Thanks to a strong autumn rally, the year 2022 is shaping up to end in red, but not deep red territory for investors. In all likelihood, though, the bear market is not over yet because earnings estimates still need to be adjusted downward some more in view of deteriorating economic conditions. The bears look set to at least launch an attack on 2022’s lows during the months ahead. The year 2023 appears destined to be another volatile one for investments.
A record-high number of COVID-19 cases and growing popular discontent have prompted the government of China to do some rethinking. There are mounting signs that the government is gradually moving away from its zero-COVID policy. This, combined with further monetary policy easing and efforts to stabilize the real estate market, raises the chances of a temporary burst of growth in China in the second half of 2023. This would also have a beneficial impact on economic activity in Europe.
Most economists and geopolitical analysts have paid little notice thus far to the interface between astronautics and geopolitics, but “astropolitics” will be -
come increasingly more important in the future, as illustrated not least by the conflict in Ukraine. Collisions, weapons, cyberattacks and space debris pose significant threats and could abruptly cause geopolitical risk to surge in the future.
On mountains of debt … and taxes
Multiple crises have caused existing mountains of government debt to grow to ever higher altitudes. Is it still even possible at all to pay them down? After all, such a feat was accomplished once before in the wake of World War II. However, the underlying conditions for a second debt miracle are much worse these days. Sounder public finances at least don’t come for free.
And still more questions: What does the divided US Congress in the wake of the midterm elections mean? Does a natural gas shortage in Europe loom in the winter after next? How much higher will central banks raise policy rates? Have fixed-income assets now become attractive again? Will value stocks continue to outperform? And how do I protect myself against (further) investment losses next year? You’ll find our answers to these queries in our quarterly Q&A.
The question of whether the USA will slip into a recession soon remains one of the most important ones at the end of 2022 because the answer has manifold implications, including for the employment market and monetary policy, and not least for the financial markets. One of the statistically most reliable recession indicators – the US yield curve – has already passed judgment on this question. The two most important yield differentials (the 10-year/2-year spread and the 10-year/3-month spread) are steeply inverted at more than minus 70 basis points and have been inverted for quite a while now. Nearly all other spread combinations are inverted as well. The inverted yield curve gives reason to expect a recession to begin in the next six to 24 months with almost 100% certainty. It could take until 2024, or it could turn out entirely differently (than in the past). A recession, though, would arguably be the best scenario for equity markets because that’s the only thing that would bring about interest-rate cuts by as early as next year.
US recession: Almost certain, but when?
The US yield curve isn’t the only portent that gives reason to expect a recession in the quarters ahead. The Conference Board’s Index of Leading Economic Indicators is now also flashing a clear warning signal auguring a contraction of the US economy soon. Surveys substantiate this expectation. The Federal Reserve Bank of Philadelphia’s tradition-steeped Survey of Professional Forecasters recently found that a record-high percentage of respondents (almost 50%) expect to see a recession within the next 12 months. US consumers are still supporting economic activity, but their windfall savings accumulated thanks to economic stimulus programs are gradually running out.
EU recession: Even more certain, but less severe than initially feared
A recession in Europe is a sure thing, at least on average in the EU and in some countries like Germany and the UK that have been hit particularly hard by inflation
GDP growth (in %)
Switzerland 2.2 0.7 1.6 Eurozone 3.2 -0.1 1.5 UK 4.2 -0.8 1.0 USA 1.8 0.4 1.3 China 3.3 4.9 4.9
Inflation (in %)
Switzerland 2.9 2.0 1.2 Eurozone 8.5 5.9 2.1 UK 9.0 7.0 2.6 USA 8.1 4.3 2.5 China 2.2 2.3 2.1
and/or an energy crisis. However, mildish temperatures, a pullback in natural gas prices and, last but not least, government relief measures have brightened consumer and business sentiment a bit over the last two months. If no new negative surprises emerge, the economic downturn could turn out less severe than initially feared.
The minutes of the last FOMC meeting and comments from a number of US Federal Reserve officials give reason to expect that the Fed will soon slow its rate-hiking program (and will thus undertake “only” a 50-basis-point hike in December). However, it equally seems clear that the top of the flagpole hasn’t been reached yet and that the Fed first wants to proclaim a decisive victory over (sticky and lagging) inflation. There is still a real risk that a monetary policy mistake will be committed. The Fed may be underestimating the delayed reactions to its policy actions thus far (see chart below).
After the daily COVID-19 case count in China hit a new record high in late November and growing popular discontent spread in recent weeks, there are now mounting signs that the country is gradually moving away from its zero-COVID policy. This, combined with further monetary policy easing and efforts to stabilize the real estate market, raises the chances of a temporary burst of growth in China in the second half of 2023. This would also have a beneficial impact on economic activity in Europe.
A recession in 2023 is more or less a certainty in many (industrialized) countries. Most central banks are aware of the risks to economic activity and look set to at least slow the pace of their ratehiking campaigns. China, meanwhile, might deliver positive surprises for a change at the start of next year.
Switzerland
Eurozone 1.50 ↗ ↗ UK 3.00 ↗ ↗ USA 4.00 ↗ ↗ China 2.75 → → 10-year yields (in %)
-5 -4 -3 -2 -1 0 1 2 3 4 5
1992 1996 2000
Most economists and geopolitical analysts have paid little notice thus far to the interface between astronautics and geopolitics, but “astropolitics” will become increasingly more important in the future, as illustrated not least by the conflict in Ukraine.
