Category: EMR

EMR April 2024

Dear Reader

RECENT DEVELOPMENTS

Most forecasts can be characterized as rather pessimistic, as far as short- and medium-term expectations are concerned. Therefore, they can be considered somewhat unpromising and relatively incoherent. In this EMR we will focus on the average performance of several equity indices to try to define a likely outlook.

The following graphical representations of specific stock indices speak for themselves. In the first graph, we focus on the average annual change over the past four years in order to derive a promising result for the year 2024. The second graph uses the same data, and a traditional visualization.

Comparing the index increases shows that annual growth rates differ significantly from index to index. Does this suggest that the factors used to explain each index performances are not the same? In forecasting term this is the real question at this time, isn‘t it? Since the graph may pose particular interpretative difficulties, let us illustrate the same data in a more “traditional” way.

The charts show 2021 as the best performing year, while 2022 was the poorest performing one. From the traditional illustration it can clearly be inferred that the composition of the various indices speak for themselves throughout the period under review. The graphs, in line with known developments, indicate that the SARS-Covid 19 outbreak affected the European indices significantly more than the other indices. Recall that the first human case of Covid occurred in Wuhan, People’s Republic of China, in November 2019. The World Health Organization declared the outbreak of Covid-19 a health emergency of international significance on 30.01.2020 and a pandemic on 03.11.2020. Looking a little more closely at the recent, rather surprising past in order to assess the near future, we find the following determinant differences.

A first determinant, according to our personal assessment, relates to the technology content of each index. The reader might recall that in previous EMRs we have expressed our concerns about this, pointing out, for example, the outperformance of the NASDAQ index in the years 2020, 2021, and for the time being also in 2024. However, the current year’s performance is not really comparable due to the availability of short-term data. There is no doubt that 2022 was the worst performing year, according to the reported stock indexes, in conjunction with the Russian aggression on Ukraine. Since February 24, 2022, targeted disinformation and conspiracy narratives have accompanied the expansion of Russian aggression. Ongoing Russian aggression has and continues to have repercussions that are difficult to quantify, both economically and politically in general, with a devastating global impact in the short to medium term. We should not forget that Ukraine has been (and should remain) the breadbasket of Europe, while Russia is a major exporter of crude oil, especially in cooperation with suppliers in the Middle East.

ASSESSMENT

The following diagram suggest significant, differential impacts between one stock index and another. We believe that these differences are a clear indication that the performance of each index is not easily comparable, mainly because of the assessment of the impact of interest rate adjustments by Central Bank authorities. This is true for both the period since December 1998 and the period since December 30, 2008, and also for the most recent period from 2019 to the present.

The charts allow us to characterize the focus on interest rates as the main determinant of market developments – mainly or even exclusively on the actions and reactions of monetary authorities – as rather questionable, if not misleading.

While searching for current clues on the whereabouts of interest rates, we came across an amazing infographic titled “The ECB and Its Watchers 24” focusing on the whereabouts of interest rates. The summary highlights the end of the inflationary spurt, the transmission of monetary policy and the banking system, and the relative impact of geopolitics. At the conference, ECB President Christine Lagarde emphasized that the ECB cannot commit to further rate cuts after a likely first move in June. … The latest move by the Swiss National Bank (SNB), on the other hand, is indeed astonishing. On March 21, 2024, it became the first central bank to announce a turnaround in interest rates, citing lower inflationary pressure and a stronger franc in real terms! At its March 2024 meeting the FED, on its part, kept rates unchanged, acknowledging that the economy is “strong”. It is worth recalling, that the FED has kept interest rates steady since July 2023.

The tricky question at this point concerns the determinants of inflation and inflation expectations. Most commentators argue about the economic outlook and the possible reactions of central banks. From a Swiss perspective, the assessment could be very contradictory to the European and/or the US views.

Our assessment for Switzerland takes the Swiss franc into account as a key factor. The details relate to the outlook for import and export prices, both in the short and medium term. Rising crude oil prices, which as we know are quoted in USD, have a different impact on the “domestic” inflation rate via the appreciating CHF, than in countries with depreciating currency. The decisive factor for the CHF, in the current constellation, is not the actions of the SNB, but the international demand for CHF, which for many foreigners, is likely to represent a value of last resort.

The USA and the European Union continue to focus on economic growth as a promising indicator for the whereabouts of the stock markets. At this stage, we see an important difference between the US and European economic outlooks. The growth outlook in the US is, in some ways, much more promising. The main determinant of US economic activity is the increasing “re-shoring” of production, particularly in technology-oriented sectors. One indication of this is the slowdown in imports of technology goods from China. If our different assessments are accurate, the Fed‘s assessment will prove to be correct, while the ECB‘s may not be as accurate.

EXPECTATIONS

The outlook remains difficult to assess. Both the Russian aggression against Ukraine and the lack of a prompt response from the most important international players make any economic assessment difficult and hardly quantifiably with sufficient certainty. Next you find our contextual assessment.

The primary determinant relates to the “end” of the Russian war against Ukraine. No politician seems to be able, willing and/or determined to confront Mr. Putin; not China, not the US, not the United Nations … We consider this to be the most difficult deterministic assessment at this crossing. We fear that international trade will lose out, also as a consequence of other conflicts around the world.

