Here are the key events of the last quarter that have and will continue to influence global equity investments. They mainly concern the attractiveness of the banking sector and developments in Asia (China, Japan and India):
Declining attractiveness of banks
Banks are built on asymmetries between their liabilities and assets. They pay depositors or the central bank a low interest rate to borrow funds, and they lend or invest these funds at slightly higher rates.
On the one hand, solvency requires bank managers to be aware of the risky nature of the assets they acquire. On the other hand, no bank can have sufficient liquidity to meet its needs if enough depositors are demanding their money at the same time. As a result, banks are essentially highly leveraged fixed-income investors. In view of this model and the eternal risk posed by banks, they have been subjected to a corset of strict rules. Some banks in the USA and Switzerland have just been rescued by state (or quasi-state) intervention. According to Kevin O’Leary, banks have turned into utilities, and will no longer be able to offer attractive returns to investors in the near future.
Bonds back on the map
Singapore’s DBS Bank is now recommending an overweighting of bonds, following the sharp rise in interest rates in some markets. It believes that companies with yields above 5% today will be a source of regular income. One way of investing while reducing the risk of individual bankruptcies is through a diversified bond ETF. Since the rate hike, iShares and Vanguard have seen strong flows into their passive bond ETFs in particular. However, investors in Switzerland should perhaps not rush in without thinking about their real need and the current relatively low attractiveness: If investing in CHF corporate ETFs, one can expect around 1% coupon, which is not particularly attractive, but should increase in the future.
China and the USA
According to Ray Dalio, the American public wants its leaders to oppose China, and China’s more aggressive Taiwan policy is dangerously affecting relations between the two powers, even though both countries fear war. This situation is also affecting currency and capital flows, which are becoming more aligned with trade flows and geopolitical alliances, as seen with the BRIC Development Bank. This could lead to more onshoring and “friendshoring”, both of which are much less profitable for companies and lower returns on investment.
Two themes could play an important role in this battle for influence: AI and currencies:
- China is said to be around two years behind the USA in terms of innovative AI (ChatGPT-type technologies). It could find it difficult to keep up, given the absence of chips, an advantage for the USA.
- Reserve currency: The mBridge project of various central banks serves as a specialized and flexible platform for multi-currency cross-border payments. The Chinese Central Bank’s Digital Currency Institute is playing a leading role, with the aim of connecting economies via CBDCs. If successful, this could form a digital infrastructure to facilitate international flows in Chinese currency.
Exchange rates and share prices in Japan
Japanese equities rallied strongly over the last quarter (despite the downturn at the end of June).
The Central Bank of Japan’s quantitative easing policy, aimed at keeping interest rates low, could come to an end, reducing the future attractiveness of Japanese equities. In addition, the yen has appreciated, making Japanese equities less attractive to foreign investors. However, Japanese companies remain attractive in many sectors: for example, they supply almost half of the world’s industrial robots. They also provide sensors, automation systems, artificial intelligence and IoT for digitalization, as well as renewable energy systems, smart grids and energy storage solutions to support the energy transition. These are areas in which Japan’s industrial electronics sector can play a key role and support the long-term growth of companies in this sector.
High price in India
The performance of the Indian stock market is largely due to price expansion rather than earnings growth. This expansion is unlikely to continue, especially as India is now trading at a high premium to emerging market equities (close to 60% for some analysts) and is at a high level of market capitalization to GDP (i.e. over 100%). The upside for India could be limited, given higher interest rates and moderate growth.
For investors in global macro equities, the reopening of China calls for an overweighting of Asian equities. Attractive entry points should be watched for in volatile markets. Japan ETFs became slightly more attractive again at the end of June after a sharp rise at the start of the year, as did emerging market ETFs with the key constituents discussed above (China and India to a lesser extent).
Sources: CIO Asset Allocation, Chief Investment Office DBS, Hou Wey Fook, 25 Apr 2023 Lessons from Silicon Valley Bank, MEMOS FROM HOWARD MARKS, 17 April, 2023 Report: Project mBridge: Connecting economies through CBDC, BIS, October 2022 What I Think Is Going On 1) with China-US Relations, 2) with Their Relations with Other Countries, and 3) in China, Ray Dalio, 26 April, 2023
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