Increasing economic and military importance…
Outer space is attracting increasing attention from more and more players. More rocket launches were registered in 2022 than during the glory days of lunar exploration in the 1970s. Recent years have also seen private industry get increasingly involved in space. The US firms SpaceX and Amazon, for instance, plan to launch thousands of mini-satellites into low-Earth orbit in order to bring high-speed internet to every corner of the world. But governments and militaries are also becoming ever more interested in space. Their share of active satellites in orbit rocketed from 10% at the start of the millennium to 29% as of end-2020. Commercial and military satellites have both played a major role this year in the conflict in Ukraine. Starlink satellites from SpaceX have provided the people of Ukraine and the country’s military with access to broadband internet, and US satellite reconnaissance has enabled Ukraine’s army to attack Russian positions with pinpoint accuracy.
…causing shortage of room and mounting risks
In an age of intensifying geopolitical rivalries, whoever wants to remain relevant has to join the “great game” in space. That’s why the United States and China in particular are accordingly investing enormous re sources into gaining control of near-Earth space. The establishment of the independent US Space Force in 2019 must also be viewed in this context. However, increasing military activity in space goes hand in hand with a growing risk of mishaps, which could result from the deployment of anti-satellite weaponry, for example. Russia, China and the USA have already tested the use of anti-satellite weapons. Meanwhile, cyberattacks
on satellites are already being registered daily these days. Potential military miscalculations aren’t the only source of risk. Another one is the exponentially increasing quantity of space debris and inactive satellites in low orbit around the earth (more than 50% of the 5,800 satellites in orbit were classified as debris as of end-2020). The International Space Station (ISS) and China’s Tiangong space station both have already had to take evasive action to avoid collisions with debris. Despite the vast expanse of the cosmos, near-Earth space has limited room. Up to 50,000 more satellites than today could be orbiting the Earth by the end of this decade. Collisions, weapons, cyberthreats and space debris can inflict severe damage on satellites and space stations and can kill astronauts and people on Earth. Since countries at present are not sufficiently cooperating with each other to address these risks, a catastrophic incident in space could abruptly cause geopolitical risk to surge in the future.
Thanks to a strong autumn rally, the year 2022 is ending in red, but not deep red territory for investors. In all likelihood, though, the bear market is not over yet. The bears look set to at least launch an attack on 2022’s lows during the months ahead. The year 2023 appears destined to be another volatile one for investments.
- + - +
Fixed Income Global Sovereign bonds Switzerland Corporate bonds Europe Microfinance UK
Inflation-linked bonds USA
High-yield bonds Emerging markets
Emerging-market bonds Alternative Assets Insurance-linked bonds Gold
Convertible bonds Real estate Duration 11/2022 Hedge funds
Currencies Structured products US dollar Private equity Swiss franc Euro British pound
Equities: Obstacles facing the (bear market) rally
• Equity markets have staged an impressive year-end rally since mid-October, advancing by around 15% in the USA and by more than 20% in some countries in Europe. However, until proved otherwise, we are classifying this as a rally within an intact bear market. In the bear market scenario, new share-price lows or at least a renewed test of 2022’s lows are on the agenda in the quarters ahead. In any event, oxygen for immediate further share-price gains is bound to grow thinner in the near term. The S&P 500 index is facing two major technical obstacles: its 200-day moving average line and its downtrend channel in place since the start of this year. In addition, the previous oversold market conditions signaled by momentum indicators have since completely vanished, and conditions are now somewhat on the overheated side. Meanwhile, market participants’ previous underinvestment in equites has returned to normal, as has the VIX volatility index, which was even already signaling almost a bit too much complacency at the end of November at levels intermittently as low as “just” 20 points.
• A certain degree of complacency is also visible in analysts’ earnings estimates thus far for 2023. Although their profit projections have dropped noticeably lately, they are still too high for a “genuine” recession scenario – even for a mild variant – and need to be revised further downward. This means that a further need of a correction also looms for equity markets. We expect to see a volatile rangebound market at the most next
year even in the best-case macroeconomic scenario because if a recession doesn’t materialize, the US Federal Reserve is likely to keep its policy interest rate in restrictive territory for a longer time. One consolation is the fact that the presumptive bear market will likely continue to trundle along without any panics. The negative sentiment discernable not just from surveys of US retail investors but also from the analyst community’s rather conservative index price targets should see to that. One statistic, though, argues against excessive pessimism: since 1950, negative stock-market performances in US midterm election years were followed by positive performances the next year in eight out of eight cases
Macro
Monetary/fiscal policy
Corporate earnings Valuation Trend
Investor sentiment
- +
Fixed income: Better prospects next year
• On the heels of a horrific year 2022, the outlook for fixed-income investors for 2023 is much better. If one applies the US economy’s potential rate of growth as a yardstick for measuring the “fair” value of 10-year US Treasury notes, one discovers that their current valuation, at a yield a little under 4%, is the cheapest it’s
been in over 20 years. So, is now the right time to start buying (US) government bonds? It definitely is for investors with a lengthy time horizon because by now they can lock in an attractive real yield and thus real value appreciation (10-year US Treasury inflation-protected securities (TIPS) are currently yielding 1.5%). Moreover, in the event of a recession, yields on government bonds are likely to decline, which means that their prices would correspondingly rise. This would make government bonds an inexpensive form of portfolio insurance. This protection would cost something – in the form of temporary price drawdowns – only if yields at the long end of the curve were to climb back above the previous tops seen in October. Such an ascent could be driven, for example, by an overly slow pullback in inflation that would not allow the Fed to back away from its restrictive monetary policy. The continued downsizing of central banks’ balance sheets and the elevated volume of sovereign bond issuance (which increases the supply of government bonds on the market) could also nudge yields upward a bit if macroeconomic conditions hold steady. It therefore is wiser to gradually build up tactical overweight exposure to long-duration government bonds.