In this “absurd” environment, technology can still be seen as the most promising sector of the global economy, which should continue to drive engine of equity markets. We believe that an investment approach focusing primarily on the local market remain indeed promising. Expectations regarding economic growth can still not be assessed with sufficient certainty. We assume that volatility will remain substantial. In such an environment, inflation and interest rate expectations remain difficult to assess with a relatively high degree of certainty. As a result, a relatively high degree of “domestic” concentration must be factored in for a certain period of time.

Suggestions welcome.

EMR March 2024

Dear reader

GROWTH COMPARISON

The frequent repetition of comments – in the media – suggests that economic developments should be reasonably consistent from country to country. The charts, in this EMR, raise the question: What can be inferred from the performance of Swiss and US GDP for the respective equity indices and currencies, in the current uncertain and controversial environment? What follows is what we presume to know.

For simplicity and specific interest, let us compare the long-term trends of real GDP and respective primary components and pertinent currencies for Switzerland and the United States. The graphical representation of official data, released by ESA (Bundesamt für Statistik) and BEA Table 1.1.6 allow us to evaluate the respective trends of the “real” data with various projections and interpretation of the current economic trend.

ASSESSMENT

Which conclusions can be drawn from the above shown charts?

A first conclusion that jumps to mind relates to the different growth trends between an open economy (Switzerland) and a relatively closed economy (the USA)!

A second argument concerns the differential performance of the five components of Swiss and US Gross Domestic Product. To facilitate the comparison, between the individual components we have indexed the respective series to 1 for the first quarter of 1980. The graphs clearly show that economic growth in the USA is 1.73 times that of Switzerland! Moreover, the differences have grown over the entire observation period. Significantly, short-term volatility is higher in Switzerland than in the USA. A markedly higher degree of volatility can be found in the data on international trade and corporate fixed capital formation. Analyzing the development of the individual components in relation to GNP growth requires a very differentiated view, both at a consolidated level and for each individual sub-component. What is not visible in the charts are the respective currency trends: the USD tended to depreciate and the CHF to appreciate.

A third deterministic difference concerns the trend and growth rates of exports and imports of goods and services. The Swiss exports growth rate has exceeded that of imports almost throughout the entire period. It is also accompanied by persistent volatility. The growth rate of US imports has outpaced that of US exports by an increasing margin, especially in the last 10 years. The inverse trend is also known to drive the respective currencies. At this point, we might ask, what does this trend differential mean for the in-vogue interest rate management of the respective monetary authorities?

A fourth significant difference is the weakness and volatility of Swiss gross fixed capital formation compared to the weak but growing US fixed investment. These differences are pronounced, and the deterministic reason for their persistence remains to be seen. It is important to consider the role of innovation in the US versus Switzerland and its implications for fine-tuning interest rates in the fight against inflation. These developments present a real puzzle.

Another potential concern is the relatively weak and steady growth rate of consumer spending and the limited contribution of government spending over time.

REQUIREMENTS

The official data used in the charts determine to a certain extent the fluctuations in the share indices shown. If we take a closer look at the development of the individual indices, the following observations can be made:

There is no doubt that technological innovation and change has had and will continue to have a significant impact on the performance of equity indices, and not just these. As can be seen, the NASDAQ and S&P500 have been particularly responsive to technological innovation. It should be noted that the focus should not only be on price changes, but also on the independence of the domestic economy. As mentioned in previous EMRs, these interdependencies should be taken into account. Therefore, it is crucial to provide a clear answer to the following question: Why have most analysts and forecasters focused so much on inflation and not on technological innovation?

We wonder why many commentators, journalists and economists continue to focus primarily or even exclusively on monetary policy as the primary influence on markets.

Analyzing the demand for technological inputs in low-cost economies presents a unique challenge. In our view, not enough attention has been paid to this approach so far.

If we look at the long-term performance of the EUR/USD and CHF/USD exchange rates relative to the equity indices presented, we see that their performance is relatively poor compared to almost all of the equity indices presented.

This sustainable approach requires answering the following question: Why have most analysts and forecasters focused so much on inflation and not on technological innovation?

Let us stress that the global economy has proven to be more resilient than expected, with falling inflation and no sharp rise in unemployment. However, there is reportedly a shortage of skilled workers and experts in various sectors.

CONSIDERATIONS

Any forecast is based on assumptions that may directly or indirectly affect the investment strategy and potential returns in the face of unforeseen events.

Since 1992 and over the last four years, the monthly performance of the equity indices is as follows:

It is unclear why the central banks’ focus on fighting inflation by adjusting interest rates has such a significant differential impact on the performance of the DJIA (+10.4%) compared to the Nasdaq (31.2%) or the NIKKEI (1.7%).

Assuming that the planned interest rate cuts by the U.S., Eurozone and Swiss central banks would not have an equivalent and significant impact on private consumption and business fixed investment, what would be the impact on consumer spending and investment be if a war were to break out, especially if it continued to hamper the development of international trade?

CONCLUSIONS

We continue to believe that war in Ukraine and the Middle East might remain more decisive than monetary intervention. In addition, we are concerned about the potential impact on world trade, due to the irregular performance of China, Russia and other competitors in the free world.

