 1896 to the late 1960, and on the other hand a dramatic, almost linear increase into 1996. In this EMR we will concentrate our attention to the second phase, i.e., the period since 1967.

Before analyzing the developments of real GDP, we would like to show the development of the stock indices since 1970. The corresponding chart (below) shows substantial fluctuations in the annual averages. The chart is hardly exactly quantifiable, is it?

In our analysis of the economic performance, we focus primarily on the development of real GDP in Switzerland and the United States. At this point, we wonder what is the connection between the fluctuations of real GDP and the stock indices, as shown in the above graph.

The available real GDP data for the five industrialized countries clearly show that there has never been an equivalent correction since the early 1980s, with the exception of the period from 2008 to early 2010! The chart shows that the Swiss economy reacted with a “substantial” lag to the downward corrections of real GDP in the U.S., Germany and the U.K. Developments in Japan are much more pronounced for the period 2002-2010.

The diagram above indicates two very different developments. On the one hand, there was a fluctuating but steady increase from 1896 to the end of 1960, on the other hand, a dramatic, almost linear increase until 2021.

One of the main reasons for this can be derived from productivity developments. For the sake of simplicity, we again limit our analysis to productivity developments in the USA. We assume that they are also valid for Switzerland and other industrialized countries.

The level and quarterly rate of output per hour, as published by the U.S. Bureau of Economic Analysis, are much less volatile than real GDP, this measured by quarterly rates of change. Why this is so is the real question. Could it be that productivity is much more responsive to inflation – and especially to inflation expectations – than to economic activity? Long-term analysis, however, seems to suggest that productivity responds much more quickly to overall economic activity than to inflation! In recent years, productivity has adjusted strongly to sectoral changes. These developments were not so readily apparent at the macroeconomic level (real GDP). This is certainly due to the fact that companies have adjusted their production lines – and will continue to do so – much faster than reflected in macroeconomic data. New production lines require different inputs, both on a material and human basis. This has happened – and continues to happen – at both the firm and sectoral levels. In case you have a different opinion, let me draw your attention to recent developments on the stock price front. The differences between the various indices shown and the Nasdaq 100 Index speak volumes, don’t they?

The chart shows dramatic shifts between the two time periods, as well as between the various indexes and the technology-focused Nasdaq. Could it be that the Covid-19 pandemic would trigger a similar shift both between the different indices and countries?

We all know that certain sectors disappear over time while others emerge. Just think of the changes in the automotive industry in the past compared to the expectations of chip-controlled automotive production of today and especially tomorrow.

How to Benefit From Productivity Changes

Can you benefit from the expected/feared productivity changes? A somewhat difficult way to answer this very deterministic question implies that one should prefer stocks that have shown the best productivity performance in the past and have responded coherently to significant productivity changes, i.e. stocks of companies that recognize and quickly react to signs of a productivity turnaround?

If this approach does not satisfy everyone, there is another way, which is to reduce exposure to companies and industries with the worst productivity histories, either in the short term or, more importantly, in the long term. Our contextual argument is to take seriously the fact that turnarounds are sometimes quite dramatic, especially for companies or industries with high debt burdens. A dramatic productivity turnaround, such as the one we are currently experiencing, is often accompanied by dilutive financing and a high debt burden. In such a case, the substantive argument is “buy the problem solvers” or, to paraphrase a well-known slogan, “invest in the doctors, not the patients.”

Conclusions for Investors

Our conclusions should be seen as a specific consequence of an extraordinary shift toward technological innovation and away from the traditional “output per hour worked.” We should take the impact of new technologies ever more seriously.

This also means that even if inflation fluctuates by 2% (which is considered historically low), equities would continue to perform better than fixed-income securities and money market instruments.

As a result, the USD is expected to rise against the EUR, the YEN and the GBP. The fact that the CHF, EUR and JPY have recently fluctuated in quite narrow ranges against the USD must be taken into account, also because the dark clouds in the currency sky do not bode well.

Any suggestion is highly welcome.


