The fourth quarter started with a big bang when the war in the Middle East broke out. People around the world are seeking normalcy, but they shall be disappointed. It seems that we need more patience. Last year, when we claimed that the global economy will slow down, we were too early in our prediction. Despite the fact of rising interest rates and big companies reducing their workforce, economic factors stayed elevated. However, finally, fundamental economics are catching up, showing a slowdown in economic activity and the forecasts are not as shiny anymore either.
Clinging to hope, investors are torn about how to position themselves. There is still fear regarding a looming recession but there is also supporting monetary policy. Investors once again face the fear of missing out. This leads to paralysis which is shown in the low volumes traded at the markets. As a consequence, the reactions toward companies not meeting expectations was especially harsh.
Most recently, there was another bang when Moddy’s, the last rating agency keeping an AAA rating for the US, changed its outlook from stable to negative. The argumentation goes along with its peers S&P and Fitch claiming the instability in the political system paired with the hike in the debt level. A downgrade by the third big rating agency would considerably increase borrowing costs of the US.
Do not get fooled by indices
If you are a loyal reader, you have heard us use this quote before:
Be fearful when others are greedy and greedy when others are fearful.
And another quote we like from the investor legend Warren Buffett is:
Never invest in a business you cannot understand.
In the last six months that is what we have increasingly prepared for. We analyzed companies that we like and understand and determined what would be a reasonable price to get involved. The determined prices are sometimes ten, sometimes fifteen percent below the trading price. However, in anticipation of another downturn, we stand by to take on the investments once they hit the predefined price. That does not mean that this price will be the turning point, but it will be an attractive level to engage in this company keeping in mind a longer-term view. The sentiment of the third quarter result publications offered some opportunities.
Looking back, we saw one of the most impressive first halfs of the year despite a banking crisis in the US and even some trouble in Switzerland. However, back in July, stock markets started to enter a correction that lasts until today. Some argue that this is the continuation of the bear market of 2022. Irrespective, the fact is that when looking to the constituents of the indices it does not look so well. As an example, I am sharing with you the year-to-date performance (as of November 10, 2023) of the S&P 500 with the member weightings as it is and the performance of the S&P 500 with equal weights.
This shows how influential the highest weighted seven companies are for the performance of the S&P 500 (Microsoft, Apple, Amazon, Nvidia, Alphabet A-Shares, Meta, Alphabet C-Shares).
Other broader indices like the Russell 2000 are down about 2.6 percent year-to-date without any special adjustments. We belive another downturn in equity prices potentially opens many new investment opportunities. Do not get fooled by the indices!
We believe that markets will further move down. A soft landing, as anticipated by others, is unlikely. We went through one of the fastest interest rates increases during the last two years and inflation still stays considerably above the target of two percent. Additionally, bringing in a quote from Mark Twain:
History never repeats itself, but it does often rhyme.
Maybe, in this specific case, it even repeats itself. In 1973, 1980, 1989, 2000, and 2007, always advance to recessions, articles forecasting a soft landing spiked. Now again, we read many articles arguing why this time is different…
Or there is another excerpt from the U.S. Bank article "Is the economy at risk of a recession?" from October 27, 2023: "It seems likely the economy may avoid a recession in the near term, though we can expect that real GDP growth will remain modest over time,” says Matt Schoeppner, senior economist at U.S. Bank. “It might qualify as what we call a ‘growth recession,’ where we see a slow economy, but with few ramifications for the job market.”
On the other side, Jamie Dimon, CEO of JPMorgan Chase, is warning that this is the most dangerous time for the world in decades.
Whatever the outcome will be, the importance is to distance yourself from what is going on in the day to day, take a step back and gain a broader view in order to make smart decisions. As described above, that is what we have done and what led to the latest add-ons to many of our client’s portfolios. Moving forward, we expect the volatility to stay elevated leading to further opportunities. In earlier publication we raised our readers’ attention to the time it took back in 2001 until the markets reached their lows (it took about two years). Accordingly, we would not be surprised seeing companies losing further ground in the coming months. However, if the business model is solid, that should again be seen as an opportunity rather than a reason to fear.
Is the USD as strong as it seems?
If you are a long-term reader of our letter, you know the US dollar index. For everyone else, you find a brief description in the box below. The USD index (DXY) has shown quite some volatility, however, trading at strong levels last seen in the early 2000. In general, we can observe several periods, where the USD showed strength, but ended up at lower levels eventually.
Interestingly enough, while most of the currencies in developed countries weakened against the USD since 01/01/2020, an emerging market currency, the Mexican peso, strengthened against the USD. Of the six currencies represented in the USD index, the Swiss Franc was the only one gaining value against the USD. We measured the performance starting from January 1, 2020 because it was before Corona broke out.
Change (%) since 1/1/20
Change (%) since 1/1/20
The question is, whether the USD will keep its strength despite the US debt spiking and rating agencies reducing the credit rating. We believe that the days of the USD’s strength are counted. The current strength of the USD does help the US, similar to Switzerland, to bring inflation under control. However, once this monster called inflation is tamed, we expect the USD returning to its path of devaluation. Accordingly, setting up an investment portfolio exposing yourself to other currencies than the USD is surely a smart move.
What to expect from central banks?
Central banks are cautious about how to continue with their interest rates. Last Thursday (November 9, 2023), Jerome Powell shared his concerns that the Fed is not convinced that they have been successful in sustainably moving inflation back to its target level of two percent. Nevertheless, the Fed as well as other central banks recently paused further interest hikes. The European Central Bank, the Bank of England, and the Swiss National Bank halted further interest increases for the time being. However, the only country of the ones mentioned showing inflation within its target range is Switzerland (1.7% - target is lower than 2%).
An ongoing stronger than expected economy has the potential to undermine the central banks’ efforts of brining inflation down. On the other hand, the ongoing wars and hot spots (e.g., Taiwan) have the potential to cause price shocks as we have seen at the beginning of the war in Ukraine in energy prices. While these are external shocks with which central banks struggle to deal, they cannot stay inactive. The Swiss National Bank dealt with these shocks by allowing the Swiss Franc to strengthen leading to an ease in imported inflation.
Accordingly, our current expectation of what we see is that central banks will keep interest rates at the current levels until they clearly see the economies suffering, which will bring down consumption and therefore eventually price pressure. Once prices come down, we expect that the movement will accelerate and that the sentiment will change so that central banks will reduce interest rates again.
Keeping in mind the election year 2024 in the US and the fact that many economies orient themselves at the Fed, we could imagine that there will be more pressure towards Jerome Powell to reduce interest rates starting mid-2024.
That’s when precious metals will shine
We do not expect that the issues will go away by mid-2024. Therefore, a combination of a weak global economy, ongoing wars, and potential new wars paired with decreasing interest rates would boost precious metals and related industries. We have seen this kind of catalyst back in 2010 and 2011 without having any threats of a new war threatening the peace of the western hemisphere.
Even today, despite high interest rates and a strong USD, we see precious metals, in particular gold trading above USD 1,900 per ounce. A reduction in interest rates which would lead to a weakening of the USD will move precious metals prices and related investments higher.
In the meantime, we are convinced that precious metals should represent a part of your portfolio already for two reasons. One is the long-term investment factor for gold as a multigenerational investment. The other reason is that gold still holds its value as a hedge in challenging times.
While precious metals, in particular gold, is often criticized as an unattractive investment because of the lack of interest or dividend payment, the fact that precious metals as an investment do not contain any debt and therefore cannot go bankrupt, justifies the inclusion of this asset class. Accordingly, we believe that gold still has its entitlement to represent a part of your wealth.
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