In other words: We expect volatility to remain high, especially in the first quarters of 2024, which will need to be managed primarily by adjusting sector and stock selection. The primary source of concern at present is none other than technology. In some sense it is viewed as a limit for the correlation between feared deindustrialization vs. economic liberty. The example of China is promising indeed. The Chinese example points to the importance of private enterprise as compared to “statalist” policies. Experts state that the Chinese economic miracle is not so much due to public policy, but rather the result of “private” efforts, so-called “grassroots capitalism”.

Our biggest fear is that the expected/feared interest rate adjustments by central banks in the free world will continue to be unsatisfactory due to the unbridled control of international trade by China, Russia and their respective alliances. In this context, the decisive factor for the development of inflation will be the period in which the possible/feared difficulties in the transit of goods through the Suez Canal cannot be overcome by interest rate adjustments.

A specific factor that will accompany us during 2024 is the presidential elections in the United States. It is very difficult for us to assess the possible outcome.

While a large majority of analysts set theirs focus on fighting inflation, we prefer to focus on economic growth especially international trade as the determinant of our Investment Outlook.

Suggestions are welcome.

EMR February 2024

Dear Reader

STOCK INDICES = EYE-OPENER?

Recent developments show on the financial markets that hope and fears are not and cannot be the only tools explaining their performance. Consequently, in this EMR we focus on the performance of selected equity indices. In addition, the environment continues to be characterized by absurd and unacceptable armed conflicts and other shocks that could shake the world.

The following chart raises the question: What can be deduced from the performance of the stock indices and currencies in the current uncertain and controversial environment? What follows is what we believe to know.

After increasing instability due to the COVID-19 pandemic, the markets collapse in February 2020. Overall, from January 3, 2023, the graph shows significant differences in growth, but rather congruent declines.

Significant differences in growth across countries are seen in the second period from 2021 and the interim peak on February 18, 2021 (1.58 indexed series or 16057.44 real closing prices of the Nasdaq index). It is worth recalling that 57.68% of the Nasdaq index is made up of technology and 17.59% of consumer discretionary stocks. In the S&P 500 Index, the main indicators are: 26.1% = Information Technology, 14.5% = Health Care and 12.9% = Financials. Consumer discretionary accounts for only 9.9% and industrials for 8.6%. The SX5P Index and the NIKKEI Index are the worst performers in our shortlist for the period from November 26, 2021 to early 2024.

DETERMINISTIC ASSUMPTIONS

The chart above prompts an inquiry into the primary factors influencing the fluctuations of the stock indices shown. Upon closer examination of the performance, the following observations can be made:

1. Technological advancements have greatly influenced the performance of the analyzed indices. The NASDAQ and the S&P500 have particularly responded strongly to these innovations. It is important to note that the focus should not solely be on price changes, but also on the independence of the domestic economy. As mentioned in the previous EMR, these interdependencies should be taken into account. Therefore, it is crucial to provide a clear answer to the following question: Why is it that most analysts and forecasters have focused so much on inflation and not on technological innovation?
2. We wonder why a large number of commentators, journalists, and economists continue to focus primarily, or even exclusively, on monetary policy as the primary influence on the markets.
3. Analyzing the demand for technological inputs in economies with low-cost production presents a unique challenge. In our view, this approach is still not receiving enough attention.
4. (d) When examining the long-term performance of the EUR/USD and CHF/USD exchange rates in comparison to the presented equity indices, it is apparent that their performance is relatively subdued in comparison to nearly all of the equity indices presented.

The global economy has proven to be more resilient than expected, with falling inflation and no sharp rise in unemployment. However, there is reportedly a shortage of skilled workers and experts in various sectors.

CONSIDERATIONS

Every forecast relies on assumptions, which can directly and indirectly affect the investment strategy and potential returns in the face of unforeseen events.

Since 1992 and over the past four years, the monthly performance of the stock indices is as follows:

1. It is unclear why the central banks focus on fighting inflation through interest rate adjustments has such a significant impact on the performance of the DJIA (+10.4%) compared to the Nasdaq (31.2%) or NIKKEI (1.7%).
2. Assuming that the planned interest rate cuts by the US, Eurozone and Swiss central banks would not have an equivalent and significant impact on private consumption and business fixed investment, what would be the impact on consumer spending and investment if there were to be a war trend, especially if this continued to hamper the development of international trade?

CONCLUSIONS

We continue to believe that war developments in Ukraine and the Middle East will remain more decisive than monetary interventions. We are concerned about the possible impact on world trade due to the uneven performance of China. Russia and other competitors in the free world.

In other words, we continue to anticipate high volatility in the first two quarters of 2024, which will have to be dealt with mainly by adjusting sector and stock selection beyond equities.

Our biggest fear is that the planned/feared interest rate adjustments by central banks in the free world will continue to be unsatisfactory due to the unbridled control of international trade by China, Russia and their respective alliances. In this context, it will be deterministic for the development of inflation over which period of time, the possible/highly feared difficulties concerning the freight transit in the Suez Canal cannot be managed via interest rate adjustments.

A specific factor that will accompany us in the course of 2024 are the Presidential Elections in the USA. We have a tremendous difficulty in assessing the possible outcome.

While the large majority of analysts set theirs focus on fighting inflation, we prefer to focus on economic growth especially international trade as the determinant of our Investment Outlook.

Suggestions welcome.

