Even by recent standards, the first quarter was interesting. Most commentators expressed shock by the developments in March as one bank after the other collapsed in various versions of insufficient risk management and complacency. Still, both bonds and equities delivered decent returns and especially growth stocks delivered a solid return towards the end of the quarter. In Switzerland, and throughout the investment world, people were surprised to see SVB go under, but it seems like the severity of the issues at Credit Suisse are only really being realised post its collapse, even though the share price of CS had declined by more than 90% by end of 2022 since it peak in 2007, and despite CS accumulating approximately 50 fines over recent years. From a “quantitative” perspective these were solid trends publicly available for anyone to see for over more than a decade. Additionally, it all happened less than 15-years after the UBS bailout! Starting next week, the Swiss parliament will assess the actions of the government, the SNB and FINMA. The public prosecutor has also started an investigation.
There are many reasons for markets finishing the quarter on a positive note, including the progress of the earnings recession and the positive development in China where Alibaba will be broken up and Jack Ma has returned to public life on the mainland. Still, we suggest that the main reason is that markets realised that the Fed and the followers (ECB, SNB, BoE etc.), firstly have tightened enough and secondly will soon also come to this realisation themselves, so even if they hike a bit more, they will soon come to a halt.
Figure 1: US and German yields reset and the recent partial reversal to Q3 2022 levels
The FOMC apparently themselves expect to hike more, but their expectations a year ago did not surpass the peak beyond 2.5-3%. As for the ECB, we note that they are from time to time right, but that does not appear to be the case most of the time. As a result of the large directional moves and increased volatility there has been some market “clean-up” via position closing and losses across both discretionary and systematic strategies. A number of fixed income “hedge funds” including Brevan Howard and Rokos experienced significant drawdowns, which in the case of the latter reached 15%+: Rokos being the company which rewarded Rokos its portfolio manager a bonus of more than GBP 400mln in 2022 (for investment results in 2021). As central banks and investors increasingly realised that the nominal tightening deliveries so far have a larger than expected effect, a reset of short and long duration government bond yields in both the US and Europe has happened (seen in Figure 1). In what appears as an unusually clear, “all else equal” experience in financial markets, cash rich companies with strong growth prospects have rallied. The broad Nasdaq index thus had its best quarter since 2020 and Nasdaq 100 is up 20% since the recent bottom. The main risks from here are that the US inflation, seen in Figure 2, does not come down as fast as expected. As the normalisation of inflation is on track for now, we remain overweight in equities and credit at the expense of the very volatile government bonds while monitoring the situation via spreads and algorithms shown in Figures 4, 5 and 6.
In our growth strategies, with up to 100% equities, we hold equity allocations close to maximum levels, with corresponding underweights in high grade bonds. In EDGE Sustainable Growth, these positions are concentrated in the low pollution, high growth sectors, such as IT and Healthcare.
In our balanced multi-asset strategies, we hold equity allocations close to maximum levels and maintain significant holdings of high yield bonds where yields are now often above 7%, while BB- rated bonds account for more than 50% of such positions.
Across our Global Fixed Income Opportunities portfolios, we remain close to a maximum allocation to high yield bonds in mandates and in sustainable and ethical investment strategies. We are maintaining short duration to limit exposure to central bank-induced volatility.
Mads N. S. Pedersen
Managing Partner and CIO