«These days, the prudent are seen as eternal pessimists, even if they are merely thinking about possible setbacks.»
(Jacques E. Stauffer, CEO, PARSUMO Capital AG)
The first quarter of 2019 will go down in history as the one that broke every record of the last 30 years. Who would have predicted that? The honest answer from most investors would be «hardly anyone». How can it be explained, and why do the arguments seem to change from one week to the next?
To put things in perspective: Our risk indicators fell back considerably from January to March, which prompted us to return to the market. With our cautious positioning at the end of 2018, we managed to avoid the worst. But we had to wait until the improved risk conditions were confirmed before increasing the proportion of real assets again. Although such a strategy is associated with opportunity costs, it also avoids losses in the event of further market setbacks, particularly if the weighting is increased further.
We commented on this scenario in our last newsletter in January: This also raises the question of what risks we might face after an accentuated, perhaps even exaggerated, correction. The opportunity costs can build up just as quickly as the setbacks before them.
The gains in the various asset classes were considerable in the first quarter, providing an early indicator of what might be expected for the full-year result in 2019:
|Asset class||Index||Return |
as of 31.03.2019
in base currency
as of 31.03.2019
in base currency
|Equities World||MSCI World Net USD||12,48%||4,01%|
|Equities Switzerland||Swiss Performance Index||14,35%||10,32%|
|Equities EM||MSCI Emerging Markets NR USD||9,91%||-7,41%|
|Bonds World||JPM GBI Global Traded TR USD||1,81%||-1,00%|
|Bonds Switzerland||Swiss Bond Index AAA-BBB TR||1,83%||2,60%|
|Commodities||Thomson Reuters/Jefferies CRB TR USD||8,85%||-3,87%|
|Real Estate Switzerland||SXI Real Estate® Fnds Broad TR||8,46%||4,63%|
|Real Estate World||FTSE EPRA/NAREIT Global TR USD||14,98%||12,36%|
|Exchange rate EUR/CHF||-0,86%||-5,00%|
|Exchange rate USD/CHF||1,27%||4,18%|
Due to the measured risk conditions, we are currently overweight in real assets. Despite persisting geopolitical risks, we expect the markets to absorb further shocks or negative news surprisingly well. We are also seeing a pleasing level of risk diversification, and thus an advantageous basis for real assets. The bull market of the past eight years is continuing, and the new highs could be exceeded again. However, we believe a slowdown in this trend is an essential prerequisite for further orderly advances. Otherwise, there is a danger of a rapid reversal, such as that seen in December 2018 but of a greater magnitude.
Short-term signals, long-term trading
Timing is one of the biggest challenges for every investor; in an effort to determine and exploit the best time to invest, they are tempted to make changes to their portfolio again and again. Relevant highs and lows are defined as targets, but often retrospectively. As long as the markets exhibit an upward trend, no investor can turn their back on the market and certainly would not publicly announce it. These days, it is common practice to sit tight through the setbacks and hope that everything will work out and the markets will fix it themselves.
Not so long ago, market participants and observers believed the end of capitalism was nigh, with each prophecy bleaker than the last. Back then, it was the eternal optimists who went against the tide and were not heard among the torrent of emotions. Today, the opposite is true: the prudent are seen as eternal pessimists, even if they are merely thinking about possible setbacks. In an environment in which investors are encouraged by short-term signals at the expense of long-term trading, the statement «fortune favors the brave» is apt.
What’s the worst that can happen if everyone is suffering at the same time?
We recall the early days of our pension system, when the assets were still very modest. The professionalization of today’s mighty pension funds started in the 1980s, and the experts began to think about the advantages of occupational pensions. Financial services providers in particular calculated a great deal of potential and speculated that the steady accumulation of capital would continue until at least 2020. After a unique savings process, pension assets grew to almost CHF 900 billion (pension fund statistics 2017, excluding assets from insurance contracts).
We also remember the time when active management was the norm and asset managers achieved either good or bad results. Not all could all beat the market – and for every winner, there was inevitably a loser under this relative view.
Now 2020 is almost here. The baby boomers will gradually access their capital, and thus put even more pressure on the pension funds. Low interest rates, an increasingly complex regulatory environment and discussions about conversion rates, redistribution and intergenerational contracts are giving pension providers a headache, made worse by setbacks on the equity markets. What happens if the indexed assets of the pension system correct themselves in line with the market? What if the regulators intervene and demand effective measures for underfunded pension funds? And what if pension funds are forced to sell their indexed products, putting further strain on pension assets?
