Central banks mutate from saviour to villain, while the cycle of interest rate hikes is showing first cracks in the system, as the bankruptcy of SVB demonstrates. In our view, investors should be patient and invested in companies that show stable margins in the current environment.
In the last issue of The Strategist, we discussed and highlighted the credibility of central banks. On a scale of one to ten, the importance of credibility as a key point in the perception of a central bank has risen from nine to ten-plus in recent days. Fighting inflation is currently the sole objective not only of the monetary guardians in Washington, but also in Frankfurt at the European Central Bank (ECB). Any doubt, no matter how small, about the ultimate determination is to be nipped in the bud immediately. This is also important to be armed against a potential second wave of inflation, which would very likely come at the expense of economic momentum.
For more than 25 years, Western central banks, led by the US Federal Reserve, had the image of saviors in distress in financial markets. We still remember 1998, when the Fed, under then Chairman Alan Greenspan, first stepped in as a savior in white armor after the hedge fund LTCM got into trouble because of the currency crisis in Russia. The term "Greenspan put" or, more commonly, the so-called "Fed put" was born. Behind this was nothing other than the conviction of market participants that central banks try to prevent a stock market crash at all costs. Greenspan's successors (Bernanke, Yellen, and Powell) not only kept this belief alive through their actions - expanding the Fed's balance sheet in every crisis - but also tempted investors to take ever higher risks.
The "Fed put" has now been gone for a good year, and the Fed has fortunately put an end to this moral hazard. Central banks are no longer seen as saviors in distress per se but have rather mutated into villains on the stock markets, as in a Hollywood movie. This image is somehow comparable to the transformation of Anakin Skywalker into Darth Vader, probably the most notorious villain in the Star Wars universe. For investors who still have (too) much risk in their portfolios, it currently looks - if we stay with Star Wars - as if the empire, i.e. the central banks, are striking back. The steepest cycle of interest rate hikes by Western central banks in the last 40 years is starting to take effect and the first cracks in the system or collateral damage are already showing. The bankruptcy of Silicon Valley Bank (SVB) has currently demonstrated this impressively and will probably not remain the only case.
Since we are no longer in a zero-interest rate environment, the business models based on it will probably come under massive pressure. Therefore, it is, in our view, important to be invested only in companies that have stable margins even in the current environment and are prepared for a possible recession.
The next interest rate steps of the Federal Reserve are still very data-dependent, and uncertainty has increased once again due to the bankruptcy of Silicon Valley Bank. In our view, the coming months do not belong to the courageous but to the patient investors. Wait and see is the order of the day. However, this waiting period is sweetened for the investor with a Libor rate over six months of 5.45% in the US dollar and 3.45% in the euro.
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We apply a “hybrid approach” (internal fundamental analysis combined with “theScreener”, an external, purely quantitative analysis tool). TheScreener is based on purely quantitative, i.e. computable variables such as (but not exclusively restricted to) profit adjustments of the past few weeks, stock valuation in relation to historical performance and comparison groups, the technical trend, performance in relation to the market etc. The assessment of the equity analysts, which is largely based on a qualitative analysis, does not need to match with the one of theScreener. For the overall judgement the assessment of the equity analysts overrides the one of theScreener. LGT Bank (Switzerland) Ltd. categorizes its analysis recommendations into five ratings: for a “Buy” recommendation we expect a relative outperformance compared with the sector. Only equities subjected to an internal fundamental analysis can be rated “Buy”. The recommendation “Attractive” is used for equities exclusively ranked by theScreener without any internal fundamental analysis as “slightly positive” or “positive”. A moderate relative outperformance versus the index is expected. For equities that we rate as “Hold” we expect a performance largely in line with the one of the sector. This can comprise both equities for which a fundamental analysis has been carried out as well as equities that theScreener ranks as “neutral” versus the index. The recommendation “Unattractive” is used for equities exclusively ranked by theScreener without any internal fundamental analysis as “slightly negative”. A moderate relative underperformance versus the index is expected. By contrast, “Sell” recommendations are based on the expectation of a relative underperformance compared with the sector. This can comprise both equities for which we are recommending “Sell” for fundamental reasons as well as equities that theScreener ranks as “negative” versus the index. Therefore the ratings always reflect a relative consideration versus the sector and/or specified index. The risk assessment is based on the individual judgement of the analyst (e.g. we assume a “high” risk for illiquid shares, highly indebted companies or shares from developing countries).
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Definition of rating categories of S&P and Moody’s which are relevant for us:
AAA/Aaa: Borrower with highest credit quality. Default risk also virtually negligible over the longer term
AA/Aa: Safe investment, default risk virtually negligible but more difficult to assess in the longer term
A: Safe investment as long as no unforeseen events impair the overall economy or sector
BBB/Baa: Average investment. However, problems must be expected if the overall economy deteriorates
BB/Ba: Speculative investment. Defaults must be expected if the economic situation deteriorates
B: Highly speculative investment. Defaults are likely if the economic situation deteriorates
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