Investment Management Update – July 2017

Review

«Every act of trust harbors a residual risk, but this must not lead to a general attitude of mistrust.» (Helmut Laufer, management author)

Since the beginning of the year, the risk conditions in the international equity markets have been very good. As a result, the markets are calm with an excellent risk-return ratio. Building on the strong market situation of the previous year – both Brexit and the election of Donald Trump as US president were well absorbed by the markets – the first half of 2017 saw the best risk-return ratio for decades. After our proprietary risk indicators sent out excellent signals at the start of the year, their values stabilized at a low level in the second quarter. The Turbulence Index, which shows the risk of increased market turbulence, is in an idle state. And despite a slight increase in the past weeks, the Systemic Risk Index suggests that systemic risk will continue to be low. Due to the persistently low values of the indicators, market setbacks also remain unlikely in the immediate future. With our risk indicators, which we calculate on a daily basis, we can pursue three key objectives very effectively:

• Protect the portfolios against tail risk
• Participate in positive market developments under advantageous risk conditions
• Increase commitment to real assets again after the emergence of tail risk

At the halfway point of the year, the international equity markets continue to be in good shape, despite recent minor corrections. All the main indices are firmly in positive territory and were able to build on the advances made in the first three months during the second quarter. The markets are being guided by fundamental factors, and the global economic recovery is giving investors confidence. The economic upturn is supported by stable growth in the US, and by accelerated economic development in Europe. The growth driver in both regions is private consumption. However, different dynamics are visible in the US and Europe, and a reversal of the interest rate trend outside the US is not yet expected. The US Federal Reserve is likely to change interest rates again this year, although the minutes of the last meeting raise questions about the speed of normalization. In Europe, the first small steps toward a reduction of the stimulating monetary policy measures are being seen (tapering), but no interest rate hikes are expected before 2019. For the Swiss National Bank, the euro exchange rate remains decisive, which is why it is expected to continue its negative interest rate policy. In the major emerging markets, the central banks can keep interest rates low thanks to lower inflation, which has a positive impact on growth prospects. The global economic growth feeds the risk appetite of investors, and in the absence of an alternative, equities continue to be the preferred choice. We expect the equity markets to continue their advance, interrupted only by minor corrections.

Outlook

«The stock market and economy are based solely on how much confidence there is in the future.» (Erhard Blanck, German author)

Findings from Risk Regime Investing (RRI)

Due to the favorable risk conditions in the financial markets, we stand by our positive forecast for the development of real assets. The risks taken are rewarded with appropriate returns. The markets are robust, have a good absorption capacity and continue to show impressive resilience. Investors appear to base their decisions on a number of factors, which also suggests stable market conditions. Isolated negative events are unable to drag down the market as a whole, plus there is a focus on fundamental considerations and stress factors have abated. We expect some smaller setbacks due to burdensome seasonal aspects, but no major sell-off. During the first quarter, we again increased our overweight position in real assets entered into at the beginning of the year. In the second quarter, we used the highest risk budget very successfully. We are retaining this overweight position due to the favorable equity market conditions.

Findings from Quantitative Stock Selection (QSS)

The rotation in the financial markets, which we have touched on in previous reports, is well supported by the improved economic growth worldwide. The shift from defensive quality stocks to cyclical stocks will become even more pronounced in the coming months. After trailing behind, the banking, insurance, manufacturing, alternative energy, raw materials and oil sectors will overtake the over-valued sectors. In the US, the economy is already experiencing an advanced boom. Europe is lagging behind in the economic cycle, as the economy is still in recovery mode. Although we expect the rotation to continue in the US, the development in Europe is still in its infancy and has outstanding potential. We generally expect a further shift in the factor preferences of investors; i.e. away from defensive style characteristics, such as high quality and low risk, toward the more cyclical characteristics of value, earnings revision, momentum and growth. In terms of regions, we currently favor Europe, Asia-Pacific and the emerging markets. In countries where they are not yet over-priced, we are holding an overweight position in small and mid caps. We see further short-term potential in the more defensive Swiss market, due to a lack of options. However, we expect the performance of the Swiss market to be slightly below that of more cyclical markets.

Global financial markets – review

(See previous table)

Equities

The first quarter of 2017 was all about the widespread recovery of global equity markets. It managed to build on its gains in the second quarter, although the growth rate slowed a little. With the exception of Moscow and Toronto, which suffered from the slump in raw materials prices, all major stock market indices finished June higher than at the end of the first quarter. The SPI has climbed 12.97%, the Dax 7.35% and the S&P 500 8.24% since the beginning of the year. However, converted into francs, this represents growth of just 1.75% for the S&P 500. In the UK, the Brexit-plagued FTSE 100 eased slightly to close just 2.38% higher. The Japanese Nikkei recovered from the negative first quarter, delivering a half-year result of 4.81%. The MSCI World Index ended the first half of the year up 10.66%, while the MSCI Emerging Markets reached 23.75% driven by the dynamic growth in the emerging countries. Once again, the emerging markets clearly outperformed the industrial countries. (All figures in local currency.)

Bonds

Investment grade bonds continued their recovery, although their performance was still well below the previous year as a result of a miserable fourth quarter in 2016. JP Morgan’s global market index advanced by 2.59% between April and June, following a gain of 1.5% in the first quarter. In Swiss franc terms, however, the performance of the index has been negative since the start of the year. With a return of -0.49%, franc-denominated bonds with a rating of between BBB and AAA slipped into the red, achieving the most disappointing half-year result of just -0.33%. Despite the improved global economic outlook, the yield differential between long and short-term bonds narrowed slightly in the second quarter.

Commodities

As in the first quarter, raw materials lost considerable ground in the second quarter. The broad CRB commodities index lost 5.76% in dollar terms from April to June, representing a minus of 8.87% since the start of the year. The losses were again caused by the falling oil price, which is suffering from high supply. At the half-way point of the year, a barrel of Brent crude oil cost 16% less than at the start of January. Silver, the biggest winner of the first quarter, lost all the ground it had gained. Gold also lost some of its shine due to lower political risks in the second quarter. However, with a gain of 7.4% since the start of the year, it is still firmly in positive territory. Only palladium was able to continue its upward trend, gaining almost 24% in the first half of the year. However, these price increases are more likely to have been driven by the demands of financial investors than by the industrial needs of the automotive industry.

Real estate

Despite the rate hikes in the US, interest rates in Europe are likely to remain very low for some time to come. Swiss real estate funds continued to perform well, recording a gain of 2.49% from April to June, after returning 4.57% in the first quarter. They again clearly outperformed franc-denominated bonds. With a gain of 3.71%, foreign real estate investments also performed encouragingly and are up by 7.23% since the beginning of the year. In francs, however, they made a slightly negative contribution to the performance.

Currencies

The euro-franc exchange rate broke free from the narrow range of the first quarter, moving closer to 1.10 EUR/CHF. This represents a rise of 0.64% at the end of the quarter. The dollar again lost 1% against the franc and was below parity for practically the whole of the second quarter. At the end of June, it was almost 6% below its value at the start of the year; most recently, it has been affected by signs that the US Federal Reserve may curb the speed of its interest rate hikes. From mid-April to the start of May, sterling became considerably stronger against the franc, but had forfeited all its gains by the end of June. Driven by the accelerated economic growth in the eurozone, the euro again gained ground against the dollar, closing the quarter at 1.14 EUR/USD. This represents a plus of more than 8% for the first half of 2017.