By Peter De Coensel,


Right at the onset of the pandemic in Q1 2020, investors had to cope with extreme market volatility. Investors had to cope with extreme monetary and fiscal policy initiatives. Investors had to cope with extreme fluidity in economic indicators. Investors had and must cope with questions around extreme valuation levels across fixed income and public equity markets. Investors are confronted today with a violent and extreme development of a 4th wave of COVID infections across many European countries.

Among many investors, a certain sense of fatigue is setting in. But also, at the edges, the fear, caused by increasing uncertainty on what lies ahead, is showing. The rate of change is high. People like innovation but unease sets in the moment the rate of change accelerates too much. Persistent homeworking is impacting our lifestyles and stresses the work-life balance in a fashion that we cannot fully comprehend today.

We briefly touch on three extremes. First, I raise attention about the impact on economies that adapt to an innovation spurt whilst pushing for adaptation and mitigation to global warming. Second, we wonder when fixed income markets will wake up to the inflation reality or is that moment already behind us? Third, we dare to ask whether COVID19, dubbed COVID21 by now, will lead to another March 2020 moment? Are we blindfolded by hope?

The fabric of our economies is changing rapidly. Ground-breaking new services and products stage aggressive growth and inflict disruption across incumbent business models that are slow to react or adapt. Under such conditions, productivity exhibits a J-curve. Demand and supply imbalances become a recurring feature. Services are confronted with mismatching labour skills. Goods are confronted with pent-up demand (think semi-conductors) or substitution effects (think energy imbalances) that immediately give rise to persistent demand-supply bottlenecks. Telling examples show up across automobile or semi-conductor sectors. Companies like US-based Tesla, Rivian or China-based Nio boast market capitalisations of USD 1.14 trillion, USD 115 billion and USD 66 billion respectively. Most expect VW, GM or Ford to catch up as they aggressively ramp up their EV (electric vehicle) production over the next decade. However, there is a growing school that adheres to a more sombre outlook. They contend that the public is comparing apples with pears. Market caps from VW, GM and Ford sit at USD 133 billion, USD 89 billion and USD 77 billion respectively. Investors value the new pure EV business models as technology companies instead of traditional incumbent automobile competitors. Tesla supposedly follows in the tracks of Amazon. We should not be surprised that some less agile incumbents fall prey to creative destruction. Schumpeter at work. Within semi-conductors, the price of Nvidia corporation that designs, develops and markets 3D graphics processors has grown at an annualized rate of 70% over the past 5 years (up 1320% cumulatively). Intel corporation advanced by 10% annually since November 2016 (60% cumulatively). Why? The straightforward answer is that they opted for a different strategic path. Nvidia gained dominance in high-performance chips used in gaming. But quickly accessed and innovated with artificial intelligence (AI) focussed chips and within cloud computing through M&A. Moreover, Nvidia outsourced production to Taiwan Semiconductor corporation. The latter fabricates more than half of the world’s chips. Intel lacked innovative strength in the area of next-generation chips. Intel operates multi-industry and carries 9 manufacturing facilities around the world. The resemblance to the automakers example is striking. In credit, the differences are less evident. The question remains to what extent balance sheet risk is properly priced into relative credit spreads within each sector. When you start digging, you find a lot more examples of sectors that get divided by disruptors versus incumbents. The impact of climate change through increased regulation and changing capital funding strategies is pushing complexity to an even higher level. Business models, business funding and business successfactors are in a state of flux. The complex equations described above might provide some contextual evidence why markets reach new historic highs. Extremes are part of the journey. A journey where digitisation, automation, (sustainable) data value chains, network economics and climate adaptation and mitigation strategies take central stage.

After a 30-year era of disinflation, we break into headline and core inflation numbers that feature under an ‘extreme’ label. But honestly, today, financial markets are not expecting anymore that inflation will dissipate quickly towards the 2.00% inflation targets set by most DM central banks. Central bankers call for patience and will not be pushed by markets into reckless tightening. A lot of ink has been flowing on the pent-up demand and supply chain disruption intensity and remediation. Fact is that financial markets have priced an episode of above target inflation. In the US, the breakeven rates curve is solidly inverted. That translates into:” Inflation might get worse before it gets better”. 2-year, 5-year, 10-year and 30-year inflation expectations sit at 3.40%, 3.04%, 2.65% and 2.44% respectively. Essentially, the US Treasury market expects the inflation narrative to become dominant over the long-term but clearly opted to clear that message through a negative real yield curve. Markets accept to invest in 2-year, 5-year, 10-year and 30-year real rates at -2.52%, -1.82%, -1.12% and -0.52% respectively. The coupon and principal will adjust with realized inflation. Inflation-linked bonds, for the first time since its inception back in 1997, strike a homerun as a diversifying component in bond portfolios. Indeed, year-to-date, global exposure to a diversified set of inflation-linked government bonds in local currency pencils in a 7.70% return. Between 2000 and 2019 the sector was never loved. Today a lot of investors missed that boat. A ‘too little exposure, too late to the party reality’ is enough for most investors to be silent about this opportunity cost and opt to remain underinvested and silent about this sector.

I conclude with COVID reverberations. A developing 4th wave of infections and resulting pressures on medical infrastructure and staff is a depressing mix of events. Booster inoculation programs are ramping up across the EU as protection effectiveness declines faster than initially hoped for. Anti-viral pills or anti-body treatments will only become widespread over 2022. The Delta variant remains ubiquitous. New COVID variants such as the Delta Plus are considered from the same family, grandchildren. The question on everyone’s lips is: “What is looming into the future on the COVID battlefield?”. That sinking feeling hit markets last Friday. Risk aversion took over across core rate markets. 10-year US rates dropped again towards 1.50% whilst German 10-year Bunds closed at -0.35%. Everyone remembers well Monday, March 15 as the EU went into lockdown. Well, since then, the 10-year Bund has averaged -0.39%…It ain’t over till it’s over.

Difficult to assess what happens next. The probability of another market shock is limited as the surprise factor has gone. However, extended episodes of implicit lockdown in combination with the ultra-prudent stance taken across Asian countries might inflict more damage on 2022 growth estimates. The nature of cyclical volatility calls for measured and not brutal corrections. We should accustom ourselves more to a larger set of scenarios when building investment portfolios as we live in interesting but extreme times.


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