Notz Stucki Investment Conference

Notz Stucki Broadcasted Investment Conference – 29 June 2021

It has been clear since March 2020 when the pandemic struck that the world has been grappling with a completely different situation to anything anyone has experienced previously. The dramatic collapse in economic activity and equally unprecedented monetary and fiscal expansion was unparalleled in recent history. The experience of 2020 and 2021 has been opposite in the sense that last year the economy was in a state of collapse, while financial markets were booming, and this year the economy has been recovering fast, while since February financial markets response has been more muted. Now a year on from the initial panic investors are starting to look forward to what the consequences will be, particularly as regards inflation.

The consensus among market commentators is that the world will experience higher inflation from the middle of the current decade. There are strong reasons for this. Monetary policy is actively trying to generate inflation; fiscal policy is ultra-expansionary with governments and central banks globally united in pursuing growth rather than price stability; the reduction in globalisation as a result of the trade dispute with China; the emergence of technology monopolies leading to the threat that disinflationary pressures will be lessened; political trends favouring labour more; and demographics being less favourable. These are all compelling reasons and it is hard to believe that there won’t be some inflation. Certainly the relentless trend of disinflation that has prevailed for the last thirty years is being interrupted. However the concerns of many in the market that inflation is going to return to levels that did so much damage in the 1970’s may be misplaced. A more benign scenario is possible, and even likely.

Future inflation may be more like that seen in the 1950’s. What is important is how high inflation reaches and how quickly it gets there. A sudden jump to 5% plus inflation would be very challenging for markets. But if inflation creeps up gradually and remains in the 1 – 3% range the markets should be comfortable with this because it will be accompanied by strong growth. This is why the 1950’s comparison is relevant because in the 1945 – 1965 period macro policies targeted growth and employment in the same way as now. Encouragingly the markets at the moment are subscribing to this outcome. Despite the plethora of inflation fears from commentators both bonds and equities are behaving as though the economy and profits will continue to expand for the next five years. The reason that markets are sanguine about inflation is probably because the scale of the economic collapse was such that it will be difficult for inflation to get traction. There are temporary shortages and bottle necks in certain areas, but overall there is too much excess capacity. In particular unemployment remains high so it will be hard for workers to achieve structurally higher wages. Equally the exceptionally strong growth that we are witnessing now will not be sustained. The re-opening boom is by definition a one off. Over the next year the imbalances in the economy should adjust and the market be able to grow higher growth than we had over the last decade, and while inflation will also be higher it will not be high enough to derail equity markets.

This leads to the following investment conclusions. Bonds will slowly lose their purchasing power. Yields are so low that they are unattractive, but they are unlikely to move dramatically. The expectation is that the yield of the US 10-year will move in the range of 1 – 2% for the rest of this year. Given this equities remain reasonably priced, and those outside the US are cheap. On a five year view the rotation from growth to value should continue thanks to the better economy. However short term growth shares, driven by technology, may have a final surge. The Nasdaq chart looks very similar today to where it was in the summer of 1999 before the final blow off at the end of 1999 and early 2000. Many technology shares look very overvalued relative to their fundamentals, but that won’t stop them going much higher if the market becomes enthused by growth again as inflation fears dissipate. After that the value trend should reassert itself, and that is likely to benefit companies outside the US. In currency markets the dollar looks well supported for the rest of this year, but as flows move out of the US it will decline. Asian currencies are likely to be the principal beneficiary of this.

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Notz Stucki Broadcasted Investment Conference

Notz Stucki Broadcasted Investment Conference – 12 January 2021

Anatole Kaletsky during our NS Broadcasted Investment Conference

2020 was one of the most remarkable years for both the global economy and financial markets, witnessing perhaps the largest short term economic collapse ever, followed by governments and central banks unleashing the most enormous stimulus packages ever to offset the lockdowns that they had mandated. These stimulus packages far exceeded what would have been thought possible a year ago, and as the crisis evolved became ever greater. The conference considered what the effects may be over the medium and long term.

The sudden collapse in economic activity last year was unprecedented, though it was met with an equally unprecedented response in terms of fiscal policy. As such history is much less helpful as a guide to the future, simply because there are no previous examples to compare this situation to. Since March the world has been stuck in a Covid induced shut down, in which large parts of the economy have been prevented by law from operating normally. Since then the global economy has been in a state of collapse, but stock markets bottomed on 23. March just three weeks into the crisis, initially in response to the huge stimulus, but latterly as they have started to look to the medium and long term and detect a brighter future. Markets are being tugged in opposite directions by these two giant forces – the economic plunge and the tsunami of liquidity. As time passes the balance of these two forces will change and today we are at an important transition as we start to exit lockdowns with the arrivals of several vaccines that will allow a slow return to normality.

