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Citation - First Quarter 2023



George Herman
Chief Investment Officer: Citadel Asset Management
Estimated reading time: 4 minutes 00 seconds

As we entered the first quarter of 2023, our cautious stance on the global economy was reinforced by several factors, including the possibility of a further slowdown caused by higher interest rates in a constrictive monetary environment. However, China’s reopening after its extended zero-COVID lockdown led to a wave of consumer expenditure and stimulus from various Chinese authorities, which provided a significant boost to the global economy. Unfortunately, it wasn’t enough to counteract the global slowdown that was already unfolding, with the United States (US) Federal Reserve (Fed) continuing to hike interest rates in its fight against inflation and nearing its terminal interest rate.

As the quarter got underway the markets were battered by a number of forces. Perhaps the biggest news in Western economies, was that the first casualties from the tighter monetary policy and higher interest rates appeared on the radar – US and European banks.

Due to the rapid rise in US interest rates, banks in the US currently all have huge unrealised losses on their reserves held in US Treasury bonds as bond yields rose rapidly during 2022. This would not be a problem if a bank didn’t require liquidity. But as soon as a bank experiences large outflows of deposits, it must liquidate any reserves, even those held in bonds, to free up cash. In doing so, however, the bank will realise the mark-to-market losses (on paper accounting losses) on the reserves. As these losses are realised, the bank’s balance sheet is demolished as all the bank’s other liquid assets are engulfed, rendering the bank technically insolvent.

When clients became aware that their deposits in certain regional banks that had concentrated deposit pools or too many reserves (how perverse?), they withdrew large amounts of their deposits rapidly. These withdrawals set in motion a death-spiral for several regional banks. In the past, bank-runs were known for the queues of people desperately trying to withdraw their deposits. In this new world, messages spread via social media and the withdrawals were done electronically and instantaneously. Silicon Valley Bank went insolvent before it even became aware of the situation! The Fed was very quick to step in and assure the markets that it will provide whatever liquidity is required to prevent any systemic meltdown of the likes seen in 2007. Despite several other banks, even those in Europe, also failing and quickly being gobbled up by bigger competitors, no fear of an industry-wide knock-on effect exists as this situation is indeed very different to the problems of 2007 and 2008.

On the other side of the world, sadly, the war in Ukraine is still ongoing, and despite Western sanctions against Russia, Russia still has very willing customers for their oil in the form of China and India. These countries can’t resist the lower prices on offer and don’t side with Western bodies that oppose the war or President Vladimir Putin. This situation has had two major impacts on the global economy. Firstly, Russia hasn’t been deprived of income which the West was hoping would force it to abandon its war efforts, and secondly, political tensions between the US and its allies and China have escalated immensely. This has led to a dramatic increase in the gold price and raised fears about the decline of the US dollar’s global use. While the peak we saw in the dollar’s value last year was a cyclical revaluation point, the currency still remains strong, which highlights that there are far too many vested interests and established contracts to rapidly change the most utilised global currency.

Moving south, but remaining east, South African politicians and specifically the ANC have aligned themselves along with Russia and China of late. This has attracted a lot of unwanted attention to South Africa, its trading partners and agreements. Combined with the greylisting of South Africa by the Financial Action Task Force, this has led to significant sales of both local bonds and equities by foreign investors. This lost capital will be hard to get back to South Africa in the future. The rand also weakened during the quarter as South Africa’s position in the global trading-community is being re-evaluated by investors. Further global economic slowdown could cause further pain for the rand until commodity prices start to rally as the next upswing commences.

At Citadel we take pride and pleasure in advising you on your wealth among all this uncertainty. Citadel Asset Management’s mandate is to provide the global research, asset allocation, and investment building blocks to provide our advisors the ability to implement your personal investment solution. We are committed to offering the best global, multi-asset wealth management solution available, regardless of the current economic cycle or turmoil.

I hope you enjoy this edition of Citation.