«It’s not that the assets are increasing in value, but rather that money is becoming worth less and less.» (Jacques E. Stauffer, CEO, PARSUMO Capital AG)
Some normality returned to the markets in the second quarter of 2019, albeit only in terms of the pace of advances. Compared with the heavy setback in December and the record results in the first quarter of this year, the markets appeared to advance at an almost leisurely pace in Q2. However, this development is much healthier than the exaggerations of the preceding quarter.
Our risk indicators remain at a low level and are showing a constructive market environment. Although there is occasional turbulence, it has not reached elevated levels and the systemic risks are even decreasing further. We also observe a broad risk diversification, which provides a good basis for real assets. Due to the pleasing risk conditions, we are maintaining the second highest risk budget in our portfolios and thus a significant overweighting in real assets. These risks should also pay off in the third quarter of 2019.
The past few months give us hope that the recent positive performance of the equity markets will continue despite – or perhaps due to – the existing worries and skepticism. Although the geopolitical risks have not diminished, we still expect the markets to be fully capable of absorbing further shocks or negative news.
In our April newsletter, we wrote:
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.
This forecast has proved to be correct: The slowdown has set in and is sending out positive signals. Large-scale sell-offs had no negative effect on the risk conditions. With the exception of commodities, all asset classes built on their Q1 gains in the period from April to June:
|Asset class||Index||Return |
as of 30.06.2019
in base currency
as of 30.06.2019
in base currency
|Equities World||MSCI World Net USD||4,00%||6,33%|
|Equities Switzerland||Swiss Performance Index||6,55%||15,98%|
|Equities EM||MSCI Emerging Markets NR USD||0,61%||1,21%|
|Bonds World||JPM GBI Global Traded TR USD||3,49%||5,66%|
|Bonds Switzerland||Swiss Bond Index AAA-BBB TR||1,36%||3,88%|
|Commodities||Thomson Reuters/Jefferies CRB TR USD||-0,98%||-7,55%|
|Real Estate Switzerland||SXI Real Estate® Fnds Broad TR||4,15%||9,82%|
|Real Estate World||FTSE EPRA/NAREIT Global TR USD||0,37%||9,02%|
|Exchange rate EUR/CHF||-0,71%||-4,23%|
|Exchange rate USD/CHF||-2,10%||-1,81%|
Interest rates and inflation
Due to the interest rate situation, asset inflation is continuing. It’s not that the assets are increasing in value, but rather that money is becoming worth less and less. Why? Because there is an abundance of it and the central banks do not have a formula to soak it up.
June marked the 10th anniversary of the upturn on the US equity markets. In July, it became the longest recovery period ever – and the signs are that it will continue. The reasons are clear; nevertheless, arguments that dispute further positive development of the equity markets should also be taken seriously. At this point, we would like to offer some thoughts on inflation, the main driver of interest rates. Inflation has remained unchanged for years. It is closely monitored and is a central tool in the policies of central banks. However, this important yardstick appears to have become slightly outdated and may no longer be adequate as an indicator of prices. Why?
Household spending has changed considerably in recent decades. Expenditure on services, healthcare, health insurance, information, leisure and education has risen continuously and now makes up the lion’s share of spending. In addition, some of these areas have shown exorbitant price increases. The problem is that these extra costs are not taken into account, since they are not included in the basket of goods used to calculate inflation. It would appear that everyone has accepted this fact. This does not augur well for social harmony and it also damages the credibility of central banks worldwide. They describe inflation as one of the most important indicators in their monetary policy, yet do nothing to adapt its calculation to today’s reality.
It’s hard to imagine what would happen if the US Federal Reserve were forced to face the facts. In addition to absorption of liquidity, it would have to measure price rises based on an adequate basket of goods and adapt its inflation expectations accordingly. Many of the major central banks are also exposed to increasing political pressure. We should focus our attention on the independence of these institutions and see a creeping dependence as a warning rather than a blessing.
