Uncategorized | SWISSCHANGE Financial Services AG

15. March 202322. March 2023

CHANGE IS IN THE AIR

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.

CONSEQUENCES

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.

FOCUS ON SWITZERLAND

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.

CONSEQUENCES

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.

OUTLOOK 2023

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.

FINDINGS FOR INVESTORS

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.

2. February 20232. February 2023

Growth & Geopolitics

EMR February 2023

Dear Reader

UNKNOWN = BIG CHANGES?

With its invasion of Ukraine, Putin’s Russia has challenged the balance that persisted since the end of the Cold War. Recently, the world has entered a very mixed phase of transition. We believe that this situation will persist in having a significant impact on consumption, investments, international trade, and currencies. This situation is expected to require a continuous updating of the investment policy.

The fact is that, in 2022, both the USD and CHF were among the few asset classes that tended to be spared from the Covid 19 pandemic and Russia’s war against an independent country. Rising inflation has been a worrisome side effect, mainly monitored by the Federal Reserve. At present, the focus is increasingly set on the whereabouts of economic activity. A growing number of analysts fear an imminent recessionary phase, including continued currency adjustments, as a consequence of the differentiated monetary policies.

CONSEQUENCES

First signs of this change are visible in the U.S. technology industry. See:: Chips Act [1], 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.”

There is another 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. See the graph below.

At this point, we wonder what can be inferred from the graph concerning the average, annual changes in monthly exchange rate fluctuations. We note that the differences in performance are indeed significant, as they could continue to determine the respective ups and downs as well as volatility.

OUTLOOK 2023

The environment outlined above 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.

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 by “administrators” or simply by the “free market” or, at best, by an egalitarian mixture of both approaches.

FINDINGS FOR INVESTORS

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

The era of runaway inflation is almost over; more price stability needs to be considered.
If our assumption that inflation will no longer rise so sharply is correct, fixed-income investments could retain some attractiveness, at least in the short to medium term.
Looking at the equity allocation as a result of the first paragraph of the of the “Consequences”, comment above, the focus on technology stocks, undoubt-edly looks more promising than any other sector.
We continue to think the CHF is promising, as well as the USD.

Comments are welcome.

[1] In July 2022, Congress passed the CHIPS Act of 2022 to strengthen domestic semiconductor manufacturing, design and research, fortify the economy and national security, and reinforce America’s chip supply chains.

9. January 20239. January 2023

Turning Points in 2023?

EMR January 2023

Dear Reader

ENVIRONMENT 2023

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:

Is significant inflation acceleration, plus 4% or more, a negative for the equity markets?
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:

The analysis of the annual rate of change indicates that changes in the DJIA are much more volatile than for the consumer price index.
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.
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?

OUTLOOK 2023

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.

FINDINGS FOR INVESTORS

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.

15. December 202215. December 2022

REVIEW 2022 and OUTLOOK 2023

EMR December 2022

Dear Reader

ENVIRONMENT 2022

Forecasting is a demanding exercise. Depending on the data quality of the series one uses it is possible to asses a “promising” outlook. In this EMR, we focus on the development of real GDP in the U.S. – depending on the business cycle – compared to the developments of stock indices.

What does the US real GDP chart describe the past cyclical developments and what can we deduce for the near future?

The recent cycle does not confirm the widespread pessimism. Actually, so far into the new cycle real economic activity has been sustained and has been surpassed only by the 1949/Q4 recovery.
Examining the longer-term cyclical developments, one finds that the divergence increases from cycle to cycle.
Are we facing a short-term correction of 2020/Q4 to 2011/Q2 or even a longer-term correction i.e., recessionary phase?

Given our interest in financial investments let us now analyze the developments of selected equity market indices since 1973.

What can be inferred form the chart?

What does the graph of stock indexes imply about their respective changes, both on an “index-by-index” basis and in cyclical comparison? What dependencies can be inferred regarding a promising investment policy?
The graph demonstrates, especially in the long run, a significant deviation between one stock index to another.
The trends of the DJIA, the Dax and the SMI indexes, while moving mostly in the same direction, add up to a significant performance differential, specifically since the early 1990s.
The performance of the UKX and NKY indexes is really amazing, aren’t they?
Contextually, it is really worth asking what the role of currencies has been, both in the long and short run, and also in relation to sectoral economic changes.

