Ask the experts – questions stirring our clients (and the financial markets) in May 2022
We are always available to answer our clients’ questions and concerns regarding their portfolios. Once every quarter, we summarize clients’ most frequently asked questions and our experts’ answers and give you firsthand insights into our asset management and investment advisory operations.
Investment Strategy
Stocks and bonds are losing considerable value this year simultaneously amid high volatility. How do I preserve my capital in times like these?
Kaiser Partner Privatbank: The year 2022 arguably presents the toughest environment for investors since the Great Financial Crisis of 2008–2009 and even eclipses the spring 2020 coronavirus crash. In both of those times, central banks responded by throwing the liquidity floodgates wide open, and they steered the financial markets back into calmer waters within a matter of a few weeks. This time they are doing the exact opposite – their very rapid moves to return monetary policy to normal in the face of massively overshooting inflation rates has caused equity and bond markets to plummet simultaneously. The year-to-date drawdown for the corresponding global market barometers is currently in the mid-double-digit percent range (MSCI World: –18%; Bloomberg Global Aggregate Index: –17%). A classic “simple” mixed portfolio composed of 60% stocks and 40% bonds has thus accordingly performed poorly.
During such uncertain times, preserving the value of capital assets should indeed be given priority over seeking potential value appreciation. One sensible way to preserve capital is to blend microfinance bonds, insurance-linked bonds and private debt strategies (such as peer-to-peer lending and real estate financing) into the fixed-income part of your portfolio. These instruments are immune to rising interest rates or even benefit from them in the medium term. Meanwhile, with regard to the equity part of your portfolio, you should refrain from engaging in overeager tactical maneuvering. Instead, it makes much more sense to use options strategies to hedge against the tail risk of a further nosedive on stock markets. This way, you remain sufficiently invested in the event of a potential (bear market) rally, which can happen at any time. The price for that is the option premium, which can be reduced to acceptable levels by designing the options strategy in a somewhat more sophisticated manner. Finally, in order to attain even greater stability and the least possible volatility for your investment portfolio, the third component of a balanced portfolio – alternative assets – becomes especially important. We include in this asset category the classics gold and real estate, which provide an added value by virtue alone of their low performance correlation with stocks and bonds. In addition, though, you particularly should also think about blending in private equity strategies, which not only promise an excess return of 3 to 5 percentage points over public stock markets in the long run, but also enforce investment discipline at the same time.
No place to hide? | Simultaneous selloff of stocks and bonds
Maximum drawdown of equity and bond markets
Sources: Bloomberg, Kaiser Partner Privatbank
Fixed Income
Market interest rates have rocketed in recent months. Have bonds now become attractive again?
Kaiser Partner Privatbank: The yield on 10-year US Treasury notes has jumped year-to-date from 1.5% to as high as 3.2% on a turbulent ride that has been accompanied by the steepest price drop for US Treasurys from an all-time high in 42 years. Yields on 10-year German Bunds and 10-year Swiss Confederation bonds have risen almost as meteorically, recently touching the 1% mark for a brief time. The big transatlantic yield differential makes it clear that if there’s anything attractive in the realm of safe government bonds, then it’s sovereign debt securities from the USA. Although the macro triad of growth, inflation and liquidity currently makes a case for a further upward drift in long-term yields in the months ahead, we think they’ve already reached the point where existing bets on a further rise in yields should be neutralized. The risk/reward tradeoff, at any rate, no longer argues in favor of maintaining a short portfolio duration. On the contrary, there are multiple factors suggesting that yields are already near the top of the flagpole. Technical analysts, for instance, are rightly pointing out the obvious resistance barrier at the 3.25% level, which is where US 10-year yields peaked in autumn 2018. Moreover, at their interim high of 3.2% in early May, long-term yields were already 80 basis points above the “neutral rate of interest” that the US Federal Reserve views as the long-term end point and which it estimated at 2.4% in its most recent projections. In the past, the neutral rate of interest has served as a natural “anchor” for the benchmark 10-year market interest rate. And finally, US Treasury yields usually reach their zenith after a rate-hiking cycle has passed the halfway to three-quarter way point. Assuming that the current cycle will proceed relatively quickly, from this perspective as well it may only take a few months (or quarters) until yields have reached a definitive apex. The bottom line here is that an underweight position in government bonds is no longer appropriate and should be corrected. If the Fed does not succeed in engineering the “soft landing” it is aiming for, in the event of a likely ensuing recession (and an equally likely downturn on equity markets), government bonds could even resume providing the valuable portfolio diversification that has been so painfully missing in recent times.
