Reichmuth & Co Private Bankers Client Newsletter Check-Up Integral Investment Management | May 2020

Editorial STATE IMPOSED A virus proves to be the exogenous From a health to economic to ? shock that triggers a recession. The limits of (over-)optimised supply chains became obvious very quickly. “Does the flap of a butterfly’s wing in Brazil set off However, what this crisis means for a tornado in Texas?”, asked meteorologist Edward N. our debt-based fiat currency will only become apparent in the longer Lorenz in 1972, referring to the unpredictability of term. Once again, enormous amounts long-term effects. The question remains unanswered, of money are being printed out of thin air to try to lessen the shock. but today we know that an invisible virus can trigger Will this lead to doubts and dimin- a global economic crisis. ishing trust in money's intrinsic value? In the short term, hardly, but the likelihood has increased further. The coronavirus did not arrive completely When will the nightmare be over? unannounced. We had all heard of it as The downside of trying to win more time Many things that were unthinkable early as January, and many scoffed at is that it also prolongs the uncertainty. previously have now happened. No China’s totalitarian methods in fighting Everyone is hoping that treatment drugs one can predict the future, and any the virus. We completely underestimated and a vaccine for the virus will be devel- assessment of the situation will the speed with which this virus would oped quickly. In the absence of a vaccine, always be a snapshot. This makes it affect the world – and even more so the herd immunity is needed, which would all the more important to engage measures taken by governments as part require a 60–70 % degree of infection. with one another and fine-tune your of their emergency legislation. “Lock- Confirmed cases are about 0.3 % of the strategy in accordance with your down” – a shocking freeze put on social population, and even including the esti- personal starting position. and economic life as we knew it! The mated number of unreported cases at 3 % reason given: capacity shortfalls in the we are still light years away from gaining healthcare sector. No government can protective herd immunity! Furthermore, accept a mortality rate of 1 % as some we will most likely have to wait at least sort of predestined act of God. Although a year for a lifesaving vaccine to appear. no specific therapy against Covid-19 has yet been discovered, the goal is to gain And what if things could be sped up? time and build up ventilator capacity. Then we would all be happy, harbour

Jürg Staub, Otherwise, there is a looming threat of some regrets about missed opportunities General Partner too many deaths in too short a time. to enter the market, and rub our eyes in

