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Market Commentary

2nd quarter 2020

Reading time 15 minutes
  • In Q2, central banks and governments launched one of the most impressive rebounds in financial market history. Typically, our risk-based strategies have been less reactive during this phase.
  • The financial markets imply that the negative impact of Covid is only of a short-term nature. On the other hand, the renewal and digitalization of the economy and infrastructure will be accelerated.
  • The decoupling of financial markets from socio-economic dynamics puzzles many observers. The high level of debt and the uncertainties surrounding the globalisation-based economic model warrant some caution.

Balcony applause for hospital staff - and now also for the central banks?

Central banks and governments orchestrated one of the strongest market rebounds in history with the help of an unconventional package of measures. The problem with such measures: Once in place, they're very hard to get rid of, they're addictive. For example, a normalization in the sense of positive interest rates, shrinking central bank balance sheets and diminishing debt mountains has been a recurring theme over the past five boom years. But nothing has been achieved. Not only governments, but also companies are sitting on record-high mountains of debt. The central banks were able to gain some time, granting access to the credit market and refinancing even for the below investment grade issuers. However, the risk of insolvency is still present.

The corona crisis has clearly shown the vulnerability of the financial markets and the global economy. Globalisation as we have known it until now, already under attack by numerous geopolitical conflicts (e.g. USA vs. China), is now being seriously questioned. Many economists are concerned about the long-term structural and fundamental challenges.

Bottom-up: Analysts and investors more optimistic

On the other hand, there are investors and analysts who focus more on the individual companies and less on the long-term consequences of the corona crisis on the globalised economy. They do not see the pandemic as a threat to our economic model. On the contrary: the crisis is accelerating the renewal of the economy and infrastructure. The past has shown that hardly anything can go wrong with the central banks backing us. In their opinion, the economic shock will not be quite as severe on average. A vaccine will most likely be found soon, and new investments will flow - especially in the area of the digital economy. In other words: after 3-5 years we are back to pre-crisis levels in terms of corporate earnings.

Price levels of risky assets reflect optimistic analyst expectations, but market risks remain above average

With central banks tailwind, the stock markets were able to recover at record speed from the losses in March. The S&P 500 had one of the strongest quarters in its history. The Nasdaq reached a new all-time high. The S&P 500, DAX, SPI and Nikkei all posted single-digit declines - this is well worth noting after a catastrophic Q1. Growth stocks continued to rise and their valuations are at historic highs. Interest rates worldwide are close to zero or below, which is pushing investors all the more into riskier assets such as equities. Equities once again seem to have no alternative. Despite the strong recovery, market risk is still substantially above the long-term average.

In the last quarter, thanks to the central banks intervention, we have seen extremely high bond issuance activity - even among borrowers with poor credit ratings. Credit spreads fell from the peak of March. However, we are still a long way from the level at the beginning of the year. The danger of insolvencies does not seem to have disappeared from investors' minds yet.

Strong rebound = underperformance for risk-based strategies

Our equity funds also gained in Q2 and were thus able to make up some of the losses from Q1. As we already have experienced on several occasions, risk-based strategies can hardly keep up with the capital-weighted indices in a strong recovery. This was the case, for example, in the aftermath of the great financial crisis in 2009. This time, too, our strategies are clearly lagging behind. The corona crisis has accelerated digitalization and investors are focusing on technology stocks. Interest in companies that offer services that can be accessed remotely from home has increased massively. No wonder, then, that companies like Apple, Shopify, Citrix, Zalando and Alphabet were able to present themselves in the best light. Such shares are usually highly valued. Their price is justified primarily by high expectations regarding earnings growth. This is usually accompanied by an above average price volatility. Our risk-based model, on the other hand, prefers more stable stocks. The underweight in such growth stocks therefore contributed to the underperformance.

High-quality bonds are in demand again after the liquidity squeeze in March

In March, we experienced an extremely high demand for liquidity. This led to a sell-off of high quality government bonds. Especially in rather illiquid markets, such as the CHF bond market, this led to strong swings. In Q2, however, government bonds with a high credit rating were in demand again - with falling interest rates, there was even a positive performance. Our bond funds closed the quarter only marginally behind their respective benchmarks despite better debtor quality and slightly lower duration.

Proven basic recipe: discipline

We are not in a position to judge what long-term (positive or negative) effects the Covid crisis will have and whether the optimistic investors are right and the market recovery will continue. What we can say, however, is that the uncertainties have definitely not been diminishing in recent months and that caution is still required for investments of all kinds. Even if the central banks can continue to play their unconventional measures and repress volatility, we strongly believe that our risk-based approach maintains its merit. It is certainly not easy to advocate this position after a quarter of clear underperformance. Patience and discipline are required. However, the past has taught us that, particularly in such circumstances, diversification and risk management must remain in focus.

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