INVESTMENT STRATEGY PRIVATE BANKING

490 views

Published on

0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
490
On SlideShare
0
From Embeds
0
Number of Embeds
2
Actions
Shares
0
Downloads
7
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

INVESTMENT STRATEGY PRIVATE BANKING

  1. 1. www.lombardodier.com Edition 2/3 Investment conclusions INVESTMENT STRATEGY The crisis which began in 2007 is still far from PRIVATE BANKING complete and we have positioned our portfolios comparatively defensively in recent weeks to reflect this observation. Within the context of a positive strategic but more cautious tactical view of risk taking, we anticipate adding exposure to risky assets in coming months as the risk return trade-off becomes more attractive against the backdrop of a clearer sense of reality 3rd quarter 2009 amongst market participants. • The US equity market has recovered to almost 11* trailing peak reported earnings and approximately 15* trend earnings, both at the very long-run median level and indicative of a market which must be considered fair value at best. In aggregate, we are strategically positive on global developed equity markets but tactically more cautious. • Massive liquidity injections have leaked into Emerging Market Equity (EME), through hugely expanded bank lending, into inflation in monetary assets in China in particular. At a near 10% premium to developed equity in aggregate, EME may be vulnerable at current elevated valuation and depressed risk premia levels. • There is little or no demand for credit and little or no appetite to lend amongst banks. As a consequence, banks are awash with liquidity, at almost zero cost, and are purchasing government bonds aggressively to take advantage of the almost free profit from the spread between the cost of cash and the yield on government bonds. We anticipate government bond yields remaining depressed for some considerable period of time. Quarterly publication of the Private Banking Investment Services of Lombard Odier Darier Hentsch IMPORTANT INFORMATION Please see important information at the end of this document. Data as of July 13, 2009
  2. 2. Investors, who express their risk taking views on the appearance of “green shoots”, are likely to be severely disappointed “The rest of the world needs The injection of large amounts of liquid- activity are not indicative of great fu- weakness, it is useful to ask one ques- ity, intended to stabilize the deposit ture returns. In effect what determines tion. If recovery comes, where will it the US economy and financial base of the banking system, alongside future asset returns is the current level come from? the provision of ample additional capi- of valuation, not a hypothetical growth system to recover in order for The straightforward answer is: not tal by governments seeking to at least rate. Similarly, it is simply not the case it to revive. We remain at the preserve some sense of solvency, has that faster-growing economies produce consumption. Although representing been both necessary and sufficient to the largest portion of GDP in the better returns than slower-growing centre of the global economic remove the threat perceived in the mar- United States, the United Kingdom economies (if anything, the opposite is and developed economies, its contri- activity with financial and ket earlier in the year of total economic more consistent with observed empiri- and financial systemic failure. As the bution to the volatility or cyclicality cal facts). trade ties to every region of system was assured of resuscitation, of economic growth is comparatively if not revival, the “Armageddon” risk modest. Economic cycles, recessions, the globe.” recoveries, booms and busts are not premia reflected in the pricing of risky Periods of strong economic assets was removed and with it the po- triggered or propagated by consumers activity are not indicative but by the extreme cyclicality in the US Treasury Secretary tential for a depression-like collapse in Timothy Geithner, speech to economic activity. Accordingly, subse- of great future returns. far smaller component of GDP that is the Economic Club, Washington, quent economic data have been unde- investment (in inventories and capital 22nd April 2009 niably weak but clearly an improvement goods by businesses and homes by the In short, investors who express their household sector). Given that these relative to previously dire expectations. risk-taking views on the basis of arbi- components of GDP are most likely to This spate of positive economic sur- trary forecasts for economic growth, be financed with leverage, you can see prises (things could have been so much or the appearance of “green shoots”, that any view that the United States worse) was enough for asset prices to are likely to be severely disappointed! and global economies can recover even correct from oversold levels. To this ex- Economies expand and contract, com- to sustain long-run trend-like growth tent, Geithner is correct in suggesting that pulling the US economy back from panies expand and contract their sales, is entirely dependent on the health of the brink and normalizing conditions is but it