When the tide is out
Low tide is followed by high tide. Investors should not rely onthis maritime law of nature for their interest-rate expectations, says Philipp Vorndran, Capital Market Strategist at Flossbach von Storch AG.
When the tide is out – you may wonder why we gave an analysis of the financial markets this particular title. From the windows of our office in Cologne, we can look directly at the Rhine River – an impressive view! During our last summer we had to watch the mighty Rhine River become increasingly narrower and narrower. Back then we started to think about the ebb and flow of the tide, so we looked at the tide chart. Low tide is followed by high tide, high tide by the next low tide and so on ... a law of nature, we all know it. We call it continuity.
I would like to give you another example – the Aral Sea. At school in the 1970s, I learned that it was the fourth largest lake in the world; it once stretched over 60,000 square kilometres across the Soviet Union. This is an area a hundred times the size of Lake Constance. And what is it like today? Today it is just 8,000 square kilometres! After low tide there is no more high tide. The majority of the lake is irrevocably lost and is threatening the existence of the people who have lived off it for decades and trusted for a long time that it would always be like it was before. They are longing for continuity.
Perhaps you are wondering what all of this has to do with the financial markets? It has a lot, in fact. Many investors – and many people in general – rely on continuity. There are no structural breaks in their world. And that can be dangerous.
Let’s take a look at the long-term yield on 10-year Japanese government bonds. First the yield went up and down, then up again and then down. In Japan, like the Aral Sea, there has been such a structural break. Not a natural catastrophe, but an economic one to which people generally pay much less attention.
In Japan, the most important parameters have shifted massively in recent decades: the economy is barely growing, society is ageing and debt is rising. The Bank of Japan had to step in to prop up the economy and keep the debt affordable in the long term. The result has been a massive fall in bond yields. Japan is a very good example of the fact that we do not live in a continuous world, but a discontinuous one.
And Japan isn’t as far away as some might think. Let’s put the 10-year German government bond (Bund) chart over the one showing Japanese yields. You can see that the trend is identical. At the end of January, German Bunds were yielding less than 0.2 per cent, only slightly higher than in Japan, where the Bank of Japan cemented the interest rate at zero per cent. A perpetual low tide! And it is all man-made.
It’s finally starting to dawn on the Germans: low tide is not always followed by high tide. One in three now considers inflation to be the greatest risk for their private investments because their savings simply don’t pay off enough to compensate for inflation. This is shown in a survey of 10,000 Germans conducted by the Flossbach von Storch Research Institute. Accordingly, only 36 per cent of Germans have changed their saving behaviour because of the low interest rates. This group of people are counting on real values, stocks, real estate, and gold.
Most Germans, on the other hand, are staying loyal to nominal interest-based investments, just as they learned it from their parents. They are finding themselves in – supposedly – good company. Federal Minister of Finance, Olaf Scholz, coyly mentioned in the “Bild” newspaper that his assets are kept in his savings account, where they are losing value in real terms, i.e. after the deduction of inflation. SPD party leader Angela Nahles described the legal pension in the “Spiegel” magazine as “the superior system” that generates a two to three per cent return. “You can’t do that on the capital markets”. We cannot comprehend how a politician is able to come up with yield data in a pay-as-you-go pension system. She is also wrong about the capital markets. For example, anyone who would have invested in the MSCI World Equity Index one day before the bankruptcy of the US investment bank Lehman Brothers, would have achieved an annual return of more than eight per cent p.a.
Nevertheless, many politicians from all parties are stirring up fears for the preservation of capital and are giving general warnings about stocks. The fear of volatility is probably the root cause of most of the mistakes that Germans make when investing money. More than half see volatility as the greatest risk when investing money (see figure 3 on the following page). How should they know any better? Investing (privately) is not a subject taught at school, during traineeships or in most courses of study. It’s no wonder, then, that eight out of 10 Germans associate the word “equity” primarily with “risk” and speculation.
This is not without consequences. During my years as Chief Strategist at Credit Suisse Asset Management, I was responsible for assisting clients in more than 75 countries with their investments. As sad as it is, I think the worst investors come from Germany and Japan. By that I mean not only private investors, but also professionals and institutional investors.
Let’s take Japan again as an example. Since 2010, the price-toearnings ratio in the Topix Index has been between 10 and 15 per cent. Nevertheless, the Japanese like to invest in bonds. If they are looking for a little more yield they should look abroad. If not, they should look at home. The gap between the yield on 10-year Japanese government bonds and the expected profit yield of the companies listed in the Topix is almost nine per cent p.a. Who wouldn’t want to reserve this difference for themselves?
Probably anyone who makes their investment decisions with a cool head and logic. The same question has come up in Germany. Here, the difference between 10-year German Bunds and the profit yield of DAX companies is also just under nine per cent. Nevertheless, the majority of German shares are in the hands of foreign investors and more than two trillion euros are in low-interest savings accounts.
The Germans are still longing for a continuous world. Low tide is followed by high tide. Interest rates will rise again at some point – they have to, don’t they? As the study shows, not even every fourth private investor would invest in shares as a savings plan for their own child (with a term of 18 years!).
The proportion is even lower amongst professionals. According to an OECD study from 2018, not even 10 per cent of German pension fund money was invested in shares in 2017. Don’t take any risks! This maxim can lead to old-age poverty in times without any interest rates. A long-term return of slightly more than two per cent for pension funds means a real return of zero per cent after inflation. In the USA, where equities have a better reputation, the average return for pension funds was 7.5 per cent in 2017 according to the OECD. According to the Allianz Global Wealth Report, the financial assets of an average American are three times higher than those of a German. Low tide is followed by high tide – but perhaps it is quite different than expected. If you don’t invest logically and consistently, then at least invest with a clear conscience. This is probably how the new ESG requirements for asset managers could be summarised. From our point of view, the “G” for Governance is what matters most. Only those who operate soundly and successfully can ultimately finance social and ecological progress. Or as our Co-Founder Bert Flossbach writes: “This issue is far too important to be left to politicians, associations and rating agencies alone”.