GRIMALDI & PARTNERS AG: Financial markets after the summer break – what next?

By Silvano Grimaldi, CEO of the independent asset management GRIMALDI & PARTNERS AG

Zurich – After the low in September, investors are wondering whether it might not be time to reduce their equity investments. Will the stock markets recover sustainably or are we at the end of a bear market rally? Silvano Grimaldi, CEO of the independent asset management Grimaldi & Partners AG, gives you answers to these questions.

Review of the first 9 months of 2023
After the beginning of the year, the prices of shares traded on the stock exchanges in the USA, the Eurozone and on the Swiss stock exchange initially rose gradually. However, price corrections due to problems at some regional banks in the USA resulted in the stock indices in the economic regions mentioned above moving predominantly sideways since the end of April, with alternating downward and upward swings. The stock indices are currently still above the values reached at the beginning of the year.

Experience has shown that the summer months of August and September are rarely pleasant stock market months for equity investors. This year, persistently high inflation rates - which gave rise to fears of further interest rate increases - as well as increasingly emerging phases of economic weakness in countries in the euro zone and also in Switzerland prevented a sustained recovery in the stock markets. In the USA, in addition to good macroeconomic data, stocks from companies in the technology sector that were able to benefit from the hype surrounding artificial intelligence (AI) have so far stimulated the stock market as a whole - despite the already high valuations in some cases.

How will it go on?
With regard to the monetary policy measures expected from the central banks Fed, ECB and SNB in the next few months, there is now a certain degree of certainty.

The ECB has raised the main refinancing rate by a further 25 basis points. It is now 4.5% and the interest rate on bank deposits with the ECB has risen from 3.75% to 4.5%. In the euro area, inflation rates are tending to fall and GDP growth rates are declining. The ECB's next interest rate move is not expected until December - if at all. However, in view of the very different inflation rates and GDP growth rates in the individual member states, the conflict of objectives between the central bank's hoped-for effects of a persistently restrictive monetary policy and the inevitable resulting economic downturn remains a problem.

The euro, which is currently weak against the US dollar and the current high prices on the crude oil markets, could once again lead to inflationary impulses and force the ECB - despite the associated economic risks - to further raise key interest rates. Demand for crude oil will only increase slightly in the next few months due to expected weaker growth in the global economy. However, Saudi Arabia and the Russian Federation have noticeably reduced their oil supply. However, the USA and Iran have recently significantly increased their oil production. It is therefore difficult to reliably estimate whether and to what extent the oil price will lead to noticeable inflationary impulses in the euro zone in the coming months. Apart from the uncertain situation on the oil market, there are clear signs that price pressure at the upstream levels (import, wholesale and producer prices) has already noticeably eased and that these developments will soon be noticeable in consumer prices.

The US Federal Reserve has currently refrained from raising interest rates and wants to keep the key interest rate in a range of 5.25% to 5.5% for the time being. However, it signaled that a further interest rate increase was still possible this year. The continuing decline in inflation rates (CPI, core inflation and PCE inflation) actually speaks against further tightening of monetary policy. In addition to inflation rates, data on overall economic development (particularly GDP, labor market and wage data) will continue to be key factors in the US Federal Reserve's decisions.

In Switzerland, the SNB has also decided to pause interest rate increases due to inflation rates (CPI, producer prices, etc.) that have now fallen to below 2%. However, the new inflationary impulses that are still to be expected (rents, electricity and hospital tariffs, VAT, etc.) could suggest a further tightening of monetary policy with interest rate increases. The SNB could also consider further foreign currency sales (a stronger CHF lowers the prices of imported goods), which - despite the productivity advantages that exist in some cases - are likely to affect the price competitiveness of companies producing in Switzerland.

The situation from an investor's perspective
For the foreseeable future, interest rates in the USA, the Eurozone and Switzerland will almost certainly remain at a high level. The interest rate cuts that many have hoped for will therefore take a while longer to arrive. The interest rate increases that have already occurred have led to recent investments in bonds not only by institutional investors but also increasingly by private investors, even though the bond yields are usually lower than the returns possible with stocks (price gains and dividend distributions). Still existing fears about further interest rate hikes by the central banks; These could cause bond prices to fall further and yields to rise.

The nominal yields on US government bonds, for example, have gradually increased since the beginning of the year. Even real returns will soon be positive due to declining inflation expectations. However, the costs of hedging the exchange rate risk actually make the interest rate advantage of these bonds quite uninteresting for domestic investors. This assessment also applies to government bonds from countries in the euro zone. However, corporate bonds usually offer significantly higher returns; However, the costs of hedging exchange rate risks remain and the associated default risks are sometimes underestimated. Investors should therefore prefer bonds from Swiss companies, as the yields on long-term Swiss government bonds are still negative in real terms despite the significant drop in inflation rates.

Many investors currently prefer to put their liquid assets in cash and in the short-term money market. However, quite a few companies in the USA, in the Eurozone and especially in Switzerland currently offer investors good opportunities for stock investments . Experience has shown that stocks should always be bought when most investors show little interest in investing in stocks. Good times are therefore phases with temporarily falling prices, as expected further interest rate increases or economic slowdowns are already priced into the prices.

Quite a few companies in Switzerland are well diversified and often have strong positions in their sales markets. The global economy – even if GDP growth rates will only change insignificantly in 2024 – determines the development of these companies more than the situation in the domestic economy. The profit forecasts for many of these companies continue to be exceptionally good for the coming months, not least due to the strong margins (purchase prices have fallen many times more than sales prices). High dividend payouts can therefore be expected. There are still a large number of companies in Switzerland whose shares can provide high dividend yields thanks to their cash flows. The shares of such companies should therefore be preferred by investors.

Conclusion: Mix of stocks and bonds depending on the investment strategy
The relative attractiveness of stocks in quality companies with good profitability and high cash flow remains unaffected despite slightly higher interest rates. Stock investors can continue to invest in stocks from strong companies with good dividend payouts. Conservative investors, on the other hand, can currently invest in corporate bonds thanks to slightly higher interest rates. In particular, quality Swiss franc corporate bonds are currently particularly attractive with yields to maturity of around 3% pa.