Equity Edge: Strategies for Uncertain Markets

In recent times, central banks in different countries have become more cautious when it comes to increasing interest rates. However, they have been vocal about their intention to closely monitor the consequences of the steps taken thus far. Despite this pause in rate hikes, equity markets have started to experience turbulence, reflecting an adjustment to the prevailing economic realities. We see significant challenges in the economic environment.

And we believe that even more economic troubles lay ahead. Here a few of the issues raising our concerns:

• The Conference Board's U.S. Leading Economic Index has experienced its 16th consecutive drop. This is the longest losing streak since the Great Recession of 2007/8.
• While consumer spending has been a bright spot in the economy, surveys indicate that it may slow down in the near future. U.S. consumers have accumulated over $1 trillion in credit card debt, and Bloomberg’s latest Markets Live Pulse survey found that delinquencies are on the rise. At the same time banks started to tighten lending standards across all loan categories in the second half of 2023.
• The ISM Manufacturing Purchasing Managers Index shows that manufacturing has been on decline for ten consecutive months.
• And then most importantly, the yield curve, particularly the inversion of the 2-year Treasury bill vs. the 10-year Treasury bill (see below) has inverted 14 months ago. This is typically a reliable sign for an upcoming recession and has last occurred just before the U.S. entered the pandemic-induced recession.

In summary, consumer confidence is low, especially regarding significant purchases, and credit card utilization has reached its limit, reflecting consumers' financial stress. Banks are becoming less inclined to lend, further constricting credit availability. The manufacturing sector continues to face challenges even in the post-pandemic era, and sticky inflation remains a persistent issue demanding attention, as it is an ongoing risk factor for a potential recession, adding to economic uncertainty.

Given these factors, it is now especially prudent for investors to explore opportunities beyond the U.S. market and truly diversify over different stock markets, currencies and geographical regions. Investing internationally can offer many benefits, most notably reduced portfolio volatility. This is shown in the graph below where we can see the reduction in volatility in relation to the percentages of non-U.S. stocks held over a time period of ten years:

Besides internationally diversifying it makes sense in the current environment to think about industries that exhibit resilience and can outperform during times of recession. In our views two of those sectors are healthcare and consumer staples. These sectors are considered defensive because they provide essential products and services that people need regardless of the economic climate. Let's delve into why these sectors shine during uncertain times and how Switzerland excels in both of them.

Healthcare Sector: During periods of economic downturns and uncertainty, healthcare remains a steadfast investment choice for several reasons:

1. Steady Growth: Healthcare is a necessity, and people continue to require medical services and treatments even in challenging economic conditions. Healthcare has demonstrated positive growth, with a remarkable 19.84% surge in 2009 and sustained expansion in 2011 and 2013 (see graph below).
2. Inelastic Demand: The demand for healthcare is relatively inelastic, meaning that people can't easily reduce their healthcare spending, regardless of economic circumstances.
3. Innovation: The healthcare industry is known for innovation, which can drive growth even in tough times. New therapies, drugs, and medical technologies continue to be developed.
4. Aging Population: In many developed countries, there is an aging population that requires more healthcare services, further bolstering the sector's performance.
5. Swiss Dominance: Switzerland's healthcare sector stands out, with Swiss companies occupying the largest positions in the indexes, comprising over 17% of the sector.

Switzerland is renowned for its world-class healthcare system, let’s explore some key reasons why that is: Switzerland is home to several major pharmaceutical companies known for groundbreaking research and development in healthcare products. The country boasts a robust healthcare infrastructure with high-quality medical facilities and a well-trained healthcare workforce. It also attracts medical tourists from around the world due to its advanced medical treatments and healthcare services.

Consumer Staples Sector: Consumer staples, which encompass essential everyday products like food, beverages, and household goods, also tend to perform well during economic downturns:

1. Non-Cyclical Nature: These products are non-discretionary, meaning people continue to buy them regardless of economic conditions.
2. Stable Dividends: Many companies in the consumer staples sector offer stable dividends, making them attractive to investors seeking income.
3. Resilient Growth: The consumer staples sector also boasts impressive performance, with a substantial 36.34% positive growth in 2009, along with robust expansion in 2012 and 2013 (see graph below).
4. Consistent Returns: Over the past 30 years, the consumer staples sector has delivered attractive annualized returns ranging from 5.46% to 8.76%.
5. Swiss Leadership: The Swiss company Nestle holds the largest position in the consumer staples indexes, representing over 16% of the sector.

Switzerland is known for its high-quality food products and consumer goods. Swiss companies in the consumer staples sector benefit from global recognition for their quality and reliability. The country produces a wide range of consumer staples, including chocolates, dairy products, and luxury goods. Swiss consumer staples have strong export potential, making them appealing to international markets.