At this point in time, it is also worthwhile to examine the developments of 10-Y government bond yields, as shown in the following chart.

Our analysis tells us that a sizeable number of analysts have omitted to take into serious consideration the interplay between supply-side and demand-side determinants of the economy, the rate of inflation as well as of the financial markets.

Central banks on their part acted and reacted mainly to demand-side determinants. During the pandemic, debt-financed funds were “generously distributed.” This expansionary policy led, as expected, to higher demand, which, combined with rising energy prices, led to dramatic energy supply shortages. Consequently, prices of intermediate goods began rising as well. The “unexpected” result has been an increase in consumer prices, which in due turn pushed wage-demand higher. The world economy found herself in the midst of a vicious cycle. In response, central banks began to push interest rates higher at an unprecedented pace. Analysts and a sizeable number of market participants reacted with portfolio-adjustments, resulting in a sizeable equity market sell-off. Given that economic data are lagging indicators, they focused on selling stocks while switching to fixed-income securities.

OUTLOOK 2023

Recalling the errors incurred in 2022 we ought not to forget that the prospects for 2023 remain characterized by well-known imponderables. The difficult question to be answered at this juncture clearly concerns the 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 in due time, reduce also fears of persistently high inflation – and stimulate the flow of much-needed technological inputs. The result would be a resumption of economic activity.

For Central Banks, this would involve deterministically reducing recession fears and abandoning restrictive monetary policy. This, in turn, would promote an economic recovery that should revive stock markets.

Historically, high inflation rates have been known to cause stock losses, as it was the case in 2022. However, history teaches us that patience is a promising attitude.

FINDINGS FOR INVESTORS

Assuming that the Russian invasion of the Ukraine will not be successful, it may be assumed that Russian oil and gas supplies will slowly increase, and that this should tend to reduce the inflation rate. This suggests that it is unlikely that national banks will have to continue to raise interest rates as sharply as they have done recently. In other words, the longer-term attractiveness of fixed-income securities is likely to diminish.

We believe that bond yields should tend to reduce the attractiveness of equities in the first two quarters of 2023. Our assumption remains largely dependent on the economic slowdown. The necessary and sufficient condition is that inflation begins to fall in line with the decline in energy costs.

Our current reading of the facts seems to suggest that the need for national banks to continue raising interest rates, as sizably as they did in the last half of 2022, is unlikely to persist much longer. In other words, the appeal of fixed income is likely to be limited to the next few months. We believe that bond yields could curb the appeal of equities in the first two quarters of 2023. Our assumption in this regard is largely driven by the economic slowdown, which will lower inflation in due course. In particular, the necessary and sufficient condition for the inflation rate to start falling will be a reduction in energy costs. In any case, special attention should be paid to currency fluctuations in international diversification. 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.

MERRY CHRISTMAS & A HAPPY NEW YEAR

Comments are welcome.

8. November 20228. November 2022

SUPPLY VS. DEMAND?

EMR November 2022

Dear Reader

ENVIRONMENT

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.

DEMAND VS. SUPPLY ANALYSIS

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 Date	Rate of Change (bps)	Federal Funds Rate
Sept 21, 2022	+ 75	3.00% – 3.25%
July 27, 2022	+ 75	2.25% – 2.50%
June 16, 2022	+ 75	1.50% – 1.75%
May 5, 2022	+ 50	0.75% – 1.00%
March 17, 2022	+ 25	0.25% – 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.

FINDINGS FOR INVESTORS

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.

10. October 202210. October 2022

Energy Crisis = Financial Crisis?

EMR October 2022

Dear Reader

ENVIRONMENT

Increasingly we read and hear analysts and market participants asking the following question about the markets whereabouts: Is the 2022 energy crisis comparable to – or even more insidious than – the 2008 financial crisis?

In this context, we would like to ask the reader to closely analyze the following chart of selected stock indices. To simplify the comparison of the two periods, we have normalized the stock indices to 1 at the beginning of the respective period and superimposed them. The first period begins on 15 September 2008, the collapse of the investment bank “Lehman Brothers”, the second period on 24 February 2022, the invasion of Ukraine by the Russians.

