Deeper into the New Era: The Importance of International Planning
In the fall of 2020, we published our special report “On the brink of a New Era–are you prepared?” and in it, we gave our readers an idea of what the next couple of years might bring. Many of the projections in the report have become reality, especially the reemergence of inflation that has become a global issue. Unfortunately, the growing global tension in an increasingly multi-polar world order is also a reality today and with the Ukraine war we have reached a new level of escalation. We also made the case in our report that investing in the future will be more demanding; a simple buy and hold strategy will not be enough anymore. We are only a few weeks away from releasing our follow up report, “Deeper into the New Era”. We encourage you to carefully review and study it, as it contains a lot of critical information and insights that could prove invaluable for investors.
Since our February investment update, a lot has happened and we saw many new developments that had a practical impact. Our regular readers might remember that back in the fall of 2022, we were projecting a peak of the interest rate cycle in the spring of 2023 and a slow easing of inflationary pressures, which should also be supportive for equity markets and allow them to find a firm bottom and start recovering. So far this has been the case and we have indeed been seeing a recovery in global equity markets from the lows of Q3/Q4 2022. In the short term, there could be renewed strong pressure on share prices, for example from pressure on earnings or a renewed banking crisis, but we continue to believe that the markets have significant recovery potential afterwards and we are preparing accordingly.
While inflation continues to slow down, we don’t expect it to fall back to the ultra-low levels we had until two years ago. However, just the fact that it is receding might already be enough to support financial markets. With the potential peak in inflation behind us for now, we are expecting central banks to adjust their strate- gies based on underlying economic fundamentals and these fundamentals don’t look very good. Growth has been slowing in most major economies and despite the fact that we are not yet seeing a recession, the outlook remains very fragile with a lot of companies probably seeing headwinds developing for corporate earnings. The most recent earnings season might have included positive surprises, but a lot of companies have also benefitted from “catch-up” activity, from their supply chain pains easing somewhat and allowing them to finally deliver products faster again.
This is the good news. The bad news is that many companies are seeing a slowing pipeline and new order intake and that will have a negative impact on corporate earnings going forward. It is hard to say if this can lead to another downturn in the market in coming weeks, but we recommend focusing on opportunities with a 2-3 year time horizon because the outlook there is a more positive one in our view.
One of the most popular Bruce Springsteen songs, “Dancing in the Dark”, is kind of reminiscent of today’s investment environment and outlook. Visibility is quite low and therefore it is more important than ever before to have a sound long-term strategy with a clear focus and risk management needs to be a key priority. This is also a good time for investors to do a fundamental review of how they are positioned and what needs to change now in order to optimize investment results in coming years. Our upcoming special report will include a lot of useful information and explain the big developments and trends we expect in the coming years.
Making sound investments has always been based on anticipating how the world might evolve. While it is very difficult, if not impossible, to make accurate long-term predictions, we believe that many of the key trends and themes that can already be identified today, can be used to make smart investment decisions.
Since the release of our last investment update, the most critical events were certainly those in connection with a growing number of banks that have gotten into problems. Our readers might recall that we have been expecting problems like these in the banking sector for quite some time now, but we were somewhat surprised to see how quickly this all unfolded. The demise of banks like Silicon Valley Bank and First Republic Bank clearly showed that there is a lot of risk on bank balance sheets, American ones in particular. Our biggest concern at this point is the huge exposure banks have to commercial real estate, a sector that is currently going through a very difficult time, and we expect even more pressures in the months and years ahead, a topic we’ll examine in the second part of this report. The pandemic has been a real game changer in this context, with many more people now working remotely or partly remotely and this change is here to stay. That also means that over time companies will make adjustments to their leases and the bottom line is that much more space will become available, which will put prices under a lot of pressure.
Overall, we are anticipating a continued slowdown in the world economy that will probably persist for the next 2-3 quarters. Whether or not this will translate into a recession in the U.S. and Europe is not yet clear, but what is clear is that growth will be anemic and slow. This, however, does not automatically mean lower equity markets: in fact, very often, a sustainable recovery in stock markets starts when growth is slow, or even negative, and before interest rates are cut. This is a very realistic scenario for the second half of this year or the first half of next year.