• The aggressive rate-hiking campaigns by central banks are also affecting real estate markets in the form of falling prices. House prices are under heavy downward pressure in countries like Australia, New Zealand and Sweden, where homes in some areas have already lost more than 10% of their value. Housing prices appear to have stopped rising for good also in heretofore resilient markets like the USA and Germany. These developments have not left private-market real estate assets unscathed. After they posted significant gains again in 2022 contrary to the trend in most other asset classes, investors recently took profits. This prompted some private-market funds to already place limits on share redemptions. Since private-market funds are mostly
The US dollar has appreciated considerably this year not just against the euro, the British pound and the Swiss franc, but also a against a broad basket of the USA’s most important trade partners’ currencies. Viewed from a wide angle, the greenback has been in an uptrend for more than a decade already. But its dynamic upward surge over the last two years has now definitively steered the US currency into richly overvalued territory. The US dollar’s real effective exchange rate, which factors in inflation differentials between the USA and its trade partners, is now higher than it was at the peak of the last dollar bull market in 2002. A variety of valuation models are signaling that the greenback is currently 20% to 30% overvalued. Although this insight provides little help for tactical decisions, it gives reason to expect that the US dollar will revert to the mean – i.e. will weaken –in the long run. This could make US stocks less attractive for European investors.
invested in resistant segments (e.g. logistics properties, data centers), we don’t see any risk of a crash at the moment. However, valuations look set to undergo a correction in the quarters ahead. Investors shouldn’t overreact and reduce their exposure to real estate if they don’t urgently need to because diversified holdings of private-market real estate are interesting in the long term as protection against inflation.
Currencies: Swiss franc poised to remain strong in 2023
• EUR/USD: Since late September, the euro has appreciated by 10% to intermittently as high as 1.05 against the US dollar. However, the fact that euro’s downtrend channel since spring 2021 is still intact despite the brisk rally shows just how severe the currency’s previous plunge was. The rebound thus far is nothing more than a technical retracement. In order for the euro to break out of its downtrend in 2023, a few conditions first have to be met: the Fed must stop raising interest rates, economic growth in Europe must surprise on the upside, and the conflict in Ukraine would need to be “resolved”.
• GBP/USD: The recent 15% rise in the GBP/USD exchange rate is also nothing more than a technical reaction. Inflation, a recession and fiscal austerity under the new chancellor of the exchequer, which will suppress future economic growth in the UK, will likely continue to weigh on the British pound in the months ahead. In the aftermath of Brexit, the pound is now even more dependent on foreign capital than before and looks destined to remain a volatile currency.
• EUR/CHF: The euro recently stabilized below parity against the Swiss franc and doesn’t look set to lastingly overcome this psychological barrier anytime soon. Although the nominal interest-rate differential favors the euro, the more relevant real interest-rate differential makes a compelling case for a stronger franc. Moreover, in the past, the Swiss currency has often functioned as a recession hedge. This also portends franc strength in view of the subdued global economic activity outlook.
Historically expensive?! | The greenback is overvalued
Real effective US dollar exchange rate
Sources: BIS, Kaiser Partner Privatbank
Kaiser Partner Privatbank impressed across the board in this year’s quality assessment conducted by the renowned independent testing firm FUCHS|Richter Prüfinstanz. It was one of only seven financial institutions to receive the highest grade, earning a “very good” overall rating. With very good performance scores, Kaiser Partner Privatbank placed first among all financial institutions tested in Liechtenstein.
FUCHS | RICHTER Prüfinstanz has evaluated nearly 100 banks and asset managers in Germany, Austria, Switzerland and Liechtenstein annually since 2003. On the basis of anonymously conducted client advisory consultations, the testing firm evaluates financial institutions in the categories “advisory consultation”, “investment proposal”, “beauty contest”, “investment expertise” and “transparency”. The quality assessment initiated by the tradition-rich Germany-based Fuchsbriefe-Verlag publishing house is the most prestigious private banking ranking in the German-speaking world.
In this year’s 20th edition of the competition, FUCHS | RICHTER Prüfinstanz wanted to find out which asset managers most convincingly address megatrends that concern clients. With superior scores across all core competencies, Kaiser Partner Privatbank not
only performed impressively in all areas assessed, but also stood out from competitors with an investment proposal rated “very good” and investment expertise deemed “excellent”. “LGT and Kaiser Partner on par with each other” was the conclusion drawn by Fuchsbriefe. For its outstanding performance, the jury of experts awarded a “very good” rating to Kaiser Partner Privatbank as one of just two financial institutions in Liechtenstein to receive that designation.
Kaiser Partner Privatbank CEO Christian Reich expressed delight over the very positive feedback from the independent testing firm: “Dealing with global drivers of change and their impacts on financial markets has always been the cornerstone of our investment philosophy. We are pleased and honored that we were able to show off our capabilities and our sustainability expertise in this year’s Fuchsbriefe test case and were awarded with a “very good” rating. It is especially gratifying that the independent testing firm deemed our investment expertise “excellent” and that we, as a boutique, achieved the best rating result in Liechtenstein. At the same time, this encourages us to rigorously stick to our chosen path, which puts our clients and their individual needs at the center of all we do.”