Continued on the next page 2 | Check-Up May 2020

disbelief at how panic-stricken govern- payment of wages with newly printed and the EUR, because nation states ments reacted to the shock with aid pack- money. More money was the “reward” for rather than supranational organisations ages and money-printing sprees. All at production downtime. That seldom ends have always proven to be most capable once the most shell-shocked shares well – especially when high government of action. International solidarity has been would be popular again, and long-term debt and deficits coincide with political severely weakened by border fences and interest rates would rise due to the colos- instability. All the necessary ingredients delivery blockades. This crisis is also sal stimulus packages. would be on hand right now, but we have dangerous politically, because it can be yet to see that scenario unfold. misused for the widest range of individual Will the post-coronavirus world interests. Dirigistes and socialists view be completely different? or a triple crisis? this as their chance. This is probably why Hardly. The most likely change will be the A triple crisis is always connected to we are seeing our neighbouring countries acceleration of existing developments. If foreign debt and usually affects individ- displaying strong interest in Switzerland anything, the crisis has reinforced the ual countries. Italy, imprisoned in a EUR as a prime depository location. defining characteristics that separate corset, has been one such candidate for countries and people. China’s reaction is some time and will remain so, but is not Can you profit from a crisis? totalitarian, the USA’s business-friendly, a victim yet. Stagflation is more likely, Hardly. It is more important to emerging France’s centralised, and Switzerland’s turning into a type of repetition of the as unscathed as possible and to be ready democratic using recommendations. 1970s due to accommodative central to take advantage of opportunities that Everyone finds arguments to bolster their bank policy. However, inflation will fall may arise. The greatest opportunity for own world view. We will have to accept due to the economic slump. After the is the chance to secure favour- restrictions for a long time yet, but we crisis, growth could deliver a positive able purchase prices. Of course, margins will learn to live with the virus. One thing surprise thanks to catch-up effects and a are under pressure, and we may have yet is clear: We can expect more state inter- lower base. Of the four types of financial to hit the bottom. But what is the alter­ vention and redistribution even after this crisis, stagflation seems most likely in native? ? Yes, the amount you may crisis has ended. the medium term, but we are not counting need for the next two to three years. on it quite yet. Bonds? Good quality ones with short to Is a financial crisis next in line? medium duration have very low returns. Financial crises arise from fundamen­- Is debt relief likely? Shares? Yes, they are a productive capital tal imbalances. In our book Déjà-vu An interesting concept would be a global stock. Prices can fluctuate tremendously, (www.reichmuthco.ch/publikationen), “Year of the Jubilee”, i.e. a Biblical year but this is clearly our preferred asset published in 2012, we analysed the of forgiveness. Many governments are class in the long term. Alternative invest- history of economic crises and identified highly indebted. One could imagine the ments? Yes, our focus here is primarily on four types of crisis: appeal: “Let’s agree on debt relief; after the “distressed cycle” (see p. 5). Gold? all, no one is at fault for this virus.” That, Absolutely, because there is certainly Depression or ? however, is wishful thinking. Much more less gold being conjured up than new In a depression, the main element is col- realistically, we view this as a welcome debt instruments or money. So what is lapsing prices as a result of weak demand. opportunity for highly indebted companies the best recipe? The right mix depends This is precisely what the enormous stim- to restructure. In the USA, the attitude on many factors such as your unique per- ulus packages from governments and toward debt is quite relaxed in general. sonal situation, world view and above all central banks are designed to prevent. When major financial problems arise, your financial goals. It is best to answer A sharp recession, yes; a depression, “Chapter 11” is an effective procedure for this question in a personal conversation. probably not. But could the gargantuan US companies. We therefore expect to be We are looking forward to it. aid packages achieve the opposite, lead- at the beginning of a major “distressed ing to hyperinflation? Governments want cycle”, which we intend to capitalise on to safeguard people’s salaries. This is for our clients with the help of specialists. reminiscent of 1923, when French troops occupied the Ruhr region with the aim of This crisis is dangerous… speeding up reparation payments by ...for all companies without a viable busi- means of raw material supplies. German ness model; these are often young com- workers put up a passive resistance, panies dependent on external financing. Christof Reichmuth, causing the government to guarantee the This crisis is also dangerous for Europe General Partner Check-Up May 2020 | 3

OUR SCENARIOS Silvan Betschart and Cajetan Bilgischer The recession is here. What kind of recovery will follow – V, U or L?

Inflation Summary Stagflation § After 3–6 months, the 10 % = 10 % exogenous shock forces global economy into recession with an open exit Bubble formation 40 % 5 % § Temporary “liquidity crisis” the lesser of two evils § Record expansion of V Economic activity monetary and fiscal policy The “system” is kept alive, U § no matter the cost

Global recession § The “treatment” of the crisis 25 % 85 % feeds long-term inflation risks

L

With many parts of the world in lockdown, it is inevitable that the global economy will enter a recession. The question is, how long will it last? At the moment, we are assuming that the global economy will come to a temporary standstill, which in a recessionary context would argue in favour of the “liquidity crisis” scenario with a V-shaped recovery. Nevertheless, there are two other possible outcomes to consider, namely a U-shaped or an L-shaped recovery. We are mentioning these possible additional sub-scenarios right now but assigning them a lower probability of occurrence.

