110/23/2020
INVESTMENT STRATEGY
Investment Strategy Q4
Investment Management
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2
GLOBAL STOCK MARKETS
The summer has come and gone, and with the first days of September, a new chapter was added to the third
quarter, when markets saw their largest pullback since March. The third quarter had been already shaping up to
become a tale of different stories. Following the steepest decline on record in equities since last March, an
unprecendented wave of monetary and fiscal stimulus has helped to propel, in some cases, an even more
impressive equity rally. However, it was not until early August that the S&P500 managed to break out of its
summer box trading. Probably it was not coincidental that two of the big leading tech companies, Apple and
Tesla, announced stock splits. What seemingly intensified the media chatter and memories of the Dot.com
bubble came back. The old stock market adage of buying the rumour, selling the fact could be applied. After the
stock splits became effective at the end of August the correction unfolded. At that time the five largest stocks in
the S&P500 made up more than a quarter of the whole capitalization of the index, surpassing the 18% seen in
2000. That US equities remained unrivaled is a sign of the ongoing broader capital flows at play. Only Chinese
stocks have surpassed the levels of 2018.
MSCI World Equity Indices (Bloomberg L.P.)
ABS RISK APPETITE MODELS, US JOB LOSSES & BANKRUPTCY FILINGS
When equities had marched to new highs in February, cross asset analyses showed that risk appetite had
already been waning significantly. The divergence between risk metrics and the leading equity indices had
become a stark warning sign, that the inherent market structure had become more risk averse. Today, once
again the level of risk appetite doesn’t match the bullishness exhibited by the level of the stock market.
S&P500 & ABS Risk Appetite Models (Bloomberg L.P.)
US Permanent Job Losers & New Bankcruptcy Filings (Bloomberg L.P.)
10/23/2020
INVESTMENT STRATEGY
In the meantime the momentum in
the economic recovery has been
easing in most regions, while
concerns about a second wave of
the virus have increased, with
infection rumbers rising strongly.
Manufacturing is doing better than
services, while return to work and
school is not clear or new restrictive
measures being put in place. This
all makes it for an uneven and
fragile recovery, a challenging
fourth quarter.
The year 2020 has surprised. It
brought a global pandemic, great
financial crisis No. 2, depression era
unemployment, fastest bear market,
speculative bursts unseen before,
negative oil prices and a very
unusual US election cycle. All that
while market dynamics are
changing as they always do.
With second and third order effects
still unclear the full economic fallout
from Covid-19 cannot be assessed.
After the terrifying liquidity crisis of
March investors face the solvency
problems. The fast and vast
interventions by governments have
helped to overcome the immediate
liquidity crunch. Now, highly
indebted corporates need to find a
pathway to deleverage. Rising
default risk will add to the
investment challenges.
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3
In previous reports we too have used the various letters that characterize the course of an economic recovery. In
general, V stands for a rapid recovery, U for slow, W for up and down, L for permanent weakness. The letter J
would represent a new boom. While some sectors and regions should prove to be long-term losers despite a short-
term recovery, others have already reached pre-crisis levels and could benefit from the changes in the long term.
This divergence is described by the letter K. We wrote in our Q3 letter that, unfortunately, a V-shaped recovery is
out of the question. The structural changes following the Great Financial Crisis No. 1 have never really been
understood nor addressed. The consequence has been too weak a growth ever since.
THE U.S. DOLLAR INDEX, JP MORGAN EM CURRENCY
The U.S. Dollar Index, JPM EM Currency (Bloomberg L.P.)
10/23/2020
The US Dollar remains the name of
the game, in one form or another. In
times of crisis it can be seen what it
means, this global dollar shortage.
Some numbers underpin this; the
US makes up around 25% of the
World’s GDP, while the Dollar
dominates close to 80% as payment
currency in global trade. One can
see that once the major currencies
start to trade weaker vs the Dollar
things get serious. Currently there
are still record long speculations in
the Euro. On the other hand the
volatility in EM currencies remains
elevated. Ultimately, we see the US
Dollar substantially higher.
