To The Moon

Although the global economy is performing better than the market expected, the banking crisis will cause the monetary policy to peak soon. This is good news for financial markets, which nevertheless are still fully expecting a recession. Interest rate curves are still inverted and the stock market is reckoning with falling profits. In addition to the war in Ukraine, investors must also take into account inflation, high energy prices, and geopolitical turbulence. Taken together, this makes for a complex and dangerous environment that can therefore be potentially very lucrative for investors.

At the end of last year, the consensus was still counting on recessions in the United States and Western Europe. The past quarter has shown that all the major countries in the global economy - the United States, China, the Eurozone, Japan, India, and even the United Kingdom - are growing faster than anticipated. This while in January the IMF was still sticking to the scenario of a solid recession. This week the IMF and World Bank people are meeting again in Washington and it is likely that current events will force them to revise their growth forecasts upward. Indeed, despite high inflation combined with mounting geopolitical and financial risks, the global economy is doing better than expected.

However, there are new medium-term concerns and they have been triggered by the recent banking crisis. That crisis itself seems to have been averted by adequate intervention by regulators and central banks, but the cause of this banking crisis has not yet been addressed. That is the current monetary policy. History shows that almost every time the central bank starts raising interest rates at a rapid pace there is a major financial accident. The last time that led to the repo crisis of 2019, before that the Great Financial Crisis of 2008, before that the bursting of the dotcom bubble in 2000, the Asia crisis of 1997, the Tequila crisis of 1994, and the Savings & Loans crisis of 1990. This banking crisis is most similar to 1990 one. Each time such a crisis was enough in itself to cause interest rates to be lowered again.

In this regard, the problems in British pension funds last year were already a harbinger. The rise in interest rates is causing more than $4 trillion in price losses on bonds in the US alone, and a relatively large portion of those bonds are on the balance sheets of commercial banks. On paper, the loss on those is about equal to the equity of these banks. That is not a stable situation, and something like that depresses economic growth via credit. The only solution to avoid bigger problems is to lower interest rates. That seems difficult given high inflation, but it will come off enough in the coming months to justify at least a pause in monetary policy. The market is going even further and even counting on interest rate cuts in the United States for this year. Not in Europe, first of all, the ECB is following the Fed with some delay, and in addition, (wage) inflation also seems more persistent here than in the United States.

In the coming weeks, the first quarter results will be published. Expectations are not high. A decline in profits is expected, but the results of commercial banks in the United States will be viewed with suspicion. Not so much because markets are concerned about bank balance sheets, but more about what the impact will be on the profits of these banks. At the same time, it remains striking how much corporate earnings have benefited from rising inflation. Whereas for bonds inflation remains the biggest enemy, equities have once again shown that they are much more resistant to it.

War, inflation, high energy prices, and geopolitical turmoil all seem to combine to make this not a good time to invest. Again, history shows just the opposite. Moreover, thanks to the growing global economy combined with the coming pause in monetary policy, the underlying fundamentals are much more favorable. There are also plenty of opportunities in private markets due to the turmoil, helped in part by forced sellers. Since in private markets, fundamental development plays a bigger role than the turmoil that creates a lot of noise in the stock market, this contributes to the financial calm in a portfolio.

The peak in monetary policy will not coincide with a peak in the stock market. Rather, it is a starting shot for financial markets to begin the climb to the next peak. Right now, everyone still seems to be fleeing into safe havens, which these days seem to consist of big tech stocks, gold, and bitcoin, but possibly the weakening of the U.S. dollar over the past two months is already signaling a reversal. If that continues, it would be wise to focus on anything with a light weighting in the index. That is markets outside the United States, that is more emphasis on value than growth, more emerging markets than developed markets, more in small caps than large caps, etc. Such a portfolio is also much more attractively valued and also benefits more from favorable fundamentals. Equities are overweight within the investment mix, bonds are still underweight.