FINANCIAL VS. ENERGY CRISIS

How did and do the stock indices react to the two states of disorder mentioned above? What does the chart suggest?

IMPLICATIONS FROM THE CHARTS

A first, summary assessment, points to differential trend movements from a one equity index to another. As each crisis perdures they become significantly less marked for the energy crisis than for the financial crisis.

A second assessment refers to the differential rates of growth, which, so far, have been significantly larger during the financial crisis than so far in the energy crisis.

A third assessment points to the shorter-term “trend reversals,” which imply a differentiated view of the actual determinants, be they inflation, interest rate policy or the ongoing war against Ukraine. In our view, these factors have determined the short-term trend much more than the longer-term one in both periods. Do they say anything about comparability? Yes, they do indeed, as we will highlight below.

Given today`s public focus on inflation, as the primary determinant, let us examine the inflation trend of the two periods, as shown in the chart on US CPI-Inflation. The chart has been comparable until July 2021, since, it has moved higher for the period of the ongoing energy crisis, while contracting in the period of the financial crisis! The real question at this crossing refers primarily to the differential interventions by the Central Banks: expansionary in the financial crisis and restrictive in the energy crisis. In addition, we should take into account that the financial crisis turned into a currency crisis as well as into a sovereign debt crisis. This setting made it easy to raise capital during the financial crisis, while making it difficult in the ensuing energy crisis.

INVESTORS` DILEMMAS

Trying to quantify the outlook based on forecasts of an impending recessionary phase, accompanied by rather persistent inflationary pressures and – for political reasons – higher interest rates, and the feared influence on financial markets and currencies, we lean toward a slightly less pessimistic assessment. There are certainly reasons why our optimism might be considered somewhat surprising and difficult to accept. Nevertheless, we believe that inflation might not be as easily reduced via higher borrowing costs. Inflation, in our assessment is determined significantly more by restrictions on the supply side than sustained demand. We would like to stress the importance of oil and gas prices as well as of food products as well as the dependence of technological components. They should fade as the Russian invasion of the Ukraine will be resolved.

In our opinion a sustained trend reversal of inflation can only take place with the end of the war against the Ukraine. This would imply a revival of international trade relations as well as an improvement in local economic activity. In addition, we expect an increasing repatriation of technological components in order to reduce – especially in Europe – the dependence on autocratic and undemocratic nations.

FINDINGS FOR INVESTORS

A closer look at the current environment reveals that the focus is on raising interest rates to counter inflationary pressures. The actual determinants of the current inflation are almost ignored. If we assume that the rise in inflation is mainly due to factors such as Covid-19, the invasion of Ukraine and China’s threat to invade Taiwan, dramatic pres-sure on the rise in crude oil, gas and food prices above and beyond normal supply and demand trends would be the consequence. So we should rather focus on how to solve the bottlenecks in the supply chains, while continuing to remain focused on the domestic market and currency.

Comments are welcome.

16. September 202216. September 2022

Economic Prospects?

EMR September 2022

Dear Reader

INFLATION – MONETARY POLICY – GROWTH = UNCERTAINTY

There is a wide divergence of opinion on short- to medium-term economic forecasts. We have the impression that the divergence has not been as great for a long time as it is now. We wonder if there are concrete reasons for these disagreements. As we all know, there is no one way to deal with reality. It depends on how the “specific model” is defined. In other words, there are different ways to quantify perspectives, but there is no certainty of uniquely quantifying them.

OUR ASSESSMENT

Interest rates were kept low – too low – for a while. Then came the pandemic, Covid 19, followed by the Russian invasion of Ukraine and the subsequent economic measures to “stem financial flows” against the invader. The rather complicated web was further obscured and made opaquer by Chinese maneuvers around Taiwan. In our view, the confluence of all the above factors has led to a focus on economic growth rather than raw politics.

WHICH ARE CURRENTLY THE REAL QUESTIONS FOR INVESTORS?

As central banks are “forced” to do everything in their power to contain the rise in inflation and bring it down to an acceptable level. Many forecasters begun to focus on economic growth as the major determinant. It should not be forgotten that the inflation rate, in many industrialized countries, has reached intolerable levels, which we have not seen for several decades.