INVESTMENT STRATEGY
GLOBAL FIXED INCOME MARKETS
Government bond yields were generally little changed although European yields fell quite some, respectively
prices rose. Whether this was all due to the news of the €750 billion recovery fund, or there is more than meets the
eye, remains to be seen. But some interesting facts nonetheless; Greece’s 10yr yield, after trading as high as 4%
in March, came down to almost the very same level as the US 10yr in early October. The hundred year Austrian
bond with a coupons of 0.85% yields 30bps less than the US 10yr. Generally, the tone was overall positive or “risk
on” in fixed income markets over the quarter.
US, GE, IT, CN 10yr Yield (Bloomberg L.P.)
It remains unclear how governments will deal with the situation to finance the various massive relief programs,
while fiscal deficits deepen further. Unorthodox policies such as modern monetary theory and debt monetisation
are likely to get greater support. As one FED member stated, some sort of MMT is already here. Investors should
expect signifcant structural changes to the global economy and everyday life. The Coronavirus hit the world at an
inopportune time. Some regions had their economies already at stall speed, while geopolitical risks, trade conflicts
and political polarisations have been on the rise. These are adding to the complexity of the current crisis. Low
yields for too long in the major economies and credit-sectors which had gotten over-levered have contributed their
part in weakening the markets’ configuration. In the FED’s hypothesis, lowering rates reduces the incentive to
save. Yet, empirical data suggests the opposite. The higher the rates the higher the pressure to consume.
The Federal Reserve announced a
change to its inflation targeting
regime in August, saying it would
target an average 2% inflation rate,
allowing periods of overshoot. It
further would allow unemployment
to run lower than officials had
tolerated. This was all that came
from a year-long review of its
monetary policy framework! One
has to wonder. In May 2018 the
FED had already introduced
inflation symmetry.
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4
COMMODITIES
The global pandemic caused a deflationary spiral from which the commodity complex was able to recover to some
extent into the third quarter. Overall, commodities still trade substantially lower than at the start of the year.
However, there were also strong gains like in copper and agricultures. For oil markets the biggest question is
whether OPEC+ will go ahead with its plans to raise output early next year. Some officials hinted that the
organization might rethink and stay put, promising that the group won’t let prices “relapse”. The price of WTI Crude
Oil has been stuck around the $40 a barrel for some time.
Bloomberg Commodity Index, Crude Oil (Bloomberg L.P.)
GLOBAL FINANCIAL CONDITIONS & MONEY SYSTEM
Financial Conditions, USD Swap Spread (Bloomberg L.P.)
US CORPORATE DEBT & PROFITS
US Coporate Debt to GDP & US Corporate Profits Before Tax (Bloomberg L.P.)
INFLATION EXPECTATIONS & VELOCITY OF MONEY & IMF NEW BRETTON WOODS MOMENT
That the world will see lower productivity, less dynamic demand and higher debt is a logical conclusion. Twelve
years after the Great Financial Crisis we find ourselves in the next one. The massive interventions by central banks
have not led to the desired pick-up in inflation. Still the doctrine of «ample reserves» prevails to some extent. The
myth of the central bank is still around, although losing some shine. A central bank has to supply currency in times
of crisis, that’s the concept of elasticity of money. However in the end, bank reserves don’t tell us about the level of
liquidity, they only tell us what the central banks did. In a bank centric system it’s what banks do that matters.
10/23/2020
INVESTMENT STRATEGY
The Bloomberg Financial Conditions
Indices track the overall level of
financial stress in the money, bond
and equity markets. These
measures had indicated extremely
tight conditions in March. Following
the central banks’ interventions
things have eased, but still no all
clear. Although the swap spreads
have remained in slightly positive
territory, they still trade too close to
where it would be indicative of a
broken hierarchy.
The low rates regime post GFC1 has
been incentivizing corporates to
engage in financial engineering like
never before. The wider use of non
productive debt has certainly
attributed to the structural
weaknesses since 2009. While
aggregate profits remained stagnant
at best over the past six years. The
deluge of debt sold around the world
is raising risks. In the US alone
corporate issuances exceeding
already $2tn this year so far.
