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Final (investment) thoughts as 2022 goes away.

We should avoid "cognitive inertia".

Psychologists use this term to describe the human tendency to stick to the "status-quo" and resist change, even when this is already taking place around them. Investing with such a bias might result to a failure to realize that the world is changing, with detrimental impact on performance. Investors have experienced the US supremacy in the equity markets, pretty much for the last ten years, but especially since President Trump took office. Then the pandemic hit, which caused millions of US retail investors and grounded teenagers to go crazy with the stock market. However, this does not necessarily mean that coming out of this bear market, the US stocks will lead again. We show as an example what happened the last time we had a bubble in US Tech stocks, which led to a major global bear market, namely in 2000-2003. The chart above shows the performance of MSCI Emerging Markets in dark blue and MSCI Europe in light blue vs the S&P500 in green, after markets bottomed in early March of 2003 for the following five years . Emerging Markets was the place to be with more than double the performance of their US peers. And European equities outperformed their US peers by almost 50% in that same period. More and more equity strategists admit that the investment landscape has changed and we tend to agree. Embracing this change, with caution, could lead to better investment results.

European banks are trading like it is 2008... We like (some of) them.

You might think that we are crazy that we like (some) European banks, even after their 15%-20% rally since the lows of September. And if you add all the gloom and doom about the European economy next year, with an on-going war still on its territory, it could be wise not to even think about investing in the sector. However, what gives us the courage to dive in the sector, is primarily the green line above and some fundamental issues which follow. The green line shows the forward price-to-earnings ratio for European banks which now stands at around 7. It had only been slightly lower at the depths of the 2008 crisis, where banks were thought to be going out of business. Again, during the Eurozone crisis in 2012 and in March of 2020, at the Covid19 outbreak. We reached those cheap valuations again in September, from which we bounced strongly. Hence valuations are already discounting a lot of bad news. At the same time, you must note that banks are mcuh better capitalized compared to many years ago. And alhough their business is closely related to economic activity and hence recessions have an impact on their revenues, it is also true that the bulk of their revenues still comes from the interest rate differential between deposits and loans, called net-interest-income (NII). Given what has happened this year in the money and bond markets, the NII is already exploding for the banks, boosting their revenues immensely. A 6-8% dividend yield is just the cherry on the pie.

China: Another bear market, but within a long-term bull market.

Since February 2021 , China has been in a sharp downtrend. Local equities had been hurt initially by the government's decisions to break the bubbles that were being created in specific industries, such as real estate, on-line education and internet/e-commerce. Then came the geopolitical worries that after the invasion of Ukraine, China will follow with Taiwan. And lastly the surge in Covid19 cases which brought more lockdowns and restrictions, as the rest of the world rarely talks about the disease anymore. The result can be seen on the above chart, where the local market has fallen for the last 22 months. However, looking at the long history and going back almost 15 years, we can also see from the chart, that similar episodes which lasted almost 2 years happened again in 2015-2016 and 2018-2019. Each time the market moved again higher and reached eventually a new high. Even more interestingly the current drop seems to have found support on the very long term line, shown in green. With most of the issues that haunted the market in the previous two years now being resolved in one way or the other, Chinese equities could embark in the next up-cycle and outperform its US and European peers, to move to a new high in the coming years. An episode with Taiwain will of course change this course.

Is 2000-2003 going to be repeated ?

The chart shows the annual changes of the S&P500 during the last 30 years. We have taken its performance until yesterday for 2022, assuming that it is difficult to close positive in the remaining few trading days of the year. There are quite a few observations one can make by looking at history. First, drops are rare, hence we belong to the camp who believe that equities can generate significant returns on a long-term basis. Secondly, consecutive years with annual drops are also very rare. Thirdly and unfortunately, the last time we had three years of falls for the S&P500 was back in the 2000-2003 period, after the internet and Nasdaq bubble burst. A scary similarity with that period is that before the crash we had many years of outsized returns, like in 2019-2021. We cannot base investment decisions on just trying to find patterns with the past of course. And enough damage has been done already where the bubble was, namely the ultra-growth, profitless technology companies which rose due to speculation after the pandemic. The sector's most well known proxy, ARK Innovation ETF is down almost 80% from its peak and back to where it was 5 years ago. But still, we must be very careful in the first three months of the year, to start getting a clearer picture of where the economy is going and how fast inflation can continue to fall.

But, this year cannot be repeated !

(chart: Capital Group)

A very interesting chart by Capital Group shows the annual returns of the global equity and bond indices for the last 45 years. Never before have both asset classes generate a negative return and of that magnitude ! Bonds are supposed to offer protection in times of economic slowdown and/or equity market weakness. But this year they both fell by 13-15%, destroying wealth for investors. However, we have now reached a very good starting point for next year's performance. Starting the year at yields that we have not seen in a decade, bonds should be able to offer a decent positive total return for investors, regardless of the performance of equity markets. And if economic activity turns out to be more benign and inflation cooler, equity returns including dividends should also be decent at the end of next year, offering the opportunity to the investment portfolios to recover at least a significant part of the lost ground. Volatility and uncertainty will persist for at least the next 3 months, but for the full year it is fair to assume that portfolio positive returns will arrive again.


• The content of this document has been produced from publicly available information as well as from internal research and rigorous efforts have been made to verify the accuracy and reasonableness of the hypotheses used. Although unlikely, omissions or errors might however happen.

• The data included in this document are based on past performances and do not constitute an indicator or a guarantee of future performances. Performances are not constant over time and can be positive or negative.

• This document is intended for informational purposes only and should not be construed as an offer or solicitation for the purchase or sale of any financial instrument and it should not be considered as investment advice. The market valuations, views, and calculations contained herein are estimates only and are subject to change without notice. Any investment decision needs to be discussed with your advisor and cannot be based only on this document.

• This document is strictly confidential and should not be distributed further without the explicit consent of Kendra Securities House SA.

Sources of the charts : Factset, if not otherwise mentioned in the chart.

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