By David Thomson
In the wake of Union Bank of Switzerland’s takeover of Credit Suisse the focus for markets remains firmly on central banks. Specifically,
the degree to which they will continue to raise interest rates and therefore will there be a recession and if so how deep might it be?
It has been obvious for some time that rising interest rates were not good for investment markets. Indeed, there was a perception central banks would keep raising rates until something broke.
However, most investors did not see the banking sector as a weak link because the banks as a whole are much better capitalised today than they were in 2008. So are there other risks that have gone largely unnoticed, or not prioritised
by markets?
Covid-19 is continuing to have an effect, with disruption to supply chains taking longer to fix than anticipated and employees who left the workforce remaining reluctant to return, despite the inflationary pressure on them.
The consequent elevated cost of living is challenging the social and political environment, highlighted by strikes in the UK and Europe.
From an investors’ perspective it is likely labour will take a larger slice of profits in the years ahead. There is a significant risk inflation will not come down as fast as anticipated. This week UK inflation spiked upwards due to the food shortages caused by poor weather in Europe.
Rising interest rates and inflation will put pressure on a number of areas; not just the banks. This will range from obvious stress points, such as those on floating rate mortgages through to emerging market governments potentially defaulting as their funding costs rise.
Closer to home, during Liz Truss’s tenure as prime minister, we have seen how markets and the cost of borrowing can influence government policy.
While the market has already moved to price in these concerns there is the chance something has been overlooked.
There is even a chance of the US Government defaulting on its debt. It seems unlikely but, technically, the US could default as early as June if Congress does not act to increase the amount the US Government can borrow. The balance between the Democrats and Republicans in Congress is so close markets may have a few sleepless nights as the deadline approaches.
On a more positive note for investment markets, a rare and open expression of discontent has also been seen in China. The context was a lockdown-weary society, but the catalyst was a fire in a residential building where the death toll was deemed to have been more severe due to lockdown restrictions.
The World Cup also played a role, with images in China of football crowds in Qatar not wearing masks reinforcing domestic perceptions that China has been slow to exit lockdowns.
Suffice to say the Chinese government has now had a surprise U-turn on its zero Covid policy. This will help ease some of the supply chain issues and should also result in the unleashing of some pent-up consumer demand.
Another potential positive could be a resolution of the Ukrainian conflict. Russia is currently subject to sanctions from the west and military support, but the conflict shows no sign of ending soon and a good dose of cynicism is probably healthy. However, a surprise resolution could provide markets with a leg-up.
As former US defence secretary Donald Rumsfeld famously said: “There are also unknown unknowns –the ones we don’t know we don’t know. And if one looks throughout the history
of our country and other free countries, it
is the latter category that tends to be the difficult ones.”
Perhaps the best way for most investors to navigate these unknowns is to build a well diversified portfolio and not to try and time the markets by dipping in and out but to stay invested for the longer term.
David Thomson is chief investment officer at VWM Wealth.
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