In the last Citation message, we looked at the hysteria caused by artificial intelligence in the first half of 2023. Three months on and the frenzy caused by AI is now well and truly behind us as the world moves onto the next big issue, in this case, a rise in geopolitical tensions.

However, before we get there, we need to reflect on the third quarter, where rising interest rates made their presence felt. Much like an anaconda, higher interest rates are squeezing every aspect of the economy and markets as their grip takes effect. Bond yields, for example, have risen all around the world, dramatically increasing the cost of borrowing. In addition, marginal purchase and investment decisions have also been negatively affected, as is the long-term valuation of all assets as a higher discount rate is being applied. The valuation of assets, combined with the realisation that monetary policy will remain tighter for longer has been priced into trades, bringing some reality checks and retracements across the markets. Higher-for-longer interest rates are also bound to cause some dislocations in certain asset classes and also negatively affect consumer behaviour.

It must be remembered that financial markets are weighing machines that compare the current reality against future expectations. Every single transaction between willing parties, can be seen as two parties that agree on the price of that specific asset, but disagree on the value or future expectation for that asset. Sometimes the difference in outlook could be a micro-detail relating specifically to the asset, or it could be more general in nature, like the macro-outlook for that asset class or even the world at large. Certain macro factors like economic growth and interest rates are inherently cyclical and thus quite manageable. However, some are sporadic and impossible to predict, model or gauge. One such factor is geopolitical risk.

Geopolitical risks and events have increased over the last two decades. Post World War II saw the globe caught in a bipolar state between two superpowers, with opposite philosophies, who were trying to impose their wills on the world. The United States of America (USA) and the Union of Soviet Socialist Republics (USSR) dominated the global scene during what was known as the cold war era. Since the collapse of the USSR, China has stepped onto the global stage again, with a clear ambition to be a greater part of the global balance of power. Like the USSR, China has different philosophies to the USA and has many, and different, allies, including India and Russia. Post the global pandemic, countries are realigning their allegiances, and they are very different and much more fragmented than before. The world is now moving to a multi-polar state where decision-making and influence is much more diverse and complicated. Leadership is no longer vested in one or two global superpowers, but rather in several regional and other political alliances and economic blocs. The global power-puzzle is being reorganised and rebuilt as we speak.

The problem with this decentralisation of power is that it increases the complexity of diplomacy and instances of regional conflict as it complicates mediation. Each one of these conflicts attracts the focus and attention of the entire globe as all new-formed alliances are somehow involved, connected or affected. The financial market only has one way of dealing with geopolitical uncertainty. It increases the overall risk premium. This means that anybody making an investment, requires a higher rate of return due to the increased uncertainty of the future. This escalation in risk premia equates to lower asset values in the present, and that is exactly what we are experiencing now. The financial markets are weighing up the future with higher interest rates and increased geopolitical uncertainty against a world looking for a new global political equilibrium. We can thus expect volatility to remain with us as we approach 2024, which will be a major election year, globally.

At Citadel the first pillar of the Citadel investment philosophy is that the future is uncertain and will surprise. This ensures that we analyse several future scenarios and construct investment solutions that can withstand surprises, change, overvaluation and volatility. The philosophy has served us well in 2023 as the year has indeed surprised! Our defensive stance during this very uncertain year is preparing us for the tipping of the scales that seems bound to happen in 2024.

MEET THE TEAM

We would like to take the opportunity to introduce you to the Citadel Asset Management team.

Enjoy this last edition of Citation for the year!