Topics in focus

Investment strategy in a state of emergency: Our weekly update

The situation in the war zone in Ukraine is extremely dynamic, nervousness on the capital markets is increasing. Capital market strategist Carsten Bensman speaks week after week with Andre Bougore, Sanford’s Global Chief Investment Officer, to assess the current situation and its implications for investment strategy.

China's role comes into focus

  • The war in Ukraine continues. The situation for the population is getting worse in many areas. The number of refugees is growing. At the same time, China’s role in the conflict has come to the attention of the world public this week. So far, the state has been largely neutral towards Russia. The overarching and clear goal of the Chinese leadership is and remains the long-term stabilization of its own economy and financial markets. On the other hand, the Russian leadership has apparently asked for support. Should China actively intervene in the war, the country faces massive sanctions with serious consequences for its own and the global economy.
  • China’s economic situation prior to the outbreak of the war was characterized by a certain degree of stabilization. The regulatory offensive of the past year had left the leadership behind, and the prospects for economic development had recently improved again thanks to targeted stimuli from politicians. The current challenges are now managing new lockdowns, which China has managed quite well in the past. In addition, foreign liquidity is being repatriated to Chinese stock exchanges after some American Depository Receipts (ADRs) of Chinese companies are threatened with de-listing on US stock exchanges. ADRs are certificates traded on US exchanges as a proxy for stocks that cannot be bought directly – which affects many large companies in China. It should be emphasized that these are not current sanctions, but a US initiative that was launched in 2020 (Holding Foreign Companies Accounting Act – HFCAA).
  • The US Federal Reserve raised interest rates by 25 basis points this week, ushering in the next interest rate cycle. This turnaround in interest rates, which was slower than pre-war expectations, was last foreseen. The accompanying comments from the FED members, which definitely point to a more aggressive course with further rate hikes, were striking. So there are still a few more steps to be expected over the next few months as the Fed now gears its actions heavily towards the narrative of high inflation rates.
  • While the stock markets have so far seemed to be supporting the course of the US Federal Reserve, the US Treasury curve flattened sharply, and in some sections there was even an inverse interest rate structure. Traders on the interest rate markets are apparently anticipating greater problems for the US economy. The FED will have to find the balance between inflation and growth on its further course as soon as the economic fundamentals deteriorate. This also applies to the European Central Bank, which recently also took the path of tightening, while more moderate tones were heard from the Bank of England. The latter could serve as an example for the future path of western central banks.
  • The situation remains uncertain for investors. Recently, risky investments such as shares have been able to recover a little more clearly after sentiment had deteriorated sharply when the war broke out. Some market participants apparently use lower prices to enter and initiated a countermovement. However, given the current uncertainty, we still think it is premature to call for a bottoming out and remain neutral for risky assets.
  • At the same time, it is definitely worthwhile analyzing what is already priced into individual asset classes and how high the corresponding risk premiums are. For example, there are better opportunities for investment grade bonds, just like in some Asian markets and in China, where the discounts have recently increased. The bottom line is that we are in favor of an overall defensive position unless there is a significant improvement in supply chain issues and margins for companies improve.

 

  • As the war progressed, the pressure from the West through sanctions also increased. The impact does not just extend to energy markets and commodity prices. Other sectors of the economy are also increasingly cut off from Russia. This is affecting supply chains and economic governance around the world. Political decision-makers are called upon to react to this.
  • The scarcity of energy and food supply means that there is a continuing risk of inflation. At the same time, concerns are growing in Europe in particular that not only is there a risk of stagflation, but that rising inflation could even be accompanied by a recession . A global recession would be significantly worse than a period of stagflation. The US will remain in a stagflation environment for the time being.The risks of errors in central bank decisions continue to rise. Capital market participants are navigating a period of conflicting positions between what central banks actually do and what they say they do. The risks of stagnation or recession create pressures that are offset by high inflation in some countries. It is currently unclear whether the central banks will maintain their interest rate turnaround in this situation. An aggressive interest rate policy is becoming increasingly unlikely, particularly at the European Central Bank.
  • We are currently maintaining a relative underweight in the credit markets but have recently increased the duration slightly. In particular, if the pendulum swings even further in the direction of recession, pricing could become difficult, because then the default probabilities for corporate bonds will increase.
  • In the stock market, looking at strong cash flows and balance sheets is becoming increasingly important when selecting stocks. In addition, regions that are less severely affected by the economic consequences of the war should be favoured. This means we continue to look for opportunities to increase exposure to China, Asia and Japan versus the US and Europe. The age of the new FANGS could begin, with fuel, aerospace, nuclear/renewables and gold as a stabilizer in times of crisis.