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Market Commentary

3rd quarter 2020

Reading time 15 minutes
  • Overall, a friendly quarter for investors. However, latent risks remain high, which is reflected in above-average VIX levels.
  • The expected V-shaped recovery of the economy has been already discounted by financial markets: the world stock index (industrialized and emerging markets) reached a new historic high at the beginning of September. The main drivers were once again the major tech stocks.
  • Investors are focusing less on fundamental data and more on infection figures and government support measures. This was particularly evident in September.
  • Structural economic imbalances, geopolitical risks and the uncertainty surrounding the upcoming presidential elections seem not to worry investors. At least until now.


V-shaped recovery already priced in

The basic scenario for the financial markets remains a V-shaped recovery of the economy. The market dynamics even imply a return to substantial growth for earnings and cash flows in the coming years. The unprecedented measures initiated by governments and central banks provide the necessary basis for such a scenario. The economy is on the road to recovery, but is still far from pre-crisis levels - the fulfillment of the "V" is far away. In contrast, the financial markets have already completed their "V". Both equity index MSCI World Developed and MSCI Emerging Markets reached new historic highs at the beginning of September. However, the dynamics are not homogeneous and show significant differences between European and US markets. The latter were boosted by extremely strong technology stocks. These account for a very high proportion of the US equity market. But the recovery was not only selective in geographical terms. The divergent pattern between cyclical, growth-oriented stocks and defensive stocks already evident in Q2 continued this quarter.

The weakness of the USD has given a boost to emerging markets. Many analysts expect USD weakness to continue in the coming quarters. This is not good news for the CHF and the SNB. However, it should continue to have a positive impact on the USD indebted emerging markets. Interest rates were slightly lower or the quarter, which resulted in a positive performance of bond investments. Credit spreads also fell, benefitting lower-rated borrowers. Risk perception, as measured by the VIX index, remains at a high level. Although it fell slightly in July and August, it then rose again in September as investor uncertainty increased. September was the first month with negative equity returns since March.

Asymmetric effects of the pandemic

As has been emphasized several times before, Covid-19 has massively accelerated the digitalization of the economy and thus triggered a market price fireworks for growth- and technology-oriented shares. But even the most attractive investment has its fair price. The valuation multiples (such as price/earnings or price/cash flow) achieved by some of the Mega Techs are historically hardly comparable. In the past, such high valuations were usually followed by a clear price correction. For all those who are invested in these stocks, of course, the hope is that this time is different. The losers of the accelerated digitalization are companies that do not manage to adapt quickly their business model to the new circumstances. In the end, not only companies, but also every single worker will have to sound out their place in the new economic context. It is therefore not so easy to predict the bottom line effects of this dynamic.

V-shaped market recovery based on rather strong assumptions

The recovery of recent months would not have been so spectacular if it had not been based on some extremely optimistic assumptions. The majority of market participants implicitly assume that there will be no new lockdowns and thus no decline in economic activity. A vaccine is also expected to be launched soon. The expectation that governments and central banks will continue to provide support measures and sufficient liquidity is almost self-evident. How nervous the market reacts to deviations from these points was evident in the market correction in September. Rising infection figures and uncertainty about a second US stimulus package were enough to trigger a rotation in favor of more defensive stocks. The outcome of the presidential elections is also becoming an increasingly important issue for the markets. Especially in the event of Trump's defeat, a smoothly functioning government and the support of the economy cannot be guaranteed.

The divergence between the positive market assumptions and the many open questions we experience every day remains a puzzle to many. The long-term effects of the pandemic as well as the growing structural problems and the resulting distortion of the economy do not seem to dampen the optimism of many market participants. As long as the central banks provide sufficient liquidity, there is indeed not too much cause for concern. And to convince even the last doubters, the FED made it clear in August that fighting inflation is no longer a sacred cow. An inflation rate of over 2% is certainly tolerated under the new regime. Fear of a more restrictive monetary policy is therefore unfounded, even if inflation should rise. The FED's message to investors could not be clearer: Relax!

FOMO – Fear of missing out

Given our less glamorous performance in recent quarters, we are aware that the fear of missing something is relatively high. The temptation to jump on the Mega Tech high-speed train is tempting. But history should be a warning to us. As long as the fundamentals of investing are not rewritten, we believe that a focus on risk and diversification is the right way to go - even if it may seem rather boring and old-fashioned in such a market environment. It is clear to us that this investment approach requires trust, patience and discipline from our clients. However, in such a challenging economic, social and geopolitical environment it is all the more justified.

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