In this quarterly update, we will review some of the signals coming out of the bond market, the misadventures of Chinese mega-techs and the high price level of growth stocks. Then we will look at the usual themes of interest rates and inflation.
- Bond market: The Financial Time (see source) reports an issuance frenzy of dollar bonds after the summer lull. Various anecdotes indicate that some borrowers feel that high inflation and a general economic recovery could lead to higher borrowing costs by year-end and are taking advantage of the September window. In particular, Deutsche Bank is encouraging clients to get in early if they need attractive dollar funds. In addition to investment grade debt, many new high yield corporate bonds are also coming to market in September (to lock in low borrowing costs in order to fund acquisitions and share buybacks, or reward shareholders) ahead of the possible end of these historically low borrowing costs and fears of less transitory inflationary pressure that would drive up funding costs again. From an investor’s perspective, there is nothing attractive about the outlook for US bonds (with expected declines in the event of rate hikes), but it is still more attractive than what is found in some parts of the world with already negative returns.
- Chinese mega-tech: The shares of the Chinese IT giants have been victims of a real sell-off in the last few months. The Chinese government has decided to restrict the technological giants and to give them access to more data, the use of which allows these giants to make important profits. This affected particularly the shares of Alibaba, the Chinese equivalent of Amazon, which lost more than a third of its value, just like Tencent. As these stocks have a significant weighting in the FTSE and MSCI “Emerging Markets” indices with the now important weighting of the large Chinese stocks, Vanguard (with FTSE EM benchmark) and iShares (with MSCI EM index) ETFs investing in emerging markets have not had the positive development that other markets have experienced. However, the price of emerging markets ETFs are much more attractive than growth stocks (see below), despite the gloomy short-term outlook for these companies.
- Technology and growth stocks: The fact that technology stocks active in semiconductors have P/Es of more than 40 may not seem rational, but it is understandable: they can benefit from significant price increases in their sector. The fact that the growth segment as a whole is similarly expensive should give more pause. Even ETFs of reference providers like Vanguard and iShares see their growth ETFs enter the lists of the most expensive ETFs, where usually very specific, niche and speculative ETFs find their place. For example, here are the P/Es for the growth ETFs as per September 2021 according ETF Database (see sources):
- VONG (Vanguard Russell 1000 Growth ETF): P/E of 38.30
- XN (iShares Global Tech ETF): P/E of 40.98
- IVW (iShares S&P 500 Growth ETF): P/E of 44.07
- VOT (Vanguard Mid-Cap Growth ETF): P/E of 45.00
- U.S. interest rates and inflation: Fed Chairman Jerome Powell spoke at the end of August at the Jackson Hole symposium and defended the monetary policy of not fighting too hard against probably temporary inflation situations. In the 1970s, the strong rise in prices however led to significant increases in interest rates (called the “Volcker shock”). If the Fed is wrong in its assessment and inflation is not so temporary, it will eventually have to take drastic measures to make up for today’s delay. Jerome Powell, however, said that there could be a key interest rate hike in 2023, whereas until May, the Fed had still ruled out any rate hike until 2024. The Fed continues to buy bonds and mortgages at a rate of about $120 billion a month, which it will reduce toward the end of the year and, according to economists, could reduce to zero within six months.
- No change for the euro: This month, the ECB reiterated its statement that it was letting inflation rise for the time being, even though it was as high as 6 percent in some member countries. It is also unlikely that interest rates will be affected before 2024 according to the ECB communication.
- Interest rates and inflation in Switzerland: As a small open economy, Switzerland is dependent on the international interest rate situation: If it were to raise its key interest rates unilaterally, the Swiss franc would appreciate even more and harm its economy. For Andrea Mächler of the SNB, “the risk of a surge in inflation in our country is extremely low” according to Le Temps (see sources). For her, production capacity remains under-utilized and if inflation were to rise, she is convinced that the SNB has the necessary instruments at her disposal. We would like to share her optimism, but we will only note that her assurance only applies to consumption inflation, since the enormous increase in stock market and real estate prices (asset inflation) is the consequence of the injected liquidity. On the Swiss real estate market, another member of the SNB board put forward an overvaluation of 30 percent a few days earlier. After the strong counter-movement in the interest rate level in February (when interest rates had risen mainly on the long side), there has been a strong reduction of this increase (compensation by a decrease of about 2/3). In August, the SNB again intervened heavily in the foreign exchange market, to the tune of at least CHF 7 billion, after the Swiss franc had risen again against the euro to 1.07. As it does every month, the SNB reiterated in August that it does not intend to change its monetary policy in the near future and will continue to use negative interest rates to prevent an appreciation of the franc. The SNB also believes that it can counter the overheating of the real estate market by other targeted measures rather than interest rate hikes. Interest rate hikes are not the right way to go due to the international situation of expansive monetary policies and therefore the indicative mortgage rates did not change much in the last quarter.
- Gold did not shine during the third quarter, as investors seem to prefer crypto-currencies as well as investing in tech or growth stocks at a very high price. An investor can still hold few percent of gold in a portfolio or in its belongings as a protective contribution against extreme risks, but it does not bring any dividend.
In essence, the development of Chinese tech stocks and US growth stocks were the major events of the third quarter, while interest rates were little changed. Even if individual investors avoid thematic ETFs, and it is in their interest to do so, these growth stocks generally constitute a very important part of US equity capitalization, which is itself very strongly represented in global capitalization (for about half). Buying a “developed world” ETF today therefore means gaining massive exposure to highly valued growth stocks. A more differentiated approach (see also Index Funds: Core Options in the guide) than a global ETF might be necessary, especially as the valuation gap between “developed” and “emerging world” ETFs has widened further, with more attractive prices for the latter, which often compensate for the risk profile and uncertain outlook for Chinese stocks.
Sources: Bankers and investors braced for US corporate debt binge, Financial Times Europe, 03.09.2021 Andréa Maechler: "Les 1000 milliards de la BNS ne sont pas la solution au changement climatique", Le Temps, 04.09.2021 www.etfdb.com