EMR January 2024

Dear Reader

GENERAL CONDITIONS

Last year saw Russia’s much-publicized military misdeeds in Ukraine and the war in the Middle East, as well as international power struggles in the technology sector. In addition, a new difficulty emerged, namely the “closure” of the Suez Canal. Shipping companies have faced longer delivery times and thus increased costs for Asia-Europe trade through the Cape of Good Hope at the southern tip of Africa. These developments raise fears of an expectation of impending rising costs. Depending on the duration of the closures, this would mean an additional inflationary element that could not be addressed by interest rate adjustments by central banks.

It is well known that central banks are currently expected to further raise interest rates, in order to “lower” the inflation rate. The exception may be the USA. Although the just published inflation rate for December (3.4%) is higher than anticipated, it is to be expected that interest rates will be reduced further in the 2024 presidential election year. Officially independent of the Administration, the FED has been often shown to be politically aware in its timing. It is generally assumed that rising inflation rates, in due course, will lead to higher interest rates. We recognize this “Truism”, however, we wonder whether, in the given constellation, the reverse argument, i.e. higher required interest rates, would lead to a lower inflation rate? As already expressed in previous EMRs, we doubt it.

Readers may be wondering why we are so skeptical, i.e. that in the current circumstances higher interest rates from central banks can hardly influence the inflation rate, i.e. reduce it? It is well known that there are many reasons why prices rise/fall, as there are multiple causes of inflation. Price adjustments are, as we know, not simply the result of an expansion/restriction of the money supply or, simply put, the result of too much/too little money for a limited quantity of goods. It is well known that inflation has many causes. Preisanpassungen sind, wie wir alle wissen, nicht einfach das Ergebnis der Ausweitung/Einschränkung der Geldmenge oder einfach gesagt, das Resultat von zu viel/zu wenig Geld für eine begrenzte Menge an Waren. Die Inflation hat, wie wir alle wissen, viele Ursachen.

The best-known causes of inflation are defined as either demand (demand pull) or supply (cost pressure). At present, most analysts and central bankers use the demand pull as the determining forecasting tool, while we assume a shortage of supply. Even a superficial analysis of the factors determining inflation must assume that the shortage of crude oil, for example, due to Russia’s senseless attack on Ukraine and the war in the Middle East, including the short-lived closure of the Suez Canal, have driven up the price of one of the most important commodities (crude oil) and, as it looks now, will continue to play a role as a determining factor of uncertainty for some time to come. The rhetorical question we would like to ask here is: can further interest rate hikes by central banks put a stop to the restrictive supply policy? It seems to us that this is hardly possible, as supply restrictions can hardly be influenced by interest rate changes. As an indication, we would like to point to the price development during the OPEC period.

ASSUMPTIONS

In the current environment, forecasts are characterized by various assumptions, which directly and/or indirectly affect investment policy. In this regard, it would be appropriate to contemplate the long-term behavior of equities and government bonds. Beginning with 10-year government bond yields, it can be assumed that the recent rise in interest rates is wearing off. However, the discrepancies should not be underestimated. It can be assumed that central banks will soon reduce short-term interest rates, which should result in lower government bonds in the short term. The latest levels (see chart) show divergent economic developments, for example between the United States (GT10) and the United Kingdom (GUKG10) compared to Japan (GJGB10) and Switzerland (GSWiSS10).

However, we think it is worth comparing the performance of various stock indexes e.g. since 1992 and, in this case, also the DJIA over the past four years, on a monthly average. The following can be deduced from the graph:

1. The growth differential of the NASDAQ index against all others shown indexes is extremely high. It highlights sectoral developments, which should have been given serious consideration in asset allocation since 2010. One may wonder why so little attention has been paid to this determinate factor.
2. Looking at the performance of the other listed indices, it is evident that there are large disparities here as well, for example between the Nikkei index and the SPI index. Overall, the difference in performance averages 10%.
3. The question now arises: what will happen next? Our hypothesis follows in the next section.

CONSIDERATIONS

Every forecast is characterized by assumptions, especially in the current situation. The respective assumptions determine, directly and/or indirectly not merely the investment policy, but also the possibility of achieving successful returns in the presence of uncertainties.

Comparing the performance of the various stock indices since 1992, and/or the other listed indices, over the past four years, on a monthly basis, the following conclusions might be achieved:

1. It remains inexplicable why the central banks’ focus on fighting inflation, by adjusting interest rates, accounts for such a marked difference between the performance of the DJIA (+10.4%) versus the Nasdaq (+31.2%) or the NIKKEI (+1.7%)?
2. Assuming that the planned interest rate cuts by the central banks of the U.S., Eurozone and Switzerland are unlikely to have an equivalent and substantial impact on purchases and the number of transactions, what will be the respective impact on consumption and investment if war trends continue to have a significant impact on international trade?

CONCLUSIONS

We continue to believe that war developments in Ukraine and the Middle East will remain much more decisive than those mentioned above.

In other words, we continue to anticipate high volatility in the first two quarters of 2024, which will have to be dealt with mainly by adjusting sector and stock selection beyond equities.

May the coming year 2024 bring us all good health, success and prosperity!

