110/23/2020

INVESTMENT STRATEGY

Investment Strategy Q4

Investment Management

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2

GLOBAL STOCK MARKETS

The summer has come and gone, and with the first days of September, a new chapter was added to the third

quarter, when markets saw their largest pullback since March. The third quarter had been already shaping up to

become a tale of different stories. Following the steepest decline on record in equities since last March, an

unprecendented wave of monetary and fiscal stimulus has helped to propel, in some cases, an even more

impressive equity rally. However, it was not until early August that the S&P500 managed to break out of its

summer box trading. Probably it was not coincidental that two of the big leading tech companies, Apple and

Tesla, announced stock splits. What seemingly intensified the media chatter and memories of the Dot.com

bubble came back. The old stock market adage of buying the rumour, selling the fact could be applied. After the

stock splits became effective at the end of August the correction unfolded. At that time the five largest stocks in

the S&P500 made up more than a quarter of the whole capitalization of the index, surpassing the 18% seen in

2000. That US equities remained unrivaled is a sign of the ongoing broader capital flows at play. Only Chinese

stocks have surpassed the levels of 2018.

MSCI World Equity Indices (Bloomberg L.P.)

ABS RISK APPETITE MODELS, US JOB LOSSES & BANKRUPTCY FILINGS

When equities had marched to new highs in February, cross asset analyses showed that risk appetite had

already been waning significantly. The divergence between risk metrics and the leading equity indices had

become a stark warning sign, that the inherent market structure had become more risk averse. Today, once

again the level of risk appetite doesn’t match the bullishness exhibited by the level of the stock market.

S&P500 & ABS Risk Appetite Models (Bloomberg L.P.)

US Permanent Job Losers & New Bankcruptcy Filings (Bloomberg L.P.)

10/23/2020

INVESTMENT STRATEGY

In the meantime the momentum in

the economic recovery has been

easing in most regions, while

concerns about a second wave of

the virus have increased, with

infection rumbers rising strongly.

Manufacturing is doing better than

services, while return to work and

school is not clear or new restrictive

measures being put in place. This

all makes it for an uneven and

fragile recovery, a challenging

fourth quarter.

The year 2020 has surprised. It

brought a global pandemic, great

financial crisis No. 2, depression era

unemployment, fastest bear market,

speculative bursts unseen before,

negative oil prices and a very

unusual US election cycle. All that

while market dynamics are

changing as they always do.

With second and third order effects

still unclear the full economic fallout

from Covid-19 cannot be assessed.

After the terrifying liquidity crisis of

March investors face the solvency

problems. The fast and vast

interventions by governments have

helped to overcome the immediate

liquidity crunch. Now, highly

indebted corporates need to find a

pathway to deleverage. Rising

default risk will add to the

investment challenges.

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3

In previous reports we too have used the various letters that characterize the course of an economic recovery. In

general, V stands for a rapid recovery, U for slow, W for up and down, L for permanent weakness. The letter J

would represent a new boom. While some sectors and regions should prove to be long-term losers despite a short-

term recovery, others have already reached pre-crisis levels and could benefit from the changes in the long term.

This divergence is described by the letter K. We wrote in our Q3 letter that, unfortunately, a V-shaped recovery is

out of the question. The structural changes following the Great Financial Crisis No. 1 have never really been

understood nor addressed. The consequence has been too weak a growth ever since.

THE U.S. DOLLAR INDEX, JP MORGAN EM CURRENCY

The U.S. Dollar Index, JPM EM Currency (Bloomberg L.P.)

10/23/2020

The US Dollar remains the name of

the game, in one form or another. In

times of crisis it can be seen what it

means, this global dollar shortage.

Some numbers underpin this; the

US makes up around 25% of the

World’s GDP, while the Dollar

dominates close to 80% as payment

currency in global trade. One can

see that once the major currencies

start to trade weaker vs the Dollar

things get serious. Currently there

are still record long speculations in

the Euro. On the other hand the

volatility in EM currencies remains

elevated. Ultimately, we see the US

Dollar substantially higher.

