Ever since the LTCM crisis in 1998, the world’s Central Banks interact in an aggressive manner to protect the financial system. Every time, the miraculous combination was to lower interest rates and inject an ever-larger amount of liquidity thereby allowing the system to maintain a pro risk-on stance. The only exception in this ever-recurring cycle of crisis was the non-bailout of Lehman Brothers.
With interest and inflation rates at historic low levels and growth being subsidized too, the only way forward is to proceed with a bigger reset. So the question is, how is this reset going to unfold?
In the last two years, inflation has accelerated on the back of multiple events, and fighting inflation has become the key occupation of Central Bankers. For a good number of quarters, we projected that inflation would be transitory, but instead, it kept accelerating in an even faster manner.
The recent banking crisis is not a result of lacking credit facilities or consumer excesses but rather capital flows. The constant requirement for profitability led to a perfect mismatch. To be more precise, in the case of SVB and CS, weak management structures allowed access risk-taking by the institutions which finally undermined investor’s confidence and resulted in the case of SVB in a bank run.
The new market conditions will not go unnoticed. In fact, the circumstances will translate into more compliance and regulations, hence tomorrow we will be having a fundamentally different background. It is probably true to say that the March 2023 banking crisis has accelerated the global fragmentation. Therefore, the deglobalization whereby production of the end product is brought closer to the consumer will rely on ever more complex global trade. But this will occur more on fragmented blocks. Investing along these blocks will be more multifaceted as new associations will be replacing existing ones. Regrettably, this rebalancement will involve an ever-greater participation of countries with fewer equal trading opportunities.
For global companies, this will require a better exploitation of both strategic and tactical opportunities. This in turn will bring online new production capacities in uncharted territories which in turn will accelerate the transformation and uncertainties for investors.
On the policy side, the Central Bankers stand in front of a fragmented and complex lecture on economic conditions. Their nightmare scenario is seeing the rate of inflation not decelerating for the next 12 months or so. This mantra would be driving economies straight into recission, unemployment would be going up, and as unlikely it might sound, inflation would be accelerating once more before finally faltering. If so, the fragmentation would not only be reaching out to the industry but also the Central Bank policies and geopolitical dynamics which up to now have played somehow in tandem with each other.
For Developed Markets to access energy and technology, cheap labor and raw materials are essential. While technology independence is critical for any further development, it can be achieved with less efforts than energy impendence. To gain energy independence, Western nations have engaged with rebuilding the entire infrastructure, from generating energy to distribution to the end-consumer. Yet and once again, DMs rely for now on resources which are most available in EMs. In the absence of own resources, everything related to solar power, energy storage systems, energy transportations, and consumption comes from EM. Consequently, the energy transition will be supportive for EM countries as the demand increases for metals such as copper, and lithium, amongst others.
It is indeed difficult for investors to navigate correctly between bank crises, high inflation, climbing interest rates, deglobalization, and fragmentation. As for now, we continue to believe that investing along secular growth trends is of an ever-bigger importance. For instance: while semiconductor stocks are in the doldrums for now, they play a key role in our modern economy. Without a stable supply chain of semiconductors, the energy transition, electric cars, advanced machinery equipment, IIoT, computers, and data centers are impossible.
The present economic reshuffling will also accelerate reshoring with the aim to approach product manufacturing as much as possible consumers in mega-cities. Countries that were up till now left out to be wallflowers or insolated statues will be, for sure, winning relative to others. The list of countries to look at includes India, Vietnam, Iran, Indonesia, amongst others.
The world of tomorrow will be more complex for businesses, thus requiring higher margins. Cost of capital is expected to increase, and leveraged companies engaged in low-quality mass-market products are expected to be wiped out. This in turn will most likely result in higher product prices for consumers that will establish the rate of inflation, against all Central Bank targets, at a higher structural level.
Welcome to the new world of opportunities!