is simply incorrect to believe that banks and the ability to intermediate necessary for an improvement in global this process is the driver of investment credit. Looking at the US data, in agree- economic activity. returns (in fact, ranking S&P500 com- ment with Tim Geithner, the chart II panies by 5-year trailing sales growth in (page 3) shows the annual change in However, whilst market participants the post-war period produces the coun- the private sector financial balance are actively seeking evidence of fabled terintuitive result that the slowest- (think of this as the budget deficit for “green shoots”, it is well worth bear- growing companies delivered the best the private sector) against the annual ing in mind that from one quarter to returns to investors). In truth, the eco- growth in gross investment. Since the the next or from one year to the next nomic growth forecasts of economists change in the private sector deficit there is no correlation between eco- are of no use to investors. represents the leverage cycle as it in- nomic growth and either earnings per creases and decreases net savings, we share growth or equity market total On the basis, however, that developed can only see a meaningful recovery returns. That is to say, if you knew ex- country banking systems (which we in investment spending, to drive the actly where and when the green shoots believe to be largely insolvent still economy overall, if we believe that the of economic recovery would appear, it and with insufficient capital at risk savings rate in the private sector is go- would be useless to you as an investor! to withstand further inevitable asset ing to fall sharply and / or households The chart I (page 3) illustrates our point writedowns) are vulnerable to the and businesses become net borrowers perfectly: periods of strong economic consequences of persistent economic again. Please see important information at the end of this document. 2 Lombard Odier · Investment Strategy – Private Banking · 3rd quarter 2009
  3. 3. Our analysis on chart III, based upon the any risk is the common equity com- I. Annualized change in equity index level vs annualized nominal GDP fact that two-thirds of Adjustable Rate ponent. Analysts who argue that the growth by decade Mortgage (ARM) resets remain ahead banks are well capitalized appear not 20 of us, with two or three predictable to have recognized this consequence waves looming, and that existing weak- of government action or are perfectly 15 Dow ness in activity and rising unemploy- happy to count the tax base as part ment will worsen the outlook for debt of the capital structure of the banking Nom GDP 10 delinquency rates, suggests that US system. As a bank bond debt buyer, banks alone still have almost two- what disincentive do you face when 5 thirds of all likely losses to come (total- supplying capital for bad lending prac- ing in excess of an additional USD 2.0 tices and excess when you know you trillion based on our estimates). To- 0 will be made good by the taxpayer? gether with the low prevailing level of Consolidated accounting, much lower capacity utilization and massive wealth leverage ratios, the potential exposure -5 destruction, this continuing pressure of bond holders to losses and capital on banks and the likelihood that credit -10 requirements proportional to total as- remains scarce for quite some time 1900s 1910s 1920s 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s set levels are preferable to more layers as the economy deleverages renders Source: Crestmont Research, Lombard Odier calculation of politically motivated and ultimately the possibility of a return to deficits unenforceable bureaucracy. Moreover, and / or a reduction in savings rates in central banks must include monetary the private sector implausible. II. Year / year change in private sector balance as a percent of GDP inflation in their target objective and not just focus on real economy infla- vs US gross investment Whilst we have long argued that liquid- tion as they currently do: the mainte- 20 -4 ity and solvency measures were entire- ly appropriate, our confidence that the nance of unsustainably low levels of 15 US banking system can be resuscitated interest rates in response to a positive Change in private -2 real economy supply shock (China sup- balance (% points, and not simply revived has been dent- 10 r.h.s. inverted) ed by increasingly politically motivated plying masses of cheap goods to the 0 5 policy actions. world and depressing prices) fuelled as- 0 2 The US banking system has been resuscitated -5 4 but revival requires more decisive policy actions. -10 Investment (% y / y, l.h.s.) 6 -15 Recent reform proposals by Treasury set inflation in the monetary economy -20 8 Secretary Geithner and Lawrence Sum- and contributed to poor and excessive Q1 1985 Q3 1989 Q1 1994 Q3 1998 Q1 2003 Q3 2007 Q1 2012 mers assume that more regulation is lending. Positive supply shocks are a Sources: Datastream, Lombard Odier calculation superior to better and rigorously imple- feature of capitalism, they have hap- mented regulation: we favor a return pened before and will happen again, to the days when banks were