It takes years to build up trust and only seconds to destroy it, but forever to repair it.
Silicon Valley Bank, Silvergate Bank, Signature Bank… three bank failures dictated the headlines at the beginning of last month. Not long after, Credit Suisse got into severe problems as well. The reasons for the failure of the banks in the U.S. and the one in Switzerland are fundamentally different but show a few similarities. There have been misjudgments which eventually led to a lack of trust and therefore liquidity issues and eventually to the end of the banks.
We are very sad to witness the end of Credit Suisse, a bank that was founded 167 years ago and was crucial for the industrialization and therefore the development of the Swiss economy. However, the issues Credit Suisse had, were not new. For a couple of years already, Credit Suisse was suffering from problems that started much earlier when they heavily moved into the risky investment banking and away from the more risk averse private banking. This move combined with a cultural shift eventually made them lose their risk-averse “Swissness”. Their bad corporate governance and unsuccessful risk management attracted greedy managers chasing bonuses without ever taking responsibility for what they were hired to do. You can hear more about our view on Credit Suisse on our latest podcast episode. In this episode, you will also learn how our chosen custodian banks differ from Credit Suisse and other “big banks.” If you are more of a reader, then you can find our written analysis here.
Back to 2008?
Many people are worried that we are back at the Great Financial Crisis. While we are convinced that history does not repeat itself, it often rhymes. The risks that result out of central banks rising interest rates in light-speed are not new. We believe that the decision of the central banks to raise interest rates has been the right one but that they clearly underestimated the inflation and thus started too late. However, not only was it a misjudgment of inflation rates, it was also a misjudgment that the Modern Monetary Theory could work. That is something we and many others have warned from repeatedly. After more than a decade of ultra-low interest rates, many market participants have forgotten how to behave in an environment of rising interest rates.
Sell and Run!
While the volatility at the markets increased and the fear of a deeper than expected recession has returned, we believe that it would be the wrong decision to sell off the portfolio and hide fully within liquidity. The success of your portfolio’s performance during the next expansionary economic period takes its start during the more challenging time of a contraction and trough. The importance in our view is to focus on quality. However, what does quality mean? We, for sure define quality different than Cathie Wood does in her Ark Invest mutual fund. We focus on financial figures and more on the actual performance of a company rather than the potential shiny future a company might have while losing tons of money.
That does not mean that our investments will not decrease in value in the short term or that the companies we have chosen cannot go bankrupt. Moreover, it is a risk management tool that minimizes these risks and therefore the risk of our client’s portfolios experiencing losses due to a misjudgment of companies’ future growth.
Currently the most important questions that are on top of our minds when choosing a new investment are, is the company making money and what is the risk that the company stops making money in the foreseeable future. An important aspect on these questions is the pricing power and the market share a company has.
In our investment analysis we concluded that among others two industries are of interest for us. These are the telecommunication industry and the insurance industry, which counts as a subsector of the financial industry. Within the telecommunication industry, we prefer companies that are a part of a countries infrastructure and therefore, by controlling it, will be able to sell their services not only to end clients directly but also have other telecommunication providers as their clients.
When it comes to the insurance sector, it is important to go with high-quality insurance companies. Similar to banks, their reputation and therefore, their pricing power is highly dependent on trust. Companies as well as individuals need insurance in different parts of their life. People are happy if they do not need it. However, if something happens and they need their insurance, they truly value it if the insurance is helping them instead of finding excuses. We believe that we have such insurance companies in Switzerland and therefore are happy to include them into our clients’ portfolios.
To conclude, as we mentioned in previous articles, we believe that the volatility we currently experience will bring up opportunities which we are planning to use.
The Shock of the Fixed Income Market
Last year, markets were shocked when they realized that the bond and the stock market lost almost equally in value. The reason for this scenario was the central banks’ efforts to fight inflation by rising interest rates. The Federal Reserve was one of the most progressive central banks of the developed countries. In the emerging markets, central banks already started earlier to increase interest rates to fight inflation.
However, investors seem to be insecure about what to expect from the fixed income market in 2023. The year had a fulminant start due to investor’s hope that there will be a soft landing with no recession and central bank stopping interest rate hikes. As often, if there are too many market participants agreeing on a specific scenario, it is usually wrong. Accordingly, it eventually became known what the FED has broken with its aggressive interest rate hikes. While banks did mismanage their risks of government bonds which led to high losses and a lack in trust from their clients, thousands of corporations globally must renew their debt within the next 12 months. Will they be able to refinance their debt without getting into financial trouble?
We do believe that there are companies that will be able to do that or even reduce their outstanding debt. However, it is crucial to look out for the high-quality companies that have this kind of financial freedom. Additionally, the same question is also valid for mortgages which affects individuals that eventually must refinance their mortgages. Chances are that we will see increasing stress in this area as well.
Shine Precious Metals, Shine
The recent development of the precious metals’ prices, particularly gold, has aroused memories of February 2022, when the war in Ukraine started. Back then, gold started to rally and found its high around USD 2,070 per ounce. This year, in the context of the regional bank crisis in the U.S and the forced takeover of Credit Suisse through UBS has increased investors’ fears which drove the gold price up to about USD 2,000 per ounce despite the ongoing increase of interest rates, especially in the U.S.
We see reasons to believe that the threat is not over yet. The First Republic Bank is still struggling despite its USD 30 billion liquidity injection through the large U.S. banks. Additionally, the most recent development of Russia positioning nuclear weapons in Belarus increases the fear of the war that is no longer between Russia and the Ukraine, but between Russia and the NATO nations. Finally, the threat around Taiwan is ongoing. In particular the visit of Chinas president Xi Jinping in Moscow was followed very closely by western governments.
Long Story Short…
The environment for investors has rarely been more challenging than it is right now. There are many threats to the global economy. However, there is still the possibility that things get solved. The war might end sooner than expected and the recession could be less deep than generally anticipated.
However, the threat remains that one will miss the forest because of the trees, making it essential for investors to take a step back and take a deep breath. Once this is done, it is important to then refocus on your guiding principles. Do not let yourself get caught by emotional decisions. Follow the numbers and keep analyzing your investments as objectively as possible. If you do that, you will increase your chances to find attractive investment opportunities while not assessing an investment as reasonably priced when it is in fact not.