The stock market to the industrial and not the financial crisis?

The stock market to the industrial and not the financial crisis?


Francois d'Hautefeuille

Few investors and entrepreneurs have experienced or even studied the last major industrial crisis.  This loss of experience at the company and manager level is a crucial factor in the growth of risk.  (Photo: Unsplash - Jeriden Villegas)

Few investors and entrepreneurs have experienced or even studied the last major industrial crisis. This loss of experience at the company and manager level is a crucial factor in the growth of risk. (Photo: Unsplash – Jeriden Villegas)

The year 2022 risks being an “annus horribilis” for many financial legacies. We must prepare for the worst (industrial crisis) and hope for the best (peace in Ukraine). Great opportunities will come from the crises we are going through. Risk weight vs. return must be at the heart of all financial management more than ever.

Chronicle of the “perfect storm” (economic storm) announced?

The main economic crises of the last 30 years have been largely financial, not industrial. These are mainly financial crashes such as 1987 or 2000 or financial bankruptcies such as Enron, Lehmann in 2008 and Greece in 2011. In 2023, we expect a crisis. It will not be financial, but industrial through industrial bankruptcies and restructurings and economic. This is Davos’ famous “Big Reset”.

This industrial crisis will be a Schumpeterian crisis of creative destruction (bankruptcies and business start-ups, restructuring of production circuits, introduction of new technologies). This will correspond to the emergence of Kondratieff’s new economic cycle. The World Economic Forum rightly emphasizes the advent of this fourth industrial revolution. It is restructuring the economy and society through climate change and digital broadcasting.

Towards an industrial rather than a financial crisis?

Few investors and entrepreneurs have experienced or even studied the last major industrial crisis. This loss of experience at the company and manager level is a crucial factor in the growth of risk.

These crises correspond to the Minsk crises. He sees the collapse of the accumulation of financial bubbles associated with a large rotation of global liquidity and the Minsk credit cycle (creation of financial and economic bubbles). The fall in rates below zero, and thus far from Wicksell’s natural rate, has led to the sometimes sub-optimal allocation of savings to sterile investments (major prestigious Chinese projects such as Hong Kong Shenzhen Bridge, unproductive Chinese real estate, euro funds in France through liquidity traps credit bonds, etc.). Slowly but surely, this led to the destruction of the middle classes and thus democracy as in the 1930s.

The current reflection combined with major technological innovations will profoundly change production circuits and therefore transform globalization. It is undoubtedly the end of globalization as we know it over the last 20 years, when China has been able to control world growth by becoming the world’s factory.

As Hayek emphasized in his key book, Price and Production, inflation should not be analyzed from a macroeconomic perspective alone, as Keynes did. Especially at the microeconomic level, distortions in the price structure are transforming production circuits. In fact, entrepreneurs often tend to misinterpret the economic cycle and pre-supply or overinvest in times of rising prices, a fortiori in the production and non-consumer goods phase (the “bull whip” effect).

However, it is the final consumer and his purchasing power that confirms the investment decisions of all actors in the production chain. The exaggerated investments and speculative behavior of producers, as we are seeing them now, are bearing the brunt of the coming crisis of severe bankruptcies, as we experienced in the 1970s. Entire economic sectors (textiles, coal, steel, etc.) were then sacrificed on the altar of Schumpeter’s creative destruction, enabling the emergence of new, more productive economic activities (information technology, electronics, healthcare, services, tourism, luxury).

It is still difficult to break the veil behind the coming changes, but the WEF and the World 2030 program have already provided interesting clues: sustainable growth that enables sustainable growth with better use of resources, especially using hydrogen associated with nuclear energy as a non-polluting energy. Replacing the “human machine” with a human machine through artificial intelligence with the potential to increase productivity and thus create significant wealth.

How to survive slender cows and take advantage of fat cows?

In an increasingly poor world, it is always difficult to get rich. Finance is only a veil reflecting the creation of global wealth.
Joseph’s interpretation of Pharaoh’s dream remains a message about the need to protect savings. It is not too late to build and store granaries that will protect against future plagues and will even thrive in storms. But then it is necessary to know how to build these attic stocks of savings on the financial rock of lasting economic value and not on the sand of delusions of speculation.

Comparison of the performance of Evariste’s active allocation since the beginning of 2022 compared to the passive allocation of 60% of European bonds and 40% of European shares. The decrease in Evariste’s active allocation is limited to -6.9% compared to -11.7% for the passive portfolio, ie the performance is almost 50% higher.

Source: Evariste Quant Research, Bloomberg LLP.  Model portfolio free of charge.  Past performance does not guarantee future performance.

Source: Evariste Quant Research, Bloomberg LLP. Model portfolio free of charge. Past performance does not guarantee future performance.

Towards the bursting of 20 years of financial bubbles?

Money market investments looked the worst in an environment of war and inflation. They may prove to be some of the best. “Cash is king” at a time when “cash is waste” (cash is king when cash seems to be malfunctioning due to inflation). USD money market funds were among the best investments in 2022.

Inflation-indexed bonds cannot play their role as risk-free assets as long as real rates remain strongly negative. They are growing in line with the Fed’s legitimate and expected tightening expectations towards 3 / 3.5% since the end of 2003, ie 0.5% on increase. Markets expect a more limited increase on the part of the ECB at a rate of 0.25% to 1.25% at the end of 2023.

Bonds have reached the end of their 40-year deflationary cycle and no longer play their historical role as a decorrelation asset for 60/40 strategies. Worse, the Fed has launched quantitative easing operations. It will participate in the renormalization of rates by selling bonds from its balance sheet.

Gold has not risen because it is sensitive to rising real rates. That is probably overrated. Commodities probably caught up or even exceeded their natural price. The speculative behavior of producers and individuals who amass stocks is early signs of future industrial bankruptcies (“bull whip management”).

So far, stocks have fallen steadily. But here again we see a new structure. The best equity funds on the market, often rightly focused on long-term growth stocks, are subject to indices and do not generate alpha declines. For us, this is not a sign of managers’ inability or the impact of rising rates on growth stocks, but above all the departure of “smart money” from stocks.

The chickens hatch home (“hens are returning to the chicken coop to bear”): the dollar confirms its safe haven status during this turbulent period.

The dollar was clearly the big winner of this global liquefaction market. It is the only asset that has really grown. Investors are encouraged to invest some of their savings there, even though it is notoriously difficult to predict exchange rate movements.

From a geopolitical point of view, the United States is a great winner of the war with Russia and the end of Chinese-style globalization.
The euro area is entering a period of fundamental change again. Strengthening the economic and political unity of a disparate economic area is a historic challenge for the ECB. The democratic deficit of the European institutions risks limiting the quality of the European people’s response, which is still being built. All the political and economic genius of Christine Lagarde will be needed to overcome the turbulent and turbulent waters we are approaching.

Conclusion

We are entering one of these great periods of creative destruction of the economy and finance. The great wealth built up over the last 30 years will be destroyed and transferred to those who know how to surf the wave of history.

Managing the coming crisis requires more than ever to believe in the miracle of collective intelligence based on the virtuous circle between democracy and capitalism, so that we can follow the Paths to Freedom that Tocqueville and Hayek tracked down.


This financial analysis is not investment advice. Evariste Quant Research and its clients may hold the securities listed in this analysis.
François d’HAUTEFEUILLE – Evariste Quant Research – Member of the Independent Analyst Circle – Former DWS Manager Frankfurt – Former Director of Structured Management Amundi – Former Director of Hedge Fund Managed Accounts Deutsche Bank London – ESSEC Graduate

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