V Liquidity crisis (~50 %): U Solvency crisis (~20 %): L Depression (~15 %): Rapid recovery of economic activity Loan defaults delay recovery No economic recovery The imposed economic standstill leads to The virus-induced curbing of economic Economic pressure pushing for the early a shortage of liquidity, not just for many activity increases the insecurity of busi- lifting of restrictions on businesses and companies but also for financial market ness owners, who feel threatened in their private individuals paves the way for participants. The former find themselves existence despite promised government another wave of the pandemic, which in a fight for survival and hope for govern- support. This uncertainty is exacerbated then actually happens. The result is an ment support. The latter, suffering from by tensions on the oil market, where extended economic downturn. Even the the exogenous shock, trigger a wave of supply and demand have been thrown off repeated bailouts can no longer keep the selling on the markets and count on the balance. The massively indebted shale economic and social fabric together, as support of the central banks – practically oil industry in the USA can no longer the effectiveness of each additional unit as an “established right”. The liquidity produce at a profit. A veritable wave of of “support” decreases and does not squeeze can be resolved since monetary bankruptcies hits the energy sector, reach the real economy. All the major policy is now flanked by fiscal policy to an infecting other areas of the credit market central banks emerge as buyers on the unprecedented extent. The second-round as well. The default rate rises sharply stock markets, and a wave of nationali- effects of the pandemic remain contained, and puts the US economy in jeopardy, sation sweeps through the private sector. restrictions on businesses and individu- making a quick recovery impossible. No economic recovery takes hold, and a als are eased, and the way is clear for a Stress on the financial markets remains reset of the economic system in place up relatively rapid recovery and return to high and rescue measures must be mas- until now becomes imperative. long-term trend growth. sively expanded. 4 | Check-Up May 2020

RETURN TO NORMALCY Rapid recovery or underestimated second-round effects?

The coronavirus pandemic is the exogenous shock that has plunged the global econ- omy into an abrupt recession. Closed borders, a prescribed economic standstill and uncertainty as to how long the situation will last are all leading to a historically unprecedented sharp and rapid economic collapse. Even if the market is supported in the short term by large-scale rescue measures and the coronavirus is sooner or later brought under control, the second-round effects of these interventions are still Patrick Erne, impossible to gauge. However, the attractiveness of cashflow-producing investments Head of Research and gold has increased further.

Slow economic recovery in second half of year Service sector in drastic slump The economy has suffered a dramatic collapse over the past two Service-PMIs months. It is showing signs of being the most severe economic 70 slump since the Great Depression. Nevertheless, the measures 60 taken to contain the virus and keep the healthcare system going 50 appear to be having the necessary effect. The planning is now in USA place to begin loosening restrictions and returning to regular 40 Global apan business activities, but it will probably be some time before 30 Switerland things are back to normal. Even if there is pent-up demand in Euroone 20 Spain some areas, initially consumers will act cautiously, especially 10 Italy if they have lost their jobs during the crisis or had to accept sig- May Aug Nov Feb May Aug Nov Feb May Aug Nov Feb nificant wage cuts. Once the crisis is over, companies are also 2017 2018 2019 2020 unlikely to immediately start hiring people or making new invest- Source: Bloomberg (as of 15.04.2020) ments. In China, the economy has already been restarted after its standstill, and business activity is on the rise again, albeit still slowly normalise risk premiums, which have risen to crisis levels far removed from pre-crisis levels. However, what happens in all segments of the credit sector. In the area of corporate if production returns to normal but the weakened, Western bonds, this has enabled the yield outlook to become attractive consumer is not consuming? Could there be a new demand shock again despite lower interest rates – even for investment grade waiting in the wings? The second-round effects are difficult to bonds with low default risk. In the high-yield segment, as well predict. Nevertheless, we expect the recovery to begin as early as in emerging market bonds and the securitised credit market, as the third quarter, although it will take several quarters before the higher default risk is currently compensated with attractive pre-crisis growth is achieved once again. premiums. However, selection is all the more important here, which is why we recommend working with specialists in these Each region has its own challenges. In real economic terms, segments (see also box on p. 5). we consider emerging countries in Asia with a rapidly growing middle class to have the best prospects. In Europe, each country Underestimated risk of inflation? is following its own path in battling the crisis. Whereas Switzer- Monetary and fiscal policy is firing from all cylinders to soften land and Germany have plenty of fiscal policy leeway, other the economic consequences of the lockdown. How long this countries are dependent on external support. Finding a forward- all-encompassing support will continue after the pandemic has looking solution for this problem within a reasonable period of been overcome is a very different and sensitive political question. time remains an immense challenge and could endanger the If economic confidence returns and consumer and investment recovery in Europe. behaviour recovers, some of this liquidity could quickly return to the market and result in another strong surge in assets. Should Attractive risk premiums on the credit market this development lead to raw materials becoming more expen- The resulting liquidity crisis on the financial markets has sive as well, the price increases will also be felt in the real econ- prompted the US Federal Reserve to intervene in practically all omy. Very expensive government bonds in particular would be segments of the credit market, including, among others, non- unattractive in this environment, since there is no chance of real investment grade corporate bonds. This should stabilise and value retention with the current low interest rates – even with Check-Up May 2020 | 5