The trend is pointed upward. Government debt in most industrialized countries has continually climbed higher over the past decade. The mountain of debt by now exceeds a year’s worth of economic output in more and more countries. The list of nations where public debt surpasses annual GDP includes the USA at 134%, France at 115%, and the UK at 105% and is growing ever longer. In the aftermath of the pandemic, it is now the costly energy crisis for governments (particularly in Europe) that gives reason to expect even more debt to pile up and is pushing the budgetary retrenchment needed in many countries into the distant future. But is it still even possible at all to melt away the mountains of debt? A look in the history books reveals that this feat has been accomplished once before.
Shortly after World War II (1946), public debt in relation to annual GDP stood at 121% in the USA, 270% in the United Kingdom and 75% in Switzerland. Thirty years later, those figures were down to just 34%, 49% and 47%, respectively. Vibrant economic growth coupled with largely prudent budget management were the two main causes of this “debt miracle.” During those three intervening decades, called “Les Trente Glorieuses” by some, real per capita income doubled (in the USA) or even tripled (in western Europe). This was driven not only by the enormous pent-up demand that had accumulated after two world wars and the global economic crisis of the 1930s, but was also attributable to the liberalization of foreign trade and tremendous productivity advancements. The demobilization of armed forces had a huge savings effect on public finances, and the top marginal income tax rate, which was hoisted to above 90% in the USA and the United Kingdom during World War II (read: war tax), was kept at or near the wartime level for many years thereafter. Even in the late 1970s, the top tax rates in those countries still stood at 70% or higher until the 1980s ushered in the era of big tax cuts. Predominantly balanced budgets and correspondingly stagnant debt (constant numerator) coupled with sharply rising economic output (increasing denominator) enabled a massive lowering of the debt-to-GDP ratio. Last but not least, a third ingredient was also helpful: occasional phases of high inflation rates gave an added boost to (nominal) gross domestic product, which additionally shrunk the ratio of debt to economic output.
A reprise of this budgetary retrenchment magic is hard to imagine these days because the first adjusting dial (eco-
nomic growth) can hardly be turned much, at least not without causing side effects. Aging populations, waning productivity growth and widening income inequality are contributing to a steady decline in the potential rate of growth in industrialized countries. The OECD projects an average annual real trend rate of growth of just +1.7% for the USA, +1.8% for the United Kingdom and +1.2% for the Eurozone for the current decade. Even fiscal stimulus does not make it possible to escape this force of gravity in perpetuity, as the British fiscal policy experiment this autumn strikingly demonstrated. The ill-conceived minibudget concocted by former Prime Minister Liz Truss and her Exchequer Chancellor (a.k.a. finance minister) Kwasi Kwarteng inflicted a maxi-disaster on the UK in a flash. Team Truss intended to enact massive tax cuts in order to turn the kingdom into a low-tax country and lastingly
Today: Limitless? | Soaring mountains of debt Public debt (as a % of gross domestic product) from 2000 onward
Multiple crises have caused existing mountains of government debt to grow to ever higher altitudes. Is it still even possible at all to pay them down? After all, such a feat was accomplished once before in the wake of World War II. However, the underlying conditions for a second debt miracle are much worse these days. Sounder public finances at least don’t come for free.
Sources: International Monetary Fund, Kaiser Partner Privatbank
Back then: Countries grew their way out of debt | High post-World War II economic growth rates helped Public debt (as a % of gross domestic product), 1900–2000
Sources: International Monetary Fund, Kaiser Partner Privatbank
“Moron risk premium” | Poorly conceived fiscal policy warrants a risk premium Risk premiums on 10-year British government bonds
2.5%
2%
1.5%
1%
0.5%
0
-0.5%
-1%
01/07/2022 01/08/2022 01/09/2022 01/10/2022 01/11/2022
vs Germany vs US
Sources: Bloomberg, Kaiser Partner Privatbank
raise its trend rate of growth to +2.5% per annum. The announcement of these unfunded tax giveaways alone was enough to hurl the British pound into the cellar and spark chaos on the bond market, where a sizable “moron risk premium” got priced into long-dated UK gilts from midSeptember to mid-October. Yields spreads over comparable German government bonds widened sharply while spreads versus comparable US Treasurys turned positive for a while contrary to the norm. The disciplining effect of the financial markets then brought about an abrupt fiscal policy U-turn and ultimately the resignation of Liz Truss. Her program has since been almost completely rolled back in the meantime by new Exchequer Chancellor Jeremy Hunt.
The spending dial also cannot be turned down at will. Defense spending has been back on the rise again for quite some time in view of an increasingly multipolar world and looks set to continue to climb in the future given the conflict in Ukraine. Demographic developments, requisite massive investments in green energy technologies and costly adaptation to climate change also necessitate rising public spending and will likely make it harder for many governments to maintain sound public finances.
