«You can force someone to close their eyes, but you cannot force them to sleep.» (Danish proverb)
The central banks know no boundaries. Using all their resources albeit with slightly different priorities, they attempt to stimulate the economy, stoke the stock exchange, weaken their own currencies and fend off the feared phenomenon of inflation. Ideally, these objectives should all be met at the same time.
Japan’s central bank takes a particularly direct approach. To increase the monetary base by more than EUR 500 billion a year, the Bank of Japan (BoJ) has been buying equity traded funds (ETF) and real-estate investment trusts (REIT) directly since last October, rather than taking the longer route through the bond markets. Europe is taking a slightly more conservative approach. On 22 January 2015, the European Central Bank (ECB) announced its intention to purchase bonds on the secondary market, with the aim of taking stronger action to kickstart growth and increase inflation in the eurozone. Between March 2015 and September 2016, it will purchase securities worth more than EUR 1.1 trillion.
Why the central banks are choosing to drag their governments out of the mire is a mystery to us. They are aiming to solve the debt crisis with low interest rates while stimulating the economy at the same time. We are particularly puzzled as to why this excessive quantitative easing is being performed indirectly, i.e. by buying vastly over-valued bonds on the stock exchange. While we are still waiting for economic recovery to arrive, there is a growing danger that bubbles will begin to form on the financial markets – and sooner or later these bubbles will burst. You can force investors to close their eyes, but you cannot force them to sleep.
«Evil cannot be conquered if it is more attractive than good» (Ernst Reinhardt, Swiss publicist and aphorist)
No one has ever developed an instrument that can reliably predict a financial crisis. However, the physician Didier Sornette and his working group at ETH Zurich are now looking to change this. At his Financial Crisis Observatory (FCO), Sornette is simulating and testing the formation of bubbles and determining whether it is possible to predict when they will burst. In his Global Bubble Status Report published in March, he argues that clear warning signals can be seen in 56% of all European equity sectors and 85% of all global bond indexes. Sornette believes that the ECB’s aforementioned impending quantitative easing program is the reason behind the stark increase in signals as compared to the previous month.
|Equity World||MSCI World Net USD||2.31%||6.03%|
|Equity Switzerland||Swiss Performance Index||3.16%||11.40%|
|Bonds World||JPM GBI Global Traded TR USD||-1.79%||-3.73%|
|Bonds Switzerland||Swiss Bond Index AAA-BBB TR||1.98%||6.85%|
|Commodities||Thomson Reuters/Jefferies CRB TR USD||-7.86%||30.44%|
|Real estate Switerzland||SXI Real Estate® TR||8.16%||19.94%|
|Exchange rate EUR/CHF||-13.21%||-14.31%|
|Exchange rate USD/CHF||-1.70%||9.95%|
Our risk indicators in the first quarter of 2015 were the same as in the previous quarter. For our investment strategy, we are sticking with target portfolio 1 and continuing to invest defensively. Investments in real assets make up 20 to 25% of the portfolio’s resources. In light of the current environment, we want to keep the level of risk low, which is also reflected in the nominal value of our investments. The proportion of bonds is neutral compared with our benchmark, but the duration is considerably shorter.
The central banks’ behavior is one of the main considerations for market participants. However, it is one of the main causes of an unstable market: If indexes are only driven by a small number of factors, they are less able to absorb negative news. In addition, investors are now behaving in the way described by Daniel Kahneman in his “Prospect Theory”, the work which won him the Nobel Prize in Economic Sciences in 2002. Instead of accepting a safe, limited loss of liquidity in a negative interest rate environment, they are choosing the more uncertain route of making risky investments in the hope of generating a profit. However, we believe that the opportunity to make a profit is becoming smaller from one month to the next. The constant search for risk is the only way to explain the way that investors are behaving and the prices of their investments:
- Money market funds have become much less attractive since 1998. Back then, the resources invested in these safe, interest-yielding instruments still made up 25% of Switzerland’s total fund volume. Today, fund investors have to pay for this safety as a result of the negative interest rates. As a result, money market funds now make up just 6%. Despite strong growth in the corresponding fund volumes since then, only CHF 53 billion is currently invested in money market funds, some CHF 30 billion less than in 1998.
- Previously conservative investors are having to take a new approach in today’s zero interest rate environment, with many favoring real-estate investments that offer a positive return in the form of a dividend. These investors are willing to pay a high price for such investments. At the end of March, the premium (agio) of all Swiss real-estate funds was 35% higher than the net asset value (NAV), compared with the long-term average of 15%. The potential for corrective action has risen considerably over the past three months.
- A lack of alternatives is causing investors to make risky investments. At the end of February 2015, shares made up 39% of Switzerland’s total fund volume, exceeding the record high set in 2000. Over the past 15 years, the Swiss Performance Index (SPI) has only generated a positive annual yield once, when shares made up more than 36% of the total volume. In all other years, the performance has been negative.
- Unlike with the euphoria surrounding dot.com shares 15 years ago or the rush for mortgage-backed securities eight years ago, we do not believe that investors are now searching for the hottest monetary investment voluntarily. Instead, the central banks’ current approach is almost forcing them to depart from safe, interest-bearing investments. The investors’ natural inclination to avoid certain losses at all costs is being exploited. The “evil” of assuming more risk cannot be conquered if it appears more attractive than the “good” of certain loss.
Global financial markets – Review
(Vergleiche vorgehende Tabelle)
The European stock markets caught up well in the first quarter of 2015. After a decent performance of 3% in 2014, shares in Germany’s benchmark DAX index rose by 22% in the first three months. In the same period, the Euro Stoxx 50 advanced by 18% after a lackluster performance in the previous year. This more than compensated for the decline on the global stock markets. In the USA, for example, the S&P 500 finished the first quarter unchanged after climbing by more than 11% in 2014. The Nikkei is also in good condition: The monetary policy and interventions by the central bank helped Japanese shares to rise by a further 10% by the end of March after already increasing by 7% the year before.
Against the backdrop of negative interest rates, bonds are see-sawing. The yields for Swiss government bonds are fluctuating between positive and negative on an almost daily basis, and the corresponding yield curves are turning from flat to inverted. In the eurozone, 30% of government bonds are now generating a negative yield. After the global bond rally began to show signs of fatigue, the value of the global bond index fell by 2% (calculated in dollars) in the first quarter. Swiss franc bonds performed better, finishing 2% up.
In terms of risk, commodities enjoyed mixed fortunes between January and March. While the fluctuation margin for monthly returns from crude oil grew wider, the corresponding volatility indicator for precious metals continued to shrink. The volatility of gold prices reached its lowest level in four years at the end of March 2015.
The investment crisis for bond investors intensified in the first quarter of 2015. As a result, real estate provided an alternative outlet for funds that were not (yet) intended for equity investments due to risk considerations. This is the only way to explain the further increase in the agio (the premium to the net asset value) for Swiss real-estate funds. This premium has now reached 35%. Accordingly, real-estate funds generated a return of 8% in the first quarter and a return of 20% in the past 12 months.
Fundamental changes in monetary policy put the Swiss National Bank (SNB) under so much pressure that it unexpectedly abolished the minimum CHF/EUR exchange rate on 15 January 2015. At the same time, it pushed interest rates even further into negative territory, after already introducing negative interest rates on deposit accounts for commercial banks in December 2014. By the end of the quarter, only the dollar had managed to recover somewhat from this shock. Although its value fell by 2% against the Swiss franc, it has still risen by 10% over the past 12 months.