Summary Q2 2023 Outlook: The Fragmentation Game

An Executive Summary

The sudden March advent of turmoil in US banks, and then a mere week later, the SNB-engineered weekend takeover of Credit Suisse by UBS, sent shockwaves through global markets in March. We scrambled to work through the consequences, as we were in mid-stream with the preparation of this Q2 Outlook. In this publication, we have endeavored to address this crisis, which will have important short-, medium- and long-term consequences for both banking systems and our economies. The crisis has sharply brought forward the coming recession, for example. In the intro to this publication, our CIO, Steen Jakobsen, leads readers through the implication of the sudden bank turmoil that unfolded late in Q1, noting that this is no 2008-09 solvency crisis, but the result of the spike in the cost of funding.

But we also touch extensively on the originally intended theme for this Outlook, which is The Fragmentation Game. This is our term for what many call “deglobalisation”, a term we find too vague. As Steen Jakobsen points out, the word fragmentation better describes how the process of deglobalisation works, as the world’s economic blocs have lurched into a profound realignment that will play out over coming decades. The game has begun for every nation to ensure that all critical supply chains, whether for medicine, energy, vital resources, technology or defense, are either completely at home or with a friendly trading partner, or ideally, both. 

Our Hong Kong-based strategist, Redmond Wong, looks at the challenges China faces as it boldly carves out a more prominent role in multi-lateral global institutions, deepens strategic trade relationships and reduces its reliance on exports for the first time in the modern era. Securing technology, and especially resources, will be China’s chief challenges. Our macro strategist, Charu Chanana, focuses on Southeast Asia’s, and especially India’s, enormous potential in a fragmenting world. She weighs, for example, India’s strong demographic profile and huge upside potential in manufacturing against the nation’s traditional speed-limiters like protectionism and burdensome bureaucracy.   

Our equity and quant strategist, Peter Garnry, looks into the equity market impact from the banking crisis after the year had gotten off to a roaring start for many pockets of the equity market, with Europe a strong performer on avoiding an energy crisis. He also delves into where the Fragmentation Game will provide both pain and opportunities in equities. The obvious sectors in focus include semiconductors, defence, renewable energy, logistics, larger companies, and especially quality companies with low debt and strong competitive characteristics.

Our macro strategist, Christopher Dembik, looks at the risk of where the banking crisis could take the US economy next, namely into recession eventually, but focuses readers’ attention on the heavy concentration of commercial real estate loans in smaller and regional US banks as a potential next-shoe-to-drop. The real estate angle is critical to watch in Europe and the UK as well.

In FX, strategist John Hardy notes that the interest rate cycle has now turned sharply and ponders the forward policy mix and jockeying among currencies as stimulus to soften the impact of further financial system turmoil, and eventually the incoming recession will have to take a very different form relative to the crises we have known over the last 25 years. Japan knows the playbook, as it will almost inevitably involve some form of yield curve control.

In commodities, Ole Hansen discusses how the China re-opening surge in commodities fizzled in Q1, but notes it is too quick to write off the potential for commodities: parts of the Fragmentation Game, like the electrification of much of our energy, are very metal-intensive, especially copper-intensive. And the traditional inflation hedge of precious metals has already revived in Q1, with gold posting a record high against several major currencies.

Finally, Investment Coach Hans Oudshoorn relays how investors can hedge downside in their equity positions using a popular approach: an options collar that involves buying a put that is at least in part financed by selling a call option, providing an example on an underlying S&P 500 future position. 

We wish you a safe and prosperous Q2 and beyond. The stakes for investors for the remainder of this year and beyond have risen with the latest market turmoil, and the Fragmentation Game will require all of us to consider how the world is ordered and what its reconfiguration will mean for our investments for the coming quarters, years and decades.