Ask the experts – questions stirring our clients (and the financial markets)
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.
Inflation figures are climbing ever higher. How long will global trade interruptions continue? What is the most probable inflation scenario?
Kaiser Partner Privatbank: The question of how long interruptions to global supply chains will continue is difficult to answer, and the response will likely vary depending on the region and products concerned. One thing’s certain, though: the situation probably will ease relatively slowly. This is symbolized by the throng of waiting container ships anchored off the US West Coast, which has grown even larger lately. However, we may now already be past the point of peak congestion in world trade. Hope of that is at least inspired by the fact that seafreight rates in recent days and weeks have edged down slightly for containerized cargo and have dropped relatively sharply for bulk cargo. Continued easing of the situation should contribute to causing inflation rates in the USA, the UK and Europe to start receding from the first quarter of 2022 onward. Alongside the goods component of inflation, base effects should cause the energy component of the consumer basket to exert a much less inflationary impact as well going forward. However, the specter of inflation is unlikely to vanish at the same speed everywhere. Although it appears realistic that inflation in the Eurozone will drop back below the European Central Bank’s 2% target by the end of next year, inflation in the United States looks set to stay stuck well above the 2% level. So, the relatively slow-acting housing cost inflation component will start becoming really noticeable there in the months ahead. Moreover, the USA appears to be the region with the tightest labor market and the one running the greatest risk that heightened inflation expectations will become sticky. This could result in rising wage demands on the part of workers and price hikes by businesses for products and services, which inevitably would necessitate interventions by the US Federal Reserve sooner or later.
At the pinnacle?
Inflation rates look set to recede in 2022
US inflation rates
Sources: Bloomberg, Kaiser Partner Privatbank
What assets can provide protection in times of elevated inflation?
Kaiser Partner Privatbank: The classic solution – gold – can safeguard purchasing power in the long run, but can do so only to a limited extent in the near term. Inflation-linked bonds have a much clearer correlation with inflation and provide corresponding inflation protection. For this type of bond, the nominal value and/or coupon payments are adjusted to the evolution of an inflation index. An investor can thus rest assured that parking money in inflation linkers will preserve its purchasing power, provided that the real yield at the time of the investment wasn’t negative. Stocks, meanwhile, do not provide comparable direct protection against inflation, but equity markets can nonetheless live well with (mildly) elevated inflation. Historical studies show that stock markets don’t come under extra pressure unless inflation exceeds 3% to 4% for a protracted period (depending on the region) because under that inflation regime, central banks typically have to raise interest rates, which eventually weakens economic activity and corporate earnings and puts downward pressure on stock valuations (due to an increased discount factor). Moreover, when inflation is elevated but not inordinately high, stock picking becomes a more important factor of success. Basic material stocks and companies with formidable pricing power that can pass higher input costs onto their customers are usually outperformers in such an environment. Unprofitable growth companies, in contrast, tend to come under pressure in such a climate. Investment in other real assets whose cash flows are directly or indirectly tied to the evolution of inflation can also provide a certain degree of inflation protection. This group of real assets includes infrastructure, real estate and private equity, for example.
Will the US infrastructure package spark an economic boom in the USA? Is it now time to load up on US stocks?
Kaiser Partner Privatbank: After months of negotiations, US President Joe Biden was finally able to put his signature on the long-promised infrastructure act in mid-November. The legislation earmarks an extra USD 550 billion to be spent over the next five years on infrastructure issues from A to Z, including funding for roads and bridges, public transit and railways, airports and seaports, waterways, improvements in broadband networks and upgrades of electricity and water infrastructure. Such a spending package is glaringly necessary because the USA’s infrastructure has been neglected for decades. Its timing, however, is not “optimal” because it comes at a time when US economic activity has already been massively stimulated by COVID-19 relief programs. This means that the infrastructure act may not only prolong the phase of above-average growth rates, but could ultimately even contribute to overheating the US economy and fueling correspondingly high inflation rates. If Biden’s Build Back Better plan additionally succeeds in getting the envisaged multitrillion-dollar social spending program off the ground, the risk of an economic boom accompanied by a boiling over of inflation would further increase. This eventually would force the US Federal Reserve to radically ratchet up interest rates, which sooner or later would have adverse implications for the equity market. But we are still a long way from such a juncture. Meanwhile, the measures that have already been passed are particularly bound to benefit the manufacturing and basic materials sectors. Whoever bets on the potential beneficiaries in those sectors – such as agricultural and construction equipment manufacturer John Deere, mining company Freeport McMoRan or oil and gas producer EOG Resources – can participate in the US infrastructure package as an investor. Across the board, however, we wouldn’t categorically prefer US equities to stocks in other regions (any longer). European stocks, for example, currently look more attractive on price-to-earnings ratios. On the other hand, in recent years it has never paid to predict an underperformance by the US market solely on the basis of valuations. A neutral tactical stance is therefore appropriate, in our view.