INVESTMENT STRATEGY

GLOBAL FIXED INCOME MARKETS

Government bond yields were generally little changed although European yields fell quite some, respectively

prices rose. Whether this was all due to the news of the €750 billion recovery fund, or there is more than meets the

eye, remains to be seen. But some interesting facts nonetheless; Greece’s 10yr yield, after trading as high as 4%

in March, came down to almost the very same level as the US 10yr in early October. The hundred year Austrian

bond with a coupons of 0.85% yields 30bps less than the US 10yr. Generally, the tone was overall positive or “risk

on” in fixed income markets over the quarter.

US, GE, IT, CN 10yr Yield (Bloomberg L.P.)

It remains unclear how governments will deal with the situation to finance the various massive relief programs,

while fiscal deficits deepen further. Unorthodox policies such as modern monetary theory and debt monetisation

are likely to get greater support. As one FED member stated, some sort of MMT is already here. Investors should

expect signifcant structural changes to the global economy and everyday life. The Coronavirus hit the world at an

inopportune time. Some regions had their economies already at stall speed, while geopolitical risks, trade conflicts

and political polarisations have been on the rise. These are adding to the complexity of the current crisis. Low

yields for too long in the major economies and credit-sectors which had gotten over-levered have contributed their

part in weakening the markets’ configuration. In the FED’s hypothesis, lowering rates reduces the incentive to

save. Yet, empirical data suggests the opposite. The higher the rates the higher the pressure to consume.

The Federal Reserve announced a

change to its inflation targeting

regime in August, saying it would

target an average 2% inflation rate,

allowing periods of overshoot. It

further would allow unemployment

to run lower than officials had

tolerated. This was all that came

from a year-long review of its

monetary policy framework! One

has to wonder. In May 2018 the

FED had already introduced

inflation symmetry.

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COMMODITIES

The global pandemic caused a deflationary spiral from which the commodity complex was able to recover to some

extent into the third quarter. Overall, commodities still trade substantially lower than at the start of the year.

However, there were also strong gains like in copper and agricultures. For oil markets the biggest question is

whether OPEC+ will go ahead with its plans to raise output early next year. Some officials hinted that the

organization might rethink and stay put, promising that the group won’t let prices “relapse”. The price of WTI Crude

Oil has been stuck around the $40 a barrel for some time.

Bloomberg Commodity Index, Crude Oil (Bloomberg L.P.)

GLOBAL FINANCIAL CONDITIONS & MONEY SYSTEM

Financial Conditions, USD Swap Spread (Bloomberg L.P.)

US CORPORATE DEBT & PROFITS

US Coporate Debt to GDP & US Corporate Profits Before Tax (Bloomberg L.P.)

INFLATION EXPECTATIONS & VELOCITY OF MONEY & IMF NEW BRETTON WOODS MOMENT

That the world will see lower productivity, less dynamic demand and higher debt is a logical conclusion. Twelve

years after the Great Financial Crisis we find ourselves in the next one. The massive interventions by central banks

have not led to the desired pick-up in inflation. Still the doctrine of «ample reserves» prevails to some extent. The

myth of the central bank is still around, although losing some shine. A central bank has to supply currency in times

of crisis, that’s the concept of elasticity of money. However in the end, bank reserves don’t tell us about the level of

liquidity, they only tell us what the central banks did. In a bank centric system it’s what banks do that matters.

10/23/2020

INVESTMENT STRATEGY

The Bloomberg Financial Conditions

Indices track the overall level of

financial stress in the money, bond

and equity markets. These

measures had indicated extremely

tight conditions in March. Following

the central banks’ interventions

things have eased, but still no all

clear. Although the swap spreads

have remained in slightly positive

territory, they still trade too close to

where it would be indicative of a

broken hierarchy.

The low rates regime post GFC1 has

been incentivizing corporates to

engage in financial engineering like

never before. The wider use of non

productive debt has certainly

attributed to the structural

weaknesses since 2009. While

aggregate profits remained stagnant

at best over the past six years. The

deluge of debt sold around the world

is raising risks. In the US alone

corporate issuances exceeding

already $2tn this year so far.

