«Risk in itself is not dangerous – it’s all about how you manage it.»
(Felix Gerg, German strategic adviser)
Risk conditions in the international stock markets improved markedly during the first three months of the year. Despite the ongoing political risks and the related uncertainty, stock markets are robust and in good shape. The markets are again more focused on fundamentals, which has meant stress factors have become less important.
In recent years, asset classes have become more correlated than ever before. What we are now observing is that correlations are becoming much weaker, improving the interplay between the different assets. In this kind of environment, diversification can achieve the desired positive effect.
Economic growth has picked up in recent months and, thanks to increasing signs of an economic recovery, the first quarter of 2017 was one of the best for investors since 2004. Real assets (notably equities, real estate and commodities) have appreciated considerably, driven by positive fundamentals – and the lasting effect of the monetary policy of the past few years, which is leading to asset inflation.
The global economic outlook is also improving. The US economy is continuing to strengthen and the markets were well prepared for the US Federal Reserve’s rate hike in March – its third since the financial crisis. Two more rate hikes are expected to follow this year. In Europe, too, there are signs that the economic recovery is gaining momentum. Key interest rates remain at record-low levels. Thus, due to their unattractive yields, fixed-income instruments are no investment alternative to dividend-bearing securities. The flood of liquidity should continue to buoy equities, though some volatility is to be expected.
Against the backdrop of already high valuations, US stock markets are hoping for deregulation and infrastructure programs. In Europe, the fundamentals for equities have improved markedly; European equities, which have significantly underperformed US equities since the financial crisis in 2008/09, have upside potential.
The appetite for risk is growing among investors. Cheap cyclical and riskier stocks are surging, while expensive low-risk quality stocks are coming under pressure. There has already been a quick and pronounced rotation, so we are now expecting a healthy consolidation.
|Asset class||Index||Return |
as of 31.03.2017
as of 31.03.2017
|Equities World||MSCI World Net USD||6,38%||14,77%|
|Equities Switzerland||Swiss Performance Index||7,50%||15,89%|
|Bonds World||JPM GBI Global Traded TR USD||1,44%||-3,48%|
|Bonds Switzerland||Swiss Bond Index AAA-BBB TR||0,16%||-0,76%|
|Commodities||Thomson Reuters/Jefferies CRB TR USD||-3,44%||9,01%|
|Real Estate Switzerland||SXI Real Estate® TR CHF||4,57%||7,65%|
|Exchange rate EUR/CHF||-0,36%||-2,34%|
|Exchange rate USD/CHF||-1,42%||4,30%|
«Only by being prepared to take risks can we limit risk.»
(André Brie, German politician and aphorist)
Findings from Risk Regime Investing (RRI)
Our proprietary risk indicators – the Turbulence Index and the Systemic Risk Index – indicate that the risk/return ratio for real assets is attractive. Systemic risks have increased slightly from a low level, while turbulence (as measured by us) remains low. This means that the markets are robust, have a good absorption capacity and negative news should not spark panic selling. Taking risks normally pays off during such phases.
We took an overweight position in real assets at the beginning of the year and increased it slightly during the course of the first quarter. Currently, we are utilizing the highest risk budget and intend to remain overweight due to the favorable stock market conditions.
Findings from Quantitative Stock Selection (QSS)
The improvement in economic conditions last year triggered the start of a rotation in the financial markets. The ongoing shift from defensive quality stocks to cyclical stocks appears well founded considering the recovery in global economic growth over the past months. The rotation out of defensive sectors such as health care, consumer staples and utilities and into sectors such as banks, insurance, materials and technology is likely to continue after the expected market consolidation.
Against this backdrop, we expect the rather defensive Swiss market to perform well but not quite as well as more cyclical markets.
The emerging markets are among the most promising and still attractively valued cyclical regions. Financial stocks are also likely to perform well in the long term. In the United States, this trend is already reflected in the price of bank and insurance stocks, which saw sharp gains. European bank stocks have performed favorably since the beginning of the year and are likely to continue to do so going forward, though not to the same extent as US financial stocks.
Global financial markets – review
(See previous table)
The first quarter of 2017 was all about the widespread recovery of global equity markets. With the exception of the Japanese Nikkei, all the major stock market indices finished the first quarter higher than they started it. The SPI climbed 7.5%, the Dax 7.2% and the S&P 500 5.8%. At +11.67% and +10.14% respectively, the Spanish Ibex 35 and the Nasdaq 100 recorded the best performances in Swiss franc terms, while the SMI Mid Caps advanced 9.88%. In Great Britain, the Brexit-plagued FTSE 100 eased slightly to close just 2.5% higher. The MSCI World Index, also in Swiss franc terms, ended the quarter 4.82% higher. Once again, the emerging markets performed very well – the MSCI Emerging Markets Index gained 9.52% – and left the industrial countries trailing far behind.
Following a miserable fourth quarter last year for bonds, investment grade securities subsequently recovered somewhat. JP Morgan’s global market index, which had lost 8% in the previous quarter, advanced by as much as 1.5% between January and March. Swiss franc-denominated investment grade bonds (those with a rating of between BBB and AAA) just about managed to stay in positive territory and generated a modest return of 0.16% for the quarter. Despite the improved global economic outlook, the yield differential between long- and short-term bonds widened only slightly in the first quarter.
The first quarter saw commodities unable to repeat their strong performance of the fourth quarter of 2016. The broad CRB commodities index lost 4.86%, dragged down by falling oil prices. OPEC, the oil cartel, announced that it would be cutting production, but to no effect: inventories and supplies remained high and the price of a barrel of Brent crude oil fell by 7.2%. Precious metal investors, on the other hand, had reason to feel pleased: with palladium leading the way, the price of gold climbed 6.85% and silver soared by as much as 12.67% (in Swiss franc terms). Against the background of improving economic conditions, a similarly good performance was only achieved by the industrial metals lead and aluminum.
Despite the rate hike in the United States, interest rates in Europe are likely to remain very low for some time to come. Swiss real estate funds posted a 4.57% return in the first quarter, outperforming bond investments once again. Real estate investments in the UK recovered from last summer’s Brexit shock to gain 1.64% in Swiss franc terms. European real estate funds also generated a positive return of 1.41%. By contrast, US real estate funds lost around 1.3% of their value. Overall, real estate funds in industrial countries have gained 1% in value (in Swiss franc terms) since the start of the year.
Apart from an attempted breakout in mid-March, the euro has been trading against the Swiss franc in a narrow range of between EUR/CHF 1.06 and 1.08 since the beginning of the year. It ended the quarter down just 0.2%. Expectations of only moderate rate hikes in 2017 caused the US dollar to lose 1.42% against the Swiss franc and to fall below parity at one stage. There were no major movements in the British pound to Swiss franc exchange rate, which fluctuated without any clear direction between GBP/CHF 1.21 and 1.26 – such that at the end of March sterling was unchanged compared to the beginning of January. The euro gained 1.3% against the US dollar, closing the quarter at EUR/USD 1.07. 2003’s low of EUR/USD 1.05 seems to be acting as a strong support level.