Return of Geopolitics
T&V Letter Q1 2022
The start of 2022 showed how quickly inflation, war, and rising interest rates can weigh on the markets. What had long been considered a stable world order came under increasing pressure. In such an environment, quality, pricing power, and a defensive portfolio structure gain in importance.
Insight
The return of geopolitics is changing the rules of the game for companies, markets, and long-term investors.
The three decades after 1989 were historically unique. With the collapse of the Soviet Empire and the progressive opening of China, several hundred million workers entered the market-oriented global economic system: these were the golden years of globalization. Companies worldwide received unprecedented opportunities to optimize their production and supply chains. China established itself as the workbench of the world. The past thirty-plus years were an abnormal time. The world grew closer together, accompanied by the hope that growing prosperity would strengthen the desire for freedom and peace. It was a time of abundance and the permanent absence of inflation. Now the world is at the beginning of a new order, which will be characterized by geopolitical fault lines, cold and hot wars, shortages, and structurally higher inflation. It will be a significantly more difficult and demanding environment for companies as well as investors. The turning of the times did not occur with Russia's invasion of Ukraine on February 24, 2022, nor with the appearance of a mysterious lung disease (COVID) in Wuhan, China towards the end of 2019. It has built up gradually over years, in secret, unnoticed for a long time. Now it is here.
NEWSLETTER
Inflation and the Russia-Ukraine conflict are weighing on the markets
The stock markets have made a poor start to the new year. The S&P 500 fell by 11.8% in the first 48 trading days of 2022, the fourth-worst start to a year in stock market history. European stock markets lost even more, falling by over -20%. The outbreak of the Russia-Ukraine conflict, skyrocketing commodity prices, sharply rising inflation rates, and mixed corporate outlooks in some cases weighed on stock prices worldwide. This continuous flood of negative news brought the markets to a virtual standstill. Following the FED meeting and continued strong labor market figures in the US in early March, a significant recovery took place, driven by purchases from investors who viewed the setback as an opportunity.
The first US interest rate hike is now a reality
After a renewed record-high inflation rate of 7.9% in the US, the central bank announced the end of its zero-interest rate policy. At the Fed meeting on March 16, 2022, the Federal Reserve decided to raise its short-term benchmark interest rate by a quarter of a percentage point. This puts the new range for the benchmark rate at 0.25% to 0.5%. It was the first time since late 2018 that the Fed raised interest rates, ending an easing cycle that began in July 2019 and ended with the pandemic-induced rate cut in March 2020 to nearly 0% in order to support the struggling global economy. Policymakers in the US are set to implement further rate hikes this year. The consensus among analysts for the end of this year is a
Is a recession just around the corner?
"Fighting inflation" may sound abstract, but put simply, prices in the economy rise when demand is too high and supply is too tight. The central bank cannot influence the supply side, so it has to curb demand: if people have to use more money for interest payments, there is less left over for consumption. But if interest rates are raised too much, there is a risk of stifling economic growth and provoking a recession.
When the facts change, we change our minds. Like the US Federal Reserve, we hoped that inflation would gradually begin to subside on its own from March onwards due to the high base effects. Unfortunately, very few people, including ourselves, had expected the invasion of Ukraine on 24 February 2022. Since the outbreak of the war and the rise in commodity prices, however, inflationary pressure is now set to intensify further. This could force the US Federal Reserve to raise interest rates more aggressively than previously assumed and potentially "choke off" the economy.
Our orientation
Financial markets are hoping that the Fed will succeed in dampening inflationary pressures without provoking a recession. In the past, however, this has usually not worked. Since we believe there is a realistic chance that this interest rate hike cycle will end in a recession, we have positioned our portfolios more defensively. We have mostly divested from companies that are not yet profitable and will partially allocate the proceeds to more defensive companies. We also want to keep our cash ratios at a higher level for a longer period. High-quality equities (high profit margins and little/no debt) should provide protection against stagflation, as they can pass on higher acquisition costs to their customers in the form of price increases.
As always, we thank you for the trust you have placed in us!
*This communication is for informational purposes only and does not constitute a personal recommendation or an independent financial analysis.
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