only gradually rising inflation. So, for those who have to hold future growth themselves, not to mention possess healthy bal- bonds, we recommend inflation-linked bonds over nominal ance sheets and distribute an attractive dividend to shareholders. bonds. The crisis has also narrowed the interest rate differential against the USD. Due to the potent mix of rapidly growing Avoid structural losers budget deficits and an exploding , we Depending on your risk appetite, we recommend adding quality have become more cautious about the USD and recommend stocks with a somewhat more cyclical business model to your reducing the allocation. In our opinion, gold is the sole remaining equity portfolio. Many of these stocks have been severely pun- “hard currency” that cannot be printed arbitrarily and thus ished during the market correction and are now trading at very remains an indispensable portfolio component, despite recent favourable valuations when earnings are viewed as normalised. price increases. Even though the business model is being directly affected by the coronavirus crisis, earnings should recover quickly once the pan- Cashflow is King demic is over, and they have high upside potential. Since it is The attractiveness of stocks in our main scenario remains high in difficult to predict when the recovery will begin, the main focus general since the cashflow or dividend yield is set in relation to is on the company’s balance sheet. It should not be overextended interest rates for share valuation. Of course, both indicators have to ensure that the company does not become dependent on lend- fallen since the outbreak of the pandemic. In the aftermath of the ers. Not every business will survive this crisis. Certain industries crisis, however, interest rates are likely to remain low for some were already facing a structural headwind before the pandemic time, while cashflows for many quality companies should recover struck. The crisis will further consolidate some of the existing quickly. This applies especially to companies with a business trends, e.g. in the area of digitalisation. The use of homeoffices, model that also performs in times of crisis and generates posi- video conferencing and online shopping will most likely continue tive cashflows. These are mainly found in the healthcare and to expand even after the crisis, and certain sub-sectors will face consumer staples sectors, but an increasing number of technol- significant challenges. Active selection and differentiation ogy and software companies now belong to this group as well. between cyclical and structural losers is essential – particularly Thanks to solid cashflows, these companies are able to finance in difficult times.

Investment idea

New distressed cycle? The policy of low interest rates in place since the last financial crisis has tempted many companies to borrow cheaply and buy back their own shares at all-time highs. With the abrupt onset of this recession, many companies are now experiencing severe payment difficulties as earnings fall, rating agencies lower their outlooks, and the suddenly risk-averse financial investors in the credit markets are now demanding high risk premiums. will be unavoidable for the majority. In the current crisis as well, the high risk premiums indicate a sharp rise in default rates (see chart).

Attractive risk premiums on the credit market Financial crisis 20.0 US banking crisis 15.0 .com / Enron Covid-19 crisis 10.0 Mean value 5.1 % 5.0 7.08 0.0 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

Mean value Credit spreads for US high-yield corporate bonds

Source: Bloomberg (as of 15.04.2020)

Anyone who has sufficient capital and applies a long-term and anti-cyclical approach can take advantage of this situation and buy in to companies at favourable prices. Distressed managers are acquiring corporate debt on the market at high discounts to nominal value, opening bankruptcy proceedings as a member of the credit committee, and restructuring the corporate debt. This often happens by writing off a portion of the debt and converting it into new equity. Existing shareholders forfeit their claim to the debt investors, who then participate in the recovery of the company as new owners. The USA in particular has an established process for this in the form of “Chapter 11”, which enables relatively fast debt restructuring. In phases with high risk premiums, “distressed strategies” offer above-average yield opportunities in the succeeding years. Together with selected managers, we have been successfully implementing this type of strategy for more than 20 years. 6 | Check-Up May 2020

ASSET ALLOCATION Cajetan Bilgischer High home bias – scepticism toward Europe and USA – positive for Asia

Our liquidity buffer has decreased as we took advan- Liquidity 0 % 10 % tage of opportunities during periods of market stress.

With their massive bond purchase programmes, the Fed and the ECB have effectively put a floor under the Bonds prices for investment-grade corporate bonds from their 20 % 60 % respective countries. We remain focused on quality bonds with a moderate default risk.