The precious metals had seen a very
strong rally into August. As often is
the case, the most commonly used
rationalization was the threat of
inflation, the expansionary monetary
policies and uncertainty. However,
the key driver are the negative real
rates, making gold a viable
alternative. Worth noting are the
supply losses in various metals due
to Covid related mine issues.0
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Bloomberg Euro-Zone Financial Conditions Index Bloomberg UK Financial Conditions Index
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510/23/2
020
INVESTMENT STRATEGY
In the past twelve years central banks have added quantitative easing (QE) and negative interest rates to their policy
toolkit. Formerly viewed as unconventional. We wrote before, that the very basic nature of QE is deflationary. We also
elaborated on these pages about Milton Friedman’s interest rate fallacy, that when money is plentiful, interest rates
will be high not low; and when money is restricted, interest rates will be low not high. What was supposed to work as
the quantity theory of money; in reality fails to positively impact the real economy. Instead, developed economies
remain stuck in a disinflationary environment.
US PCE & Inflation Expectations (Bloomberg L.P.)
Central Banks Balance Sheet & Target Rates (Bloomberg L.P.)
US CPI & Velocity of Money M2 (Bloomberg L.P.)
US High Yield – Moody’s Baa (Bloomberg L.P.)
Demographics, technology and the
growing stock of debt are seen as
causes for the persistent disinflation.
As much of QE has not found its way
into the broader economy and banks
have not abandoned their more
cautious lending practices, the velocity
of money has collapsed. Alongside
lackluster growth data.
At its October meeting the IMF warned
that “the recovery is tentative and
uneven and marked by significant
uncertainty”. It revised its global
growth forecast to -4.4%, from -4.9%
seen in June. And; it called for a new
Bretton Woods moment, to
fundamentally re-evaluate the global
economic order. It is not alone. Early
October the ECB issued a white paper
on possible issuance of digital Euro.
Four out of five of the world’s central
banks are engaging in a work on digital
currencies.
The world is in a transition, a paradigm
shift from monetary dominance to
fiscal dominance. Central banks are
readying a technology that could tear
down the wall between sovereign
government fiscal policy and central
banking. The implications will be far
reaching.
Generally, we continue to advocate a
neutral allocation to fixed income.
There are selective areas where
opportunities and value can be found.
Investors have to bear in mind, that
after nearly 40 years of a bull run in
the fixed income markets, we are likely
to see a new era. There will be a
resolution to the debt super-cycle, in
whatever way.
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610/23/2020
S&P500 & VOLATILITY
S&P500 & ABS Volatility Model (Bloomberg L.P.)
SUCCESSFULL INVESTING
There is no single form of investment that protects against all risks. Investing is no hard science. To have long-term
sustainable success in investing, discipline is required together with flexibility, while keeping an eye on diversification,
quality, solvency and value.
INVESTMENT STRATEGY
On page two we stated the market dynamics are changing. 2020 demonstrates that markets have become
increasingly fragile in both directions on low liquidity functions. We wrote before, that the rise to dominance of the
passive investing crowd has led to a co-dependence with the big tech stocks. 2020 has also brought the new retail
trading, which is not reluctant to chase the most speculative trades. As a result this segment has grown to 25-30% of
the US equity market volume, according to brokerage firms. A decade ago it was less than 10%. Another aspect of
2020 is the huge surge in call options on tech stocks, what creates a lot of technical buying, as long as the trend is up.
What this unusual election cycle has yet
to bring will most likely not end with
“…happily ever after”. The vola-model is
on warning. Investors should have an
open mind that confusion could reign.
We started the year with an underweight
in equities. As of the end of February we
moved to neutral. On March 24 we
changed our recommendation to
overweight. In May we changed to
neutral. Since beginning of the third
quarter we advocate an underweight.
Change
Country Allocation Recommendation Q1 Q2 Q2 Q4
USA Overweight
Europe Underweight
United Kingdom Underweight
Switzerland Neutral
Japan Neutral
Emerging Markets Neutral
Asset Allocation
Cash Overweight
Bonds Neutral
Fixed Coupon Overweight
Floating Rate Underweight
Sovereigns Neutral
Corporates Overweight
High Yields Neutral
Equities Underweight
Discretionary Underweight
Consumer Staples Overweight
Energy Neutral
Financials Underweight
Health Care Overweight
Industrials Underweight
IT Neutral
Materials Overweight
Telecoms Neutral
Utilities Overweight
Alternative Investment Neutral
Commodities Neutral
Industrials Metals Neutral
Precious Metals Neutral
Energy Neutral / Underweight
Agricultures Neutral / Overweight
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Volatility Structure S&P500
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