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T&V Commentary | Q1 2022

Updated: Jun 9, 2023

The return of geopolitics

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-based world economic system: these were the golden years of globalisation. Companies around the world were given unprecedented opportunities to optimise their production and supply chains. China established itself as the workbench of the world. The past thirty years have been an abnormal time. The world was growing 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 that will be characterised by geopolitical fault lines, cold and hot wars, scarcities and structurally higher inflation. It will be a significantly more difficult, challenging environment for companies as well as investors. The turning point did not occur with Russia's invasion of Ukraine on 24 February 2022, nor with the appearance of a mysterious lung disease (COVID) in Wuhan, China, towards the end of 2019. It has been building insidiously over years, in secret, unnoticed for a long time. Now it is here.

Inflation and the Russia-Ukraine conflict weigh on the markets

Equity markets have had 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 more than -20%. The outbreak of the Russia-Ukraine conflict, soaring commodity prices, sharply rising inflation rates and, in some cases, bleak corporate outlooks put pressure on share prices worldwide. This persistent flood of negative news brought the markets to a virtual standstill. After the FED[1] -meeting and continued strong labour market figures in the USA at the beginning of March, there was a clear recovery, driven by buying investors who saw the setback as an opportunity.

The first interest rate hike in the USA is a fact

After another record high inflation rate of 7.9% in the USA, the Federal Reserve announced the end of its zero-interest rate policy. At the FED meeting on 16.03.2022, the Federal Reserve decided to raise its short-term interest rate by a quarter of a percentage point. This puts the new range for the key interest rate at 0.25% to 0.5%.

It was the first time since late 2018 that the FED raised rates, ending an easing cycle that began in July 2019 and ended with the pandemic rate cut in March 2020 to near 0% to prop up the reeling global economy. US policymakers are set to implement further rate hikes this year. The consensus range for the short-term policy rate among analysts is 2.5-2.75% by the end of this year.

Is a recession around the corner?

"Fighting inflation" may sound abstract, but simply put, prices rise in the economy when demand is too great and supply too scarce. The central bank cannot influence the supply side, so it must inhibit demand: If people have to use more money for interest payments, less is left for consumption. But if interest rates are raised too much, there is a risk that this will stifle economic growth and provoke a recession.

When the facts change, we change our minds

Like the Federal Reserve, we had hoped that inflation would gradually start to decline on its own from March onwards due to the high base effects. Unfortunately, few people, including us, had expected the invasion of Ukraine on 24.02.2022. Since the outbreak of the war and the rise in commodity prices, however, inflationary pressures will now intensify once again. This could force the US Federal Reserve to raise interest rates more aggressively than previously assumed and possibly "stall" the economy.

Our allocation

The financial markets hope 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 cycle of interest rate hikes will end in a recession, we have made our portfolios more defensive. We have divested the majority of companies that are still unprofitable and will allocate some of the proceeds to more defensive companies. We also intend to keep our cash ratios at a higher level for a longer period of time. High quality stocks (high profit margins and little/no debt) should offer protection against stagflation, as they can pass on higher manufacturing costs to their customers in the form of price increases.

[1] The Federal Reserve Bank or "Fed" is the central bank of the United States.

quarterly report Q1 2022
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