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Quarterly Report Q2/2023

Review

The markets started the second quarter of the year with considerable momentum. On the stock markets, positive sentiment prevailed following the negative reports in the banking sector, whereas on the bond markets, financial stocks in particular were unable to benefit from the change in sentiment.

As was to be expected, the Federal Reserve (USA) and the European Central Bank (ECB) once again turned the interest rate screw in the past three months. The FED Fund Rates are now at 5.00-5.25% (March 2022: 0.0-0.25%) and thus opened, with a U.S. inflation rate of 4%, the opportunity for a pause, which was then immediately used. In direct comparison with the Americans, the ECB’s current key interest rate is “only” 4.0% after the 25 basis point increase in mid-June and therefore leaves further room for improvement in purely visual terms, especially as inflation in Europe is also clearly higher than in the USA. The chart below shows the flag-mast-like rise in interest rates, starting in 2022:

From the end of April/beginning of May, equities increasingly treaded water and a certain lethargy among many investors visibly dominated the scene. The combination of persistently high inflation in Europe, rising interest rates, a sharply inverted yield curve and, in some cases, negative economic data led to noticeable restraint on the part of market participants. The well-known stock market adage “Sell in May and go away (but remember to come back in September)!” may also have been one reason why many investors exercised restraint and the markets entered a pronounced sideways movement. In mid-June, the DAX even soared to new all-time highs, but was subsequently unable to defend them.

Performance

Our equity fund shows a performance of +8.62% in Euro and +7.45% in Swiss Franc since the beginning of the year. This compares to the major indices: DAX +13.81%, STOXX600 (Europe) +9.31%, S&P500 (USA) +12.37% and MSCI World (worldwide) +11.07% (all values in Euro). For the first time in many quarters, we were not able to beat the indices because we did not blindly follow the hype AI (Artificial Intelligence), but stayed true to our focus on quality stocks. This strategy, in combination with our ever-present hedges, has cost some performance in the short term. We consciously accept this, as the past has shown that euphoria with little substance can end quickly and badly. It should also be mentioned that we made a distribution of CHF 2.50 in April.

Our bond fund distributed 5.00 Swiss francs or 4.80 euros in mid-April, which resulted in a proud distribution yield of 5.4% or even 6.4%. The performance itself, at +0.07% (CHF tranche) and +0.14% (EUR tranche), continues to be heavily impacted by the negative headlines surrounding the failure of Silicon Valley Bank and the resulting negative sentiment, especially among bank stocks. We expect the sector to calm down over the next few months and valuations to return to normal. The trend towards interest-bearing investments remains positive, so the pressure on prices should ease significantly, which should then also result in clearly rising prices.

Current positioning

The second quarter was characterized by constant ups and downs on the stock markets in general, within the various sectors, and also for most of the individual stocks we hold. In this respect, our focus was on buying companies during the phases when they were under pressure and, in turn, selling them when they were in a positive wave movement.

At the beginning of the quarter, we bought back energy stocks somewhat, thus offsetting our short-term underweight in the sector. Later in the quarter, we added to U.S. technology stocks to raise our weighting to neutral there as well. In the financials and basic materials sector, we took some profits and sold companies or at least reduced the weighting. In the healthcare/healthcare sector, we fully realized the large gains in Novo Nordisk and in return further increased our existing position in Roche following a promising corporate visit by the pharmaceutical group to Basel. In the financial sector, the unease in bank stocks has subsided, as has the interim euphoria over artificial intelligence in technology stocks. However, both can flare up again at any time.

We do not expect interest rates in Europe and the USA to rise much, but neither do we expect them to fall much in the foreseeable future. The economy may be weakening somewhat, especially in the manufacturing sector, but overall we do not expect either Europe (with the exception of Germany) or the USA to experience a severe recession. In our view, the stimulus and structural programs in the individual countries are helping to ensure that the economy does not weaken too much after the exuberance caused by the Covid recovery and the subsequent destocking (and subsequent restocking).

From a regional perspective, we continue to maintain an increased weighting in bonds denominated in US dollars in our bond fund in order to benefit from the higher interest rate level there. In the case of new investments, in addition to reasonable quality, we pay attention to above-average yield potential, which also ensures above-average distributions for our investors in the future. Even if longer-dated bonds appear interesting due to the interest rate level, we remain risk-averse and deliberately keep the average remaining term in the fund short.