So, while there are a lot of uncertainties in the short-term, we think investors would do well to remain almost fully invested, but at the same time they should have solid downside protection in place, which is pretty much standard for our clients’ portfolios. We also recommend higher allocations to real assets such as precious metals and commodities.
The most important advice that we can give to investors at this point is to set their priorities right. That means, first and foremost, having a very safe and secure place for the custody of your assets, which brings us to the Swiss private banking model. “How to own”, rather than “what to own”, has really become one of the most critical questions in wealth management and the recent banking crisis in the U.S. shows that investors simply can’t assume anymore that banks are safe. The Swiss private banking model offers very significant advantages, because private banks tend to be much more conservative and also keep a lot more capital on their balance sheets. Once you have a solid situation in place, the long-term journey for the best investments can begin. There are great benefits and opportunities to be found in international planning and investing, since it doesn’t just offer more investment options, but it also greatly enhances wealth protection too.
We would be happy to be your partner and ally for global investments, as we have been doing this for exactly three decades - 2023 was our 30-year anniversary. We are looking forward to hearing from you and please make sure to reach out and get a copy of our upcoming special report, “Deeper into the New Era”. We are sure that you’ll find it practically valuable as a guide to your investment journey.
Commercial Real Estate: the trigger of the next banking crisis?
So far 2023 has been a very bad year for the banking sector. The monetary policy U-turn, spearheaded by the Federal Reserve, but quickly adopted by other central banks too, put immense pressure on the banks, and it didn’t take long for the cracks to start showing.
The persistent and prolonged interest rate hikes caused the value of bank bond holdings to plummet. Especially in the US, this was combined with the so-called“Tech Winter”, that saw stock prices of Big Tech giants tumble, but also affected tech start-ups, that had their funding slashed. These were the dynamics that caused the first domino to fall: the tech-heavy Silicon Valley Bank, the 16th largest bank in the country and the biggest one to default since 2008. Officials were quick to respond, to guarantee deposits, but most of all, to assure investors and the public that this would in no way be anything like the last recession. However, fears spread anyway and bank stocks took a serious hit. Two more banks crumbled in the US after that, as well as Credit Suisse in Switzerland, a global player and not one of the Swiss private banks we work with, which have very different business models.
Although it might seem like some calm has returned to the sector recently, investors should remain vigilant, because in all likelihood this sense of being “back to business as usual” will prove to be temporary. The banking crisis is far from over. In fact, we might very well be seeing the makings of the next wave of bankruptcies and the epicenter of instability this time could be in the very troubled commercial real estate (CRE) sector.
Regional banks: a cornerstone of the “real economy”
Although most investors and most American citizens had never even heard of Signature Financial or First Republic before their collapse, or of any of their peers for that matter, regional banks are the backbone of the US economy. They are essential to economic growth, as they provide the majority of credit support to small businesses and ordinary households. They provide almost one-third of small business financing, which in turn generate two out of every three new jobs in the nation, according to the Small Business Administration. Also, as a recent Goldman Sachs analysis showed, banks with less than $250 billion in assets are the source of around 60% of all US mortgages, 80% of all commercial real estate loans, and 45% of all consumer loans.
However, this is all now under threat. The aforementioned pressures emanating from the higher interest rate environment - the bond portfolio markdowns - were already worrying enough, but the fear caused by the defaults also led to record levels of deposit flight, placing many regional banks in a very precarious position. The KBW Regional Banking Index is already down about 30% since March 8. And now, alarm bells are ringing increasingly loudly, as trouble in the CRE space could be the undoing of many of them, causing a domino effect and creating a perfect storm.
Small banks hold close to 70% of CRE loans and according to a report by JP Morgan, “compared to big banks, small banks hold 4.4-times more exposure to U.S. [CRE] loans than their larger peers. Within that cohort of small banks, CRE loans make up 28.7% of assets, compared with only 6.5% at big banks. More worrying, a significant percentage of those loans will require refinancing in the coming years, exacerbating difficulties for borrowers in a rising rate environment.”