As we enter the next stage there is a high probability that the tremendous stimulus will start to overcome the economic collapse. The public health situation is on the brink of improving because of the vaccines. Further there is always a time lag between the announcements of a stimulus and its impact on the economy. Usually this lag is about six to nine months, but this time it is likely to be one to two years because of the delay that has occurred before business is allowed to return to normal. So the various stimulus packages will arrive with full force this summer and it is highly likely that 2021 will see a strong return to growth, and this boom should last for the next two to three years. The market has anticipated this, rallying with extraordinary speed in reaction to the size of the packages and the explicit statements by Central Banks that they would keep monetary policy loose for several years. Indeed the conditions are extremely conducive for the bull market to continue. On top of current fiscal and monetary policies two other supports to growth were achieved last year. First the EU has finally managed to agree a unified fiscal policy which goes a long way to removing the risk of another European crisis. Second the Asian bloc has handled the crisis far better than the West both in terms of protecting its economy and its public health. It looks as though this area can grow strongly even if the US and Europe remain subdued. These more vibrant economies may decouple from the West, but in any event they are providing a strong support to global growth. All these conditions are ideal for creating bubbles in equities and there is little doubt that in some areas these already exist, with some areas of US tech being the most obvious example. Bubbles always burst eventually but timing this is impossible and they have a tendency to go far further than what is believed to be possible. Investors need to be aware of this but there are plenty of other areas of the market which can do well.

Looking further ahead there are consequences that investors need to start to consider. The first is inflation. The likelihood is that the massive money printing and spending by governments will lead to inflation. It is almost certain that over the next decade inflation will be higher than the rate that has pertained over the last forty years. There were anyway a number of structural forces pushing inflation higher namely: the weakening of globalisation; expansionary fiscal and monetary policy; the shift in technology from being a disruptive force to the establishment of monopolies; politics shifting to a position that is more supportive of labour leading to the rise of wages; and demographics. The debt piles that have been built up over the last few years also make inflation a temptation for governments, as historically that has always been the way that they have repaid them. So the question becomes how rapidly does inflation return? If it bounces back to a 4-5% rate in the next couple of years then that will be very negative for financial asset classes and social stability. However if it only creeps up gradually over the next few years then we could see a repeat of the Keynesian Golden Age that dominated the period from the late 1940’s to mid-1960’s which enjoyed strong growth and employment. This scenario is plausible because output gaps are so large coming out of Covid it is hard to see where inflation will come from. There is a strong possibility that we get strong growth accompanied by controlled inflation. This period could last a decade or even more. What is strange at the moment is that many commentators are expressing a lot of concern about inflation, but making almost no comment on this possibility that we may be entering a long term expansion, while financial markets appear completely unconcerned by inflation but are starting to price in the longer term growth.

The next nine to twelve months will be a crucial period. If we see growth returning and inflation does not take off in an alarming way then sentiment in financial markets will harden towards the view that we can get a low inflation boom. There are plenty of themes for markets to get excited about such as the energy and transportation revolutions that are taking place. Globally markets may start to focus more on the East as those countries return to normal more quickly than the West. With liquidity and stimulus so abundant valuations may rise to much higher levels than those witnessed in the past as PE ratings rise. The main danger to this outlook is inflation. If there are signs that it is starting to move significantly higher, then that would end an era that has prevailed since the early 1980’s. For several decades bond and equity values have been set on the basis that prices would be relatively stable. If they start to jump higher that changes everything, but for the next few months markets should enjoy the combination of lots of liquidity and a recovering economy.

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Notz Stucki Investment Conference

Notz Stucki Investment Conference – 14 January 2020

Louis-Vincent Gave during his presentation @NS Investment Conference, 14 January 2020

2019 was a great year for financial assets with every major market rising, some of them strongly, such as oil and the S&P 500. Against this backdrop there were some surprises which may have significant influence as we head into 2020. The meeting discussed four of these. First the breakdown of the China/HK relationship. Second the Fed reversing its tightening policy and restarting QE. Third, the unprecedented situation of $17tn of negative yielding bonds that was reached in August. Finally the divergence between the oil price and the performance of energy stocks; oil was the best performing asset of the year, but energy was the worst performing sector in the S&P.

Xi Xinping is the first Chinese President who has had a foreign policy of significance. Under his leadership China has adopted an imperial vision with its belts and roads policy which aims to tie China into the world and make it more central in global trade. To finance all the infrastructure surrounding this project required a deep, liquid financial centre which China was fortunate to inherit from the British with Hong Kong. However Hong Kong’s role was compromised by the elections in November when, with a big turnout, the population voted emphatically for the pro-democracy parties. Effectively 70% of the electorate voted against Beijing. As a result China will promote Shanghai and Shenzhen as alternatives, but for them to be credible China needs to take off capital controls, and this a risky process in a command economy. However it is because of this that official pronouncements from China have changed more from threats to devalue the RMB, to announcements talking of a strong currency supported by positive interest rates in line with Chinese people’s savings culture.

In the last quarter the Fed reversed its monetary tightening and restarted QE. They did this when the repo market broke down in September, and they started adding $60 billion a month to ensure it worked smoothly. Why did the repo market break down? It is not clear but it may have been caused partly by the fact that the borrowing needs of the US government are so enormous now that the private sector cannot absorb them, and so the Fed has to step in to maintain stability. From 2010 to 2016 US Government spending was flat (due to the constraints imposed by the Tea Party), but now it has exploded. The budget deficit now runs at $5.6bn a day, and the Fed funds between a third and half this. The Fed is scheduled to end this support in March, but in an election year the likelihood is that it will continue. In effect MMT has arrived, and it is noticeable that since the Fed reversed course the dollar has fallen.