forced to and if the consequences are not to take “haircuts” on assets and hold capi- be the same next time then central III. United States, next reset peaks driven by option ARMs tal accordingly rather than rely on the bankers need to drop the excuses and statistical “witchcraft” that passes for start to monitor asset price inflation. It 70 2,200 Amount in USD bn Estimated cumulative reset amount in USD bn modern banking supervision, changes should not be beyond them to measure 2,000 60 Agency (l.h.s.) Option ARM* (l.h.s.) to securities laws that allow bank bond premia and identify bubbles. Prime (l.h.s.) Unsecuritized ARMs (estimated) (l.h.s.) 1,800 holders to realize losses in accordance Alt-A (l.h.s.) Estimated cumulative amount 50 1,600 with their place in the capital structure Our analysis suggests that whilst we Subprime (l.h.s.) (USD bn, r.h.s.) 1,400 without triggering default clauses on have successfully avoided a systemic 40 all debt in the capital hierarchy, an em- collapse, measures to sustainably re- 1,200 phasis on debt / equity swaps to halt structure the banking system are still 30 1,000 the tidal wave of mortgage delinquen- not evident nor is the financial system 800 cies that is likely to stem from two to “out of the woods” yet given the waves 20 600 three years of continuous ARM resets. of losses that loom and far exceed the 400 Moreover, we simply cannot accept capital at risk in the system. 10 200 that a leverage ratio of 30-35 times is Months to first reset acceptable in an environment where Turning to markets, if the financial 0 0 the only capital that appears to face system still faces headwinds and eco- 11.2008 09.2009 07.2010 05.2011 03.2012 01.2013 11.2013 09.2014 * Option ARMs show estimated recast schedule based on current negam rate. Sources: Credit Suisse (US Mortgage Strategy), LoanPerformance, FH / FN / GN Please see important information at the end of this document. Lombard Odier · Investment Strategy – Private Banking · 3rd quarter 2009 3
  4. 4. IV. Minimum annualized 10 year S&P500 holding period return ranked nomic growth is not the driver of equity trades at a near 10% premium to devel- by implied 10 year risk premium deciles market returns, what is? As if investors oped equity in aggregate, that markets 6% (as opposed to speculators, traders and may be vulnerable at current elevated 1st decile = smallest / worst risk premium, 10th decile = largest / best risk premium: 1874 – 2009 3% trend chasers) needed a reminder, from valuation and depressed risk premia 4% a decade of rampant global growth levels. The chart VI shows the Chinese 2% that delivered desperately poor equity market’s implied risk premium at wafer- market returns, the only two variables thin levels: investors have forgotten 0% that we consider important are valu- that growth does not drive returns -2% -1% ation and the implied risk premium. and seem happy again to take risk -2% -4% -3% The former because it gives us an indi- with little or no compensation (the -4% cation of the bias in the direction of re- same applies to the market in India). -5% -6% turns and the latter because it gives us With China at the heart of all things -6% -8% -7% an indication of the potential for losses emerging, we would be very cautious -8% if things go wrong: the chart IV shows at these levels, especially when domes- -10% -10% the US implied equity risk premium tic demand simply cannot grow quickly -12% ranked by decile over the last century enough to offset the lack of demand 1st 2nd 3rd 4th 5th 6th 7th 8th 9th 10th (Worst) (Best) and the worst case annualized 10-year for exports that is evident in the shrink- Sources: Datastream, Lombard Odier calculation return associated with each decile. age of the US deficit as US savings rise. As expected, higher risk premia give Emerging market investors, many of meaningfully lower downside! Given whom came to the asset class in recent V. World equity index ex United States projected 10 year holding period that the gains necessary to recover years, need to learn that recent growth return with trend 6% EPS growth losses are exponential (a 50% loss re- rates were fuelled by US leverage as the 30% quires a 100% gain to break even and a chart VII (page 5) shows. Given dividend yield and specified terminal P / peak E ratio 25% Actual Trailing maximum (= 32.9*) Central banks must include monetary inflation 20% in their target objective and not just focus 15% on real economy inflation as they currently do. 10% 5% 70% loss requires a 300% gain to break Turning to bond markets, fiscal stimu- even), avoiding large losses is more lus measures to boost growth and the 0% important that chasing large gains. insertion of taxpayers into the capital -5% Trailing median P / peak E The US equity market has recovered structure of banks to take losses for Trailing minimum (= 7.1*) to almost 11* trailing peak reported which they are not responsible have -10% earnings and approximately 15* trend resulted in significantly larger budget 01.1975 01.1980 01.1985 01.1990 01.1995 01.2000 01.2005 01.2010 01.2015 earnings, both at the very long-run deficits in many countries. As the pro- Sources: Datastream, Lombard