This basic constellation is increasingly causing uncertainty and fear among both consumers and investors. Some analysts are worried about a possible increase in unemployment and thus a slowdown in economic growth. We would like to point out that not long ago feared an overheating of demand, because of low interest rates. Nevertheless, one should not forget that inflation might not be reduced as fast as expected via higher interest rates. Telling indeed is a close analysis of the chart on interest rates both nominal and real long-term for the USA. Worthwhile is to examine the reduction of 10-year interest rates, both nominal as well as inflation adjusted since the 1980’s.The question one may ask is: Is the US-economy moving back to the below 4 to 5 % interest rates, or will it go higher over the short-term?

The chart of the Dow Jones index by inflation rates over the period since 1872 is indeed revealing. What conclusions can be drawn from the data? It is striking that both inflation rates above 5 percent and negative inflation rates below 3 percent signal negative returns on capital.

Another way to analyze the current development is that the supply of inputs (intermediates, crude oil and gas, and food) is predominantly due to very “constrained” supply chains and continues to be largely determined by barely quantifiable but increasingly unacceptable political as well as economic behavior. At this stage, we doubt that the prediction of a price decline will follow a traditional cyclical scheme, as policymakers tend to follow a completely “non-economic” model.

A third argument to quantify concerns the adaptation of technological innovation in the energy sector, which, in due term would imply the “repatriation” of specific production lines.

Another difficulty we continue to face relates to the assessment of the impacts on income and on market liquidity. Will they offset each other, as it can be assumed that income will not react immediately and to the same extent as liquidity? At this stage, it is difficult to precisely quantify the proportionality of the change, also because of the war in Ukraine, especially in light of the current interest rate policy stance of central banks.

FINDINGS FOR SWISS INVESTORS

A closer look at the current environment reveals that the focus is on raising interest rates to counter inflationary pressures. The actual determinants of the current inflation are almost ignored. Assuming that the rise in inflation is mainly due to factors (such as Covid-19 and, above all, the invasion of Ukraine and China’s threat to invade Taiwan) that put dramatic pressure on the rise in crude oil, gas and food prices above and be-yond normal supply and demand trends, we should rather focus on how to solve the bot-tlenecks in the supply chain.

At this point in time, we believe that an extraordinary tightening of monetary policy could rather constrain demand without a rapid improvement of supply! However, supply disruptions are expected to ease in the coming quarters, while “financing costs” may rise. We agree with Fed Chairman Powell that monetary authorities can manage de-mand, but not supply. Therefore, it would be worthwhile to distinguish between compa-nies whose prices move in response to changes in demand from those that move in re-sponse to changes in supply. In this context, we argue that the most promising invest-ment approach would be one that focuses on increasing supply as prices fall. We consid-er it deterministic to focus on technological improvements as well as on the adjustment of wages to the cost of living.

Examining the main components of real GDP, and focusing at this juncture to the Swiss market we find that a most intricate question mark refers to whereabouts of the mortgage market. Increasingly we read about the possibility the Swiss property market could suffer while losing some attractiveness. If the available data represent the most probable reality, that risks exist. Nevertheless, despite the recent increase in the ratio of real estate to income and the ratio of mortgage debt to GDP, the environment remains sustainable. Particularly deterministic is, in the case of Switzerland, that employment has remained sustained.

At this juncture, it can be assumed that we are close to the cyclical peak in real estate prices. Fact is, that there is a great demand for real estate (residential and commercial), thus, the threat of higher interest rates should not be underestimated. Land and also property remain in demand in Switzerland. Well known is that real estate also can offer protection against inflation. The big unknown remains the timing of the respective peaks of inflation and interest rates. Let´s not forget the special role of the Swiss franc.

Comments are welcome.

17. August 202217. August 2022

Real Estate Environment

EMR August 2022

Dear Reader

ECONOMIC FRAMEWORK

The monetary authorities have recently begun to raise interest rates in unprecedented steps. The declared aim is to contain the ongoing retail price increases. The reactions by the monetary authorities can be interpreted as an indicator of tightened monetary policy. One could argue that the specific objective is to disentangle the links between the financial sector and the development of the real economy.

