The beginning of the end
This year was the most profound and crazy year of my 12 years with Saxo. As a young kid I traded stocks in 2007 and during the Great Financial Crisis (GFC) where everything almost came to an end which was a gut-wrenching experience. In late 2010 at Saxo, I smelled hope coming out of the recession, before everything was thrown into chaos with the euro crisis before ending with Draghi’s famous words “whatever it takes” that ended up saving the euro project. In 2014, the oil market came tumbling down as USD soared and the Chinese economy slipped into its worst activity levels since the GFC which ended with the G-20 meeting in Shanghai in February 2016 as global policymakers supposedly sealed the “Shanghai Accord” to weaken the USD; this theory has never been confirmed, but things improved after the G-20 meeting.
Then came the year of 2017, the lowest ever recorded volatility across all asset classes, which became a one-way street for all asset classes and at one point we asked ourselves on the Saxo trading floor whether markets had died and would ever return. Selling volatility became the opioids of the market providing a “cheap” way to get high returns. But in February 2018 the “Volmageddon” event happened with the VIX Index suddenly exploding from its average level of 11 in 2017 to above 50 intraday on 6 February 2018. The move was so sudden and violent that the popular XIV ETF, which was short volatility, got crushed and left a permanent scar in volatility markets. But 2018 was done surprising investors. As the year came to an end, the US central banks misinterpreted the direction of the economy and the market dynamics hiking the policy rate on 19 December 2018 amid low liquidity cascading into chaos in equities. It all ended with Powell admitting a policy mistake in early 2019 showing that it was the market that dictates policy and not the Fed.
2019 was spent easing monetary policy as the global economy cooled and the year ended being an uninteresting one. But the boredom quickly ended as 2020 started with rumours circulating that a virus had emerged in China which eventually turned into a global pandemic. Societies went into lockdowns and policymakers slashed interest rates to zero and governments unleashed fiscal stimulus on par with the post WWII years. At this point, the fastest development of a vaccine had been around four years. That was the information picture policymakers had in early 2020 and thus in hindsight the size of the stimulus made sense. In November 2020, the mRNA vaccines were published breaking all previous records on vaccine development and with the rollout of these vaccines the world opened up much faster than expected.
In 2021, bottlenecks became apparent everywhere in the economy and there were so many signs of inflation. Most economists and central banks kept saying it was temporary because supply curves are flexible and will expand to meet the increase in demand. Our team kept arguing since December 2020 that the inflation would be structural and higher for much longer. This is my proudest moment working for Saxo. We got inflation absolutely correct and we kept the view despite consensus was strongly in favour of temporary inflation. In December 2021, the Fed acknowledged that inflation was more sticky and the Biden Administration made it paramount for the US central bank to get inflation under control. In between all of these events, I also experienced several flash crashes, Brexit, Russia’s annexation of Crimea, the Trump presidency and its trade war with China, and the Swiss National Bank unpegging from the EUR.
As you can read, I thought that I had experienced most things. But the world is fat-tailed and so crazy things happen all the time. 2022 started with the US warning the world about Russia’s troop build-up at the Ukrainian border and about Russia’s real intensions. Nobody listened, especially not Europe led by Germany. The Trump Administration, despite in hindsight being right on several geopolitical topics, had burned the trust of Europe. Russia launched a full-scale invasion of Ukraine on 24 February 2022 bringing a massive war back on the European continent. This was the biggest victory for the US intelligence agencies since the 9/11 attack took it by surprise, and Europe was finally pulled out its sleep. Ukrainians showed bravery on a new scale fighting for its freedom, and maybe even all democracies, and when I eat dinner with my family at Christmas eve and later with friend on New Year’s eve the Ukrainian people will be part of my toast and thoughts.
2022 deserves so many more words as this year will go down in history as the year when unconstrained globalisation, that started in early 1980s with start of market reforms in China, changed forever and the world was on track towards a bipolar world with the US and Europe on one side, and China and Russia on the other side. It will also be remembered as the year when inflation came back and we came out of long dream of the digital world being the only meaningful driver. The physical world is roaring back.
Geopolitical risks will dominate as we gallop towards a bipolar world
It was a long introduction, but it was necessary to understand 2022 in its right context. We are at a fork in the road. It is becoming clearer that two value systems are emerging in this world and every country must likely decide which system they want to be part of. Everything will be about self-reliance, that is to have economies that have less dependencies with countries that are not part of the same value system across both energy, metals and agriculture. This is why Europe will eliminate its dependence on Russia and engage more in Africa over time which over time will lead to competition with China for ressources. India is the largest country that is trying to strike a neutral stance on the new emerging world order and the country is befitting from US and European reshoring some manufacturing away from China.
Globalisation was an unique period in modern history as it was dominated by capital and trade flows with reduced state interventionism. As national security issues are now more important and global supply chains are being realigned under the bipolar world theme governments will begin to play a bigger role in the economy. Just as in the past. Governments will dictate capital allocation and policies for which technologies to foster across energy and semiconductors to name a few. This is most clearly seen in the US CHIPS Act that was passed this year and is the biggest industrial policy in the US since WWII. It aims to reduce the developed world’s dependence on Taiwan as the issue over Taiwan is transforming into the biggest potential tail-risk for the global economy.
All roads are leading to higher inflation and thus higher interest rates. The market just do not want to see it yet, which is also the setup for a big market surprise in 2023. The bipolar world will kill the unconstrained just-in-time concept creating more buffers and more fragmented supply chains to increase robustness; that is inflationary. The green transformation amid a war in Europe, lack of energy and metals supplies will make a greener society more expensive in the short-term and renewable energy sources come with significant costs over a certain point; that is inflationary. Climate change will disrupt food production at an increasing pace; that is inflationary. Mining companies are still not delivering very return on invested capital and thus we need much higher metals prices for mining exploration and supply to expand to accommodate our aspirations; that is inflationary. Employees fighting to crawl back from the hit to their real wealth and income will accelerate wage growth; that is inflationary. The list goes on and on.
The seismic shift in the world has also been evident across our theme baskets. Commodities and defence stocks have by far done the best up 24% and 22% respectively as of today. Our energy baskets such as renewable energy and nuclear power have done relatively well compared to the overall equity market. The logistics and India baskets have benefitted from the realignment in global supply chains. In the bottom we find the three themes that have been hit the hardest by the physical reopening of the economy after the pandemic, the interest rate shock, and the energy crisis with elevated electricity prices curbing the green transformation most clearly seen in the lower demand for EVs during the year.