Outlook

Let’s first take a look at the equity landscape. Inflation and economic development, among other factors, are decisive for the direction of further share prices.

We have highlighted the issue of inflation several times in our publications. In our view, the highs in the rates of price increases are behind us. A contributing factor, of course, has been the fact that energy prices (oil, gas, electricity) have corrected considerably after the peak prices last summer, although they have not yet reached pre-crisis levels. There are also signs of a certain easing in food prices. However, these downward trends are being counteracted by enormously high wage settlements, which make the ECB’s inflation target of around 2% a distant prospect. In this respect, we do not see any major easing and assume that interest rates will continue to rise for the time being.

Inflation is also continuing to retreat in the USA, which could well make the FED think twice about lowering interest rates over the next 12 months. The significant tightening of the money supply inevitably leads to commercial banks also pursuing a more restrictive lending policy, which consequently increases the risk of a recession. We can therefore imagine the Fed taking a downward interest rate step in the first quarter of 2024 to counteract this. Falling interest rates, if initiated in good time, generally have a positive effect on the stock market.

While inflation in Europe and the U.S. is clearly above the target level of 2% (and thus the ECB, in particular, will hardly be able to avoid further interest rate hikes), the Swiss National Bank (SNB) can relax in the face of a price increase of 2.2% in May. After the last hike in key rates in mid-June to now 1.75%, many market observers see only very limited scope for further increases.

Turning to the economy, the important question will be whether we see a soft landing (i.e., only a mild recession) or whether the economic demolition does go deeper. The half-year results of the companies will give an idea of what may happen next. What is amazing is the current resilience of the markets given the many question marks around the globe. And perhaps it is precisely this rather cautious, not to say negative, sentiment that is keeping the markets hovering at a still high level. Over the summer months and into the fall, there is a definite likelihood of greater volatility. The volatility indices remain at low levels and the traded volumes do not exactly indicate a bullish scenario either. The market breadth, which is an indicator for the substance of an upward movement, also does not send any signals that currently speak in favor of new investments. We therefore remain true to our conservative DNA, do not fall for any fashionable hypes and continue to focus on quality and consistency.

If we take a closer look at the bond markets, we see that they are still in a kind of crisis mode since the first interest rate jumps last year. This can be seen, on the one hand, in the continuing strong fluctuations in liquidity, which continue to make sensible trading difficult. On the other hand, the valuation of many securities still paints an exaggeratedly negative picture. Sentiment in the financial sector in particular, especially with regard to bank bonds, is still burdened and is causing distortions in prices. We assume that it is a question of time before the situation normalizes, accompanied by a recovery in prices (also supported by the expected turnaround in interest rates). This is because money supply growth has also turned negative in Europe, once again putting the ECB in a dilemma. Massive rate hikes (especially if miscommunicated in terms of justified) could do the economy a real disservice. To make matters worse, the real estate market in Europe has already gone into reverse gear in numerous countries. We don’t even want to talk about the construction financing that will expire in the next few years (at interest rates that were still low at the time). Added to this is a sentiment that has suffered considerably from the price losses of the past year and a half. This is a positive signal for bond investors, as the outlook has clearly improved, and it is encouraging for the rest of the year. All in all, the signs for excess returns can be classified as very good.

Conclusion: We are assuming a hot summer, not only in terms of temperatures, but also on the stock markets. Although the markets ran upwards again in the last two weeks, the sustainability of this movement can be doubted. If we stick to dry, brittle and boring facts, and leave out the euphoria, not to say hype, in the field of AI stocks, we can definitely expect very volatile market movements in the coming weeks. From a seasonal perspective, the summer months have also often been a guarantee for astonishing and challenging price developments. Nevertheless, we remain positive for equities in the medium term and will consistently exploit opportunities that arise in the form of any setbacks.

We wish all of you who have already gone on vacation or are about to do so a relaxing time. Enjoy the days, soak up the sun and energy, relax and come back safe and sound with lots of wonderful memories in your luggage! In the meantime, we will take care of your assets in the best possible way, as you know it from us.

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