In summary, during times of uncertainty and recession, the healthcare and consumer staples sectors tend to shine due to their defensive nature and essential products. Switzerland's excellence in both these sectors further enhances its appeal as an investment destination, providing opportunities for investors seeking stability and growth, even in turbulent economic times. If you’d like to learn more about investment opportunities in times of recession have a look at the following webinar recording.

Fixed Income in Flux: Navigating Recession, Inflation, and Rates

Investing in fixed income during a recession and high inflation rates, along with fairly elevated interest rates, presents a unique set of challenges and opportunities. As we discussed previously, the cautious stance of central banks suggests that we may be approaching an interest rate peak. In the longer term, it's likely that central banks will either maintain rates at current levels or starting to decrease them again. This "higher for longer" scenario, while providing some stability, also allows for flexibility in finding investment opportunities within the fixed income market.

However, it's important to recognize that heightened volatility can pose risks in fixed income investing. Bond prices may experience fluctuations before stabilizing. This phenomenon is due to the argument for short-term lower gold prices during market crashes. Speculators who have leveraged their portfolios might be compelled to liquidate positions, adding pressure even to asset classes that are typically considered safe havens.

Additionally, 2023 and 2024 present a challenge as a significant amount of debt is set to mature, requiring repayment or refinancing. This situation demands enhanced due diligence to avoid potential losses resulting from liquidity shortages or investors' hesitance to extend credit at reasonable interest rates.

In navigating this complex environment, investors should exercise caution, diversify their fixed income portfolios, and remain vigilant for emerging opportunities while being mindful of potential pitfalls. The interplay between central bank actions, inflation, and interest rates will continue to shape fixed income, making it essential for investors to stay up to date and adapt their strategies accordingly.

From Pump to Paycheck: The Ripple Effect of Rising Oil Costs

Commodities, especially oil, are becoming increasingly critical indicators of economic health. While politicians express optimism about a strong economy with no impending recession, the surge in oil prices to nearly USD 100 per barrel paints a different picture. This uptick in oil prices serves as a crucial signpost, pointing towards the looming specter of higher inflation. This is particularly significant as it unfolds in an environment where global oil demand has hit record levels.

Although core inflation calculations exclude energy and food, the pervasive influence of oil on various industries cannot be ignored. From transportation to manufacturing, numerous sectors rely heavily on oil. The recent strikes in the automobile industry highlight the ripple effect of rising oil prices. Workers increasingly demand higher wages to offset the mounting cost of gas required for their commutes to work.

Adding to the complexity, the northern hemisphere is entering colder months, amplifying the need for energy to heat homes and vehicles. This spike in energy consumption further underscores the challenges presented by rising oil prices. As the global economy navigates these different dynamics, commodities will continue to play a pivotal role in shaping economic outcomes and investor strategies.

Precious Metals: Shining Bright Amidst Rising Interest Rates

Precious metals, most notably gold and silver, have long held their reputation as a store of value, even though they don't generate interest like traditional investments. The recent shift toward positive real interest rates has therefore placed some downward pressure on the prices of these metals. Investors often pivot towards assets that offer yield when real interest rates turn positive, diverting attention from non-interest-bearing investments.

However, the unique quality of precious metals becomes apparent during periods of heightened market volatility. In these situations, they have historically demonstrated their ability to outperform traditional asset classes, serving as safe-haven assets that retain their allure when uncertainty prevails. The prospect of increased market turbulence, fueled by factors such as geopolitical tensions and conflicts, provides a compelling case for precious metals.

Geopolitical hotspots, including the ongoing situation in Ukraine and potential conflicts between major global players like China and Taiwan, underscore the need for a certain exposure to precious metals. In times of escalating international tensions, these metals can act as a reliable hedge, preserving wealth when conventional assets may falter. Consequently, while the absence of interest income may scare away some investors, we continue to firmly believe in their enduring role as portfolio diversifiers and wealth protectors, especially in today's unpredictable world.

Final Remarks

Amidst the array of global risks and uncertainties, it's essential to maintain a balanced perspective. While traditional indices may not always accurately reflect the underlying health of real economies, succumbing to fear is not the answer. Stepping back and gaining a broader perspective is paramount. Despite the prevailing risks and tensions, there are discernible trends shaping specific industries, poised for growth and success. As asset prices exhibit signs of decline, seizing this opportunity to secure strategic investments is crucial for positioning oneself for the years to come. It's important to remember that a recession, although challenging, can also mark the inception of a new beginning—an opportunity for fresh starts and renewed prosperity.

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