The negative yields in bond markets represent the biggest bubble in financial history. It seems extraordinary that this happens at a time of monetary and fiscal profligacy. It rests on two pillars. The first is that interest rates will never go up again, and the second that investor demand for bonds will remain strong. The first pillar remains as strong as ever, but the second is wobbling a bit. Markets became more sceptical last year of assets with stretched valuations, as evidenced by the collapse of WeWork, and a sharp derating of companies like Uber. This scepticism could one day extend to the idea of paying to own an asset whose raison d’être was to pay you. Another development was that Sweden raised interest rates after judging that negative interest rates had not improved growth but had done significant damage to the financial sector and pensions. Sweden was an early adopter of negative rates, but their move will at least raise the level of debate in other Central Banks. More fundamentally, negative rates will start to battle with rising inflation figures. The US CPI is at a ten year high. More inflation may be in the pipeline – many of the riots and discontent seen around the world stem from the loss of purchasing power by workers. With labour markets tight, wages have the capacity to rise. In any event the ability of the negative interest rates’ bubble to expand further seems limited as governments turn more to fiscal measures. The new ECB Chairman said in her first speech that fiscal deficits should rise.

Q&A Session. Louis-Vincent Gave, Munib Islam, Stefan Blum

Finally what will come of the disconnect between the oil price and oil stocks? The oil price rise exceeded the S&P gain in 2019, but oil stocks were the worst performing sector in that index. This is even odder given that analysts predict that the energy sector’s earnings will be the strongest in 2020. There has been little new investment in the sector in recent years, and oil is a finite resource. There is a strong likelihood that it may break out upwards from the $40-60 trading range that it has been in the last few years.

Some of the assumptions that underlay 2019’s strong performance may be challenged in 2020. Inflation and the US dollar will need close watching. Inflation could rise further as a result of higher energy prices, or labour costs. Politics is an influence on both, and in the case of labour the increase in nationalism and consequent pressure to reduce flows of labour and immigration could lead to labour shortages. This takes place in the context of budget deterioration almost everywhere. For the investor it is time to look at currencies beyond the dollar – in the emerging market bloc, Australian dollar, Canadian dollar, sterling and gold. Negative yielding bonds should be sold, and only selective Emerging Market debt offers much interest in the fixed income space. In equity markets investors should start to look outside the US to the Japanese, European and Emerging Markets, and to sectors like energy and biotech.

From left to right: Louis-Vincent Gave, Stefan Blum, Munib Islam

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Notz Stucki Investment Meeting – Pierre Gave

Is the worst of the global slowdown behind us?

In 2018 there was no place to hide in financial markets, but in the first quarter of this year a much better environment took hold. The turnaround is surprising in some ways. The fundamentals of most economies have not changed much. Growth has been slowing everywhere, but this was not unexpected. Given the length of the expansion, now a record 37 quarters in the US, a slowdown was inevitable. But for financial markets liquidity was the critical factor. After 10 years of central banks adding liquidity to the system, this reversed last year led by the US and China. Markets foundered, but when the Fed made a complete reversal of policy in January, and China announced a new stimulus package, the market rallied hard. The market reaction suggests they have repriced growth, but that growth has not come through yet. If there is one message that investors should take away it is that when the world’s monetary base contracts trouble follows.

While liquidity conditions remain benign it will still require fundamentals to do well for asset prices to rise from here. The outlook for the US economy is still positive, but the growth is more moderate than before. Two areas look likely to do well are the consumer and housing. Mortgage activity and construction should pick up, as affordability is good. A further positive is inflation is not a problem. There is some wage inflation, but it is modest. Globalisation and automation/robotics remain powerful forces on labour’s ability to bargain. A boost to the stock market could come from the dollar falling. On a PPP basis the dollar is expensive, but it enjoys a yield premium and the relative strength of the US economy. The principal concern in the US is debt. The US government deficit is projected to reach $1.4 trillion this year. Corporate debt has ballooned and much of it has been deployed in financial engineering, not invested in productive assets. For example in Q4 2018 there was a record $225 billion of share buy backs. But total US leverage is not so bad because household leverage has declined.

Europe is much more vulnerable to world trade and global growth declining. If President Trump introduces tariffs on the auto sector this would be significant. For Germany in particular the auto sector is an important part of the economy. Car production already faces a weak environment as it is in the middle of a big technological shift, and sales in China slow as capacity has been reached, and demand there now enters a replacement cycle phase. Europe’s domestic demand remains sluggish, and this is being worsened by the recent rise in oil prices. The ECB are at the limits of what they can do with monetary policy. In theory Europe should undertake a fiscal stimulus, but it is constrained by fiscal rules on this. Indeed the German Finance minister has just said that weak growth limits the ability to make fiscal packages. If Germany slips into recession then this thinking may start to change. To reinvigorate Europe probably requires massive fiscal stimulus by a tax cut and infrastructure packages. For now there is little appetite for this.

China has also slowed, but it should pick up in the second half. China’s slowdown is different from its previous ones which centred on its industrial economy. This time the slow down relates more to the consumer credit. The export numbers have also fallen, but this may be due to buyers building inventory ahead of US tariff imposition. Nonetheless China is ramping up stimulus and the results should be seen in the second half. It will mean that leverage will rise again in China, which may become a problem in the future, but is not a concern for now. A recovery in China will help the emerging markets where investors are massively underweight, but they are unlikely to rebalance until the dollar weakens.

There is a calmer mood in the market compared to the end of last year. It has been created by the Fed stepping back from raising rates, China’s stimulus, and a brighter outlook on the US-China trade talks. Against that must be weighed the fact that global growth is slowing, Europe is on the brink of recession and US government borrowing is far too high for this stage of the cycle. A big unknown swing factor is the oil price which has been rising recently. If this continues it could upset the better sentiment. But the combination of the world’s two major economies looking set for steady growth this year, and no sign of inflation, provides a good background for equities.

