Edmond de Rothschild

You’ll never walk alone


At the beginning of a financial bubble, there is always some great story that a growing number of investors buy into. This brings asset prices to ever higher levels. Credibility grows and then all the ingredients come together. All bubbles end up bursting and drive many over-leveraged investors to ruin.

To the killjoys who warn of the dangers of investing in a company valued at 300x earnings3, an ever-growing number of actors respond, “it’s different this time”. These words have particular resonance for market operators, because they have heard them many times in the past. They are a warning that a financial bubble is forming. That’s the observation that we now have to make about many companies active in the two themes we referenced.

However, while there is likely a bubble within digitalisation and decarbonisation pure players, the fact remains that these issues will be central to the investments of all companies for many years to come. The following chart illustrates investors’ unbridled enthusiasm for green energy companies. These spectacular price spikes are mostly cause for caution and prompt us to steer clear of these specialised companies in the coming year.

Debt matters. Sacrificing principles in the name of an emergency is a choice, but this decision comes at a cost and the cost of debt is never free or without consequences. Debt is the compounding factor in the bursting of a bubble when a sudden drop in prices materializes.

2020 was a very unusual year which saw the global economy collapse. Amid the turmoil, a sharp division arose between COVID winners and losers. Thus, companies active in the digitalisation of the economy and the green economy performed remarkably well while the more traditional consumer, tourism and oil sectors collapsed.

At the same time, investors could see that sovereign bonds were helpless to protect diversified portfolios. Gold proved to be the right choice of instrument to absorb the market shocks.

Growth projections of GDP – Milder slow-down & fast recovery after Covid

2021 will be the year in which the economy rebounds. The arrival of the COVID vaccines is a key step in returning to a more normal economy in which people and goods move more freely than in 2020.

Supported by very large-scale fiscal stimulus plans (between 5% and 10% of GDP) and with interest rates held at near-zero levels (on all maturities of all bonds of all developed countries), the economy is expected to rebound very strongly. The stimulus plans will focus on digitalisation and energy efficiency.

Risky assets, and equities in particular, are expected to be the big winners in the gradual shift back to normalcy… provided they are carefully selected. In 2020, the markets acknowledged the credibility of these themes by pushing the market valuations of green energy and digitalisation pure players to very high levels.

For 2021, we believe that the most robust investment opportunities will be found among companies that have the most to do in this area (construction, industrial and 5G sectors, among others).

The excessive valuations of some of the companies in these sectors are both the main theme of economic growth in the coming years and one of the main risks to the financial markets. No one knows when a bubble will burst and excessive valuations could become more unreasonable for some time yet before slowly or suddenly losing steam. In 2000, the technology bubble popped suddenly, dragging the entire market along with it. It was, however, during this period of collapse that investors rediscovered the virtues of reasonable valuations in the least glamourous sectors of the time: banks. The latter subsequently delivered record stock market performances.

The monetary and fiscal stimuluses are large in scale and occurring simultaneously in all developed countries. It is therefore more than likely that the excesses of these last few months will continue in 2021. We nevertheless believe this is the right time to incorporate certain high-quality companies, which may indeed be more cyclical and thus less trendy but which will benefit from implementation of the stimulus plans. 2020 was the year when stark divergences emerged between the stock-market performances of the digitalisation and green economy leaders and the rest of the market. We believe that, in 2021, equity valuations will reconverge between virus winners and losers in favour of the latter.

In addition, the Chinese economy is emerging from this crisis even stronger as it is the first to return to the same level of activity as in 2019. Major technology and telemedicine groups have expanded significantly and the country’s interest rates remain positive. The weight of Chinese and Asian securities in portfolios is likely to increase dramatically in the coming years. As such, the stability and openness of the Hong Kong financial market to the world is a key issue, not just for China but also for investors worldwide.

On the bond side, while hopes of gains melted like snow in the sun as interest rates converged towards 0%, we believe the environment remains robust for corporate credit and emerging bonds. This region benefits from its still-positive rates and is expected to benefit from budgetary spending by developed countries. With their orders, the latter are expected to send larger amounts of dollars into international channels. This will ease the risk premiums weighing on certain countries and thus push bond prices higher.

Lastly, the inflationary risks to prices in many sectors of the economy, coupled with continued 0% rates, mean that gold is a vehicle particularly well suited to the environment.

For the economy, in 2021, a strategy based on the intensity of public spending is the one that will be applied. We believe it will prove effective. However, higher debt, excessive stock-market valuations and the potential inflation generated by the stimulus plans are some of the potential medium-term risks we have identified.

Extract from the investment letter by Sébastien Cavernes – Chief Investment Officer – Edmond de Rothschild Monaco

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Post Author: Wealth Monaco