Required Homework

EMR October 2021

Great Upheavals Create Major Investment Opportunities

Dear Reader

The investment outlook is rather bleak, driven mostly – but not solely – by lagging productivity, fears of rising inflation, and high and rising governmental indebtedness, as well “unwarranted” fears of an impending equity market correction.

What does the chart on long-term indexed equity indices suggest?

Poorest performance = NIKKEI
Mediocre performance = UKX and CAC
Best performance = SPI, DAX & DJIA.
Does the chart imply something about productivity and/or on something else?

Why the Focus on Productivity?

Over the years, we have learned that the best-performing companies (represented here by the respective stock index) in some sense can be quantified by the interaction of productivity, inflation growth and currency performance. Recently, however, productivity gains have been increasingly hampered by governments’ deficit spending. It is a fact that in the past those sectors of the economy that have been able to improve their productivity while providing “new” equipment (through innovation and technological progress) have experienced a significant boom and have prospered significantly. What role have currencies played is an interesting question. In this sense, we are not surprised that the SPI, the DJIA and the DAX perform so differently compared to the NIKKEI, the UKX and the CAC index. We do assume that equity markets are not an inflation hedging instrument but a play-ground for currency specialists! It can be deduced from the chart on real GDP that the problems dominating the current technological progress point to a difficult identification exercise of the companies and industries with the highest potential capabilities to solve the productivity problems, inflation expectations and currency reactions. We thus continue to focus on the innovative spirit of each company and/or sector of the economy. The focus must thus be on the power to innovate, to counterbalance the power to tax = the power to destroy.

The available real GDP data for the five industrialized nations clearly show us that there has never been a similar correction since the early 1980s, with the exception of the period from 2008 to early 2010!

The chart shows that the Swiss economic activity reacted with a “substantial” lag to the downward revisions of real GDP in the USA, Germany and the UK. The development in Japan is much more pronounced for the recession period 2007-2010.

The level and quarterly rate of output per hour, as published by the U.S. Bureau of Economic Analysis, are much less volatile than real GDP, relative to quarterly rates of change. Why this is so is the real question. Could it be that short-term productivity is much more sensitive to inflation – and, in particular, inflation expectations – than to general economic activity? Long-term analysis suggests that productivity responds much more quickly to general activity. In recent years, there has been a strong adjustment of productivity to the sectoral environment, which has not always been immediately visible in the macroeconomic data (real GDP). This is certainly due to the fact that companies have had – and will continue to have – new products and appropriate capabilities to increase productivity, both at the sectoral and company level. We all know that certain sectors fade over time while others emerge – just think of the changes in the automotive industry in the past, compared to the expectations of chip-driven automotive production.

How to Benefit From Productivity Changes

We take the liberty of asking the reader how he/she can benefit from the expected/feared productivity changes?

A rather arrogant way to start answering this very tricky question implies that one should preferentially invest in stocks that have historically shown the best productivity gains and a coherent response to significant productivity changes, i.e. stocks of companies that recognize and quickly respond to signs of a productivity turnaround?

If this approach may seem too difficult, there is another way, which is to reduce exposure to companies and industries with the worst productivity histories, either in the short term or, more importantly, in the long term. Our contextual argument is to take seriously the fact that turnarounds are sometimes quite dramatic, especially for companies or industry sectors with high debt burdens. A dramatic productivity turnaround, such as the one we are currently experiencing, is often accompanied by dilutive financing and a high debt burden. In such a case, the contextual argument is: “Buy the problem solvers” or with the corresponding slogans: “Invest in the doctors, not in the patients”.

Conclusions for Investors

Our conclusions should be seen as a specific consequence of an extraordinary shift toward technological innovation and away from the traditional “output per hour worked”. We should take the impact of new technology ever more seriously.

This also means that even if inflation were to fluctuate by 2% (which is historically low), equities would continue to perform better than fixed-income securities and money market instruments.

As a result, the USD is expected to rise against the EUR, the YEN and the GBP. The fact that the CHF, EUR and JPY have recently fluctuated in quite narrow ranges against the USD must be taken into account, also because the dark clouds in the currency sky do not bode well …

Any suggestion is highly welcome.