Shares When the drastic pandemic measures were initiated, 20 % 60 % the need for liquidity meant that everything was initially disposed of. Only towards the end of the quarter did the wheat separate from the chaff. Securities selection be- Switzerland = came essential. We consider our favourites, which defi- Europe – nitely include solid dividend stocks and global leaders, well equipped to withstand the current turbulence. We USA – remain committed to a high home bias and recognise long-term opportunities in China. Emerging economies =

In the current phase, the selection of sub-segments is also decisive for real estate. Operators of logistics prop- Real estate 0 % 15 % erties and data centres are of interest. Regionally, we clearly prefer Asia in addition to our home market.

With its massive distortions, the volatile financial market environment offers opportunities for active and flexible Alternative hedge fund managers. In addition to merger arbitrage investments 0 % 25 % strategies and long/short credit, we consider the dis- tressed area to be promising.

As the only real “hard currency”, gold is profiting from the current monetary and fiscal policy experiments being carried out. Although at the beginning of the correction Gold 0 % 10 % the precious metal suffered from widespread liquidity shortages and as a result was subject to a massive sell-off, the long-term upward trend remains intact.

Our strategy’s neutral position Current weighting

Our clients can request our detailed investment policy with thorough market estimates from their client relationship manager or register for it themselves by contacting [email protected]. Check-Up May 2020 | 7

OPPORTUNITIES WAITING TO BE SEIZED What you need to consider now

“Never let a good crisis go to waste” was § Improve quality: The market at large the same time quickly increasing or a saying of the former British prime min- usually corrects in a crisis. It is there- decreasing risks as needed. ister Winston Churchill. Here is a selec- fore necessary to sift through the in- tion of concrete ideas: dividual investments in your portfolio From an integral viewpoint according to criteria such as debt When looking beyond your investment Buy (additional) shares now? financing, strength, manage- portfolio, you need to consider: The longer the investment horizon and ment, etc. It can be worth your while the greater the fluctuation tolerance, the to switch from a poor-quality stock § Prefer pension benefit purchases more attractive the securities in these to a better-quality one – above all if If you are planning a tax-privileged three groups are looking to us: they have both previously undergone purchase of pension benefits in 2020, similar corrections. it may be worthwhile to implement it § Global leaders: Companies that § Diversification: Alternative invest- now and take advantage of the lower rank among the market leaders in their ments such as gold, agrarian country prices – following the recent correc- industries and whose business mod- hedge funds, infrastructure, etc., can tion – for the assets. The same applies els are comparatively less affected by help to stabilise your portfolio, espe- to the third pillar. the pandemic. These include compa- cially during volatile market phases. § Review your liquidity planning nies from defensive sectors such as The latest turbulence offers hedge After such turbulent times, it is advis- pharmaceuticals or consumer staples, fund managers tremendous opportu- able to analyse and, if necessary, and which stand out thanks to high, nities that can often only be tapped adjust your liquidity planning. Start by relatively secure yields in the current with special instruments and market taking into account current circum- low interest rate environment. access. In our opinion, gold also con- stances and evaluating whether new § Growth stocks: These are quality tinues to be attractive. scope could possibly be created to stocks from companies in structurally § Bonds: Whereas more than 80% of enable you to take advantage of expanding market segments. Due to the Swiss bond index components today’s opportunities with additional the high margins, these companies recently showed negative returns on investment capital. Our financial plan- are usually very profitable and as a maturity, the picture has changed ners would be more than happy to result have enjoyed high valuations in with the crisis, and there are now assist you with these adjustments. recent years. Now, after a long period, isolated opportunities. We also see some of these shares are once again this trend in new issues from good “People and money in harmony” available at reasonable prices. borrowers who are borrowing money has always been our motto. There is a § Bottom fishing:These are more at short notice due to the current wide range of levels to work from to cyclical and economically sensitive liquidity crisis. achieve the optimal orientation for you. stocks, which were hit especially § Become more agile: Investors We have only outlined a selection of hard by the virus-related economic whose risk capacity and risk appetite them here. We are always available to downturn. Measured against “nor- have so far led them to pursue a rath- discuss these and other possibilities with malised” earnings, these stocks are er defensive strategy may now have you and then tailor them to match your now at bargain prices and may rise the chance to take a more dynamic personal starting position. We look for- substantially in a recovery scenario. approach. Insofar as your individual ward to hearing from you! In the current environment, however, starting position allows, switching particular attention should be paid to a strategy with a higher equity to the soundness of balance sheets. weighting is worth considering. Our modular concepts, among other op- How am I invested at the moment? tions, are also well designed for this If your current stock quota already corre- purpose. They implement the individ- sponds to your target quota, we would ual asset classes with both internal recommend considering the following: and external funds, enabling you to Urs J. Beck utilise economies of scale while at Partner and Zurich branch manager 8 | Check-Up May 2020