In today’s world shaped by low trend economic growth, there is a clear conflict of objectives. According to a working paper recently published by the Center for Research in Economics and Statistics (CREST),1 only two of three desirable goals can be achieved in the long run in such an environment: low inflation, full employment and/or sustainable public debt. The last of the three goals cited means budget deficits that are small enough to be credibly paid back in the future via increased tax revenue or spending cuts. A textbook example of unsustainable public finances is Japan. Although inflation and unemployment are both very low in Japan, the country’s public debt policy resembles a Ponzi scheme: year after year, the government amasses annual budget deficits of 6% to 8% and has to borrow new money to service old debts. The mountain of debt grows interminably and has swelled in the meantime to 260% of Japan’s annual GDP. But the only reason why the “Japan model” works is because the country continually produces
high current-account surpluses and is a huge worldwide net creditor, entirely unlike the UK for example.
The USA and Europe have been careful thus far not to go down the Japan route. Although EU fiscal rules are being eased a bit at the moment to adapt them to the current reality, sustainable public finances remain one of the bedrock principles of European monetary union. But if a government can’t or doesn’t want to cut spending by much, then sooner or later there’s no choice left but to raise revenue. It is against this backdrop that the recent debate in Germany also has to be understood. In early November, the German Council of Economic Experts, a five-member panel known as the “sages of the economy,” advocated raising the top marginal tax rate in Germany, introducing an energy solidarity surcharge for top earners and postponing the planned easing of income tax bracket creep, albeit only temporarily, mind you, with the overarching goal of countering the socially inequitable scattergun approach of energy price caps, but definitely also with reference to Germany’s mounting debt load as a result of the EUR 200 billion “double whammy” household and industry support scheme. While Social Democrat and Green politicians rejoiced over the unaccustomed backing received from the council, which heretofore had rigorously upheld the principles of ordoliberal economics, predictable objections came from the Free Democratic Party and the business community, giving Germany’s flailing traffic-light coalition government new discussion material. Regardless of near-term developments, the hot-button issue of tax hikes is bound to reappear on the agenda in the medium term – and not just in Germany, as a parting look at the British Isles reveals. Income tax brackets in the UK look set to stay frozen for years, which in the face of massive inflation is tantamount to a drastic (stealth) tax hike.
Another possible way to handle the trilemma of low-growth economics depicted above while tackling the debt problem at the same time would be simply to live with higher inflation rates. But this “solution” as well would entail an array of risks and side effects that would particularly include a weak currency and even greater income and wealth inequality. In conclusion, it remains to be said that as so often happens, there are exceptions to the rule even with regard to mountains of debt and the macroeconomic trilemma. A case in point is Switzerland and neighboring Liechtenstein, two countries that have achieved the triad of low inflation, full employment and sound public finances thus far and combine that with a strong currency and thus remain attractive locations for labor and capital.
1Jean-Baptiste Michau (2022): “The Trilemma for LowInterest-Rate Macroeconomics”
are always available to our customers for concerns and questions about their portfolios. As a representative of this, once a quarter we summarize the most frequently asked customer questions and the answers provided by our experts, thus giving you direct insights into our asset management and investment advisory services.
Geopolitics: The outcome of the US midterm elections turned out tighter than expected – the “red wave” didn’t materialize. What are the implications for politics, the economy and the financial markets?
Kaiser Partner Privatbank: Joe Biden’s election victory can’t be trivialized. The US president was up against more than just historical election statistics, according to which the party of the sitting president traditionally loses a large number of congressional seats in mid-term elections. Biden’s historically low public approval ratings were also a liability, and soaring gasoline prices, generally exorbitant inflation and flagging economic activity posed additional obstacles. Democrats nevertheless held their ground in the US Senate, where they continue to control a de facto majority when Vice President Kamala Harris’s tiebreaking vote is factored in. If they also win the runoff election in Georgia on December 6, the final score would be 51 seats to 49, giving the Democrats the upper hand also on Senate committees. Although the Republicans were able to gain the upper hand in the US House of Representatives, their majority is much smaller than was expected by pundits and projected by polls in the runup to the midterms. The list of election losers includes former President Donald Trump (which didn’t stop him from announcing a renewed
candidacy for the 2024 presidential race), the MAGA Republicans and the so-called election deniers. That last group failed to win any of the key secretary of state seats that were up for grabs in 27 states, which, if they did, would have been a bad omen for the next presidential election. So, it’s entirely justified to construe the midterm election outcome also as a “victory for democracy.”
Political uncertainty now looks set to subside for starters in the near term. On the other hand, though, the end of the 2022 midterm elections means that the 2024 presidential election is around the corner, and a divided Congress isn’t devoid of risk looking ahead to the upcoming electoral battle. Success in fighting inflation or in averting a recession would boost Biden’s chances of winning reelection. The Republicans therefore are bound to have little interest in working out real solutions. Obstructionism and renewed brinkmanship on the debt ceiling issue are more likely to loom. However, the Republicans, in turn, will hardly be able to advance their own agenda of aims such as pursuing deregulation of the economy and the energy sector and appropriating more funding for the military, the police and border security while implementing spending cuts elsewhere. Only one thing seems certain: Republicans will block any further tax hikes. Effective corporate taxes look destined to stay low, which is marginally beneficial to profit margins and investors. The Democrats, for their part, will be unwilling to make cuts to the social safety net or to curtail Biden’s legislative initiatives that have already been enacted. Against this backdrop, the US budget deficit looks set to stay at its current high level or even increase further. In any event, budgetary retrenchment is nowhere in sight in the impending gridlock scenario.