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Notz Stucki Investment Conference

Notz Stucki Investment Conference – January 8th 2019

2018 was an ugly year in financial markets with every major asset class falling. Equities were the worst performer, but even US Treasuries fell. Only US cash showed any return. Our meeting reviewed some of the causes of this poor result, and also the outlook for 2019.

The principle reason was that there were lots of demands on liquidity last year, that sucked cash out of financial assets. Interest rate rises were one of these pulls. Another was the Federal Reserve shrinking its balance sheet, a process that had reached a level of $50bn a month by the final quarter. On top of all this the US budget deficit is expanding steadily and is projected to reach 5% of GDP in a few years. The budget deficit is of particular concern as it is expanding despite robust growth and low unemployment. Expanding budget deficits are commonly associated with recessions when governments try to offset contracting growth. Worse the ageing of the US population mean that the deficit has a structural character as pension and medical demands mount up. Europe faced a similar demographic profile twenty years ago and solved it by cutting its military budget. The US is unlikely to do the same. Current projections for the US budget deficit are based on resilient future economic growth. Lurking in investors’ minds is the uneasy question of what would happen to the deficit if US growth slipped. It may be for this reason that the US dollar was not even stronger last year, when almost every factor was in its favour – vide hawkish Fed, US growth better than elsewhere, imploding EM and Italian dramas.

Notz Stucki Investment Conference January 2019 – Louis-Vincent Gave

After such a gloomy year it is natural for investors to worry about the most fragile parts of the system. The main candidates that are mentioned in this context are the likes of the Italian bond market, Deutsche Bank, and China. However a prime concern of Gavekal is the US corporate bond market. The last few years have seen a massive issuance of corporate debt. Much of this has been used for financial engineering not investment. Share buybacks by US companies represented the largest buyer of US equities last year – $750 billion in all of which $200bn was in the last quarter – and still the market went down. US corporate debt relative to GDP is at levels usually associated with recessions. Within the debt structure the lowest level of Investment Grade is BBB and there is a danger that some of this could be downgraded to junk status. A particularly interesting sector at the moment is energy. The sharp fall in oil in the last few months is positive for global growth, but not necessarily for US industrial production. The shale revolution has been a substantial part of US capex in the last decade, and much of that capex has been financed in the bond market. It is not a coincidence that the oil price plunge has been matched by a spike in the yield of high yield corporate bonds. In contrast to the old days a higher oil price is now helpful to US growth and many corporate bonds.

The other major change that was revealed in 2018 was in US China relations. For twenty years the international community has been striving to integrate China, and Chinese production has become intimately woven into the global supply chain. This process abruptly stopped last year, and is being replaced by something akin to a new Cold War. The difference to the old Cold War with the Soviet Union is that the Soviet Empire was economically separate from the West. By contrast China really matters both by virtue of its size and relationships. Apple is a good example of this. Perhaps no company has benefited more from being able to produce parts and assemble them in low cost China, and then sell the value added whole globally, with China itself being one of the largest markets.

The US China dispute is a major concern. What many in the West underestimate is China’s resolve to transform itself into a global trading superpower, building commercial routes that ensure the supply of hard and soft commodities, and access to export markets for them to send their finished goods. Xi Jinping is different from previous Chinese leaders in having what amounts to an Imperialist strategy. It is a direct challenge to the US hegemony. Another aspect of this challenge is China’s attempt to present the RMB as an alternative to the USD. China is trying to de-dollarise commodity markets. 12% of oil market futures are now priced in renminbi compared to nothing a year ago. If this trend continues there will be less need for countries to save in dollars, which they need to buy commodities, currently priced in US dollars. Control of the reserve currency has allowed the US to run its twin deficits. If this ends the US will have lost a huge advantage. As such China may have made a mistake by being so brazen in its confrontation with the US. This is the significance of the arrest of the CFO of Huawei in December, as in 2018 Huawei overtook Ericsson as the top telecom vendor in the world (and ZTE is the fourth largest now, another Chinese company that the US attacked). China seems to have miscalculated and overplayed its hand. One casualty will be the semiconductor industry. As a matter of national security China is pouring money into Chinese production to ensure they are no longer dependent on the US for these products. Consequently profits for the whole industry will evaporate because there will be no pricing discipline and significant new supply.

2018 marked a significant change because the forces of populism made politics much more uncertain, and the tensions between the US and China broke the surface. There was also further evidence that China’s tremendous growth rate is decelerating. Equities were hardly in a bubble before 2018 but valuations fell a lot last year throwing up some real value. For example, some UK equities and corporate bonds sold off dramatically even though the companies appear to be little effected by Brexit in any outcome of the negotiations. Some sectors that have worked well recently are facing more pressures, like technology and the FANGS, but the world does not look like it is heading into recession so for the patient stock picker there is abundant opportunity.

Through their presentations, our guest speakers offered a concise and readily applicable overview of the recent developments in financial markets.

