Europe’s weaknesses to be exposed in the long term
The author is Chief Investment Officer and Managing Director of Knight Vinke Asset Management
Many well-known and respected experts are predicting a stock market collapse in the coming months or quarters due to rising bond yields, strained valuations and the speculative behavior of market participants.
This may or may not be true. A market correction is certainly possible, but any real threat to global financial stability will continue to face massive doses of monetary and fiscal stimulus.
This is especially true in light of the “blank check” most governments have received for pandemic relief. Budget deficits will increase, as will public sector debt, and the currencies of countries that finance their deficits by printing money will fall, stoking inflation through the back door.
The value investor in me thinks a correction is long overdue, but the euphoria – brought on by vaccinations, government handouts, and the lifting of restrictions on travel and social interactions – is hard to ignore. Dealing with this contradiction is difficult for many asset managers and often leads to paralysis.
But there are solutions. Investors who have the capacity to do so should focus on creating value over long periods of time rather than seeking to catch up with the next market downturn. The effects of capitalization are such that it only takes a small increase in yield to compensate for even a large fall in the market.
What worries me most is that debt to gross domestic product is now at record levels in the United States, the Eurozone, the United Kingdom, Japan and China. Private sector debt is particularly dangerous because it tends to rise steadily over very long periods of time and will often lead to the downfall of a number of banks when the cycle comes to an abrupt end.
Debt cycles are interrupted by deleveraging, which, in the context of a fragile economy, can be triggered by even a small shock to the system, like the straw that broke the camel’s back. The catalysts can come from any direction, regardless of the economic outlook: they range from civil unrest to a hedge fund collapse, a pandemic, or a military crisis.
Supercycles with a life span of 75 years or more are unlikely to be of interest to most investors, but are of the utmost importance to those whose responsibilities include protecting the interests of our children and grandchildren.
Each of the most significant debt-deleveraging episodes over the past 300 years has not only caused immense disruption to the global economy, but has also been associated with a geopolitical ‘changing of the guard’: the French Revolution and the conflicts that followed coincided with the decline of France, as did the Great Depression for the United Kingdom. Likewise, the Japanese crisis of the 1990s may have paved the way for China to replace it as a global manufacturing power.
The longevity of supercycles makes private sector debt crises almost impossible to predict although the causes (and consequences) can be identified in advance. To this day, I think the main risks still lie in the financial sector where indebtedness has increased (unlike regulatory measures which give the impression of stronger balance sheets).
The debt crisis that is brewing today may, I suppose, contribute to the split of the eurozone into two blocks: a hard currency block in the north and a tourism-based economy in the south.
Official debt statistics do not yet take into account the full costs of the pandemic, and anecdotal evidence suggests that the level of distress in some countries is totally at odds with the “rebound economy” described by some. The debt of several countries is raised to levels that have never been tested by the “vigilantes” of the bond market. Expect a re-emergence of the loop of fate in Europe – which links the creditworthiness of banks to that of their host countries. France, Italy and Spain are the countries to watch.
What advice can an asset manager give investors today? First, focus on creating value and investing for the long term by locking in all possible returns for as long as possible.
With returns on investment on a secular downtrend, I firmly believe that this is the only way to avoid reinvestment risk: the risk that once an existing investment matures it cannot be replaced. by a new investment with an equally attractive return. Second, focus on real assets that offer some degree of inflation protection. Third, hedge currency risks. From a sector and geographic perspective, we have for some time recommended that our clients focus on infrastructure assets – acquired through investments in public markets rather than private auctions – and avoid exposure to the market. southern euro area.