In our October 2022 investment update, we anticipated inflation would fall from the extreme levels reached at the time and that with falling inflationary pressures, financial markets would start gaining positive momentum again. We’re not at the end of the bear market yet, but at least we see substantial improvement from the very negative dynamics of 2022.

So far, things have been unfolding pretty much as we had expected back in October. Inflationary pressures, while still too high by historical standards, have indeed started to dissipate and the substantially lower input costs that we mentioned in our last report, have started to put downward pressure on production costs. This is certainly good news and the effect on global financial markets can be felt already. Stock markets were able to recover in Q4 of 2022 and also seem to be off to a good start in 2023.

Also, as expected, falling inflation has already started to put downside pressure on the U.S. Dollar. In 2022, the USD went up by around 20%. Since Q4 of last year, this is now going into the opposite direction and the Dollar Index has already fallen sharply from its high in the fall. Often when the dollar is falling, precious metals prices move inversely and start to rise. The past few weeks have not been an exception. Starting from the low 1600s, gold prices have recently surpassed $1900 and continue to be well supported.

The improving market momentum that we have seen in the last couple of weeks is certainly encouraging, but we want to stress that the bear market is not yet over. We might be close to the end, but a cautious approach is still the way to go. This is also the reason why we decided to add downside protection to our standard strategies by way of put options. We want to be protected against a sudden and severe market drop for reasons that we can’t foresee. As we have stressed many times in the past, in our view, prudent risk management and downside protection in uncertain times are the key to long-term capital preservation and growth.

From a macroeconomic view, the picture seems to be stabilizing or even improving a little bit at the moment. Growth has been weakening in the past 12 months and the sharp increase in interest rates in most major economies has had a dampening effect on these economies. Whether or not we are going to see a recession in developed markets will become clear in the coming weeks or months. However, what is already certain is the fact that growth will be very weak. This is not surprising, considering the destructive effects of spiking inflation since 2022, which has acted like an extra tax on every household by significantly reducing the purchasing power of savings.

Probably the most significant development in the past few weeks has been the end of the Chinese “Zero-Covid” policy. Since the pandemic begun, China has had a very strict, zero tolerance policy with widespread and lasting lockdowns. This made it even more difficult for Chinese businesses to operate and since Chinese companies are often the starting point of global supply chains, the lockdowns have resulted in severe disruptions around the world. It was also very interesting to see that the Chinese government ended its zero-tolerance strategy as a result of rapidly growing frustration among the people. What this shows is that it does indeed matter how people in China react to political decisions from the central administration. For many people in the West, this came as a real surprise.

While China’s reopening is certainly positive for Chinese businesses, the question is whether it is inflationary or deflationary for the global economy. Rather than guessing, it is better to check what the actual effect of the country’s reopening has been so far on prices, especially commodity prices. Iron ore or copper, for example, already moved up by around 10% since the reopening was announced and it seems that prices are still trending higher. The European Central Bank recently commented on this and it expects China’s reopening to be inflationary for western economies. What seems to be clear is that the long-term outlook of major central banks is leaning towards higher inflation rather than deflation, which could be a disaster given the high levels of debt in the government, corporate and private sector.

So, keeping inflation above target but bringing it down to more sustainable levels seems to be the obvious strategy that central banks are following. Therefore, inflation could settle somewhere around 3% going forward. The challenge is that it is much easier for inflation to go higher in today’s situation. Almost the entire developed world is suffering from chronic labor shortages, the market is very tight and this means higher prices in the future. At the same time, these labor market conditions will also limit the potential growth rates of western economies. Growth rates in coming years will probably be significantly below what we saw in the last two or three decades and the contribution from developed markets will likely continue to decrease, while the contribution from markets like India, China and other emerging nations continues to rise.

Geopolitical shifts are making the situation even worse, as we are moving to an increasingly multi-polar world with increasing tensions (or even wars!) between the various blocks, which is also inflationary rather than defla- tionary. In the short to medium term, let’s say the next 12 to 18 months, it seems very likely that growth will initially weaken and then stabilize at lower levels. A subsequent recovery will be slow and the long-term potential growth rate will be relatively low for a long time to come, unless there are any significant improvements in terms of efficiency gains, which we don’t see as very probable. For many developed nations, excessive levels of debt have become a serious problem, which is set to create more and more headwinds for economic growth. As part of the “solution”, we expect a continued effort to try to reinflate these economies in order to indirectly devalue the debt. In fact, we are not only seeing this as just the most likely scenario, but as the only realistic way to move forward.