We have already mentioned the culmination of pension assets: They have reached a peak and net outflows from these important investors are imminent, which could potentially trigger a stock market correction. Last but not least, social harmony – or a lack of it – could turn our world order upside down. Developments in Europe and the US do not bode well. Power politics, protectionism and an «us first» mentality could destroy what we have accomplished over centuries in just a few decades. The upward spiral would be replaced by a vicious cycle.
«Let the markets take their course for now and remember that trees don’t grow to the sky.» (Jacques E. Stauffer, CEO, PARSUMO Capital AG)
Findings from Risk Regime Investing (RRI)
In the second quarter of 2019, our proprietary risk indicators recommended that we maintain a high proportion of real assets in our portfolio. Nothing has changed in this respect. We are riding the persistent upward trend, and the performance of our portfolios is positive and stable. With the more leisurely pace of the markets at present, we believe that conditions are good for further price increases. As long as we do not identify any exaggerations, and none of the highlighted problems appear, we will maintain our offensive portfolio orientation.
Findings from Quantitative Stock Selection (QSS)
In our last newsletter, we wrote about some unique events:
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 seems 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.
This U-turn has now taken place. In the second quarter, almost no traces remained of the extraordinary developments in January to March. Life has returned to normal, with investors liking quality and low valuations and shying away from risk.
After a difficult phase, the results of the QSS approach have improved and we have again been able to absorb style premiums. In terms of styles, we prefer quality, reasonable valuations, lower risk and momentum. This weighting corresponds to the current economic cycle, which is in a cooling phase and requires a slightly more defensive positioning. In our QSS mandates, we are weighted neutrally across sectors, countries and currencies, which reduces tracking error and has a calming effect. The selected securities with advantageous benchmarks decrease the portfolio’s risk relative to the benchmark.
Global financial markets – review
After the astonishing first quarter, in which all key indices recorded double-digit growth, the second quarter progressed at a more leisurely and healthier pace. With the exception of commodities, all asset classes recorded slight gains. With an increase of 6.55%, the SPI again posted a very pleasing result and continues to go from strength to strength. The MSCI World equity index rose by 4.00%, while the MSCI Emerging Markets index advanced by 0.61%, held back by the escalation of the trade war between the US and China. Swiss franc investors suffered minor currency losses on dollar and euro-denominated investments.
Investment grade bonds also performed well in the second quarter of 2019. JP Morgan’s global market index advanced by 3.49%, representing growth of 1.32% in franc terms. Franc-denominated bonds with ratings between BBB and AAA also continued their slight upward trend again, ending the quarter with a gain of 1.36%. The yield differential between short and long-term franc-denominated bonds has remained virtually unchanged.
Prices of commodities indices are driven largely by the oil price – and have been so since the beginning of the year. The impressive advances of the first quarter were not repeated in the period from April to June, and the broad-based CRB commodity index closed the second quarter with a slight loss of 0.98%. The price of crude oil experienced a volatile downward correction, while gold recorded considerable gains. In Swiss franc terms, commodities saw an increase of 6.70% in the first half of 2019.
After the US Federal Reserve had raised key interest rates on a quarterly basis in 2018, it took a break from this policy in the first quarter of 2019, giving the real estate markets an enormous boost. It again left interest rates unchanged in Q2, defying President Trump, who is calling for an interest rate cut. No hikes are foreseeable in Europe and Switzerland, and interest rates are likely to remain very low there for some time to come. Swiss real estate funds gained 4.15% in Q2, and foreign real estate investment was up by 0.37% (–1.73% in franc terms). This represents an impressive return of 12.96% for Swiss real estate and 15.41% for foreign real estate since the beginning of the year.
The Federal Reserve’s decision not to increase interest rates in the first half of 2019 put a brief halt to the diverging interest rate movements between the US and the rest of the world. The dollar was down 2.10% against the Swiss franc in the second quarter, after a gain of 1.27% in the first quarter. The single currency continued its general weakness, falling 0.71% against the Swiss franc and 1.40% against the dollar between April and June.