Gold doesn’t generate payouts. Can it nevertheless make sense to invest in gold?
Kaiser Partner Privatbank: Anyone who puts the yellow metal in his or her portfolio (or in a safe) cannot count on receiving regularly recurring dividend payouts (like with stocks) or interest coupon payments (like with bonds). Gold’s added value as a sensible component of a strategic asset allocation stems from three other points. For instance, adding in gold improves the risk/return characteristics of a portfolio. Since stocks and gold have a very low performance correlation (correlation coefficient of 0.12 over the last 50 years), using gold to diversify a balanced portfolio of stocks and bonds improves the risk-adjusted return of the entire portfolio. Secondly, gold can act as a sturdy anchor in a portfolio and can cushion stock-market drawdowns during crisis periods. It’s not for nothing that the precious metal is often referred to as a “safe haven.” However, gold’s track record as an “insurance policy” isn’t immaculate. At the nadir of the coronavirus crash in March 2020, for example, investors in gold had to tolerate a temporary 20% plunge in the yellow metal’s price. And the third argument in favor of gold – based on its purported ability to protect against inflation – also warrants closer scrutiny. While it’s true that investors have been able to “preserve” purchasing power with gold over lengthy periods stretching over multiple decades (in real terms, the price of gold in US dollars is roughly at the same level it was 40 years ago at the apex of US inflation), the correlation between gold’s performance and inflation is much less clear-cut in the short run. Gold, for instance, threatens to end this year in negative territory even though inflation in the USA has recently been hovering at a 30-year high. For gold, like all other assets, it’s ultimately the interplay of supply and demand that determines the price both in the near term and the long run. Since gold is increasingly in competition with other alternative currencies – cryptocurrencies to be exact –, this blurs the yellow metal’s long-term prospects somewhat and makes any forecasting attempt even more speculative. The bottom line, though, is that gold remains a steadfast but fairly unexciting component of our asset allocation.
Building block of diversification…
…and long-term protection against inflation
Gold price in US dollars (nominal and real)
Sources: Bloomberg, Kaiser Partner Privatbank
A new resolution by the Central Committee of the Communist Party has effectively named Xi Jinping China’s core leader for life. What does this mean for geopolitics and the financial markets?
Kaiser Partner Privatbank: The sixth plenary meeting, at which the aforementioned resolution was adopted, can be viewed as a prelude to a much more momentous event: the 20th National Party Congress in autumn 2022. Under rules that have applied in the past, Xi would have to step down from the presidency at that time after having served two full terms in office. However, he already hinted back in 2017 (at the last party congress) that he did not want to honor term limits and preferred to stay president for life. In the months ahead, he now likely will want to strengthen himself and his faction more than ever against any opposition and will react very vigilantly to domestic or foreign policy threats. We see a number of risks emanating from the personality cult surrounding Xi Jinping:
- Greater country risk: China heretofore has been governed on the basis of party consensus. In the future, sole rule by the president will be further institutionalized. However, autocratic governments lack the guardrails needed to avert drastic policy errors. If Xi wishes (or is forced) to step down someday, a succession crisis will practically be inevitable.
- Greater macroeconomic risk: There is an increasing probability that China will get stuck in a middle-income trapand will not be able to catch up economically with industrialized countries in the long run. The new historical resolution and the Xi administration’s broader agenda both deprioritize liberal, pro-market economy reforms. Centralization is already repressing inventive and entrepreneurial spirit in China today.
- Greater geopolitical risk: The reversion to autocracy and the turn away from economic liberalism also bring in their wake a conflict with the United States, which is still the world’s largest national economy and mightiest military power. The USA is thus likely to forge additional economic and military alliances and use them to put pressure on China.
These risks admittedly do not pose a “problem” today or tomorrow, but if they do materialize someday, they could necessitate higher risk premiums for Chinese stocks (and other asset classes) in the medium to long term. Future developments in Chinese politics therefore have to be watched closely in the quarters ahead and thus have a permanent place on the geopolitical heat map in our Monthly Market Monitor publication.
Are investments in Chinese high-yield bonds recommendable at the moment, or is better to keep my hands off them?