Notz Stucki Investment Conference January 2019 – From left to right: Louis-Vincent Gave, Al Breach, Andrew Jackson

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Notz Stucki Investment Meeting – Anatole Kaletsky

“Bull Market Will Continue – despite all the risks”

2018 has been a difficult year in financial markets with almost every equity and bond market suffering, with the notable exception of the US stock market. A further complication for investors has been that this has not been caused by a serious deterioration in economic fundamentals. Instead markets have been driven by political risks and uncertainties. Ultimately the question for investors is whether this is just a painful correction, and therefore a buying opportunity, or is this the start of a reversal in markets, signalling the end of the US bull market. The presentation considered three causes of the setback in markets since April/May, and then how far these issues might develop or revert. Anatole made a case that the bull market would resume, but cautioned that others in Gavekal were more cautious.

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Notz Stucki Investment Conference Notes 09 01 2018

Notz Stucki Investment Conference Notes

Most financial markets were strong in 2017, adding to what has been a strong decade. This begs the question of how long it can continue. Since the crisis only commodities have performed poorly. Equities have continued to defy the sceptics, in particular the US, and within that market technology has been the best sector by some margin. In 2017 tech stocks’ performance started to go parabolic. In the past this sort of move has often been the precursor to a period of poor performance as valuations become so stretched that financial gravity forces them back to more normal ratings, and they enter a long period of consolidation. The weighting in the technology sector has become a large part of the indices so judging what happens to this sector has become of prime importance. An analysis of the world’s largest companies shows a list dominated by big tech names. This is also a danger sign. At the end of the 1970’s the equivalent list was dominated by oil stocks; at the end of the 1980’s by Japanese companies; the end of the 1990’s by technology stocks; and the end of the 2000’s by China and oil names. In each case subsequent stock price performance of these companies disappointed. Clearly as a company gets larger growth becomes ever more challenging. Do tech stocks today face the same fate as their leviathan predecessors? In their defence on many valuation metrics they are better value than the tech names that rose to the top in 1999. However the problem can be illustrated in Alphabet (Google) and Facebook. Their profits derive from the $500bn global advertising market. $240bn of this is online of which these two companies command $120bn. To continue to grow 30% a year in this market when they are already a quarter of the total and half the online becomes harder and eventually impossible, but that is the growth rate that investors have come to expect of them. In general terms the massive outperformance of growth over value is showing some signs of mania now, and this is clearly evident in some other cases like biotech and bitcoin. Above all, as has been frequently commented on before in previous meetings, there is also a monumental misallocation of capital in bonds. We have reached the unprecedented situation of investors buying BBB bonds in order to secure a loss. However manias also create opportunity in the areas that have been ignored.

One big difference in this bull market from all previous ones is the lack of new issues. Usually a bull market engenders a flood of IPOs. Yet this time the number of companies are shrinking. In the US the number of listed companies has shrunk from 8000 in 1995 to 4300 today. In Europe it is a similar story with a decline from 14,400 in 2007 to 7600 now. The exception is Asia (mainly due to China) where new listings have boomed. Since the Asian crisis the number of listings has risen from 8000 to 17,000. Is this the reason that the Asian stock market’s performance has been so pedestrian in the last decade compared to that of the US? There has been too much supply of equity in China which has soaked up liquidity, while in the West equity is becoming a scarce resource, particularly when share buybacks are included.

The other unusual quality of this market was that despite synchronised global growth Central Banks did not remove the punch bowl. Instead they added vodka. With the combination of $2 trillion of liquidity injections from them and no new listings, it was no wonder that markets rose. However there are signs of change. The Fed has started to tighten, and now the People’s Bank of China is withdrawing liquidity. The PBOC’s move could be the more important one. For twenty years China has pursued a strong growth policy, but in November Xi Xinping’s speech changed the emphasis of policy from growth to a focus on education, health and curbing pollution. The risk becomes that instead of China’s growth surprising on the upside it surprises on the downside. The ECB and Bank of Japan are still printing hard. Might this change? In Japan the domestic sector is complaining about the flat yield curve. Banks will go bust if it continues. With the yen competitive and exporters flourishing, it is hard to see who benefits now from their aggressive monetary policy. It would be a shock but Japan might raise rates before long. The consensus view is that we will have deflation forever, and that Central Banks will remain active. The bond market is priced for this scenario. If this is proved wrong it will be a profound shift of direction.

Tightening liquidity and higher interest rates will make owning growth stocks with expensive PEs dangerous. It looks as though companies are likely to depend on their earnings to grow rather than PE expansion. Some de-rating is likely. This makes judging the inflation outlook crucial. For twenty years there have been tremendous structural forces creating disinflationary pressure – China, the internet, an ageing population. Some of these forces may be abating. The German PPI is now running at 3%, Japan’s is also 3%, and China’s is 7% so it is no longer exporting deflation. Recently there have been price breakouts in energy, metals, shipping prices and even semi-conductor prices. Labour markets are tightening everywhere. The lack of capex globally, now exacerbated by China closing capacity for pollution related reasons, means that, as the world recovers and demand grows, those manufacturers with spare capacity are growing volumes, which combined with some pricing pressure is a potent mix. Last year Asian markets were up sharply and this probably reflected their role as the marginal producer in a number of industries. Japan is a particular beneficiary of this trend. The recent outperformance of cyclicals could be a sign that inflation is starting to come through. If that is true then investors need to alter their position because there will be a dramatic change in leadership.