Target overshot? | The air is getting thinner for US yields
US yields and the Federal Reserve’s estimate of the “neutral rate of interest”
Sources: Bloomberg, Kaiser Partner Privatbank
Commodities
Commodity prices have risen sharply since the start of this year. Are commodities (still) a good investment today?
Kaiser Partner Privatbank: “The trend is your friend, until the end when it bends” – this adage applies to both rising and falling asset prices. After broad commodity indices like the Bloomberg Commodity Index broke out of their longstanding downtrends last year, today one can no longer be unreservedly pessimistic about this asset class at least from a tactical perspective. Aside from the US dollar, commodities in fact are the only major asset class in the liquid investment universe that has posted a positive performance year-to-date. However, the question of whether one should invest in commodities now cannot be answered solely on the basis of the upward price trend. The market fundamentals are equally as important, especially the supply-and-demand relationship for individual commodities. Supply/demand conditions are very tight for some industrial metals and especially for crude oil and some agricultural commodities, which would make a case for continued high or further rising prices. The armed conflict in Ukraine and its collateral effects have further worsened existing supply bottlenecks lately. But as a peculiarity of this asset class, the attractiveness of an investment in commodities additionally depends on conditions on the futures market because the wide array of investment vehicles that investors make use of generally do not invest directly in commodities, but rather indirectly via commodity futures. Futures contracts must be rolled forward at regular intervals, a process that results in either roll profits or roll losses depending on the slope of the futures curve. Over the last ten years, the aggregate roll yield for the Bloomberg Commodity Index was negative practically the entire time. Although the spot price index rose by a respectable 50% or so over the last decade, roll losses kept the total return for investors slightly in negative territory for that period. In recent months, though, the slopes of futures curves have taken a turn to the benefit of investors for the first time in a long while (and for an extended period). Due to the acute scarcity of certain natural resources, for many commodities higher prices are being paid at the moment for near-term delivery than for delivery farther in the future. The futures curves are inverted (or in backwardation), and rolling futures contracts forward under this circumstance results in roll profits. In recent weeks, the aggregate annualized roll yield for the Bloomberg Commodity Index has risen to almost 10%. This means that investments in commodities yield a positive return at the moment even if spot prices do not climb any higher. So, is this a green light signaling that there’s still time to jump on the commodities bandwagon? While the slope of commodity futures curves is relatively rigid on a near-term horizon of one to three months, in the past a reversion to the mean has been observable on a longer timeframe of twelve months and beyond – the roll-yield pendulum is therefore likely to swing back in the medium term. Moreover, shortages of certain commodities should lead sooner or later to an expansion of supply and to a new equilibrium and a new equilibrium price, which could very well be higher than the current price level. However, in contrast to stocks, there is no permanent risk premium to earn with commodities. That’s why we’re steering clear of the current hype about a purported revival of commodities with a good conscience, particularly also because we consider investments based on commodity futures highly questionable from a sustainability standpoint. We think the better way to play the comeback in energy prices is to do so indirectly by investing in leading energy companies while taking ESG aspects into account. This kind of play provides a certain degree of protection against inflation, just like direct investments in commodities do, so that one doesn’t have to forgo this feature.
Mind the gap | A lost decade for investments in commodities
Bloomberg Commodity Spot Index vs. Total Return Index
Sources: Bloomberg, Kaiser Partner Privatbank
Cryptocurrencies
Bitcoin has shed a lot of feathers lately. Are digital currencies a suitable means of diversifying a portfolio in these turbulent times?
Kaiser Partner Privatbank: In February we asked ourselves whether Bitcoin merits a place in our or a retail investor’s asset allocation. Our answer at that time was “no.” We came to the conclusion that Bitcoin is just for hardcore crypto bulls, and even then only in small doses and with maximum diversification. The passage of time has since confirmed the soundness of our rather restrained enthusiasm about using digital currencies as investment instruments. The correlation between Bitcoin and the tech-heavy Nasdaq index has climbed to new highs in recent weeks. In the meantime, the most famous of all digital currencies has plummeted by more than 60% from its all-time high hit in late 2021. Even those who were invested in crypto in a diversified way took a beating because other coins like Ripple, Solana and Polkadot, which experts deemed promising alternatives, have already lost more than 80% of their value. We stand by our cautious assessment that instead of protecting against inflation or making a beneficial contribution to diversification, cryptocurrencies these days are nothing more than a plaything for (retail and institutional) speculators. The withdrawal of central-bank liquidity around the world is hitting what are arguably the riskiest instruments on today’s capital markets with full force. A (temporary) recovery rally isn’t to be expected until the liquidity environment improves a bit, which doesn’t look set to happen anytime soon.