Kaiser Partner Privatbank: Yields on Chinese high-yield bonds have intermittently climbed in recent weeks to as high as 27%, the highest level since 2009. However, something that looks extremely attractive from a purely optical standpoint doesn’t necessarily present a good buying opportunity. In this case it’s because the opulent showcase yields and cut-rate prices have a cause behind them: the beleaguered Chinese property development sector. Although, Evergrande in recent weeks has consistently been able to meet its liabilities at the last minute, competitors like Sinic, Fantasia and China Modern Land officially defaulted in October. Investor sentiment toward the sector has brightened a bit lately after Chinese state media reported news about a potential easing of regulations. A number of banks have already issued buy recommendations on Chinese “junk” in light of the allegedly cheap valuations and the prospect of a potential rollback of regulations. We definitely see an opportunity here for pocketing quick gains, if only because this market segment is heavily oversold and even just a little favorable news is enough to spark a rally. But this means that a purchase right now would be a speculative trade and not a long-term investment because the risk of a miscalculation by the government of China and of missing or inadequate support or easing measures is too big to ignore, in our view.
A tempting bargain?
Only for people with a big appetite for risk
China High-Yield Index yield
Sources: Bloomberg, Kaiser Partner Privatbank
COP26 is over. Are the pledges that were made there just green marketing, or are they serious steps toward limiting global warming?
Kaiser Partner Privatbank: Almost 200 member states took part in the world climate conference in Glasgow under the principle of unanimity, as always. Under such preconditions, it is more than difficult to hammer out compromises on anything beyond the lowest common denominator. It’s outright impossible for a solitary climate summit to halt global warming and its consequences. Disappointments such as India’s and China’s last-minute dilution of an exit from coal have to be accepted as natural byproducts of complicated climate diplomacy. In the final analysis, the outcome of COP26 was nonetheless positive and more than just green marketing because climate targets not only became more ambitious, the actions to be taken to reach them also became more specific. In addition, the measures also became more binding, though there is still plenty of room for improvement on this point. The following items rank among the highlights of the two-week Glasgow climate summit, in our view:
- 5 degrees Celsius: The participating countries reaffirmed their intention to limit the increase in global temperatures by 2100 to a maximum of 1.5 degrees Celsius. According to calculations by the International Energy Agency (IEA), the climate pledges made – provided they are kept – are only enough to hold global warming below 2 degrees Celsius.
- Coal and fossil fuels: For the first time ever in the final declaration of a climate pact, coal and petroleum were explicitly cited as key causes of global warming. Equally noteworthy was the agreement reached to phase out “inefficient” subsidies for fossil fuels and to (largely) exit coal power.
- USD 100 billion: At the 2009 climate conference in Copenhagen, industrialized nations had already pledged to provide USD 100 billion per year to emerging economies to help them cope with climate change, but since then haven’t yet delivered on that promise. The same vow has now been reiterated in the context of the Climate Finance Delivery Plan (which includes mobilizing USD 40 billion per year from the private sector). In addition, funding for prevention and adaptation measures in the Global South, which faces the worst impacts of climate change, is to be doubled by 2025.
- USA and China: These two economic giants together account for around 40% of worldwide greenhouse gas emissions. Despite geopolitical tensions, in a joint declaration the USA and China vowed to work together on tackling climate issues. This marks their first pledge to cooperate on climate matters since the 2015 accord in Paris. Both countries’ willingness to act in concert sends an important signal to the rest of the world.
- Methane: Methane has 80 times more warming potential than carbon dioxide, but doesn’t linger nearly as long in the Earth’s atmosphere (12 years on average as opposed to 300 to 1,000 years for CO2). So, it has accordingly large leverage in reducing the atmospheric greenhouse gas concentration in the near term. More than 100 countries vowed in Glasgow to cut their methane emissions by 30% by 2030.
"More and more politicians, policymakers and businesspeople appear conscious of the need for immediate accelerated action."
The list of positives can easily be lengthened. For example, outside of the UN framework (where the methane pledge came into existence), initiatives were also launched to phase out internal combustion engines by between 2035 and 2040, to end deforestation by 2030 and to accelerate the advancement of clean, sustainable, zero-emission technologies. Finally, heretofore missing rules were defined to facilitate the breakthrough of cross-border trading of emissions credits.
To say that the COP26 summit was all just “blah, blah, blah,” as Greta Thunberg opined, would be to draw a false, naïve conclusion because in the end, the climate conference didn’t just deal with climate protection, but also with its economic and social implications, which inevitably necessitates compromises. With a couple of demerits, the two-week conference marathon was a successful start to a much longer endurance run in this fledgling and likely already crucial third decade of the 21st century. More and more politicians, policymakers and businesspeople appear conscious of the need for immediate accelerated action and even more strenuous efforts beyond that. This is evident last but not least in two additional points. First, governments next year already intend to further step up their national contributions to achieving the climate targets and want to discuss the progress annually in the future. And second, every climate summit in the future is to be kicked off by a meeting of heads of government and state (as COP 26 was).