ajooda Quicknews for investors – October 17, 2022

Inflation

Currently, the nominal economic growth of industrialized countries is very strong. For example, the labor market in the U.S. is thriving like it hasn’t in a long time. There are currently three times more job vacancies than job seekers! Spain and Italy have the lowest unemployment rates since 2009.

However, inflation remains at such a high level (although mostly declining since June) that the central banks will continue to raise interest rates and thus have to accept a rising unemployment rate.

On Thursday, 13.10.22 the USA published its inflation data. Result: 8.2%, lowest since February 2022. And yet, the stock markets crashed because 8.1% was predicted.

Current inflation is considered a measure of central bank action. So if one doesn’t reach the forecast level, the measures were not yet severe enough, leading to even more aggressive measures (more rate hikes by central banks to follow).

Inflation data of some countries:

In Germany, inflation is currently so high that Germany’s nominal economic growth is no longer keeping pace and negative gross domestic product (GDP) growth is expected in Q1 2023. Not lastly due to the overexposure to Russian gas, which represents an increased risk.

On the subject of gas: Norway has now become Europe’s largest gas supplier!

It should be noted that China through their zero covid policy is experiencing a reduced economic development and therefore the inflation there sits at only 2.8%.

Also the Chinese real estate market, which accounts for 25% of China’s GDP, is on a constant downward slide.

If China were to accelerate as in previous years (with GDP growth of up to 8% per year), global inflation would currently be much higher.

End of rising inflation in sight?

At the beginning of winter, inflation should have peaked and be slowly declining (in Spain & France, for example, inflation has already been declining for 2 months).

However, it is still far from the central banks’ targets (Usually around 2% is desired).

Therefore, central banks will continue to adhere to tightening policies to reduce high demand, even if this may mean accepting a (mild) recession in industrialized countries.

How long this would last is uncertain. Experience shows that interest rate changes usually show their full effect only after about 6-9 months.

Bonds = Diversification? Forget it

Until recently, it was always preached to combine an equity portfolio with bonds for diversification reasons, to ensure some risk diversification, as bonds are usually stable.

Well, welcome to 2022 where everything, yes even bonds have lost 15-20% in value due to historically high interest rate hikes.

How is that possible?

How can a bond lose value?

Bonds are usually issued at par value of 100 and the interest rate on a bond is fixed (e.g. 3%) until it matures.

If the central bank now raises prime rate, the interest rate on newly issued bonds increases (e.g. the same bond is now available for 5% instead of the previous 3% interest rate).

Now, however, one still holds “old” bonds which yield only 3% interest. Let’s assume the remaining term is 10 years.

That would be 2% less interest per year, and 20% less return over the whole term!

So what does the investor do? He tries to get rid of his “old” bond on the market to buy a new one. Due to the selling pressure, the bonds lose value.

Especially bonds with a long maturity are exposed to a higher risk (default risk), therefore we recommend investors to rather dedicate themselves to short-term bonds in order to invest the money in a new bond with a higher interest rate in the foreseeable future.

ajooda Conclusion

It is important to realize that the fundamentals of industry-leading companies are rock solid, but macroeconomic factors are still dragging the market down.

Therefore, we recommend focusing on the industry leaders that have pricing power, as they can generate even higher profits than usual in inflationary times.