EMR December 2023

Dear Reader

REVIEW 2023

Examining the developments of the SPI (Swiss Performance Index) and the DJIA Index e.g., for the last four years, both on the end of month and on a monthly average basis, as implicitly shown in the following charts, is indeed highly revealing. What can be deduced from the following charts is here the following:

Although the graphs of the SPI and DJIA stock indexes do not show striking differences, indicating a rather stable environment, with the exception of the period between January and February 2020 and 2021, it should not be forgotten that in the years under review there have been divergences in their respective daily performances, although they have not been as significant as might be inferred from repeated comments by various experts. However, it should be noted that the differences in the monthly averages are rather small compared to the month-end averages.

Readers might object that an analysis based on only two stock indexes is insufficient. For this very reason, we report the annual % change in the respective monthly averages for a number of stock indices, as shown in the following graph, which shows drastic differences, does it not?

The annual variations, as shown in the graph above, are indeed remarkable, both in terms of size and from index to index. A first specific argument, inherently contained but not deducible from the graph, concerns the fluctuations in the respective currencies (not shown in the graph). A further argument concerns the “technology” content of each index. Recall that during the period analyzed, technology has played – and will continue to play – a decisive role, not only for stock markets, but especially by virtue of the differential in economic activity between countries. At this point it is worthwhile, at least as a mere example, to compare the fluctuations of the DJIA with those of the S&P500 and/or the Nasdaq.

CURRENT ENVIRONMENT

Contextual analysis reveals to us that there are no “additional and decisive factors” to take into account. The Russian war against Ukraine and the war in Gaza continue to remain deterministic. The expectations remain conditioned by geopolitical instability, while technological innovation and central bank measures aim to fuel certainty. As a consequence, we find the economic outlook to be far from rosy. Crude oil producers continue to play a rather dangerous role. Their goal is to keep energy prices as high and as long as possible, essentially to be able to finance absurd and devastating wars.

In addition to the fact that consumption is the engine of economic activity and thus has been and continues to be the promoter of prosperity, we also expect several stimuli from international trade in essential goods and services. It will be difficult to contain price increases. Consequently, the actions and responses of monetary authorities should not focus excessively on fighting inflation, but rather on stimulating domestic economic activity, which requires a shift from foreign investment to domestic renewal. It should be noted that the other components of GDP have apparently not contributed as significantly to economic activity, which is a surprising sign.

To explain what we mean, and for simplicity’s sake, we limit our analysis to the developments in the United States, assuming that the impact may be somewhat similar in other industrial countries. U.S. data since 1947 show that consumer spending remains the largest contributor to GDP. Nevertheless, the following table of U.S. GDP and its major components reveals rather surprising results. Over time, consumer spending has tended to be less pronounced, that is, less driving. The spread has widened over time. The growth differential is clearly visible in the data (see table), while all other GDP components seem to make only a marginal contribution. Whether this assessment is “right” or “wrong” as a measure of the respective levels, is the appropriate question at this stage. is it not?

In order to analyze the U.S. economic activity data shown in the following table, let us first define the headings: GDP = Gross Domestic Product; C = Consumption Expenditure; IFIX = Investment Expenditure; X = Exports; M = Imports; and G = Government Expenditure. The overall rates are summarized in the following table:

A close examination of the data in the table above speaks volumes. Although the data point to consumption spending as the driver, the growth rates of the other components of GDP suggest to us that imports are the key determinant of GDP growth, followed by exports and investment. Consumption spending ranks only fourth, while government spending precedes all other major GDP components. The table confirms our conclusion that the causes of the current disorder lie not so much in interest rate trends as in international social and moral disorder (Russia’s war in Ukraine)!

OUR EXPECTATIONS

The interpretation remains controversial and it is difficult to define a plausible and credible scenario. Volatility affects both the short and medium term. The monetary authorities and most forecasters are primarily concerned with restoring price stability, e.g., through higher interest rates. Against this backdrop, we continue to favor quality stocks, especially in the technology sector. The level of long-term interest rates is favorable for quality bonds, at least in the medium term, which promise attractive yields and opportunities for capital appreciation for the first time in a long time. Overall, we remain strongly focused on the domestic market for both equities and currencies. Never before in human history has a pandemic caused governments around the world to shut down their economies so abruptly and almost simultaneously, only to revive them with massive stimulus. The result remains uncertain, somehow pointing to the return of inflation, contraction in the labor market, rising bond yields expectations, and persisting high government indebtedness, continuing to nourish volatility.

MERRY CHRISTMAS & A HAPPY NEW YEAR

Comments are welcome.

EMR November 2023

Dear Reader

TOUGH OUTLOOK

It is well known that the IMF has issued a specific warning, namely that “financing the fight against climate change, only by means of incentives, seriously risks putting states” budgets in crisis. The IMF warning makes explicit reference to competition in the context of the energy transition campaign, and in particular to the U.S. Inflation Reduction Act (IRA), of August 16, 2022, which in hindsight has much more to do with fighting against inflation than with climate change.

This very important caveat leads us to examine the relationships between inflation, interest rates, and stock indices to be able to present a likely or possible outcome in terms of investment diversification. The following chart indicates significant differences.

Labeling: DJIA = Dow Jones Index; iS = 3 months interest rates; iL= 10y Govt Bond yields; Pdot = Consumer Prices; ls = left scale, rs = right scale.

