Navigating the financial market cycle, energy crisis called off for the time being, big move on the bond markets

Chart of the week

The chart shows the four phases of a financial market cycle, which can last from 4 to 12 years. The blue line indicates whether the economy is growing or shrinking.
Why this is important
In each of the four phases of the financial market cycle, you should follow a different investment strategy. We are currently in the fourth phase. Central banks are trying hard to reduce inflation, which will trigger a recession. Market participants are currently speculating whether there will be a strong or weak recession and how high interest rates will rise before inflation falls. The question is which companies will perform best in this market situation.

In this market phase, conservative value stocks that can demonstrate a solid balance sheet and steady growth perform best. If a company is large enough and the market leader in an area or niche, they can raise prices with inflation and protect their margins.

The stock market is usually 6-9 months ahead of economic trends. Even though the recession is yet to come, the stock market is already concerned with what will come after the recession. We think that we are already at the end of the fourth phase. It may well be that by the end of spring or summer we will have to change the portfolio to the new first phase. But now it is too early for that.

Energy crisis canceled for the time being

The graph shows the price of gas in Europe. When the war in Ukraine began a year ago, the roller coaster ride started. The biggest panic was in the summer of 2022. Compared to February, the price had increased by almost 400% at the highest.  Everyone was afraid of an energy crisis in the winter. Currently, the price is about 30% below the price that had to be paid just before the outbreak of the war.

The graph shows the current gas reserves of 2023 (red line) and the development of gas reserves 2022 (green line). The gray channel in the background shows the range of reserves since 2017).
Governments in Europe have made very large efforts to avert an energy crisis. Companies and individuals have been asked to save energy and new sources of gas have been developed. It seems that the governments have been successful so far. When the war began, reserves were very low, and despite the crisis, inventories have been steadily increased. This also decreases the probability that we will have energy problems next winter.

However, we must not forget that Europe still receives gas from Russia. If these supplies are completely cut off, it will still be uncomfortable for Europe. The conclusion from the current figures, however, is that the governments in Europe have done a good job so far. What is important now is that the conversion of the gas and energy networks continues to be pursued as rigorously as it was in 2022.

Major movement on the bond markets
There has been a lot of movement on the bond market in recent weeks:

The chart shows the current level of key interest rates in America (black line). This is followed by investors' forecasts for the development of key interest rates, up to 2024. The colors show how the forecasts have changed in recent weeks. From the first to the 14th of February, expectations have changed significantly.

Investors now expect a higher peak in key rates and only one rate cut by the end of 2023.

This change is leading to falling bond prices and falling equity prices.
One of the main reasons for this development has been many statements by the U.S. Federal Reserve in support of higher interest rates. The majority of their arguments are based on PCE (Private Consumer Expenditure).

The chart shows the annual change in the core PCE rate (i.e. PCE excluding spending on houses and housing). The indicator is also often referred to as the favorite indicator of Jerome Powell, the head of the U.S. Federal Reserve. It rose again in January, much more strongly than had been expected.

Inflation can only fall if consumers also curb their consumption. But that didn't happen in January. In fact, quite the opposite. Consumers are in a good spending mood. This almost forces the central bank to raise interest rates further in order to achieve the goal of monetary stability.

This chart shows how the interest rates of various bond investments and the earnings yield of equities (black line) have changed since the first interest rate hike. This enormous movement has led to the largest losses in bonds since World War II.

During the period when interest rates on bonds have multiplied, the earnings yields on stocks have fallen slightly. This impressively shows that bonds are once again a real alternative to equity investments.

The chart shows the risk premium of equities over the yield on ten-year government bonds in the USA. Due to the sharp rise in bond interest rates, the premium is now at its lowest level since the financial crisis in 2007.

Various market participants interpret this as a buy signal for equities. However, we interpret the chart differently. Either companies are increasing their earnings and thus the return on equities, or equities are too expensive and need to become cheaper.

The chart shows stock market returns 365 days before the first rate hike and up to 1095 days after the first rate hike. The blue line shows the average return of the stock markets in each rate hike cycle since 1955 and gray shaded the range of returns. The red line shows the current stock market return. We tend to be at the lower end of the gray shaded area. Most of the correction seems to be over already, yet there is some room for stock prices to fall. To build a long term portfolio, it is a good tactic to buy now during correction phases.

The graph shows whether we have a normal or an inverse yield curve. In a normal yield curve, short-term interest rates are lower than long-term interest rates. The longer you lend money to a company, the higher the risk that something could change negatively.

Currently, we have an inverse yield curve. Short-term interest rates are higher than long-term interest rates. With a recession looming in 2023 and the fear that individual companies won't survive it, the short-term risk seems higher than the long-term risk.

An inverted yield curve does not happen often and usually lasts for a relatively short time. It has always been a clear signal that a recession is coming. Since 1980, it has also always been the case that the inverted yield curve dissipated 1-2 months before the real recession. The inverse yield curve can resolve in three ways:

- short-term interest rates fall and long-term interest rates remain stable

- short-term interest rates remain stable and long-term interest rates rise

- short-term interest rates fall slightly and long-term interest rates rise slightly.

If you invest in bonds now, you should buy short-term bonds (1-3 years) and not long-term bonds (10 years or more).

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