“NOT THE FIRST CRISIS” Interview with Remy Reichmuth about the current situation

What has been happening during term – especially if you compare it to the are working from home. These organisa- the first few months of 2020? negative interest rate environment for tional adjustments were carried out January is always a busy month with lots nominal assets. Equities remain one of quickly and relatively smoothly – and of annual reports. It was a pleasure to the most attractive asset classes. Adding almost unnoticed by our clients, which prepare them since the 2019 investment alternative investments such as gold, really pleased me. year delivered very satisfactory results. infrastructure, hedge funds or even Then things took a different course in insurance-linked securities help to diver- What is it like to be personally February. Naturally, we were following sify your portfolio and make it more liable in such uncertain times? the development of the coronavirus in robust. This is one of the reasons why our Our structure as an owner-managed China, but the reports from Lombardy corporate strategy has suffered less in family business with unlimited liability were dramatic. The markets crashed comparison with others. encourages personal responsibility in almost immediately. Computer-based general and ensures that we do not try strategies and margin calls only intensi- How have clients reacted to the our hand at experimenting. The result of fied the correction, as did most likely market turbulence? this approach, which is of central impor- those passive investors who buy up the No one is happy to see negative share tance, is that we always have risks under entire index in such phases and no longer price development in their portfolio. control. That’s why as a bank we don’t differentiate between higher and lower However, based on the headlines, many operate a commercial lending business, quality stocks. clients expected the losses to be higher for example, which could have been a risk than the ones actually reported. The in the current environment. We focus on In the meantime, the Swiss stock majority remained calm; after all, it’s not those activities through which we can market has dropped 25 % from its the first crisis for many of them. Espe- offer added value. This also protects highest level. cially in turbulent phases, it’s crucial not against dispersal. We have also given our That is, after it succeeded in growing to lose sight of your strategy’s long-term bank a very solid foundation. As an exam- around 200 % since the end of 2008. The goal. There are also clients who were ple, we have far exceeded the capital collapse is manageable over the long waiting for the opportunity to buy in at adequacy requirements of the banking attractive prices. They can see entry supervisory authorities for years now. Coming opportunities now. Wissens-WERT up What is your advice for our readers? Pension fund information How have you adjusted your or- Our team is in close contact with clients (in German only) ganisation in light of the current and is assisting them in aligning their from Reichmuth & Co situation? personal asset goals with the current Business owners report on We had to convene our crisis committee, environment. Any readers who have not their experiences: Featuring which has two objectives. Firstly, to keep yet been in direct contact with us are Zur Rose Group AG, operations fully functional for clients more than welcome to call me! After the Mövenpick-Gruppe, and markets, and secondly, to protect recent upheavals, there are many oppor- Ärzte-Treuhand Finanz AG, everyone involved – clients, business tunities that provide added value. Marigin Tierklinik and partners, employees, etc. – to the great- Krucker Partner AG est degree possible. So, we activated and refined our pandemic plan with Interested? different steps. We are implementing Order it right now exclusively the measures provided by the federal from your client relationship government and have reorganised our manager or at office set-up in the teams to allow for [email protected] physical distancing for individual Remy Reichmuth, employees. More than half of our staff General Partner

Rütligasse 1, CH-6000 Lucerne 7 Schmiedgasse 28, CH-9004 St. Gallen Telephone +41 41 249 49 49 Telephone +41 71 226 53 53 Tödistrasse 63, CH-8002 Zurich [email protected] Telephone +41 44 299 49 49 www.reichmuthco.ch