English Markets

Bank turmoil (1st Quarter 2023)

The dilemma central banks between financial instability and high inflation continues.

This quarter was again full of significant events in the financial markets: Beyond the banking stress episodes in the US and Switzerland, long-term retail investors should keep an eye on valuation and interest rates to strive for balance in their portfolios. This review curates around 100 memos and articles (see the main in the source) from our preferred references for diversified global macro retail investors: Oaktree, Bridgewater, the Economist, NNZ or the Financial Times.

Health of the banking system

According to Ray Dalio, the triggers for the bank stress are the issues of negative cash-flow projects, private equity companies and commercial real estate impacted by higher interest rates and tight money. The turbulence at leveraged banks with asset-liability mismatch could be a “canary in the coal mine” with wider impacts such as further sales of assets at discount, credit problems and “more seizures and shutdowns” to come according to Larry Fink. Central banks will then have to move from “raising interest rates and selling debt (QT) to lowering interest rates and buying debt (QE)” again according to Ray Dalio and the next rate cut could be in less than a year, leading potentially to a massive decline in the value of money. For The Economist, the banking system must be strengthened by removing exemptions to mid-sized banks and recognizing the risks from rising interest rates (especially for banks with unrealized losses).

Interest rates in Switzerland and beyond

The SNB  raised the key rate by 50 basis points to 1.5 percent, which is still low by international standards. As other central banks, The SNB faces a dilemma: On the one hand, inflation at 3.4 percent was well above the target range below 2 percent, which suggested an interest rate hike. On the other hand, the banking crisis is causing nervousness and has led to calls for monetary policy not to add stress to the system. So, the trade-off of central banks between financial instability and high inflation will remain according to the Economist.

Overall economic outlook

According to Ray Dalio, the current tightening of money to fight inflation leads a contraction and stress. This goes on until central banks provide easy money again. These alternate actions continue until they are unsustainable and lead to a gigantic “restructuring and debt monetization (which typically happens about once every 75 years, give or take about 25 years)”.

Valuation across asset classes

According to Howard Marks, markets are currently not excessively high or low, which does not permit a “market call” with a good chance of success. Even if we have moved from a low-return world (2009-2021) to a full-return world, there are high risks in EM debt investment and high yields bonds because they do not offer a yield commensurate to the current high-risk situation.

There are certainly opportunities due to the economic damages that are happening for bargains, such as in distressed credits or real estate. These opportunities will persist if the authorities cannot bail out economies with financial easing due to their need to control inflation. But as stated by Steve Eisman, who is buying bonds for the first time in 15 years : In such an environment: “Don’t be a hero”.

Positioning for retail global macro diversified investors

As stated by Larry Fink, we are paying the price “for decades of easy money”. These bad economic conditions, with potential social unrest and international conflict will make the next two years very risky according to Ray Dalio. To reduce risks, without reducing expected returns, investors should look for a balance between “uncorrelated good return streams”, without directional bets to conditions improving or worsening. As “valuations are not crazy” Howard Marks recommends to look for an equilibrium between defensiveness and aggressiveness. This corresponds our approach to limit risks through international diversification (see our short investment guide) versus short-term bets and speculation.

- After SVB's collapse The prop-up job, The Economist, 18.03.2023
- Es gibt wieder dieses Gefühl des Jahres 2008, Handelsblatt, 17.03.2023
- The great balancing act, The economist, 25.03.2023
- The Roundup: Top Takeaways From Oaktree’s Quarterly Letters - March 2023 Edition, Oaktree Capital Management, 23.3.2023
What I Think About the Silicon Valley Bank Situation, Ray Dalio, 14.3.2023