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.
I really want to invest my money with the long term in mind and have set an investment horizon of around ten years. Is this principle still correct against the backdrop of the many (geo)political upheavals afoot today? Or should I be thinking on a shorter time frame?
Kaiser Partner Privatbank: In our opinion, a sustainable, prudent investment of your assets should continue to be geared toward the (very) long term regardless of near-term political moods and the inevitable ups and downs in world economic activity. For one thing, it takes a long time horizon to reap the benefits of (investment) opportunities that arise as a result of societal and technological trends. Moreover, an overly sharp focus on short-term market movements is not just cost-intensive with regard to trading expenses, but also often brings little success. It takes a medium- to long-term time horizon of five to ten years to reap the potential of a well-conceived strategic asset allocation. You especially have to be willing to hold investments for a long time if you wish to pocket the full rewards accruing from assets such as private equity, infrastructure and real estate that tend to deliver higher returns.
Asia is becoming ever more important economically and politically. Shouldn’t my portfolio reflect the new weights in the world economy?
Kaiser Partner Privatbank: A balanced, diversified investment portfolio these days should fundamentally be set up globally to profit from all of the investment opportunities around the world. The biggest economic areas – North America and Europe – should continue to be assigned the largest weightings. The increasing economic relevance and innovative prowess of aspiring regions like Asia should be reflected in an expanding strategic allocation to emerging-market countries. Along these lines, we have increased the weightings of emerging economies in recent months as part of our revision of our strategic asset allocation. In this context, it should be remembered, though, that high economic growth in a given country does not necessarily correlate with a good performance of the local stock market there. The specific configuration of the strategic asset allocation by means of selectively choosing high-quality investment products is therefore just as important as the possibility of setting tactical (and regional) areas of emphasis.
"It takes a medium- to long-term time horizon of five to ten years to reap the potential of a well-conceived strategic asset allocation."
Are there asset classes I should avoid?
Kaiser Partner Privatbank: Almost all asset classes are expensively valued these days. At the same time, though, the return prospects on conventional investment-grade government and corporate bonds are extremely constrained while there is considerable price drawdown risk (in the event of a rising interest-rate level). Conventional bonds are therefore a return-free risk and should be either avoided entirely or at least underweighted if possible. There is an array of alternatives including insurance-linked and microfinance bonds, for example, that you can use to construct the fixed-income part of your portfolio.
Since there are “no alternatives to stocks,” and in light of the enormous glut of central-bank money, can traditional valuation metrics still really be applied to the equity markets these days?
Kaiser Partner Privatbank: By “classical” valuation metrics such as price-to-earnings or price-to-sales ratios, stocks today are expensively to extravagantly valued in historical comparison. However, any answer to the valuation question must also take account of the prevailing macropolitical climate, which is currently being shaped by extremely low interest-rate levels and central banks’ ultra-accommodative monetary policies. Against this backdrop, investors should mainly be looking at the relative attractiveness of different investment options. Measured by the equity risk premium (equity earnings yield minus risk-free bond yield) or by a simple comparison of stock dividend yields against bond yields, stocks as an asset class remain attractive in relative terms in spite of their lofty absolute valuations.
Since the equity market has had a good run, is it advisable to step up our allocation to stocks incrementally? What do you recommend to clients who aren’t invested in stocks yet?
Kaiser Partner Privatbank: Studies have shown that buying into the stock market gradually over time (as opposed to taking the all-in approach) doesn’t pay off in the majority of cases, particularly because the equity market tends to be headed upward most of the time. Moreover, nowadays, whoever would like to get started in the stock market is increasingly faced with having to pay negative interest on the uninvested part of his or her assets. He or she therefore has to bear not only opportunity costs (of missing out on share-price gains), but also explicit interest expenses. Nevertheless, we have to remember that investors are only human, and we need to keep human psychology in mind. Use of option strategies (short puts) enables an investor to enter the stock market gradually in a way that minimizes opportunity costs.
Ongoing climate change is a big concern on my mind. What can I do with my investment portfolio to contribute to making the world a bit more sustainable?
