Looming risks for investors

High inflation and central bank’s hawkishness have squeezed real disposable income and increased the possibility of another global recession. Stresses in the credit market remain pronounced, following several bank failures and the US Federal Reserve continues to emit contentious signals, locking global liquidity away from money markets.

Global supply chains, which were under pressure even before the Ukraine war, are now facing more shocks, as China which lies at the heart of global supply chains, is less stable.

The Fed’s obsession with inflation means that all these risks could have a more significant impact on markets than in previous years. Other central banks, bar China, are following with a lag, allowing them to remain hawkish well after the Fed has paused rates.

We expect macroeconomic and market volatility to last well into 2023. Having said that, the deciding factor in all this is the stance of the US Federal Reserve itself. If the Fed reverts to a more accommodative stance, risks as a total could be less impactful. Conversely, if it chooses to dial up the fight against inflation then the risks not only become more pronounced but also more interdependent.

Overall, risks as broadly balanced. China’s reopening appears to have helped growth as opposed to hurting prices. This means that while there’s higher uncertainty as to the final outcomes, and even greater about the quality of the journey there, the ‘more positive’ and ‘more negative’ scenarios have roughly the same probability.

Heightened volatility: At present, the most prominent risk, comes from volatility. As the world becomes more unbalanced, macroeconomic volatility is heightened. This is reflected on interest rate unpredictability, translating into financial market volatility, for equity, credit, bonds etc.

The effects of heightened macroeconomic volatility, a phenomenon that we haven’t experienced since the 1980’s could be far reaching; from financial accidents, a result of mark-to-market practices or counterparty failures, to fiscal and monetary policy mistakes, to difficulty in making accurate business predictions and sound decisions. In this environment, companies and nations could be more vulnerable than they would seem.  

Global and UK Real Estate Market Crash: The stresses in the global real estate market are rising, as a result of higher interest rates and lower disposable incomes. We are already seeing a significant drop in sales in the US and a downward pressure on prices. The European real estate sector is preparing for significant write-downs, as new rules are implemented. Commercial real estate looks to be a key area of concern. We are observing a similar, yet more benign trend in the UK. Having said that, all-time high 30y yields could significantly pressure the UK real estate market.

Private Equity Valuations: Since the Global Financial Crisis, risk has been systematically transferred from the banking sector to the private equity world. Due to the economic and financial oscillations of 2022, many PE companies have not updated their valuations. If that happens on masse, it could have a significant impact and potentially spill over onto regulated investments.

Persisting inflation and a global recession: There is evidence that global inflation may peak, but we believe it will remain significantly above 2% for most of 2023. Hawkish central banks and lower disposable incomes have already had a significant impact on global demand.

Credit Event/Financial Accident: US peripheral banks and Credit Suisse were the first victims of a credit event. While tensions have eased for major institutions, at the time of writing this, smaller banks are still borrowing heavily from the central bank. We still observe some (expected) dislocations in the high yield space, as well as rising dangers in the European periphery.

A US default: In the summer, a divided US Congress will debate on extending the debt ceiling. Failure to do so could lead the US to default, with potentially significant consequences for the global financial system.

George Lagarias, Chief Investment Officer