OUR ASSESSMENT

The graph based on long-term series indicates a complicated period. We would like to highlight that the outlook continues to be driven by a high degree of uncertainty and therefore it is very complex and difficult to define precisely, especially in the short to medium term. Monetary authorities remain primarily concerned with restoring price stability, while in our view there should be a much greater focus on international trade and the corresponding impact on consumption and investment spending (private and public). Recent actions and reactions by governments do not seem to have been very appropriate, do they? Against the background of the change in sourcing of electronic products (chips and their manufacturing content), we are called upon to carefully analyze the “cost-benefit” ratio of the threat of protectionism, especially also because of Russian aggression in Ukraine and fratricidal wars in the Middle East and elsewhere. Moreover, we should evaluate this complicated scenario not only against the backdrop of China’s loss of productive power, but also against the backdrop of the expected and much-needed turn in favor of free market economies. Recent real GDP data in the U.S. (Q3 2023) clearly point in this direction. Important issues in this context are undoubtedly the “subsidy war” related to the Inflation Reduction Act (IRA) and the rather worrying rise of government debt to unsustainable levels, with perhaps one particular exception, that of Switzerland. Compared to the EU countries and the United States, the relationship in Switzerland is rather limited.

In this context, we ask ourselves what this reversal towards “domestic production” might imly for international investment diversification. Any suggestions?

Dramatic changes in the production process are in the air. We expect an increasing focus on domestic content, especially in the technological environment. However, this trend-reversal is not expected to evolve at high speed. This will be a determining factor in the long run. A second aspect we see will be the found in the evolution of labor markets, a change in trend from production offshoring to relocation to the local markets. Although this change may not be felt in the short term, it will have an impact on employment, especially in the field of technology. There is no doubt in our mind that international trade can modify the expectations of economic growth of those countries that are willing and able to finance new investment factories. Moreover, free trade will have to, increasingly, take into account the fact that it will move from being a promoter of the economy into second position, after local production. The well-known and much-vaunted virtues of global free trade in capital and goods as engines of economic growth will have to be consistently changed and adapted.

DETERMINISTIC RELOCATION

In the context of the expected shift in production, we focus on the following three factors, which we consider to be highly deterministic means of profitable investment allocation:

1. The relocation of production from abroad to the home markets or shores.

2. The deterministic importance of the availability of domestic inputs relative to imported inputs; and

3. The availability of domestic developped and produced technologies.

Recently, we have witnessed a deterministic revision of the importance of domestic versus imported production. Costs and benefits are more and more evaluated from the perspective of increasing protectionist interventions. In the international competition of free markets, the advantages and disadvantages are increasingly evaluated dynamically rather than predominantly statically. These shifts are increasingly seen as a reassessment of the concept “cheap” is no longer as deterministic as “on-time availability.”

A second aspect relates to the “content” of the means of production. The “low-cost production countries” began to raise prices and/or introduce specific costs. Production in China was defined as profitable compared to local production. In the context of the IRA mentioned above, the U.S. determined that production quotas were essential because computers could not function as expected without certain components that were only available in the U.S. The IRA was a major step in this direction.

The third aspect, which may be the most determinative, relates to the availability of domestically developed and produced technologies, i.e. an increased focus on domestic production. In terms of economic activity, we expect a significant impact on consumption and investment spending as we face, in a sense, a resurgence of protectionism. This trend is clearly visible with regard to the production of electric vehicles, but not exclusively so.

IMPACTS ON INVESTMENT POLICY

Currently, investors expect further, moderate, interest rate hikes as well as further exchange rate adjustments. As Swiss investors with a relatively high home bias, we continue to expect the CHF to outperform the EUR, USD and GBP as well as the YEN.

Economic activity is likely to remain subdued despite recent interest rate hikes, mainly driven by consumer spending. In addition, we are concerned about the weakness of the European economy, mainly due to German weakness, and the ongoing difficulties in China.

Nevertheless, stagflation is currently assumed. The global economy is suffering from a weak economic outlook and inflation that is difficult to control, especially through further interest rate hikes. Moreover, a growing number of analysts are asking: How can inflation be reduced, primarily by further interest rate hikes? Our answer, as expressed in previous EMRs, requires a rapid reduction in certain imports – especially crude oil and gas and an increase in domestic production of essential goods. The arguments outlined are our main reasons for focusing on investments in our local market, especially into account the expected and feared currency changes and also the technological developments triggered by an increasing focus on domestic activities.

Although the impact of political changes should mainly affect the medium to long-term outlook, we believe it will be imperative to closely monitor any feared economic recession. At this point in time, our outlook is also determined by the outcome of the war between Russia and Ukraine.

Behind the recent political, economic and social developments, which speak of a destructive competition, there seems to be an increasingly negative future, the so-called “chip war” (between the United States, China (including Taiwan and other manufacturers not only from Asia, but also from Europe). A further example is the electric car market. The graph on interest rate differentials points to an imminent reversal, doesn’t it?

Comments are welcome.

