After the Storm
T&V Letter Q4 2022
2022 was an exceptionally difficult year for investors: equities and bonds came under pressure at the same time, while rising interest rates reshaped the valuations of many asset classes. It is precisely after such phases that a calm look ahead is worthwhile. The key remains to distinguish between short-term market noise and long-term quality of companies.
Insight
After an exceptionally difficult stock market year, it remains crucial not to confuse short-term fluctuations with long-term quality.
2022, a year to forget. The season is grey, and the headlines on the economy, war, and politics make everything a little bit greyer. The mood is lousy because markets in 2022 were weak across almost all asset classes. Historically speaking, 2022 was also a genuine exception. In the last 100 years, it has only happened five times that the S&P 500 (the largest 500 companies in America) and US government bonds fell at the same time. This makes 2022 the worst year since 1931 for a balanced portfolio of 60% equities and 40% bonds. The tighter monetary policy of central banks around the world is the main cause of this regime shift, as rising interest rates take their toll on high valuations in various asset classes and market segments.
Today, the prophets of doom are naturally having a field day: a recession next year comparable to 2009 is conceivable. Really? Central banks will continue to raise interest rates, and this will cause pain for many companies, but the prospect of a systemic crisis with GDP declines of 5 to 10% is presumptuous. There is plenty of bad news to be found at the moment. Perhaps it is therefore time to take a different perspective.
Political: The movement of the "strongmen" is in retreat. Bolsonaro and Trump are fading into obscurity, and the days of the aggressor Putin are numbered. He may not fall in 2023, but the Russian "model" is visibly broken for everyone to see. Putin has only death, destruction, and Russian fascism to offer. The Soviet Union was more creative in this regard: the supposedly communist harbinger of salvation presented itself as the savior of the oppressed masses worldwide. Even more important are the signals from China. Xi Jinping recently made it clear that the (guided) market in China is back at the top of the agenda. China is not becoming North Korea. China needs growth. That requires a certain degree of openness.
Markets: The state of the global economy and the financial market may be serious, but prices signal hopelessness. That is not appropriate. You can look at it positively: the US economy is so stable that the Fed continues to raise interest rates. There are good reasons why a deep recession might not happen in 2023 after all, due to the resilience of the US economy. A positive surprise will give markets a boost. Especially since valuations today are at their most attractive levels in many years. This is particularly true for digital stocks. The future belongs to them. The only question is when the stock prices of these companies will start setting the tone again. Perhaps in April, perhaps in May, or even later. The last two major crashes of this millennium ended in March 2003 and 2009. History does not repeat itself, but it often rhymes.
NEWSLETTER
Self-Reflection and Alignment Thalmann & Verling Trust reg.
Our clients have suffered. We have not lived up to our standards, as the portfolios we manage have developed roughly in step with the broad market, which has been extremely unsatisfactory this year. In order for us to beat the global market again, we need significantly lower inflation rates. However, we are cautious about making forecasts on the development of inflation because we believe that neither we nor anyone else can predict it. However, the direction over the last few months is correct.
Our approach to investing in an inflationary environment is derived from Buffett. He argues that in an inflationary environment, it is best to own companies that have high pricing power and require little capital. Unfortunately, the strategy has not yet been particularly successful last year, as many of these high-quality companies (rightly) enjoyed high valuations. Due to the rapid rise in interest rates, the valuation level has come down, although little has changed operationally within these companies in many cases.
We see the criteria mentioned by Buffett well implemented in our portfolios. The technology sector is very unpopular today, but it seems to us to be one of the best places to park money when inflation is the biggest concern.
A good example is Microsoft: it is difficult to imagine a company better positioned to navigate an inflationary environment. Microsoft 365 Business Standard (Outlook, Word, Excel, etc.) costs CHF 12.30 user/month, but is essential for almost any business. No company will cancel Microsoft Office or go to the trouble of switching providers just to save a few francs a month. In fact, Microsoft announced in early 2022 that it would increase prices by 21% and yet experienced almost no impact on churn.
Times are extremely difficult for everyone, agreed. One of the keys to investment success is to drown out the noise. As a long-term investor, one should not let short-term market fluctuations distract from the long-term financial plan.
As always, we thank you for the trust placed in us and we look forward to investing together in 2023!
*This communication is for informational purposes only and does not constitute a personal recommendation or an independent financial analysis.
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