With the bond market at such extreme levels investors have little alternative but to invest in equities, and balance those positions with as much cash as suits their risk profile. But within their equity allocation they need to start thinking about shifting from growth towards value. The more that economic growth takes hold globally the more neglected sectors will be supported, and the shine will come off the highly rated growth stocks whose growth has been so prized when growth was scarce, though true growth companies can be held with confidence for decades. Stock markets have advanced without a significant fall for so long that a setback is almost inevitable soon, and this could provide an opportunity for investors to reallocate. Nonetheless there is a caveat, which is there is little margin of safety anywhere. There is so much debt that the stock market requires the world to continue to have steady growth. The tightrope is higher than is comfortable.

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Notz Stucki Investment Conference – Notes 27 06 2017

So far this year the optimists have been proven right, as stock markets have advanced steadily. This is supported by evidence that the world economy is in better shape, and is in a more predictable and sustainable condition than it has been for ten years. While this has been increasingly evident in economic statistics over the past year it has been overshadowed by political turmoil, particularly Brexit and Trump’s election, which could have had a serious impact on world growth if it had been followed by similar results in Europe’s elections this year. The Dutch and French elections conclusively rejected the populist surge, and now financial markets have a reassuring combination of stable economic growth and political calm. Where are the best opportunities to take advantage of this?

It is clear that the US has discounted this brighter outlook the most, largely because their recovery was well ahead of the rest of the world. From 2010 to 2014 the US economic expansion was driven by QE. However, since that ended interest rates have been rising slowly, yet the economy has still maintained modest growth. Employment has grown at a rate of two hundred thousand jobs a month with the odd soft patch, and US private sector GDP has been growing 3% p.a. since 2010. There was a danger that Trump’s election would bring a Reaganomics style economic boom which with employment already full could have caused inflation to take off. However, the Trump Administration has become paralysed through some self-inflicted actions, and as it collided with the Congressional process. As a result it seems that it will get little of its agenda through. This is disappointing for cyclical assets, but to the extent that it puts less pressure to raise interest rates and a higher dollar it is helpful for most other assets. From here the US economy should follow a slow self-sustaining expansion. Nonetheless the stock market has largely discounted this story, and as interest rates rise and monetary support is gradually withdrawn the headwinds will build making further advances of the index more difficult. Moreover the US stock market has become very narrow with just a few stocks pushing the index up, which is a sign that the market is not healthy. These market leaders are all technology companies and their profitability is based on monopolistic practices. History has shown at some point these monopolies get broken, or at least reined in. The US bull market is looking mature, and it is worth highlighting that the last four years global stock market performance has been carried almost entirely by the US. Since 2013 the US has surged ahead while the rest of the world’s markets have been almost flat when measured in US dollars (they have done better in local currencies). It looks to be a good time to start to rotate assets elsewhere.

Europe appears the most attractive alternative. The threat of the break-up of the Eurozone has gone, and Europe is reporting much better data, with even Italy improving and Greek debt recently upgraded. The shift in politics from six months ago has been dramatic and this takes away the risk premium that, quite rationally, had been there before. The genuine concern about a political nightmare that Draghi would not have been able to solve has disappeared. Furthermore the ECB continues to pump gargantuan quantities of liquidity into the system; €85bn a month or the equivalent of 200% of net sovereign issuance.

The other concern of investors last year, which was the collapse of China’s growth, is also receding. It is clear that China is slowing but if the rate of slowdown is held at 0.5% that still represents considerable economic growth given the large base effect. The concern on China is rather the lack of reform that has taken place, the build-up of debt levels, the signs of increased central planning and poor corporate governance. By virtue of its size these concerns mean that China has become a potential source of instability. When China sneezes the world will catch pneumonia, but that day is a year or two away.

The tremendous positive factor in the world today is the oil price. The fall of the oil price from over $100 to under $50 represents a transfer of two trillion dollars from producers to consumers. This is underwriting the recovery around the world as it releases consumers spending power and allows for more debt repayment. It has the effect of a giant tax cut.

As the global picture becomes one of steady growth everywhere bonds look more and more overvalued, particularly in the US. Policy has been unprecedentedly stimulative, for example in the US real rates have been negative for ten years. The expectation must be that US bond yields will drift higher. However, in Europe and Japan bond yields will probably stay low despite the recovery of their economies because their Central Banks are determined to keep monetary policy loose. The same does not apply to their currencies. The dollar looks extremely overvalued, arguably as overvalued as it has been in the last fifty years, with the exception of the brief peak in the mid 1980’s driven by Reaganomics. The euro looks correspondingly undervalued and but for the expectation of interest rates rising the euro would probably be climbing against the dollar now. But Fed tightening will not be enough to hold the dollar at its current levels. As Europe recovers the euro should recover with it over the next few years.

World growth is solid, and is supported now with a much more constructive political environment. The US has largely discounted this situation but the road map for the rest of the world is one that should follow the US with a lag. Japan is probably about three years behind the US and Europe maybe five years behind. This gives plenty of opportunity for equities in these countries to catch up over the next several years as growth comes through. Care needs to be taken as there are areas of the market that exhibit a high element of speculation; a number of companies are selling on high multiples while their growth is nothing special, and overall equities are not cheap except when compared to very expensive bond markets. However, the better environment in Europe should bolster returns there, though it should be noted that the returns are likely to derive as much from currency gains as stock appreciation.

