Dear investors,
The summer has been full of unexpected events. Between a surprising interest rate hike from Japan's central bank, a major monetary stimulus package in China and an expected but not so major interest rate cut from the US central bank, it was all about keeping a cool head and not liquidating investments at the beginning of August.
Indeed, from mid-July to early August, stock markets devalued by an average of 10%. Cryptos fell between 16 and 20%.
The most influential event for the markets was the rise in interest rates in Japan. The reason for this was a monetary strategy known as “carry trade”. This strategy is traded on currency futures markets, where an exchange rate risk between the USD and the JPY is contracted in order to profit from the interest rate differential between the two currencies. The idea is to sell JPY forward against the USD and accumulate a profit on interest rates for the duration of the strategy. The longer the interest differential persists, the higher the amounts invested in this strategy. An expected fall in USD rates and a surprise rise in JPY rates triggered a significant rise in the JPY against the US currency, with some players having to sell off their stock market assets and digital currencies to recoup their losses. This created a shock with major financial consequences for the markets.
Despite these upheavals, the general situation remains favorable for a recovery towards the end of the year. The three themes raised in our last report are still valid. Here are a few additional comments from the last quarter which I feel are pertinent:
1. Inflation is falling as expected, and the FED is slow to cut interest rate despite reducing its key rate by 0.5% at its last meeting. In Switzerland, the SNB was surprised by the fall in inflation to close to 1% over the summer. Further rate cuts are expected from central banks.
2. The geopolitical situation in Ukraine is improving, as mentioned at the beginning of July. Tensions in the Middle East have increased, with oil prices rising in recent days. However, it seems unlikely that the conflict will spread beyond the geographical areas directly concerned. The Israeli government seems to want to put an end to threats outside its borders, while taking advantage of the US elections, which are moderating any clear-cut decisions on this subject on the part of both Republicans and Democrats in the USA.
3. It is not in the interests of the big states to suffer oil blockades and growing political and economic instability in Europe and the Middle East. China is spending colossal sums to stimulate economic growth. Europe will have to take the same steps and boost its economic recovery. This requires global geopolitical stability.
Current risks focus in particular on economic growth in China and Europe. Germany, in particular, could see negative GDP growth in 2024.
Government debt remains a latent risk of monetary slippage. This puts the brakes on any grand ambitions for economic recovery through government borrowing. It should be noted, however, that whenever the State has to choose between austerity and economic recovery, it is the latter that wins out, with a continual increase in debt. This can be seen by analyzing the figures for global money supply (M2).
Recently, China injected over USD 100 billion to boost its economy. This was achieved by issuing bonds. The real problem with bond issues is that the government has to repay what investors have paid in exchange for the securities they have received.
The State must constantly repay loans, and its capacity to do so is becoming limited. If it doesn't use its unique privilege - money printing - then it is declared bankrupt.
This increase in money in the financial system is mainly visible in financial market values. In fact, inflation in consumer goods remains under control, and even very low, to the point of being negative in China.
States find themselves in a trap, where excessively high interest rates further deepen budget deficits and debt levels. It is therefore foreseeable that interest rates will continue to fall in order to minimize borrowing costs.
Investment strategy:
Despite the high volatility of recent months, portfolios suffered little (-2%). The monetary signals given by the FED and the Chinese government signal the start of an expansive monetary cycle, rather than the restrictive one we have seen in recent years. In this context, one segment sensitive to this change of direction is small to medium-sized companies. This segment is represented by the Russell 2000 index in the USA. All the indications are that it should outperform the general stock market, in order to catch up with the large-cap segments. Our portfolios are exposed to SMEs and should therefore benefit from this recovery. We sold a PUT option premium on the URA ETF (uranium sector). This is a promising sector, given the growing need for electricity. Exposure to digital currencies remained stable, as this sector will benefit not only from the development of blockchain, but also from an expansive monetary policy.
Digital currencies:
Stable crypto market in Q3. Summer is often synonymous with status quo on crypto stock prices. That said, both the behavior of the cycle on BTC (see previous report on the “halving” effect) and monetary decisions militate in favor of a bull market for the months ahead. Institutional adoption continues, with more and more banks setting up structures for depositing and trading digital currencies. There is also talk in political debates of government reserves in BTC. So there's a positive trend in terms of understanding the economic and monetary advantages of cryptos. It's difficult to give price targets for the next few months, but it seems that the advantages inherent in blockchain technology and the scarcity of BTC could trigger periods of significant price rises.
Conclusion:
Autumn is a time when investment decisions are made with a view to the end of the year. Many market participants have liquidated positions in stocks that experienced the “mini-crash” in July-August. This is likely to create upside potential for the markets before the end of the year. This is against a backdrop of lower interest rates and economic stimulus plans, mainly in Europe.
Sometimes, it only takes a few weeks to realize most of the year's performance. In this case, “buy, hold and check” is the best and least costly strategy.
I hope you enjoy the beautiful autumn colors.
Yours sincerely
Steve Dubied,
Financial Analyst
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