What does the election outcome mean for the financial markets? Caution is called for when answering this question, not only because the importance of elections and politics in general is overrated, but also because historical analysis of the correlation between different constellations of power in Congress and market performance tells little about the future. Macro (economic growth, inflation, interest rates) and micro (corporate earnings, valuations) variables are bigger determinants of asset prices than the colors red, blue and purple in Washington, D.C. are. The prevailing hypothesis among many investors that political gridlock is good for the equity market has proven true since the dawn of the Ronald Reagan era in the early 1980s, but is false for the high-inflation period from 1966
to 1982. Whoever absolutely needs historical patterns as a guide could take a look at the presidential cycle, which presages an above-average performance for stocks for the year between midterm elections and the next presidential election year regardless of which party holds the majority in Congress.
In fact, it’s mainly the inflation trajectory in the months and quarters ahead that is likely to have the biggest impact on the equity market as a whole in the near future. In this regard, the stalemate in the US Congress is mildly disinflationary in the near term (no new economic stimulus programs), but will tend to be somewhat inflationary in the medium term (due a to a tendency to nudge up spending). The job of combating inflation and kick-starting economic activity in the event of a recession thus falls to the US Federal Reserve. Looking at individual business sectors, the divided US government could definitely produce winners and losers. Sectors like “dirty energy” (mainly oil and gas) and pharmaceuticals, which would have faced significant regulatory or legislative crackdowns under a Democratic majority, will probably receive a reprieve. Sectors like renewable energy and infrastructure, on the other hand, could lose a bit of momentum, but nothing more than that because legislation like the Inflation Reduction Act that has already been passed can’t be overturned by the Republicans since they lack the two-thirds majority needed to do that.
Energy: Energy storage facilities in Europe are filled to near capacity, and the coming winter no longer appears to pose a problem. Does a natural gas shortage loom in winter 2023/2024?
Kaiser Partner Privatbank: Thanks to mild autumn weather and frantic (and expensive) efforts in recent months to import natural gas, gas reserves in Europe are very well filled at the moment at a level far above the norm. EU-wide gas storage was filled to more than 95% capacity as of mid-November, and storage sites in Germany were almost 100% full. This comfortable situation owes in large part to a reduction in demand. Businesses and households have cut gas usage, switched to alternative sources of energy and/or scaled back production in response to the high prices. The German manufacturing sector, for example, consumed 27% less natural gas than usual in October. Since the risk of a gas shortage this winter has diminished significantly, natural gas prices have plummeted in the meantime. Since peaking at almost EUR 350 per MWh in late August, the price of gas has retreated by around two-thirds and has stabilized at a level a little above the EUR 100-per-MWh mark. This has beneficial implications for the economic outlook in the Eurozone: the unavoidable winter recession will be less severe (we anticipate a cumulative contraction of 1% to 2% from Q4 2022 to Q2 2023), and households and businesses will need a bit less support (which will ease the strain on national budgets somewhat).
So far, so good. But winter 2022/2023 will eventually be followed by winter 2023/2024. Our analysis of scenarios for the cold season after next indicates that a
certain gas shortage risk lingers, but only in the most adverse and unlikely scenario. In the baseline scenario of a (1) normally cold winter, (2) 10% to 15% lower natural gas consumption by households and industry compared to the average in recent years, and (3) continued elevated or mildly rising imports of (non-Russian) gas, natural gas stocks in the EU are still likely to be filled to more than 60% capacity in spring 2024. Even if Russia were to completely turn off the gas spigot to the West, the supply inventory situation under the above conditions, at a projected good 40% of storage capacity, would likely still reassuringly far exceed the minimum fill level since 2015 (approx. 20%). The risk scenarios, in contrast, envisage a colder-than-average winter and/or flat imports of non-Russian gas (limited supply of liquified natural gas). In our estimation, shortages and a need to ration gas are unlikely to arise unless both adverse conditions cited above occur in tandem. But even if the worst case probably won’t materialize in the end, one thing seems certain: the era of cheap natural gas in Europe is over. The manufacturing sector will have to adapt to this new reality in the quarters ahead, and the inflationary pressure caused by high energy prices will likely persist for a while longer.
Comfortable | The coming winter does not (yet) pose a problem Natural gas storage fill level in the European Union
100%
80%
60%
40%
20%
0
current Avergae 2015-2020 Maximum Minimum 10/2022 01/2021 04/2021 07/2021 10/2021 01/2022 04/2022 07/2022
Sources: AGSI, Kaiser Partner Privatbank
Monetary policy: How much higher will central banks raise policy rates?
Kaiser Partner Privatbank: Central banks continue to have to walk a delicate tightrope between persistent rampant inflation rates at the moment and mounting risks to economic activity. With benchmark lending rates standing at 2% in the Eurozone and 4% in the USA at last look, the monetary policies being pursued by the European Central Bank and the US Federal Reserve are already exerting a forceful restrictive impact, in our view. The 200 basis points of rate hiking thus far by the ECB and the almost 400 basis points of hiking to date by the Fed have dealt a delayed-action shock to
many submarkets (real estate, corporate finance, etc.). More and more central bankers in recent weeks apparently have come to share this view; voices advocating a slower pace of rate hiking in the near future have predominated lately. The minutes of the last central-bank policy meetings also point in this direction.