Notz Stucki Investment Meeting – Notes 11 04 2017

Over the past year world economic growth has been stronger than expected, for several reasons. First China’s growth has been solid. Instead of imploding the industrial side of the economy bounced back in 2016 in response to the policy measures of a year ago. Growth in China may fade a bit this year as the stimulus wears off, but it won’t collapse. Second the Brexit shock turned out to be a damp squib. Aside from sterling’s fall it affected little, though it underlined Central Banks’ determination to underwrite the system in response to any shock. Third Trump’s election led to a surprising rally in risk assets on hopes of a reflation. There are signs now that this rally is fizzling out as Mr Trump is running into the usual Washington impasse. Meanwhile the Eurozone appears to be bottoming out and growth rates are improving. Even the southern countries are doing better. The Germans are realising that some inflation is needed, and if German wage growth outpaces wage growth of the Mediterranean countries then the long-hoped for rebalancing will be underway.

While economic growth is better, the outlook for asset markets is more complicated. Equity markets have discounted the recovery, and have been further puffed up by governments’ monetary policy. Low interest rates didn’t trigger new investment, it just raised asset prices. The rate of growth of US productivity, a vital component of growth, has been falling since 2005 as business investment has been meagre, and creative destruction didn’t happen. At the time of the crisis in 2008/09 western governments were already carrying too much debt so fiscal stimulus was unpalatable, and they had little choice but to cut interest rates and adopt quantitative easing. The resulting asset price rises did nothing for productivity. Structurally companies face more problems than in the past. The companies that should have been allowed to fail in the crisis have continued, and these zombie companies have prevented the stronger companies from taking market share. Regulation is more complex. The tax code is fiendishly complicated. All these factors favour the big company over the small start-up who faces much greater obstacles than in the past, and the steadily declining productivity growth may point to the economy being less dynamic today. In this context Trump’s promise to cut taxes and regulation are clear positives, but his cronyism (e.g. appointments of family members) and his threats of protectionism are likely to weigh on productivity.

An important question will be how the US dollar behaves. It is strong already and Trump seems to want it lower. On the other hand the Fed is in tightening mode and the trade balance is starting to improve which will support it. On balance the dollar is unlikely to go much higher, and will probably weaken somewhat. Traditionally a weaker dollar is good for Emerging Markets as it allows them to loosen their liquidity. The more problematic question is who will fund the US fiscal deficit. The Fed is trying to reduce its balance sheet. The best outcome would be the consumer saving more, but Trump wants to boost consumption through tax cuts. Foreigners can usually be relied on to plug the gap but with shrinking trade deficits they have fewer dollars to invest. The fracking revolution may help on this score as the American energy sector is the most dynamic in the world, and is creating energy surpluses and jobs in the US.

China remains a conundrum for investors. Western observers worry about the debt – both the scale of it, and its alarming rate of increase. But with capital controls this is less of a problem, and there is no obvious trigger for the debt to undermine the system. For twenty five years investors have expected the Japanese bond market to blow up. Chinese debt is matched by the deposits in the banking system, but as the debt expands it will be supported by interbank funding, and as this requires more confidence in counterparties it can be more flighty. It is also likely that China’s growth will slow slightly. Slower growth and lower inflation, similar to the Japanese model, will make Chinese bonds an attractive asset. The risk is the currency but China is determined to make the renminbi the deutschemark of Asia so Gavekal see little risk of a devaluation.

If the bull market continues then investors need to start to look outside the US. European and Asian markets represent better value, and sectors like defence and financials should be favoured in equities generally, and Asian consumption and Indian financials in particular. In currencies sterling stands out as good value, and the Brexit negotiations may be smoother than the market fears. Finally after several years of lacklustre performance there is increasing evidence that stock picking is starting to work again, possibly because, with markets at expensive levels, relative valuations are more interesting than the momentum investing that has dominated recently.

Notz Stucki January 2017 investment conference in Geneva : notes

On the occasion of its semi-annual Investment Conference in Geneva held on January 10th, 2017, Notz Stucki welcomed the following guest speakers:

Jeffrey Saut, Chief Investment Strategist & Managing Director, Equity Research, Raymond James
Louis-Vincent Gave, Chief Executive Officer, Gavekal
Christian Kopf, Director of Economic Research and Investment Strategy, Spinnaker Capital Group
Juerg Nagel, Partner, Member of the Management Board, Head of Portfolio Management & Marketing, MIV Asset Management

DPC and audience — Damiano Paterno Castello introducing the conference and our guest speakers

Here are the notes on the conference.

2016 was a year of political surprises, and in markets a year in which almost all managers struggled to keep up with the indices. The political upsets have been well covered. The poor relative performance of active managers has been widely discussed too. 2016 was a tough year for them as illustrated by considering that the Dow moved 31,000 points as calculated by the daily moves, yet ended the year almost flat. The speakers all pointed to signs of a better environment for active managers, and a few other reasons why the last few years have been so difficult. First the S&P has been remarkably strong, outperforming almost everything. For example in 2015 only US Real Estate and International Small Caps did better. More interestingly if the cash holdings in mutual funds and implementation costs are stripped out then 50% of active managers beat their relevant ETFs. Indices have been driven by a fairly narrow group of stocks. These dominate the ETFs. As these stocks become overvalued it makes sense to have active rather than passive managers. Rising interest rates will also favour active managers as company fundamentals will count for more. Likewise the withdrawal of QE will help as QE has gushed money into relatively few stocks which have developed a momentum trade of their own. As QE ends stocks will have to rely more on their earnings to rise. The conference was presented with two different views of the US. Raymond James presented an extremely bullish view, and then Gavekal gave a much more cautious view, though they remain positive on markets elsewhere.

