What to expect in the financial market during the second half of 2022
Gulf Insider catches up with Yves Bonzon, Group Chief Investment Officer and member of the Executive Board at Swiss Wealth Manager, Julius Baer to discuss their secular outlook, what’s to come in the financial markets, and advice for investors for the second half of 2022.
The 2022 market decline has been extremely broad-ranged, from safe-haven bonds to equities. What do you predict is next?
The market decline during the first half of 2022 was a broad-based reset for the new paradigm that resulted from the geopolitical situation in the wake of the war in Ukraine. This can be summarized as the ‘end of the era of supply abundance in the Western world’ (cheap labour, capitals, raw materials, energy, cheaply manufactured goods, etc.).
For three decades, we were living in a state where supply was never a problem. The central banks stepped in to support the market during every single shock that the Western world has experienced. In the wake of the Ukraine war, the reaction function involved the central banks beginning to change. In the midst of a shock such as this, for the first time, we saw the federal reserve tightening interest rates, monetary policy, etc. This is how fast and how radically the situation has evolved.
The first phase of that adjustment was having higher interest rates, higher cost of capital, and readjustment of all assets. That’s why safe-haven bonds, credit, and equities have readjusted to almost the same extent. Going forward, there’s a lot of uncertainty. Therefore, it’s very difficult to make a forecast.
The cost of energy has exploded in Europe. In terms of inflation, the US is facing demand problems resulting from excessive stimulus to support the economic and post-pandemic economic recovery. There are different sets of circumstances, which might imply a slightly different path forward for management policy.
At the corporate level, the key question to us is: how will the profit pool of the corporate sector migrate? Those who were the main beneficiaries of the old paradigm, will probably no longer be the main beneficiary going forward. Priorities have changed in the US and Europe. Therefore, we expect new leadership to emerge.
In your April 2022 Secular Outlook, you mention that you have put an end to your five-year call on Chinese equities rising to core asset class status. Why is this?
In 1992, I was convinced that China would tremendously develop over the next couple of decades. But Chinese equities were not very attractive to investors for a variety of reasons. At the time, the kinds of companies listed on the stock market were of very mediocre quality. So, for 25 years, I hardly considered an asset allocation for Chinese equities. In 2017, we came to the conclusion that China had reached the development level at which it could no longer afford to allocate capital in a suboptimal way. Therefore, going forward, efficient allocation of capital required adapting best practice, such as that which you observe in corporate management in the US.
This whole scenario has been unfortunately wrecked by the domestic policy shift towards common prosperity. Clearly, the Chinese government has set very clear priorities for society and development. This has challenged the case for efficient allocation of capital. Furthermore, we’ve learned the lesson from what happened in Ukraine earlier this year. The value of Russian assets, both bonds and equities have been tremendously impacted, but the main driver of the asset value decline above and beyond the conflict, have been the sanctions imposed by Western governments and regulators. There is additional risk and it’s something that is very difficult to price. Whether you want to accept that risk and harvest the benefit of China’s diversification, is something very personal to each and every investor.
So, there are diversification merits to Chinese capital markets. But, we have these new sets of circumstances with common prosperity, which challenge the case.
What is motivating investors to buy stocks amidst a highly volatile economy today?
It’s plain and simple. Stocks are real assets. So are revenues, company turnover, and benefit from higher inflation over time. In this new environment, we expect stocks to outperform bonds by a greater margin. One reason is the cash flow of bond investments won’t be indexed in most circumstances to inflation, whereas the corporate sector will have the tailwind of more inflationary condition. However, that also has implications in terms of who benefits in the corporate sector of Europe and America.
What is your advice to investors for the second half of 2022 to secure returns and reduce risk?
We recommend investors to stay invested and manage the overall portfolio risk separately. In our case, we’ve made the choice to implement through a position in short S & P 500 futures, reducing thereby our equity exposure.
We like the portfolio construction where you stay invested and have a hedge. As we saw on 26 August 2022, markets have developed a tendency to rise in a relentless manner until they break abruptly. This occurred a number of times in the last few years. In our experience, it’s easier to unwind the hedge after a market decline and harvest the profit of the hedge rather than redeploy fresh money in the midst of a market decline. We think the second half 2022 is time to position the portfolio for the next cycle. The most important question is not so much about timing the market short term, but about how, where, and in what you want to be invested for the next 3-5 years.
What is your preferred asset class for long-term investment today and why?
If I had to own one asset class at this point, I would probably go for Canadian equities. This is because Canada’s stock market structure has a lot of exposure to everything the Western world needs for reshoring purposes. I think Canada is one of the unintended beneficiaries of the new geopolitical situation. Therefore, it’s certainly one asset class that we would rank higher on our hit list.
Where do you see cryptocurrencies going?
We believe Bitcoin is gold in digital form. It shares many of the characteristics of the yellow metal. It’s complicated and risky to store. It can be stolen. And we think in the exact same way gold benefits from inflation in the long term, Bitcoin will fulfill the same role. It will be the gold of the new generation of investors.
Ethereum and other coins that enable smart contracts are a different story. We think there is still tremendous potential for those technologies to develop into real world applications that are profitable. We’ve hardly seen those applications starting to emerge yet, and we should not be fooled by the digital asset space responding to the reset of liquidity conditions and interest rates.
When equities eventually bottom later this year, you will also observe a bottoming process in the digital asset space. The ones to own are really those that will enable the digitization of trust, the switch in the financial sector from T+2 settlements to T+0 instant settlement, and eliminating counterparty risk. All of those revolutions are still in the pipeline and eventually will happen. And those protocols that support these revolutions will be very valuable in the future.
For more information on Julius Baer, visit their website.