EMR July 2023

Dear Reader,

A detailed and specific assessment of the current global economic environment remains a major challenge, especially given the difficulties of reliable forecasting, which still has to rely on lagged data sets. In this context, two causes are particularly instructive. The first concerns visible anti-Americanism versus growing support for China and Russia, in particular. This can be explained by the specific commitments of various governments and also by the systematic support in favor of global corporations. In other words, there is a clear trend toward a left-wing political positioning that is in opposition to the democratic economic concept of free trade. The second reason also argues for the end of a politically conditioned focus on cheap imports. Considerations in this regard are clearly to be found in the reversal of the world situation that has taken place since the end of the Second World War.

A concrete assessment of the near future remains a cause for great concern. The main arguments for our rather pessimistic view of the current situation are to be seen as consequences of the financial crisis of 2008-2009 and the Covid 19 pandemic, which highlighted the fragility of supply chains. These developments persist in being mainly politically motivated and not so much to do with economic constraints. In addition, fears of recession were and are seen as a consequence of the Russian military’s invasion of Ukraine. The Russian invasion of Ukraine has shown everyone, how vulnerable the risk of overdependence on undemocratic regimes is. These developments call for a new industrial strategy, especially in the area of technological economic innovation. This setting is due in particular to the relative commitments and systematic support of the respective governments for globally active companies. In other words, there is a visible and discernible trend toward a left-wing political stance as opposed to a democratic, free-trade approach to entrepreneurship.

From the current overview it can be deduced that a new industrial structure is required, taking into account geopolitical needs and requirements. The promotion or punishment of companies should not be the task of politicians, as is implicitly the case in “dirigiste” states. In general, and especially in the area of “private enterprise”, which is of particular interest to us, the transfer of sensitive technologies to countries with hostile regimes such as Russia and China should no longer be so strongly encouraged.

THE CURRENT FRAMEWORK

The originally internal slogan from the 1992 Clinton campaign sums it up: “It’s the economy, stupid”. While the focus is increasingly on a modern and innovative industrial strategy, repatriation is currently a very hot topic. It is about maintaining and expanding domestic production lines, especially in the field of new technologies, in harmony with nature and the environment. Therefore, what is necessary and required, is a shift from public to private investment, i.e., a de facto “repatriation” of the production of strategic goods and services.

Focusing on economic growth is no longer sufficient. Rather, it is imperative to focus dynamically and continuously on the core areas of the economy. This assumption speaks of a trend reversal towards a newer innovation capability. Another feature implicitly calling for a trend reversal, points to the significant economic impact of the failure of “economic integration and cooperation” in the free world. This due to the fact that it has not made countries more peaceful and cooperative. In this context, we again find two relevant explanations. Primarily, European anti-Americanism, and secondly, China’s policy of continuing to subsidize various aspects of the economy, without ever considering the impact on other nations. This behavior is called “erosion of competitiveness” and is usually a determining factor in specific sectors of the economy. These tendencies are particularly evident in the Russian invasion of Ukraine.

Another aspect that ought not be underestimated concerns the rise of individually feared, politically motivated interdependencies in supply chains not only for semiconductors but increasingly also for medical devices; all interdependencies that might be useful for geopolitical domination, including the mastering of inequality. The interdependencies we have witnessed in the recent past are not very helpful in drawing concrete conclusions about the future course of economic activity and, by extension, profitable investment policies.

INVESTMENT APPROACH

Even if the above-mentioned difficulties are not exhaustively listed, it is necessary, in due time, to review the criteria for future developments of economic activity, as they may concern, among others:

• the policy of regressive tax cuts,
• the reduction of public investment,
• the reorganization of corporate focus,
• the possible reversal of corporate concentration and
• the management of domestic and foreign interest rates.

IMPLICATIONS FOR INVESTMENT POLICY

If our analysis of the current situation is accurate and credible, then the near future may be characterized by a much stronger sectoral bias than has been the case in the recent past; with an emphasis on country selection. Therefore, it is not a “domestic bias” versus a “foreign bias” but a “sectoral bias” that should be the determinant and motivating factor. A promising investment policy should therefore focus more on selecting the most prospective sectors of the economy. This approach could be called “crowding out public investment.” In other words, the future focus should be primarily on private investment, even though we may have to deal with widespread anti-entrepreneurial attitudes in the media.

Comments are welcome.

EMR June 2023

Dear Reader,

Due to the recent economic turmoil and diverging developments in the equity and foreign exchange markets, the economic environment in Switzerland, as in most other democratic countries, requires special attention. According to the latest press release of SECO (State Secretariat for Economic Affairs) of 30.05.2023, the economy is not yet in a recession compared to e.g. Germany. At the same time, Seco forecasts modest growth for 2023 and 2024, albeit at lower growth rates. The available data indicate a non-negligible economic resilience. The difficult international environment has slowed both manufacturing output and exports. Domestic demand, on the other hand, grew robustly, despite rising real import prices, especially in the energy sector. The available data show a non-negligible economic resilience. The challenging international environment curbed manufacturing output as well as exports. Domestic demand, on its part, showed robust growth, in spite of real import price increases, particularly in the energy segment.

Examining the developments, as portrayed in the chart of Swiss real GDP, one can deduce the following:

1. The worst correction of the indexed real GDP, Q1 1981 = 1, took place in the second quarter of 2022!

2. The overall average change over the period 1981 to end 2022 amounts to 1.75%, compared to 0.82% in Q4 2022. It is worth noting that, compared with developments during the 2008-2009 financial crisis, the recent correction had a noteworthy, differential impact on real GDP. Investors should seriously consider the hoped-for or feared impact of the upcoming turnaround in favour of domestic production. The aim is to restore competitiveness in key technologies while increasing local production and productivity.