While this remedy is known to work not only in theory but also practice, it will have a sharply negative effect on the valuation of currencies. This will become a big problem, especially for the U.S. and the USD, while other currencies will benefit and rise in relative terms. For example, the level debt/GDP in Switzerland is below 30%, while the U.S. is already at 123% and rapidly catching up to nations like Italy. Investors need to take this into consideration when making long-term investment decisions. We believe this creates an even stronger case for constructing a global portfolio.

Investors have to realize that we are not simply “going back normal”, to the world as we knew it before the pandemic. This is an entirely new chapter, something we have already written extensively about in previous years. Our special report (On the Brink of a New Era – are you prepared?) that we wrote more than two years ago offers a great summary of what we are seeing now and what we can expect to see next. The sharp spike of inflation in 2022 has left consumers with less buying power and the full effect of that will only be seen in 2023. The chart above shows that the U.S. consumer is far worse off than before the pandemic as savings rates plummeted. This is not a good signal for consumption going forward.

As we are moving in to this “New Era”, we must bear in mind that it will become more challenging to invest. Simply buying and holding a basket of growth stocks is not going to be enough. Over the last 10 years, technology shares and the FAANG stocks have outperformed everything else by a huge margin and investors have increasingly pumped money into a relatively small basket of tech mega cap stocks. This was also the main reason why the U.S. stock market has outperformed just about any other market globally. This is most likely now coming to an end and the relative outperformance of international stocks over U.S. stocks in recent weeks and months might already be a con- firmation that this paradigm shift is now underway.

These changes are also influencing our own investment approach, as we are now focusing on sectors and companies that not only have strong current fundamentals but also a strong business model for the coming years. Valuation is another important criterion, which has not been that important in the past, as investors were willing to buy growth stocks at huge premiums. Now, however, stocks like Facebook/Meta, Google, Amazon, tc. have already tumbled by more than 50% from their peaks, highlighting the need for investors to be much more selective going forward. This is the reason why we are screening globally for attractive investment themes and trends and why we don’t want to limit ourselves to just the U.S. and/or Europe. We believe that the future will require a global investment approach and that indexing the market will not work.

We think that 2023 will offer investors very attrac- tive buying opportunities, but despite the improving momentum, there are still risks in the coming weeks that should not be ignored. Investors are expecting central banks to eventually stop their interest hikes when they see inflation move lower. We share this view, however, the timing remains uncertain. With economic momentum slowing, there comes the realization that very weak growth or even a mild recession is now becoming a very real possibility. This could, at least in the short term, cause additional downside pressure for markets, which would in turn bring the reversal of central bank policies even closer. This will eventually be the time when a strong and more sustainable recovery can start. We think this is now getting closer, but we are not quite there yet.

We hope that you all had a good start to 2023 and that you’re ready for another interesting year. We live in a highly dynamic world and this can sometimes create concerns, but we are also living in a time of fascinating transformations. The last three years have brought changes for all of us that would have been unimaginable a few years ago, especially the pandemic and the way it affected all of us. Last year, the outbreak of the Ukraine war reminded us that freedom has its price and that we should always be proactive and protect the freedom that we have. But the biggest risk to our freedom might not come from the outside, but from the inside.

The last couple of years have shown that western societies tend to create their own problems and that government interventionism and control is on the rise. Freedom is based on true tolerance, individual responsibility and respect for others, and a strong market economy. Capitalism, the free market and our western democracies are certainly not perfect, but they work better than anything else we’ve tried. Instead of pushing for more laws and rules, the world needs a renewed sense of optimism and a strong belief in a better future. Instead of drowning in pessimism and problems, we need to focus on solutions and opportunities.

With these words, we would like to wish you all a great 2023!

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This report was prepared and published by BFI Infinity Inc., a Swiss wealth management company registered under the U.S. Investment Advisors Act of 1940 with the U.S. Securities and Exchange Commission (SEC) as an investment advisor.

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