The Perfect Storm

The month under review produced an astonishing number of unexpected movements in financial markets. These include worse-than-expected and relentlessly rising inflation numbers in developed economies; robust hikes in interest rates by many central banks around the world intent on shedding the mantle of being behind the curve; vociferous pronouncements by existing and past leading central bankers to cement their credentials as inflation fighters; the resulting accelerated bear market in sovereign and non-sovereign bonds; the overspill into stock markets, mortgage markets and consumer behaviour that will be felt at least for months to come as recession is bound to ensue and worsen; volatility in leading world currencies, the likes of which have not been felt since last century; the ratcheting up of war rhetoric in Russia, Ukraine and beyond, including the now-open discussion of potential nuclear escalation triggered by Vladimir Putin; sham referenda in Eastern Ukraine; Russia’s cutting off of the supply of energy to Europe; and many other factors.

This is the perfect storm.

Most recently, the violent collapse of the pound sterling and British bond markets, and the necessity for the Bank of England to act as a market-maker of last resort at the long end of the gilt market (to prevent an impending meltdown in the assets of leading pension funds), have been attributed in part to one of the many economic effects of Brexit. The new British prime minister and her chancellor have been described by the Financial Times as “mad, bad, and dangerous” for the economic naivete adopted in their first budget. Most recently, the  rating agency S&P has placed the UK on negative credit watch. Far from basking in a honeymoon period, the new British prime minister is already under heavy pressure as the opposition has swiftly and brutally overtaken the Conservative Party in the polls. (It has not taken long for the British government to reverse the budget decision of abolishing the proposed higher income tax rate for higher earners.)

More importantly in the wider context is the question of whether the British pension fund crisis and its effects could spread into other bond and/or currency markets where pension funds are equally highly leveraged and badly regulated. This bears close watching because, if the British model were followed, it would result in simultaneous quantitative tightening and a resumption in quantitative easing. No wonder observers are confused.

What has stood out during all of 2022, and especially in the past few months, is the sharp acceleration of the external value of the US dollar against most mainstream currencies. The dollar is now viewed as the only haven offering protection from today’s turbulence. Apart from the well-cited interest rate differentials between the US dollar and other currencies, this acceleration has resulted from the well-known phenomenon by which US investors tend to repatriate non-US assets whenever international tensions rise.

On top of this there are the usual suspects who have no hesitation in announcing once again the impending demise of the euro. Its steady devaluation to parity with the US dollar and the Swiss Franc is described as the beginning of the end of the European single currency, as so often in the past, with understandable economic arguments but which are lacking in financial reality. Even the new Italian government, decried by many as harbouring fascist tendencies, has wisely chosen not to pick a fight with Brussels.

The glaring international liquidity crisis has been the hallmark of today’s severe strains in global financial markets. Its reversal will be the crucial factor that could serve to calm tensions and restore confidence, other things being equal. When this reversal would set in and what could cause it are the hot topics of discussion among market participants and observers. But despite predictions from all sides, no investor or observer enjoys the benefits of a crystal ball. Instead, and however difficult this might be for investors who have suffered sharp falls in the share prices of most types of businesses, a long-term approach by the investor is the surest way for his or her portfolio to be protected from wrong decisions that risk causing a permanent loss of capital.

Meanwhile, however, stock markets and bond prices are grinding down in what is a typical bear market on all fronts. Bear markets, say veterans, are designed to take money out of investors’ pockets. Even the share prices of the highest-quality businesses, such as quality growth companies, are penalized with the argument that the more solid a company’s margins, the more vulnerable these can become in the future. Where margins are low and have already taken a battering, the safety net is wider for the investor, runs the current mantra, as the damage is done. This is turning the rules of investment on their head.

The rear-view mirror currently represents the greatest danger to investors in the best businesses in the world and who have seen their share prices melt away, swept down by the mainstream negative sentiment against all asset categories. Apart from isolated hedge funds, there has been nowhere to hide as inflation gnaws away at the perceived safety of nominal cash returns while share and bond prices have not escaped the savage declines. (Even inflation-linked bonds have not delivered significant protection.)

The decline in share and bond prices as well as the growing negative sentiment represents the path of least resistance for investors, commentators and observers. Any contrarian stance has, so far this year, proved to be a fool’s errand, and an expensive one, at least for the moment.

What has become most difficult is to adopt a positive stance, both in general and for investors in quality growth companies in particular. The latter’s share prices have fallen back to levels from which they rose strongly in past years. Yet as the year 2022 has unfolded in grim economic circumstances, quality growth businesses have once again proven why they enjoy this label, contrary to the vast majority of companies listed on stock exchanges around the world.

For the long-term investor in quality growth businesses, their share price declines are not a warning signal of any impending deterioration in their superior qualities.

However difficult, investors should remember that the stock market’s role is to put a price today on the earnings of tomorrow. But in today’s environment, the markets will have none of it as they focus not on the opportunities of the future, but on the travails of today.

For the shrewd investor, therefore, carpe diem should be his conclusion.

P. Seilern-Aspang

Any forecasts, opinions, goals, strategies, outlooks and or estimates and expectations or other non-historical commentary contained herein or expressed in this document are based on current forecasts, opinions and or estimates and expectations only, and are considered “forward looking statements”. Forward-looking statements are subject to risks and uncertainties that may cause actual future results to be different from expectations.  Nothing in this newsletter is a recommendation for a particular stock.  The views, forecasts, opinions and or estimates and expectations expressed in this document are a reflection of Seilern Investment Management Ltd’s best judgment as of the date of this communication’s publication, and are subject to change. No responsibility or liability shall be accepted for amending, correcting, or updating any information or forecasts, opinions and or estimates and expectations contained herein.

Please be aware that past performance should not be seen as an indication of future performance. Any financial instrument included in this website could be considered high risk and investors may not get back all of their original investment. The value of any investments and or financial instruments included in this website and the income derived from them may fluctuate and you may not receive back the amount originally invested. In addition stock market fluctuations and currency movements may also affect the value of investments.

This content is not intended for use by U.S. Persons. It may be used by branches or agencies of banks or insurance companies organised and/or regulated under U.S. federal or state law, acting on behalf of or distributing to non-U.S. Persons. This material must not be further distributed to clients of such branches or agencies or to the general public.