3. Noteworthy – in terms of forecasting relevance – is the comparison of the quarterly rate of changes vs. the yearly changes.

4. At this point, we advise investors to seriously consider the implications of reversing the trend in favor of domestic production in order to regain competitiveness in key technologies as part of the reconstruction process. Under the current circumstances, we ask ourselves what are or could be the main effects of today’s investment policy?

For simplicity, we focus here on the following two periods, i.e., between 2007 and 2009 and developments since 2019. We believe it is worthwhile to look at the sequence of the two crucial periods to draw appropriate conclusions for future asset allocation. Here are our key findings:

a) We believe it is advisable to closely examine the feared effects of a reversal in favor of domestic production in order to regain competitiveness in key technology stocks and rebuild local production and productivity.

b) The intervals between each “high” and subsequent “low” do not represent uniform fluctuations, neither in size nor in strength.

c) The variance of the individual growth phases (positive or negative) differs significantly from each other, both when evaluated on the basis of the respective index level and when adjusted to “1” on October 10, 1998.

d) In addition, it should be noted that the duration of the “correction phases” differ significantly from each other in both duration and extent.

e) The recent correction phase, due in particular to the Covid 19 pandemic and even more so to Russia´s war against Ukraine, has had and continues to have a devastating impact on international trade and on energy prices (both for crude oil and gas and for various industrial products). The associated price increases have led (and continue to lead) to price increases in consumer and industrial goods, due to the reduced availability of energy compared to all previous critical periods. The current environment is very difficult to adequately quantify in terms of the impact on asset allocation.

f) The time spans between a high and subsequent low do not all reflect coherent fluctuations, either in magnitude nor strength. Nevertheless, the data suggest increasingly large differences (between highs and lows). The magnitudes of the individual growth phases (positive and negative) differ significantly.

g) In the current correction phase the public attention remains focused on monetary policy, especially with regard to the expectation of higher interest rates. The fact is that the outlook for the financial environment is not easily comparable with developments in past decades. What the future demands is that various dislocations have created or will create a new need, namely the urgency for “greater strategic autonomy” in many sectors of democratic economies. In this context, the possibility of “repatriation” of production in the semiconductor sector, i.e., in the field of technology, should be increasingly considered. At this stage, the question arises as to what kind of economic leadership we are dealing with.

h) The periodicities between a high and subsequent low do not all reflect coherent fluctuations, either in magnitude or strength. Nevertheless, the data suggest increasingly large differences (between highs and lows).

i) While the current correction phase is primarily explained by rising consumer goods and energy prices, the public’s attention remains focused on monetary policy, especially with regard to the expectation of higher interest rates.

j) While the current correction phase is largely explained by rising consumer goods and energy prices, the public’s attention remains focused on monetary policy, especially with regard to the expectation of higher interest rates.

The thorny question that many analysts, and especially financial experts, are asking is, “How were we prepared in the face of this vulnerability?” Or, more proactively, “How are we preparing ourselves for the next phase of economic growth?” The fact is that the outlook of the financial environment is not easily comparable to the developments of past decades. What the future demands is that various dislocations have created or are going to create a new need, namely the urgency of “greater strategic autonomy” in many sectors of the democratic economies. In this context, the possibility of “repatriation” of production in the semiconductor sector, i.e., in the field of technology, should be increasingly considered. What economic leadership are we facing at this time, is the real question.

USA: GDP TRENDS

In most cases the outlook for the stock market can be predicted on the basis of real GDP growth and growth expectations. The following chart shows the evolution of economic activity in the United States since 1947. The data suggest that this might not be an easy task, as three distinct phases are implicitly known: the first from 1947 to 1984, the second from 1984 to 2018, and the third from 2018 to the first quarter of 2023. We emphasize that the current cycle (defined as the period starting in 2019) is the weakest and most volatile phase of them all.

PROSPECTS

We continue to believe that the economic outlook is difficult to quantify and yet remains deterministic, as illustrated by the two stock indices shown in the chart: “DJIA & SPI indices”. Again, we believe that the economic outlook should be analyzed in terms of external trade developments and the respective impact on consumer and capital spending. Accordingly, energy prices and especially the Russian war in Ukraine remain crucial. The most difficult question is how long the Russian war in Ukraine will last. This is definitely a sensitive issue, as it could remain an important determinant of inflation, which in turn and due course ought to influence central bank policy. We believe that consumer and investor expectations and activity will continue to be critical to central bank interest rate actions and reactions. This is definitely a thorny issue, which is hard to forecast with sizeable precision.

IMPLICATIONS FOR INVESTORS

We continue to expect several quarters of weak economic activity. Howev-er, a recession cannot and should not be ruled out, given the unquantifiable consequences of the Russian war in Ukraine and the associated impact on inflation and inflation expectations, as well as the interdependence with in-terest rates and related policies.

In the short term, despite rising volatility, we continue to view equities as promising, compared to fixed-income securities. After further interest rate hikes, a rebalancing may emerge over time. On the currency front, we continue to favor our local currency over the USD and EUR. The most promising investment advice one can give is to focus on high quality.

Comments are welcome.