Receding inflation rates would make it easier for central banks to initiate the pivot that financial markets have been hoping for. The disinflation process appears to be long since underway in the USA. Headline inflation there in October surprised well to the downside at 7.7% (consensus estimate: 8.0%). Prices actually even declined month-on-month when the volatile energy and food components and the sticky rent component are stripped out. It wouldn’t astonish us if US inflation continued to ebb much faster than expected in the months ahead. The year-earlier comparison base effect suggests that it will, and so do the continued easing of supply-chain bottlenecks, rising inventory levels, waning demand and significantly slowing rent price momentum, which also is likely to start showing up in inflation figures from spring onward. Inflation in the Eurozone, meanwhile, will peak later on, probably in the next two to three months, but a recession there is already a sure thing and the economic climate in the Eurozone is more fragile. The ECB, too, thus has limited room to raise interest rates further. On balance, we see potential for the world’s two most important central banks to ratchet rates higher by another 50 to 100 basis points. We thus see the terminal policy rate in spring 2023 at 2.5% to 3% at the ECB and at 4.5% to 5% at the Fed. The policy rate in Switzerland looks set to end up at a somewhat lower level of 1.5% to 2%. However, the strong franc gives the Swiss National Bank an additional tool to employ to combat inflation pressure, and the SNB will likely make active use of it. The rhetoric from central banks, which is slowly but surely becoming more cautious, is also being reflected on the interest-rate markets, where terminal rate expectations have already fallen considerably since Fed Chairman Jerome Powell’s emphatically hawkish performance at
the last FOMC meeting on November 2. The question of where policy rates will peak is a hard one to answer, but an even tougher one is what trajectory rates will take afterwards. The interest-rate markets are anticipating a return to rate cutting by as early as the second half of 2023 and are thus pricing in a monetary-policy mistake by central banks, i.e. overaggressive hawkishness that will have to be corrected soon. There, in fact, is a high probability from today’s perspective that this will happen. However, if a recession in the USA doesn’t come to pass, the federal funds target rate could stay at a very restrictive level between 4% and 5% for a longer time because the Fed will probably want to avoid an overly swift and economically needless easing of monetary policy since that would significantly increase the risk of sparking a 1970s-style inflation spiral.
Equities: Value stocks have substantially outperformed growth stocks this year. Will they continue to do so in 2023?
Kaiser Partner Privatbank: The year-to-date performance differential between value and growth is quite sizable. While value stocks as measured by the MSCI World Value Index are down “only” around 10% for the year at last look, growth stocks are down by around 25%. Interest rates have been the biggest driver of the massive underperformance by growth stocks this year. A year ago, only two small 25-basis-point rate hikes by the US Federal Reserve had been expected for 2022 and not even a single rate hike was priced in for the Eurozone. In actual fact, however, the Fed has raised its benchmark lending rate six times since then in a sequence that has included four oversized 75-basis-point hikes. Market interest rates at the long end of the curve have also shifted upward sharply. A year ago, a quarter of all government bonds were yielding negative interest rates, but today investors have reverted to receiving a yield of around 3.8% on US Treasurys, and some Japanese government bond tenors are now the only ones left still yielding negative interest rates. These interest-rate movements have been fatal to the valuations of growth stocks because the revenue and profits that growth companies by their very nature won’t begin earning until far into the future (long duration) must now be discounted with a much higher interest rate than before.
On top of that, however, the macroeconomic climate has also inverted. In the years ever since the Great Financial Crisis until recently, growth stocks were more attractive than average in the face of sluggish nominal economic growth (and low inflation) and low profit growth in other sectors. The earnings growth reported by growth companies was exceptionally high, particularly in the USA. The low cost of capital was also a positive driver and disproportionately boosted the valuations of long-duration stocks. Traditional value sectors, meanwhile, encountered headwinds (such as tighter regulations on banks and falling commodity prices for natural resource companies). Seemingly at-
tractive dividends thus became value traps. Today the macro picture looks completely different. Nominal economic growth is high (due to soaring inflation) and the earnings of classic value companies are robust while big tech firms are reporting disappointing profits. The cost of capital has risen sharply. Previous value traps are now turning into value opportunities because the increase in interest rates and commodity prices translates into high earnings, high free cash flows and ultimately attractive, reliable dividends. Sectors with a direct tie to inflation (commodities) and beneficiaries of higher interest rates (banks) have accordingly performed well lately.
But what’s next? There won’t be a return to the postfinancial-crisis environment for the foreseeable future. Ultra-accommodative monetary policy is unlikely to experience a renaissance anytime soon, and inflation looks set to stay above central banks’ 2% target even in the best-case scenario. So, it would be unrealistic to expect the exceptionalism of growth stocks to make a lasting comeback. However, this doesn’t mean that growth stocks will enduringly underperform in the future. Looking ahead to 2023 from a tactical perspective, it’s once again (long-term) interest rates that will exert a crucial impact. Our estimates on bond yields (the peak perhaps has already been reached) and interestrate expectations (central-bank pivot in sight) laid out above indicate that the downward pressure on stock valuations in the growth segment looks set to abate significantly. If, in the event of a rapidly darkening economic climate, the Fed starts to backpedal as early as in the second half of 2023, at least a brief revival of the growth investment style would be conceivable.
In the future, however, long-term investors should no longer look solely through the growth lens or make binary choices between growth and value. In times of elevated interest rates, revenue growth becomes not just less valuable – higher economic growth also makes it less rare at the same time. Meanwhile, higher input costs (for energy and labor) put downward pressure on profit margins. So, what’s called for are companies that are capable of sustainably boosting their revenue and earnings year after year. Attributes such as stable, high profit margins, sound corporate balance sheets and steady dividend growth will stand in the foreground in the future. Diversification will also become more important again in the future. Investments outside the US technology sector tended to detract from returns during the past decade, but regional and sector diversification now look set to resume paying off again in the new macroeconomic climate of the future.
