After a marvelous first quarter, markets started to stutter. Investors are desperately looking for good news that support the lofty valuations. Because lower interest rates currently do not work, at least not in the U.S., we see Europe and the U.S. drifting apart. They find themselves in different stages of their business cycle. While the U.S. has been celebrated for its strong economy, Europe has moved ahead and is at the end of a recession, ready to steer its ship into growth territory again. Switzerland finds itself somewhere in between. While not experiencing a recession, we can also not boast of being in a strong economy. Economists in Switzerland understand unemployment is not the holy grail of an economy’s well-being. There is much more to that. We are lucky enough to present ourselves with an unemployment rate of 2.4% (USA: 3.9% | Germany: 5.9% | China: 5.3%). However, the backbone of our economy, our small- and medium-sized companies, are struggling. The Purchasing Managers Index fell to its lowest level since October 2023. As a relatively small country, we are used to this dependency on other economies. Our companies have always found a way to prove themselves. Accordingly, international businesses are willing to pay a premium for the quality we deliver and the stability we provide.

Lofty highs – not everywhere

As mentioned earlier, equity indices often fail to accurately reflect the state of economies. However, this is where the astuteness of investors shines through. They are often a step ahead, their valuations based on anticipated future earnings. This foresight is what sets them apart.

 As a long-term investor, it is crucial to maintain a broader perspective that defines the investment strategy, looking beyond the immediate market movements.

On the other hand, this makes the markets more vulnerable to unexpected events. Often, in a first reaction, investors shift their focus to areas that still support their view. We have seen such behavior when, starting in October 2023, markets began to rally due to disinflation (inflation, which is still positive but is cooling). This led to the anticipation of central banks starting to lower interest rates as early as March 2024. While the Fed, in particular, was disappointing in this regard, the Swiss National Bank unexpectedly took action in March, lowering interest rates by 0.25% to 1.5%. In the US, chances are that there are only up to two interest rate cuts starting as early as September. In Europe, the expectation is that the European Central Bank will undertake a first cut in June. In the meantime, investors are cheering worse economic numbers, hoping it will incentivize the central bank to lower interest rates sooner rather than later.

While we may critique the short-term fluctuations, we also see the silver lining. These market volatilities, driven by met or missed expectations, can actually unveil investment opportunities. This is a reason for optimism. However, as a long-term investor, it is crucial to maintain a broader perspective that defines the investment strategy, looking beyond the immediate market movements.

Therefore, we see industries that are suffering today due to the excitement for other trends going on. Artificial intelligence (AI) is the most common theme driving markets. While we acknowledge the importance of technology, we respect the risks that come out of such overly optimistic environments. Like the internet, AI will significantly influence the economies, making them more productive. However, while the hardware has to be updated and the logistics built, the real value behind AI is the data. Therefore, we believe that companies in all sectors will eventually benefit. In other words, not including AI-driven technology in your industry will bear a high risk of becoming redundant.

Accordingly, while indices reach one high after the other, there are sectors that are currently out of favor in the investment world and, therefore, offer great opportunities to enter following an anticyclical approach.

Bonds… foreign bonds

As we claimed in our last publication, central banks will eventually lower interest rates. In the meantime, we saw the Sveriges Riksbank (Sweden’s central bank) following the Swiss national bank by taking a first cut, lowering interest rates by 0.25% to 3.75%. This cut was made despite the inflation rate still being above the two percent target rate, making it a bold move. On top of that, the rate cut led to a further weakening of the Swedish krona (SEK) against the USD. However, we will talk about currencies later. The point I make is that once central banks more broadly start lowering interest rates, that will affect the valuation of bonds. Bonds are issued at a particular time with a coupon and price structure that compensates the investor for the risk taken.

In our example, the yield consists of the risk-free rate (the yield you get from a US government bond) enlarged by an additional interest rate due to the company-specific risk. The risk-free rate would be 4.9% for a 2-year US government bond. Adding another 1.6% for the company-specific risk, we end up with a yield of 6.5%. This 6.5% is the annual return if you buy this bond today and hold it until maturity. Once the Fed lowers interest rates and the 2-year treasury falls to 3.9%, you will not have the chance to buy the same investment offering the same yield for the same level of risk (the yield at that time would be 5.5%).

My point is that if you invest in bonds today, you can lock in a sound yield that will accompany you throughout the coming years. Obviously, it is almost impossible to see what the future brings. There is a certain risk that inflation will reaccelerate, and central banks will have to increase interest rates further. Due to the risk such action bears for the financial system (remember Silicon Valley Bank and others), we currently see this risk as limited.

FOREIGN

Our previous title included the word foreign. Considering the current strength of the USD and the high interest rates in the U.S., one might ask why foreign. As our loyal readers already know, we see the USD depreciating over the long term. We have repeatedly presented the case, showing how the USD is loosening its purchasing power and how you can avoid being overly exposed to this development. Above, I shared one consequence of Sveriges Riksbank's interest rate decision on their currency (SEK). The same was true when the Swiss National Bank decided to lower interest rates in late March. The Swiss franc did lose value.

However, the Fed will eventually also loosen its monetary policy, either forced by the economy or the government. We already got a taste of what that looks like in Q4, 2023 (see the graph below that shows the USD index, DXY, from October 2023 to April 2024). Back then, the whole movement was solely based on the markets' expectations of up to six interest rate cuts starting as early as March 2024.

_{Source: Trading View}

Having said that, we see a strong case behind the ongoing USD devaluation once that happens. We have to keep in mind that the Fed will not be the only central bank that will cut interest rates. However, given the current interest rate levels, the Fed has more leeway to cut interest rates than its peers.

The scariest development was the Japanese yen (JPY), which lost about 30% against the USD within the last five years. Considering that it was not too long ago that the Bank of Japan moved its interest rates outside the negative territory, the weakening JPY is not overly surprising. However, the question is how well the Bank of Japan will be able to go against the trend once central banks around the world start loosening their monetary policy. If they can pull it off, there is a chance that the JPY can gain back strength. Additionally, it is encouraging that the U.S. is making efforts to strengthen its bands with Japan. That puts Japan in a position where they can expect some support from the U.S. in stabilizing their currency under certain circumstances. However, as the outcome is uncertain, we have to closely follow the further development of the Japanese economy and monetary policy.

A last exciting fact before we move on is the development of the Swiss franc over the previous five years. The graph below shows the USD index (DXY) and the price development of the constituent currencies against the USD within the last five years. Of the six constituents, the Swiss franc is the only one that has actually strengthened against the USD by over 10 percent.

_{Source: Bloomberg}

Gold takes a breather

Gold has shown an impressive development starting in October 2023. In our last edition, we wrote “Gold, the Silent Winner.” After such a performance, who can blame gold for taking a breather? However, that happened after gold reached another all-time high in mid-April at USD 2,448.80. Furthermore, silver, which had been lagging for quite a long time, eventually took off in April, reaching a high of over USD 29 an ounce. In the meantime, the silver price took a breather, too.

Last but not least, platinum struggled a lot, being unable to catch up. Within the last few days, platinum started another attempt to follow the gold and silver prices. Accordingly, we saw platinum hitting USD 1,000 an ounce. However, we are not convinced that platinum can conquer this level and move even further in the short-run. For gold and silver, we are cautiously optimistic that once an interest rate cut from the Fed becomes more evident, their prices can increase even more. However, there is always a risk at the current levels that a broader setback will be in the cards due to more extensive corrections in the broader markets. Corrections that trigger margin calls can negatively affect precious metals prices since cash is needed at short notice.