Even though there may be no signs of a crisis today, it is worth thinking about what might happen in such a situation. In 2017, CHF 28 billion was paid out in pension benefits and CHF 8 billion in capital benefits. These figures will increase in the future. Pension assets achieved an excellent net result of CHF 64 billion in 2017, but this performance was not replicated in 2018. The gap between capital inflows and outflows will continue to widen.
«Despite a slowdown in global growth, there is a state of euphoria on the equity markets. What does this mean?»
(Jacques E. Stauffer, CEO, PARSUMO Capital AG)
Findings from Risk Regime Investing (RRI)
In the fourth quarter of 2018, our proprietary risk indicators recommended the gradual reduction of the real asset ratio in our portfolio. We therefore switched to an underweight position in mid-November, before putting the portfolios into protected mode in mid-December. This helped us to cushion the massive market corrections efficiently.
But the subsequent shift in sentiment was remarkable: Just as quickly as the risk conditions had deteriorated at the end of 2018, they improved again in the first quarter of 2019. From mid-January to the end of March, both the Turbulence Index and the Systemic Risk Index were practically in free fall. Accordingly, we carried out a rule-based increase in our position from the lowest risk budget to the second highest risk budget (target portfolio 5) during the course of the quarter.
Increases and decreases of this magnitude and frequency are rather atypical and call for caution. A close eye should be kept on further developments, as good performance of the equity markets conceals the economic and geopolitical risks. We monitor and analyze our indicators on a daily basis.
Findings from Quantitative Stock Selection (QSS)
The first quarter of 2019 brought record returns, but it was also marked by high volatility and controversy. Investors appeared to stick very closely to the maxim «good is bad, and bad is good». But there appears to be no logic behind the corresponding extreme developments. High risk, high valuation and low quality are in demand, momentum appears to be upside down, while earnings revisions and growth do not play a big role.
Although a slowdown in global growth is on the horizon or has already set in, there is a state of euphoria on the equity markets, with double-digit growth recorded. The markets seem to have no respect for the imminent economic developments. This goes hand in hand with the accentuation of the risk conditions – and it does not bode well. But there is no clear trend – the markets could swing either way in the next three to six months.
The results of the QSS approach show that absorption of the style premiums is not linear, or possible on a monthly basis. In contrast, the neutral weightings across sectors, countries and currencies have a calming effect and reduce the tracking error, and the selected securities decrease the portfolio’s risk relative to the benchmark.
Global financial markets – review
The shift in sentiment could hardly have been more extreme: The worst December on the US equity markets since 1931 was followed by the best January since 1987. The first quarter exceeded all expectations worldwide across the board. All leading indices recorded significant gains, mostly in the higher double-digit range. The SPI delighted investors with its excellent performance of 14.35%, and the MSCI World equity index gained 12.48%. The MSCI Emerging Markets index was up 9.91%, again demonstrating the excellent potential of these equities. Swiss franc investors were able to make additional currency gains on dollar-denominated investments.
In 2018, investment grade bonds were the only asset class able to keep its head at least slightly above water. They continued their pleasing performance in the first quarter of 2019. JP Morgan’s global market index advanced by 1.81%, which represents growth of 2.86% in franc terms. Franc-denominated bonds with ratings between BBB and AAA finally started to move again, ending the year with a gain of 1.83%. The yield differential between short and long-term bonds has remained virtually unchanged.
Driven mainly by the volatile oil price, commodity prices fluctuated wildly in 2018. Crude oil prices plummeted by more than 40% in the fourth quarter, and commodity indices also collapsed. This trend has seen a reversal since the beginning of the year, with the broad-based CRB commodity index rising by 8.85% in the first quarter of 2019. The price of crude oil recovered, while the gold price fluctuated in line with daily investor sentiment.
The US Federal Reserve raised key interest rates quarterly in 2018. It took a break in the first quarter of 2019, giving the real estate markets an enormous boost. In Europe and Switzerland, there is still no end in sight to the ultra-loose monetary policy of recent years and interest rates are likely to remain very low for some time to come, not least due to the poor economic outlook in the eurozone. Swiss real estate funds gained 8.46% from January to March, and foreign real estate investment was up by as much as 14.98% (16.16% in franc terms). Confidence in monetary policy and the real estate markets appears limitless.
The Federal Reserve’s decision not to increase interest rates in the first quarter of 2019 put a brief halt to the diverging interest rate movements between the US and the rest of the world, and stimulated the performance of the most important currency pairs. The dollar gained 1.427% against the franc and 2.09% against the euro. The single currency continued its general weakness, falling 0.86% against the Swiss franc.