An unaccustomed sight | Growth lags far behind in 2022 MSCI World Value vs. MSCI World Growth
110
100
90
80
70
60
01/2022 03/2022 05/2022 07/2022 09/2022
Sources: Bloomberg, Kaiser Partner Privatbank
Learn more on our blog:
You want to be always up to date? Then sign up for our newsletter or follow us on Linkedin.
11/2022
Asset class YTD
1 Month 1 Year 3 Years
CHF 0.0% -0.2% -1.6%
Sovereign bonds
EUR 0.2% 0.2% -0.8%
USD 0.4% 1.9% 2.9%
1.9% -11.7% -9.4%
Corporate bonds 5.4% -16.8% -10.4%
Microfinance 0.3% 2.3% 7.6%
Inflation-linked bonds 2.7% -15.9% -1.7%
High-yield bonds 2.2% -7.9% 0.6%
Emerging-market bonds 7.9% -17.3% -13.8%
Insurance-linked bonds 1.5% -3.7% 7.2%
Convertible bonds 3.2% -17.3% 20.7%
Alternative assets
Global 5.7% -8.0% 27.5% Switzerland 2.7% -8.7% 9.1% Europa 8.4% -4.7% 11.0% UK 7.1% 13.9% 15.8% USA 5.4% -11.5% 33.8%
Emerging markets 14.6% -19.8% -6.5%
Currencies
-0.2% 0.2% 1.9% 0 -10.9% -17.0% 1.8% -14.8% -9.8% -18.5% -4.1% -17.1% 0 -11.5% -14.0% -9.2% 8.7% -14.8% -21.1% 0 17.0% -3.3% -16.4% -4.5% 0 -8.5% -5.2% -10.9% Monthly Market Monitor - December 2022 | Kaiser Partner Privatbank AG 20
Commodities 2.4% 21.1% 50.5% Gold 8.3% -0.3% 20.8%
Real estate Switzerland 1.6% -13.2% 0.5%
Hedge funds 0.0% -4.0% 7.1%
-21.1% 0 17.0% -3.3% -16.4% -4.5% 0 -8.5% -5.2% -10.9%
-0.2% 0.2% 1.9% 0 -10.9% -17.0% 1.8% -14.8% -9.8% -18.5% -4.1% -17.1% 0 -11.5% -14.0% -9.2% 8.7% -14.8% -21.1% 0 17.0% -3.3% -16.4% -4.5% 0 -8.5% -5.2% -10.9%
-0.2% 0.2% 1.9% 0 -10.9% -17.0% 1.8% -14.8% -9.8% -18.5% -4.1% -17.1% 0 -11.5% -14.0% -9.2% 8.7% -14.8% -21.1% 0 17.0% -3.3% -16.4% -4.5% 0 -8.5% -5.2% -10.9%
-0.2% 0.2% 1.9% 0 -10.9% -17.0% 1.8% -14.8% -9.8% -18.5% -4.1% -17.1% 0 -11.5% -14.0% -9.2% 8.7% -14.8% -21.1% 0 17.0% -3.3% -16.4% -4.5% 0 -8.5% -5.2% -10.9%
Numerous “holidays” have been invented by the retailing industry. One that belongs in the category of “useless knowledge” is Green Monday. The second Monday of December falls always at least ten days before Christmas Eve and was once considered the last day that shoppers could place an online order that would arrive under the Christmas tree in time.
In central banks’ ongoing global race to raise interest rates, the Swiss National Bank looks set to follow suit in December – anything other than at least a 50-basis-point hike would come as a surprise. But everything is relative – the interest-rate level in Switzerland remains relatively low in international comparison.
Above-average inflation, below-average investment returns, geopolitical uncertainties and slowing economic activity – many people likely are more than keen to forget the year 2022. We wish all of our readers a Happy New Year and are looking ahead to 2023 with optimism. Stay healthy!
This document constitutes neither a financial analysis nor an advertisement. It is intended solely for informational purposes. None of the information contained herein constitutes a solicitation or recommendation by Kaiser Partner Privatbank AG to purchase or sell a financial instrument or to take any other actions regarding any financial instruments. Furthermore, the information contained herein does not constitute investment advice. Any references in this document to past performance are no guarantee of a positive future performance. Kaiser Partner Privatbank AG assumes no liability for the completeness, correctness or currentness of the information contained herein or for any losses or damages arising from any actions taken on the basis of the information in this document. All contents of this document are protected by intellectual property law, particularly by copyright law. The reprinting or reproduction of all or any parts of this document in any way or form for public or commercial purposes is expressly prohibited unless prior written consent has been explicitly granted by Kaiser Partner Privatbank AG.
Publisher: Kaiser Partner Privatbank AG
Herrengasse 23, Postfach 725 FL-9490 Vaduz, Liechtenstein HR-Nr. FL-0001.018.213-7
T: +423 237 80 00, F: +423 237 80 01 E: bank@kaiserpartner.com
Editorial Team: Oliver Hackel, Senior Investment Strategist Roman Pfranger, Head Private Banking & Investment Solutions
Design & Print: 21iLAB AG, Vaduz, Liechtenstein