Please click below on the magazine image to read the article on page 7 in French or continue reading below, the text translated in English.
(Translated in English):
What a decade this has already been! We started with a global pandemic where countries literally shut down for weeks and we are continuing with a war in Europe and inflation at unseen levels for many decades.
In the middle of 2020, global consumers saw their personal savings at record highs as their expenses were cut significantly during the lockdowns. Governments started offering cash to their citizens, paying them for not going to work and promised to spend trillions in order to save the economies from depression.
The sudden move from a low inflation environment to the current situation is primarily the result of this massive money supply provided for “free” to buying goods during and after the pandemic. The spike in commodities and oil prices due to under-investment in the previous years, as well as the war in Ukraine made matters only worse. The final step of this inflation process is when wages and rents start moving higher, a situation which we are now experiencing.
In this journey from low to high inflation, the Central Banks play an important role. At times of high inflation, they have to increase interest rates to drain liquidity and people tend to borrow less and consume less, so inflation eventually goes down. At times of bad economic conditions, they lower the interest rates and push liquidity back into the system to help individuals and corporations recover.
Those of us living in Europe during the 2010 decade have been accustomed to hearing about negative interest rates and our cash in the banks earning zero income, at best. Now, things have changed in a dramatic manner. Central Banks are rushing to push interest rates higher and the result is that all financial assets have corrected significantly this year, including gold. On average, high- quality bonds in the major currencies have dropped in price about 10-15%, lower quality bonds have fallen more than 15% and equities have also lost 15-20%. Nasdaq, the big winner of 2020/2021 has fallen about 30% since January. One can imagine that a balanced portfolio, consisting of 45% bonds, 50% equities and 5% gold could have easily lost this year more than 15%.
But current market conditions provide the ground for significant returns for the potential investor who has a 3-5year horizon if he were to invest now in such a balanced portfolio, equally split between high quality stocks and bonds.
On the stocks side, we see again attractive valuations in some high-quality companies, which generate positive cash flows, have strong balance sheets and business models that have endured through good and bad times. We also prefer companies which, in such a turbulent year, have managed to raise dividends, another source of income for the investor, but also another sign of confidence in their financial health.
The Swiss SMI Index is now trading at just 15 times its earnings, (ie its P/E ratio), which is close to the lowest level of the last 5 years. The index is down 17% this year as of September 19th and at the level where it was when the pandemic made its appearance in February of 2020. The SMIM index which includes smaller Swiss companies has lost 27% this year and it is trading just 18 times earnings. For comparison the index had a P/E of 16 only when it was at the lowest level of the market during the Covid19, March 2020 crash.
Most importantly, we now experience the re-emergence of an asset class, which had been “lost” from our radar for almost a decade: the fixed income part of a balanced investment portfolio.
Our firm’s view had been negative on Fixed Income since early 2021, finding the yields back then too low given the situation with inflation. We had also been negative on lower quality bonds, the so called high-yield, as their yields were not that high at all. But we think it is the time to cautiously go back into bonds. Investing in bonds of rather short duration (3-4 years) of very high-quality companies not only offers income again but provides protection in case a global recession takes place.
For example, the yield of a Swiss corporate bond (Investment Grade) of 4-year duration is now about 2%, while it was negative until a few months ago (see chart). Of course, these yields can move even higher in the coming months, as the Central Banks are going to attack inflation by raising even more their deposit interest rates. But one could argue that most of this tightening process has already been discounted by financial markets.
The “beauty” of the Fixed Income asset class and in particular the ultra-safe bonds of very high-quality corporations (for example Nestle) is that they tend to behave well in an environment of bad economic growth. Their prices tend to move higher when a recession hits the economy, because the markets start discounting that the next move by a Central Bank is to cut its interest rates.
In summary, it could well be the return of the balanced portfolio consisting of 50% of fixed income and 50% of equities. Indeed, the fixed income part will now generate an interesting and quite defensive return whereas the equity part looks less risky than a few months ago. Is it a good time to invest? Most probably yes, but don’t put all your eggs in the same basket and be patient as the road might be bumpy until we financial markets rise again...
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