The precious metals had seen a very

strong rally into August. As often is

the case, the most commonly used

rationalization was the threat of

inflation, the expansionary monetary

policies and uncertainty. However,

the key driver are the negative real

rates, making gold a viable

alternative. Worth noting are the

supply losses in various metals due

to Covid related mine issues.0

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510/23/2

020

INVESTMENT STRATEGY

In the past twelve years central banks have added quantitative easing (QE) and negative interest rates to their policy

toolkit. Formerly viewed as unconventional. We wrote before, that the very basic nature of QE is deflationary. We also

elaborated on these pages about Milton Friedman’s interest rate fallacy, that when money is plentiful, interest rates

will be high not low; and when money is restricted, interest rates will be low not high. What was supposed to work as

the quantity theory of money; in reality fails to positively impact the real economy. Instead, developed economies

remain stuck in a disinflationary environment.

US PCE & Inflation Expectations (Bloomberg L.P.)

Central Banks Balance Sheet & Target Rates (Bloomberg L.P.)

US CPI & Velocity of Money M2 (Bloomberg L.P.)

US High Yield – Moody’s Baa (Bloomberg L.P.)

Demographics, technology and the

growing stock of debt are seen as

causes for the persistent disinflation.

As much of QE has not found its way

into the broader economy and banks

have not abandoned their more

cautious lending practices, the velocity

of money has collapsed. Alongside

lackluster growth data.

At its October meeting the IMF warned

that “the recovery is tentative and

uneven and marked by significant

uncertainty”. It revised its global

growth forecast to -4.4%, from -4.9%

seen in June. And; it called for a new

Bretton Woods moment, to

fundamentally re-evaluate the global

economic order. It is not alone. Early

October the ECB issued a white paper

on possible issuance of digital Euro.

Four out of five of the world’s central

banks are engaging in a work on digital

currencies.

The world is in a transition, a paradigm

shift from monetary dominance to

fiscal dominance. Central banks are

readying a technology that could tear

down the wall between sovereign

government fiscal policy and central

banking. The implications will be far

reaching.

Generally, we continue to advocate a

neutral allocation to fixed income.

There are selective areas where

opportunities and value can be found.

Investors have to bear in mind, that

after nearly 40 years of a bull run in

the fixed income markets, we are likely

to see a new era. There will be a

resolution to the debt super-cycle, in

whatever way.

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610/23/2020

S&P500 & VOLATILITY

S&P500 & ABS Volatility Model (Bloomberg L.P.)

SUCCESSFULL INVESTING

There is no single form of investment that protects against all risks. Investing is no hard science. To have long-term

sustainable success in investing, discipline is required together with flexibility, while keeping an eye on diversification,

quality, solvency and value.

INVESTMENT STRATEGY

On page two we stated the market dynamics are changing. 2020 demonstrates that markets have become

increasingly fragile in both directions on low liquidity functions. We wrote before, that the rise to dominance of the

passive investing crowd has led to a co-dependence with the big tech stocks. 2020 has also brought the new retail

trading, which is not reluctant to chase the most speculative trades. As a result this segment has grown to 25-30% of

the US equity market volume, according to brokerage firms. A decade ago it was less than 10%. Another aspect of

2020 is the huge surge in call options on tech stocks, what creates a lot of technical buying, as long as the trend is up.

What this unusual election cycle has yet

to bring will most likely not end with

“…happily ever after”. The vola-model is

on warning. Investors should have an

open mind that confusion could reign.

We started the year with an underweight

in equities. As of the end of February we

moved to neutral. On March 24 we

changed our recommendation to

overweight. In May we changed to

neutral. Since beginning of the third

quarter we advocate an underweight.

Change

Country Allocation Recommendation Q1 Q2 Q2 Q4

USA Overweight

Europe Underweight

United Kingdom Underweight

Switzerland Neutral

Japan Neutral

Emerging Markets Neutral

Asset Allocation

Cash Overweight

Bonds Neutral

Fixed Coupon Overweight

Floating Rate Underweight

Sovereigns Neutral

Corporates Overweight

High Yields Neutral

Equities Underweight

Discretionary Underweight

Consumer Staples Overweight

Energy Neutral

Financials Underweight

Health Care Overweight

Industrials Underweight

IT Neutral

Materials Overweight

Telecoms Neutral

Utilities Overweight

Alternative Investment Neutral

Commodities Neutral

Industrials Metals Neutral

Precious Metals Neutral

Energy Neutral / Underweight

Agricultures Neutral / Overweight

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Volatility Structure S&P500

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