The credit that regional banks provide, the oil that greases the entire economy, has already tightened considerably: in fact, US bank lending shrank by the most on record in the last two weeks of March. However, it could grind to a halt if the CRE crisis materializes. This could be the next trigger of a much wider and much deeper banking meltdown.
The trouble with CRE
The problem, in a nutshell, is that there’s too much empty real estate. Office space is a particularly severe pain point. The covid-induced remote work phenomenon is still here and most likely it’s here to stay. The current level of remote work remains 7 times higher than it was in the pre-covid days. For example, only 20% of financial services firms require full-time office attendance, according to a new survey by Scoop and across all industries, around 50% of companies insist on employees working three days a week on-site, while 41% require just two days.
As Reuters highlights: “The current overall vacancy rate of 12.5% is comparable to where it was in 2010, one year after the onset of the Global Financial Crisis.” Of course, it’s not only the pandemic working habits that stayed with us that are at fault. The massive and persistent waves of corporate layoffs and downsizing efforts, especially in the badly battered tech sector, have also contributed considerably to the weakened demand for office space. As might be expected, the high vacancy rates have had a heavy impact, but what might be more surprising is just how heavy it has been: no rent is being paid on 1 in 5 of all US office space.
It is also important to note that its not just office space that’s struggling. Retail too is under pressure. The rise of e-commerce over the last decade has slowly but surely decimated demand for physical brick and mortar shops, as evidenced especially clearly by the demise of the American mall. Demand has shifted to logistics facilities and warehouses instead, and as though the ease and convenience of the online shopping competition weren’t enough, physical retail also has to contend with the added challenge of inflation. According a survey by Mirakl, ”89% of global consumers say inflation has made them look for better value when shopping – and 75% are moving more of their spending online in the next 12 months to find that value.”
Adding another, and arguably more serious, layer of concern is the fact that by nature CRE assets are particularly vulnerable to higher interest rates. Even if interest rates simply stay where they are, or even slightly decline, a CRE crisis could still emerge, because there are loan renewals coming up in the next few years that can only be done at massively higher interest rates. And this would come at a time when both landlords and tenants are already financially weakened.
The deteriorating outlook of the CRE space and the extent to which regional banks are exposed to it could very easily trigger a severe banking crisis and an avalanche of bankruptcies. The remedy that worked in previous bank failures this year, the Federal Deposit Insurance Corporation (FDIC) is extremely unlikely to be of any meaningful use in that scenario. The FDIC is an independent US agency that member banks fund, and it is meant to protect deposits, up to $250,000, in the event a failure. However, it is dangerously underfunded and in no position to respond to a more widespread banking crisis.
What’s more, in the case of the SVB failure, most deposits were above that amount and thus uninsured, which is why the US government had to step in and guarantee all funds, to avert investor panic. That is not a realistic solution either in the case of multiple bank collapses, neither can we expect every failed regional bank to be bought by a big one. The only remaining option in that case would appear to be the return to the bail out approach, something that would be politically untenable and could trigger severe sociopolitical tensions. Yet, even if that road is taken, it is not certain at all that it will be enough to stabilize the banking sector.
Finally, investors must keep in mind that the situation doesn’t have to deteriorate to this point for substantial risks to emerge. Even before we reach a serious dead-end like this, or even if we never do and disaster is somehow averted, investors need to consider what will precede it and what dangers like ahead. As struggling regional banks keep tightening their lending standards, small and medium sized businesses will face either higher costs or just lose access to financing. The same is true for households, as they are bound to lose their credit lines too. All this is bound to have a seriously detrimental impact on the economy and given that we’re already veering worrying close to a recession, this could make sure it will be long and painful one. For this reason, we at BFI Infinity remain very cautious and vigilant and prefer an active and selective investment approach for the future, in which risk management considerations and tools are an essential component.
This report was prepared and published by BFI Infinity Inc., a Swiss wealth management company registered under the U.S. Investment Advisors Act of 1940 with the U.S. Securities and Exchange Commission (SEC) as an investment advisor.
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