Curmi & Partners

Reality Check

Article by Karl Micallef 

The recent past has been witness to some major shifts in the financial markets. Shifts in risk appetite and regulatory forces as well as technological advancements which are today becoming more and more difficult to keep up with and use in a structured and coherent manner. Coupled with this backdrop, the Insurance industry remains one where risk management remains at the core of a long term operational and investment strategy – an approach which, up until some months ago, had delivered significant returns over the past decade, even though the investment approach and structure had been a conservative one.

This changed, at some point during 2018, when the market seemed to get stage fright when faced with the reality that normalisation in global economic performance maybe closer than expected. At the outset this would normally be welcome – such a situation would have definitely been very welcome back in 2008 when the collapse of Lehman Brothers almost brought the entire world to a halt. After the market managed to overcome such a brutal moment thanks to some very drastic actions employed by various Central Banks across the world, the market is still unsure whether to embrace normal economic activity or shy away. The thought of a slowdown quickly raises concerns on the possibilities of another economic recession which may be round the corner. And the jury is still out in this respect.

So Europe and the US may be facing another possible economic recession, however we believe that the respective economic slowdowns (and we need to keep in mind that the data being published is not even consistent in this respect) being experienced are impossible to avoid given the abnormal levels of economic growth witnessed over the past decade, due to the steroids injected in the system. There are valid arguments to make in both these camps and the next months will provide better insight. In addition, if this were not enough, politicians across both sides of the pond want their fair share of attention too. Europe seems to be less united than ever before and the US wants to ensure that the rules of the game are once again enforced but is doing this in a manner which fuels uncertainty to unprecedented levels. Not to mention Brexit and the mess this brought about.  

On the regulatory front, this is just motoring ahead with no end in sight. It seems like the objective is simply to have more and more regulation to achieve a better outcome. This could not be further from the truth. It is suffocating the capital markets and the participants of these same markets, which makes investment returns all the more important to achieve but also all the more difficult to deliver.

So looking back to 2008 and what happened since then – on the one hand we have the capital markets which went from the brink of collapse to a decade long bull market and on the other hand a regulatory regime which went from a free for all to the other extreme. However, behind all this there was also the beginning of a new technological chapter. A level of innovation which was born out of the frustrations resulting from the solutions adopted to avoid a complete market collapse. The concept of a decentralised process was being introduced in a centralised system. But that was just the beginning - an idea which would open up so many other important technological frontiers which, today, provide the means and tools to process, interpret, utilise and store a quantum of data which has reached unprecedented levels. A platform from which information, trends, expectations, and a plethora of other data points, can be managed and juggled in a meaningful and productive manner. A tech workshop we have never seen and experienced before. Such is the power of this technological step-forward that a sense of can-do is restored. Today, with the tech tools available to manage Big Data, investment managers can work more efficiently and effectively and integrate their models with that of respective insurance companies in order to allow investment and operational analysis to be carried out in real-time. An approach which would also allow ideas to be simulated, stress-tested and applied like never before.

So looking to 2019 and beyond – the low lying fruit is gone and investors need to realise that the market is not a one-way bet. Uncertainty and nervousness has been steadily increasing which is clearly reflected in the level of volatility we are currently witnessing. But are we on the doorstep of another recession or is this merely a much needed correction, as a result of a reality check, within the context of a long-term strong and positive trend. Judging from a number of economic indicators, the fundamentals are still strong and robust. Yes, economic and earnings growth are slowing down, but was it reasonable to expect such growth to persist in the first place. When countries move closer to their normal level of economic activity how could supernormal levels of performance be consistently achieved and maintained.

The market may have moved ahead of itself in the first quarter of 2018, but we strongly believe that the volatile corrections we saw take place in the latter part of last year are healthy to maintain longevity of this decade old upward trend. Obviously, the markets do not operate in a vacuum and the politics across the globe need to be addressed. Agreements need to be reached sooner rather than later in order to allow the markets to refocus on the fundamental principles of investing without being distracted by that background noise which is so difficult to assess and cater for within an investment solution. Market sentiment has been dented but these are the moments which provide the reality check needed to ensure the validity (or otherwise) of the underlying assumptions behind each and every investment position.

The economic health indicators over the coming months are going to determine the faith of 2019 coupled with the reaction of the respective Central Banks. The market is currently very focused on the current state of affairs of some of the world’s major economies in order to determine whether the slowdown in economic growth is a result of natural normalisation or whether we are past that point and at the beginning of a recession in the economic cycle. We believe that we are witnessing the former, however this alone is not enough to bring back a risk-on approach. Central Banks need to make sure that this positive traction being achieved without life support is not killed at such an early stage.       

We remain cautiously optimistic that the markets will adequately compensate investors over the coming year for the risk taken. However structure in portfolio composition coupled with a focused and disciplined approach will be key to achieve the desired investment outcome.            

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.