Kaiser Partner Privatbank: First of all, it’s important to know exactly how your portfolio stands with regard to its “sustainability.” Ask yourself: How big is my portfolio’s ecological footprint, and how good is its ESG rating? Do I have exposure to controversial business areas? Our sustainability reporting provides answers to all of those questions. Once you have comprehensively reviewed your portfolio holdings, you can then set specific emphases. You, for instance, can align your portfolio with the United Nations Sustainable Development Goals or can invest in specific sustainability themes. Impact investments, on the other hand, can be implemented very well in private market asset segments such as private equity or private credit. In any case, an investor doesn’t necessarily have to sacrifice return to invest (more) sustainably.
Long-term market interest rates have pulled back significantly in recent weeks. What’s going on right now on the fixed-income markets? Will we continue to have to live with ultralow interest rates in the years ahead?
Kaiser Partner Privatbank: Long-term yields have indeed fallen sharply lately. The yield on 10-year US Treasury notes, for instance, plunged from a level above 1.7% in April to a recent intermediate low below 1.2%. There are varied reasons behind the yield pullback. One of them was a technical effect commonly seen on the market. Bonds were heavily oversold at the start of the second quarter, which made a contrary movement very likely. Moreover, many market participants were positioned short and were betting on further declines in bond prices (and on further increases in yields). As so often happens, the consensus bet didn’t pan out in this case. In addition, the recovery in US economic activity reached its peak in the second quarter in terms of its growth momentum. Meanwhile, in China, the first country to reemerge from the pandemic last year, the economic recovery has already been slowing for quite a while now. This is inferable in part from China’s credit impulse, which measures growth in new lending as a percentage of economic output. This good leading indicator of world economic activity has been contracting in recent months. And, finally, this has been joined in recent weeks by new uncertainties (about economic growth) caused by the Delta mutation of the SARS-CoV-2 virus.
However, we consider all “concerns about economic growth” overblown at the moment. The Delta variant of the coronavirus spread mainly in the United Kingdom, but case counts there have already receded (as they have also in the Netherlands, Spain, Portugal and Ireland). Moreover, current mortality and illness rates are still far lower than they were at the start of this year. So, the good news is that the vaccines help and the correlation between infection counts and cases of serious medical complications is rapidly decreasing. Against this backdrop, the latest coronavirus wave is unlikely to put a sizable dent in economic growth. And otherwise as well we expect economic growth rates in industrialized nations to remain above average in the quarters ahead. We therefore expect long-term market interest rates to start rising again in the medium term, not least because more and more central banks – in the UK, Canada, Norway and New Zealand, for example – are making preparations to (gradually) exit their ultra-accommodative monetary policies. Nevertheless, a return to positive market interest rates, regardless of whether for short or long terms to maturity, appears unrealistic in the years ahead particularly in Europe.
US Federal Reserve policymakers seem to be in disagreement about when they intend to put an end to the glut of money. Won’t the Fed eventually curtail its bond purchases? When it does, will that rattle financial markets once more like it did in 2013?
Kaiser Partner Privatbank: In 2013, quantitative easing was withdrawn for the first time since the outbreak of the great financial crisis. This caught the markets on the wrong foot – long-term market interest rates spiked sharply, and equity markets likewise corrected briefly but severely. The Fed learned its lessons from this experience and will try especially hard to steer market expectations by providing forward guidance about future monetary policy. Meanwhile, many emerging-market countries have paid down their foreign debt to some extent in recent years, so now less risk exists here than before if interest rates and the value of the US dollar start to rise again.
"Over the longer term, though, gold would benefit in a climate of elevated inflation (and persistent low real interest rates)."
How inflation evolves is surely also a determinant of the future interest-rate trend. The jump in inflation in recent months worries me in this regard. When and under what circumstances can classic inflation stage a comeback, forcing central banks to take action?
Kaiser Partner Privatbank: When discussing the subject of inflation, it’s important to draw a distinction between the short-term and long-term view. Inflation rates have, in fact, risen significantly in recent months in both Europe and the USA, but this development is primarily attributable to base effects resulting from comparing this year’s price levels with the depressed price levels twelve months ago caused by the COVID-19 pandemic. Temporary supply and production bottlenecks in the manufacturing sector and other one-off effects such as the expiration of the temporary value-added tax cut in Germany are other factors driving inflation. In the USA, in addition, very generous unemployment cash transfers have slowed idle workers’ return to the job market. However, most of the factors that are currently pushing up inflation will probably prove to be transitory. The current bottlenecks in many sectors should ease in the quarters ahead, and supply and demand are likely to resettle into an equilibrium in most cases. We therefore do not expect to see lastingly elevated inflation rates in the medium term.