Where is the added value? | Bitcoin is (merely) a risk-on proxy
Sixty-day moving correlation between Bitcoin and Nasdaq index
Sources: Bloomberg, Kaiser Partner Privatbank
Inflation
Inflation figures have consistently come in higher than expected lately. When is an end to this trend in sight? And how can I construct a robust investment strategy in this environment?
Kaiser Partner Privatbank: The trend is still intact – the April inflation figure of 8.3% in the USA came in higher than expected (8.2%) once more. However, the annual inflation rate pulled back for the first time since early 2021. Inflation in the USA thus likely has now peaked, and (core) inflation looks set to pull back by around half by next spring due to “base effects” alone (as the price increases of the past year gradually drop out of the 12-month comparison). The fact that the wage growth rate of 6% recorded in the second half of 2021 has recently already slowed to less than 4% is also good news with regard to inflation. This is bound to alleviate concerns about a wage-price spiral at least to some extent. However, it is obviously still too soon to sound the all-clear on the inflation front because even though we are now seeing signs of easing particularly for prices of goods such as used cars, services prices registered a month-on-month inflation rate of 0.7% in April, marking their biggest jump in decades.
In any event, it is extremely unlikely that inflation will pull back in the next 18 to 24 months to below the 2% target that most central banks have been pursuing thus far, and that goes as well for Europe (with the exception of Switzerland). On the contrary, disruptions such as the acute shipping container backup at Chinese ports and the effects of the armed conflict in Ukraine on energy and agricultural commodity prices signify a sustained upward risk for inflation. Investors, too, should get used to the realization that we likely find ourselves today in a new inflation regime under which nominal assets like conventional bonds and especially cash provide the least conceivable protection against value debasement and in fact are highly exposed to it. This makes it all the more important for them to strengthen the “real asset” nature of their portfolios by blending in investments in real estate and infrastructure as well as private equity. All three of those asset categories have proven in the past that they retain their value and thus protect against inflation. This trend looks set to persist in the future, in our opinion.
US inflation surprises… | …have peaked
Citi Inflation Surprise Indices
Sources: Bloomberg, Kaiser Partner Privatbank
China
There is (almost) nothing but bad news coming out of China these days. Is the country’s 5.5% growth target still achievable this year?
Kaiser Partner Privatbank: “Zero Covid” remains the motto in China. At the Politburo Standing Committee meeting on May 5, Xi Jinping reiterated that no letup in efforts to reduce COVID-19 cases to zero would be tolerated, but there was no longer any talk about reconciling the containment measures with economic growth targets or about minimizing the pandemic’s impact on China’s economy. The Chinese president’s priorities have evidently shifted in the runup to this year’s main event: the 20th Party Congress this autumn. More than 40 cities in China with a combined total of around 300 million residents and accounting for 30% of the country’s economic output have recently been under a partial or total lockdown. It is becoming ever more evident that this policy is taking a toll on growth: purchasing managers’ index readings for the manufacturing and service sectors tanked in April, Chinese exports to industrialized countries plummeted, and data on industrial output and retail sales also disappointed at the start of this week. Although the daily number of new infections appears to have peaked (after hitting a pinnacle 29,411 on April 13, the daily new case count has recently fallen to below 2,000), the second quarter probably is no longer salvageable and looks set to go into the statistics almanac as a period of negative growth because the containment measures will likely be eased only gradually and it will take some time for economic activity to return to normal.
Leading economic policymakers in the Communist Party and the People’s Bank of China are well aware that the zero-COVID policy is not without risk and is manifestly angering the public. Recent days and weeks have accordingly bought forth a litany of soothing words from officials stressing the need for stabilizing measures, some of which have already been adopted in contradiction to the harsh words from President Xi. They include stepped-up investments in infrastructure, local relief measures in the real estate sector and less confrontational action against internet giants. The People’s Bank of China has also already implemented easing measures, lowering interest rates for instance, albeit by perhaps less than the public had been hoping. But in recompense, the PBoC appears to be employing an alternative tool lately: the renminbi. After PBoC officials continually adjusted the USD/CNY fixing rate upward in recent weeks, the Chinese currency quickly depreciated by around 7% against the US dollar. China’s export industry becomes more competitive again this way, so this policy move ultimately is also an economic stimulus measure. Although GDP growth in China looks set to resume accelerating gradually in the second half of this year, the 5.5% growth target for 2022 is probably well out of reach by now. A growth rate of 4.5% would even be ambitious from today’s perspective. Our earlier projection that China would drop out this year as a growth driver for the world economy or would only act as a half-inflated lifesaver appears more and more to be coming true.
Not an engine of growth | Chinese purchasing managers’ indices at trough levels
Purchasing managers’ indices (manufacturing and services combined)
Sources: Bloomberg, Kaiser Partner Privatbank
Do you have any further questions? Then please feel free to contact us.