Jeffrey Saut, Chief Investment Strategist & Managing Director, Equity Research, Raymond James @Notz Stucki Investment Conference

Raymond James’s view is that the market will continue to grind higher, albeit with periodic setbacks which are part and parcel of all bull markets. This is the most hated bull market in history and consequently most people are not in it. Yet bull markets usually endure for fourteen years suggesting that we are barely half way through this one. Encouragingly in July 2016 the market broke out to the upside after an eighteen month consolidation. Following the US elections and the Republican sweep of the Presidency and Congress there will be much more co-operation in Washington. This will enable the smoother passage of the proposed tax reform, and fiscal package. Alongside this the Fed is likely to raise interest rates at a glacial pace. As profits recover the market will transition from one driven by interest rates to one driven by earnings. Low inflation, rising earnings, and slow rises in interest rates will create a strong environment for a rising market. Employment is strong which will keep consumption strong and the US is underpinned by soaring levels of creativity and technological improvements. US energy is booming, the banks are in good shape, manufacturing is improving, and corporate balance sheets are healthy. In 2017 S&P earnings are forecast to be $131 which puts the market on a multiple of 17 times. However every 1% of tax cut can increase those earnings by $1.31 so if Trump achieves the 20% tax cut he’s proposed the earnings can increase by up to $26. The one area to avoid are the bond proxies as the bond bull market is probably over. Themes like waste collection, cyber security, e-commerce, defence and disruptive technology all have powerful tailwinds. With no sign of investor enthusiasm for the market and plenty of supports the market should grind higher.

Louis-Vincent Gave, CEO, Gavekal @Notz Stucki Investment Conference

Gavekal is not worried about two of the issues that are on many commentators worry list for 2017, namely Europe and China. Europe’s elections this year will be less dramatic than last year’s. Le Pen won’t win in France, and Merkel will win in Germany. With oil prices low and the euro weak the European economy is supported. Indeed it may be a coiled spring as having experienced little investment for ten years, if things do improve then the rebound could be dramatic. Europe can therefore be a source of upside surprise. China is in a year of political transition and will be focused on things being stable at all costs.

Gavekal’s concerns centre more on the US. These concerns are largely Trump related. The largest uncertainty is the question as to what extent his campaign rhetoric on reducing globalisation to protect American jobs will be put into practice. Potentially this is extremely harmful for a whole range of US companies and those in the rest of the world. If Trump really attacks globalisation it will be hugely disruptive. The risk of this seems uncomfortably high. It is hard to assess but given the high levels of US equities they seem vulnerable to having priced in the good news (not yet enacted), and to be ignoring any negatives which could be substantial.

Another concern is how the fiscal deficit will be financed. Trump starts his Presidency with US Government debt at $20 trillion. This debt has ballooned in the last few years and most of it was bought by the Fed, but they have stopped buying and are trying to unwind their position. US consumers or companies could buy it but the Trump plan envisages them to continue spending and to start to invest. Foreigners could but they have been selling US bonds recently. With the Fed shrinking its balance sheet and foreign Central Banks withdrawing money, liquidity is tightening. This could lead to problems but markets have been behaving as though we are entering a reflation. This is why Trump’s attitude is on globalisation and trade is so crucial. If the US turns protectionist then from the current exuberant position the markets’ reaction could be severe. If not, and Trump retreats from his rhetorical position and basically accepts the evolving trading relations of past decades, then the world may experience a similar cycle seen in the last forty years whereby a strong US lifts everywhere else, but particularly those export countries that sell there like North Asia. The US fiscal deficit will then expand to the benefit of the rest of the world. The binary nature of this situation shows the difficulty of this market. It is impossible to invest for both outcomes.

Christian Kopf, Director of Economic Research and Investment Strategy, Spinnaker Capital Group about "A Rising Tide – Spinnaker Capital’s Outlook for Emerging Markets" @Notz Stucki Investment Conference — Christian Kopf, Director of Economic Research and Investment Strategy, Spinnaker Capital Group about
“A Rising Tide – Spinnaker Capital’s Outlook for Emerging Markets” @Notz Stucki Investment Conference

Markets have started strong in the first week of 2017, continuing the rally in the last two months of 2016. Mr Trump will be inaugurated as President in ten days and then we will start to see what his policies really are. Given the strength of the recent rally a consolidation is likely anyway. Whether the optimism of the markets is justified or whether the markets have got ahead of themselves will become evident as the new administration reveals itself during the course of the year. However the dynamism of US business should never be under-estimated and that will continue to present opportunities regardless of the politics. There are lower valuations in the rest of the world and following several gloomy years if Europe and Asia can achieve a more confident attitude then these markets may surprise. The US market may be the most hated bull market but virtually no-one owns Europe with confidence so any improvement in sentiment could lead to a better market.

Juerg Nagel, , Partner, Member of the Management Board, Head of Portfolio Management & Marketing, MIV Asset Management about "Innovation in Medtech" @Notz Stucki Investment Conference — Juerg Nagel, , Partner, Member of the Management Board, Head of Portfolio Management & Marketing, MIV Asset Management, about “Innovation in Medtech” @Notz Stucki Investment Conference

Written by James Macpherson