In the long term, though, we see several reasons why inflation during this decade could at least end up at a somewhat higher level on the whole than the one during the past decade at rates around 2% (in Europe). These predominantly structural factors include, for example, globalization and its reversal. Under the influence of ongoing trade disputes and reinforced by experiences during the pandemic, more and more companies in industrialized nations are repatriating their production from lower-cost emerging-market countries to reduce the vulnerability of global trade chains. There are demographic developments to consider on top of that. When (wealthy) baby boomers in Western societies enter retirement in the years ahead, they will continue to consume prodigiously (even if they’re “only” spending on healthcare), but will no longer produce economic output. If the ratio of consumption to production increases, which looks destined to become a worldwide phenomenon, this could likewise fuel inflation. The same problem – aggregate demand outstripping supply – looms because productivity growth in many industrialized countries has tended to regress in recent years.
What would happen on the financial markets in an inflation scenario?
Kaiser Partner Privatbank: If there is a sustained increase in inflation, sooner or later this inevitably would be accompanied by a rise in (longer-term) bond yields and – depending on how central banks react – an increase in the short-term interest-rate level. In this scenario, bonds would suffer price drawdowns (substantial ones in some cases). This would also cause an adverse reaction on the equity market depending on the magnitude and duration of such a rise in market interest rates – whereas a brief interlude would probably be well digested, a genuine interest-rate shock could spark a major correction in stock prices as well. In a shock scenario, even the price of gold could come under pressure in the short term. Over the longer term, though, gold would benefit in a climate of elevated inflation (and persistent low real interest rates).
The economic stimulus programs in Europe cost yet another enormous amount of money, and government debt continues to balloon. It seems to me that public finances are on the verge of careening out of control, even in Germany. Isn’t a reform of the euro currency inevitable sooner or later? How might a currency reform unfold?
Kaiser Partner Privatbank: Rapidly mounting government debt in nearly all industrialized nations, especially in the countries of southern Europe, makes concerns about an impending currency reform understandable. (Germany has undergone a total of seven (!) currency reforms since 1800, so fears about another one happening are particularly rampant there.) A reform of the euro could become necessary if interest rates in the Eurozone rise substantially and the enormous debt load thus becomes unserviceable for some countries. If wealthier countries then are not willing (any longer) to communitize the debt and take over the costs associated with it, centrifugal forces between northern and southern Europe could grow strong enough to tear the euro apart. In a reform of the euro, which would then become necessary, the current euro could be exchanged into a euro 2.0 (with a lower countervalue) or could be split into a northern euro and a southern euro. Since central banks are already working on projects aimed at creating a digital euro, a future currency reform could proceed purely “digitally,” which would make it easier to implement and enforce.
How probable is this scenario?
Kaiser Partner Privatbank: We estimate a very low probability of a euro currency reform at the moment. Very high inflation (or hyperinflation) and high interest rates that made it impossible for governments to service public debt were consistently the warning signs of currency reforms in the past. We consider a reemergence of runaway inflation rates and very high market interest rates (i.e. above 2% on 10-year German government bonds and 4% to 5% on 10-year Italian sovereign debt) hardly realistic even in the longer term. Moreover, although the risk of a euro crackup was indeed elevated during the 2008 financial crisis and the Eurozone debt crisis of 2010-11, since then a variety of mechanisms, processes and institutions (such as the European Stability Mechanism (ESM)) have been created that address the economic imbalances between Eurozone member states and the resulting financial problems facing individual countries. With the issuance of the first joint bonds (coronavirus bonds) in response to the pandemic, European policymakers once again demonstrated last year that the will to defend the euro as the continent’s common currency by all means remains very strong.
Can I gird my portfolio against such a scenario, and how?
Kaiser Partner Privatbank: To gird against the unlikely event of a currency reform, you should minimize holdings of nominal assets such as cash, term deposits and bonds in your portfolio. The bulk of your wealth should be invested in real assets that provide protection against the money devaluation associated with a currency reform. The universe of real assets particularly includes stocks, real estate, gold and private equity investments. In addition, a small liquid part of your assets should be held in traditional safe-haven currencies like the Swiss franc.
Do you have any further questions? Then please feel free to contact us.