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Citation - Fourth Quarter 2022



George Herman
Chief Investment Officer: Citadel Asset Management
Estimated reading time: 4 minutes 17 seconds

It’s a new Gregorian calendar year, 2023, and as Western society citizens, we typically go into a ritual of recalling the ‘lessons’ from the previous year and planning and forecasting about the new year that’s starting. Personally, I think that trying to do such an important exercise in the middle of summer, during a holiday period, is foolish. This exercise requires dedication and laser-like focus, combined with honesty, humility and an open mind. My personal habit is, thus, to do this exercise every year around my own birthday, in February, once the noise of the thousands of others trying to predict the future, has settled.

Cycles in the global economy and the financial markets don’t follow the calendar year with perfectly predictable dates or periods. The financial world pulsates in cycles of varying length and amplitude, depending on the stimuli and knock-on effects that causes movement or change in the first place. Whatever the disturbance to the system, it ripples through the entire interconnected world, just like when a stone is thrown into a still pond. The ripples through the financial world, however, are not as predictable and concentric as those in a pond. Friction and counteractions affect the impact and distribution of this movement throughout the globe.

Last year was one for the books. The Russian invasion of Ukraine threw an enormous rock into global financial and political pools! Supply chains and alliances were obliterated, and Putin’s invasion of his neighbour brought an immediate end to the three decades of globalisation and any hopes of increasing interconnectedness. National interest and supply security suddenly became the new mantra, but at a higher cost. The inflation genie, that was well contained for four decades, popped out of the bottle with a classic new-year’s-party bang. That bang woke up central bankers, who were happily asleep on their beds of monetary stability. The surge in inflation was a tsunami of a ripple, which caused a cost-of-living crisis for the average global citizen as the cost of everything, but especially food, energy and shelter, skyrocketed. This synchronised global tightening of monetary policy was a shot in the guts of global economic growth. Furthermore, the higher interest rates obliterated the valuation of all financial assets, including bonds and equities. This rate-reset, away from a zero-rate world that financial assets became accustomed to, forced revaluations of all long-term growth assets

But while growth assets were coming to grips with higher discount rates, the world and especially Europe, had to come to terms with a shortage of energy and food staples. As the West withdrew Russia’s ability to transact in dollars and implemented sanctions, Putin, in an act of spite, withdrew supply of Russian carbon fuels to Europe. The world also lost one of its biggest grain suppliers, in Ukraine, and suddenly food and grain-oil shortages appeared all around the globe, exacerbating the surge in inflation.

As we start 2023, where is this cycle now? Has it evaporated or changed just because some calendar has a new digit at the end? Not at all! The world is still in the grips of the aftermath of all these impulses that infiltrated the global economy, finances, markets and politics. This global game of commodity and political chess is far from over. Only now, it is operating from a platform with much higher interest rates and tighter liquidity. As such, much fuss is made every time the United States (US) Federal Open Market Committee meets to announce official interest rates for the US, but in fact this is but a small variable on the global gameboard. This economic cycle of higher interest rates in order to choke inflation has come at the cost of lower economic growth. How much less economic growth? The abundance of outlook reports all suggest economic growth will slow down this year, which comes as no surprise, as the cycle finds a new deglobalised equilibrium.

In the meantime, financial markets are quick to reset and look past what is considered short term noise and start looking at a world where the war is over, energy and food is once again abundant, and central banks reduce interest rates, allowing for the next growth-upswing of the cycle. Is this an appropriate assumption, or is it too early? Have the markets become spoilt over the last two decades by central banks that have bailed out growth-slowdown cycles with liquidity, thanks to the mysterious lack of inflation? Will inflation subside back to levels where central banks can relax monetary policy or have new dynamics entered the reconfigured world? We have formulated our views on these matters as the year begins, so please do read our Chief Economist, Maarten Ackerman’s piece in this edition of Citation.

At Citadel, our investment process runs in time with the Gregorian calendar, but our thinking is entirely based on the globe as a whole, and the equilibrium that needs to exist between the growth cycle and financial markets. It’s exactly at this intersection where our services add value to your life, no matter what the calendar says.

I hope you enjoy this edition of Citation.