Why is this so? Well, they provide very valuable 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, while disagreement concern the relative importance of the various instruments.

TODAY´S ENVIRONMENT

We believe that the recent and the foretold actions of the Central Bank (specifically of the Federal Reserve) to push interest rates on deposits of the banking industry higher, must be defined as a tightening indicator. The real puzzle of this tightening lies in the specific reactions of the market. We might ask whether it is reasonable to assume that further increases in interest rates will reduce the supply of money?

In the course of our many years of work in economics and finance, we have been involved in quantifying the relationship between price increases and their impact on interest rates. We have learned several lessons: one is that interest rates tend to rise when inflation rises, especially when inflation rises sharply and abruptly. Another lesson is that interest rates respond with a lag to price increases. That is not quite the case at present! The recent, marked interest rate hikes by central banks, in concert with the rise in inflation, especially due to the Covid 19 pandemic and the Russian invasion of Ukraine, are indeed quite unique. The current divergent conditions are seen as an implicit new environment, especially by lenders and borrowers. This is mainly due to the fact that the expected inflation development and the corresponding impact on interest rates and the economy have been difficult to predict and quantify.

WHICH ARE CURRENTLY THE REAL QUESTIONS FOR INVESTORS?

The first and hardly predictable question relates to the fate of the inflation rate. Do we expect that the recent and further announced interest rate hikes by central banks will significantly slow down the growth of price increases and, in due course, significantly reduce them? We doubt that this will be the case in the near term. Why is that? We continue to expect inflation to be driven by “exogenous” and almost “unpredictable” factors (war in Ukraine and, even worse, the Chinese threat to Taiwan, as well as increasing political unrest), which remain difficult to quantify.

Second, the supply of inputs (intermediates, crude oil and gas, and food) depends predominantly on very “constrained” supply chains and continues to be largely determined by barely quantifiable but increasingly unacceptable political behavior. At this stage, we doubt that the prediction of a price decline will follow a traditional cyclical scheme, as policymakers tend to follow a completely “non-economic” model.

A third argument to quantify concerns the adaptation of technological innovation in the energy sector, which, in due term would imply the “repatriation” of specific production lines.

Another difficulty we continue to face relates to the assessment of the impacts on income and on market liquidity, Will they offset each other, as it can be assumed that income will not react immediately and to the same extent as liquidity? At this stage, it is difficult to precisely quantify the proportionality of the change, also because of the war in Ukraine, especially in light of the current interest rate policy stance of central banks.

FINDINGS FOR SWISS INVESTORS

A closer look at the current environment reveals that the focus is on raising interest rates to counter inflationary pressures. The actual determinants of the current inflation are almost ignored. Assuming that the rise in inflation is mainly due to factors (such as Covid-19 and, above all, the invasion of Ukraine and China’s threat to invade Tai-wan) that put dramatic pressure on the rise in crude oil, gas and food prices above and beyond normal supply and demand trends, we should rather focus on how to solve the bottlenecks in the supply chain.

At this point in time, we believe that an “extraordinary tightening of monetary policy” could rather constrain demand without a rapid improvement of supply! However, sup-ply disruptions are expected to ease in the coming quarters, while “financing costs” may rise. We agree with Fed Chairman Powell that monetary authorities can manage demand, but not supply. Therefore, it would be worthwhile to distinguish between companies whose prices move in response to changes in demand from those that move in response to changes in supply. In this context, we argue that the most promising investment approach would be one that focuses on increasing supply as prices fall. We consider it deterministic to focus on technological improvements as well as on the adjustment of wages to the cost of living.

Comments are welcome.

26. July 202226. July 2022

Inflation vs. interest rate?

EMR July 2022

Dear Reader

ECONOMIC FRAMEWORK

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.

PRESENT SITUATION

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 (M^d) 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.

INSIGHTS FOR INVESTORS

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.

26. June 202226. July 2022

Focus on Switzerland

EMR June 2022

Dear Reader

ECONOMIC FRAMEWORK

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 RECENT PAST

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.

FRAMEWORK CONSIDERATIONS

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.

FINDINGS FOR INVESTORS

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.