Odier calculation median level and indicative of a market vider of the reserve currency, concern which must be considered fair value at seems particularly focussed upon the best. The global market ex the United United States. It seems a common VI. MSCI China equity index projected 10 year holding period annualized States has recovered to 9* trailing peak view that larger budget deficits will return earnings from 7* at the March 2009 drive government bond yields higher: 30% low, as the chart V shows, consistent however, a quick look at the data in Assuming normalized 2% per annum EPS growth and reversion 25% to given terminal price / trailing peak earnings level with an attractive risk / return profile the chart VIII (page 5) of the change in over the course of the next cycle (al- the budget balance versus changes in 20% though with near-term vulnerabilities bond yields shows that over the last 60 15% Trailing maximum years, spanning inflation, disinflation, (19 * peak earnings) along the lines outlined earlier). In ag- 10% gregate, we are strategically positive the Vietnam War and Cold War periods, 5% Trailing median on global developed equity markets there is no correlation between defi- (6.0 * peak earnings) cits and yields. It is simply not the case 0% but tactically more cautious. that large budget deficits will force -5% Trailing minimum Looking at Emerging Market Equity government yields higher. Again, like (2.5 * peak earnings) -10% (EME), massive liquidity injections the perceived link between economic which have leaked, through hugely growth and equity returns it is a com- -15% expanded bank lending, into inflation monly held view that is divorced from -20% in monetary assets in China in particu- empirical fact. One reason for the lack 01.1999 01.2001 01.2003 01.2005 01.2007 01.2009 01.2011 01.2013 01.2015 of relationship is the fact that deficits lar suggest to us, given that EME still Sources: Datastream, Lombard Odier calculation Please see important information at the end of this document. 4 Lombard Odier · Investment Strategy – Private Banking · 3rd quarter 2009
  5. 5. tend to be cyclical, they rise when activ- VII. Chinese real GDP growth vs US current account as a percent of ity weakens and inflation expectations US real GDP decline: the decline in inflation expecta- 14 -7.0 tions and real interest rates offsets any 13 -6.5 upward pressure on rates from a rise in the risk premium. We are often asked 12 US current account -6.0 (r.h.s. inverted) “who will buy all of these government -5.5 11 bonds?” The answer remains “the -5.0 banks”. In the United States (and the 10 -4.5 United Kingdom), budget deficits are 9 rising and current account deficits are -4.0 shrinking, implying that the private sec- 8 -3.5 tor is increasing its saving faster than 7 Chinese GDP -3.0 the government is reducing its saving. (% y / y, l.h.s.) 6 -2.5 At the same time, there is little or no demand for credit and little or no appe- 5 -2.0 tite to lend amongst banks. As a conse- 09.1999 09.2001 09.2003 09.2005 09.2007 03.2009 quence, banks are awash with liquidity, Sources: Datastream, Lombard Odier calculation at almost zero cost, and are purchasing government bonds aggressively to take advantage of the almost free profit VIII. Annual change in US government bond yield (vert. axis) vs annnual from the spread between the cost change in US federal budget deficit (as a % of GDP, horiz. axis): 1953 – 2009 of cash and the yield on government 4 bonds. Lower-risk government bonds are replacing higher-risk private sector 3 loans on the balance sheet of banks. 2 The chart IX shows the increase in US bank holdings of Treasury debt in the 1 last year or more, with ample room for 0 further expansion there and elsewhere. We anticipate government bond yields -1 remaining depressed for some consid- erable period of time. -2 -3 In conclusion, we will continue to focus upon valuations of assets measured -4 on a normalized basis and risk premia -4 -3 -2 -1 0 1 2 3 4 to measure our shortfall risk, taking Sources: Datastream, Lombard Odier calculation risk when it is well rewarded (typi- cally when valuations are attractive and most investors are compelled to IX. US government securities / total assets (%): US domestic commercial want to sell). The crisis which began in banks 2007 is still far from complete and we 24% have positioned our portfolios com- paratively defensively in recent weeks 22% to reflect this observation. Within the 20% context of a positive strategic but more cautious tactical view of risk-taking, we 18% anticipate adding exposure to risky as- sets in the coming months as the risk 16% return trade-off becomes more attrac- 14% tive against the backdrop of a clearer sense of reality amongst market par- 12% ticipants. 10% Paul Marson, CIO 8% 01.1973 01.1979 01.1985 01.1991 01.1997 01.2003 01.2009 Sources: Datastream, Lombard Odier calculation Please see important information at the end of this document. Lombard Odier · Investment Strategy – Private Banking · 3rd quarter 2009 5
  6. 6. IMPORTANT INFORMATION This document reflects the opinion of Lombard Odier Darier Hentsch & Cie or an entity of the Group (hereinafter “Lombard Odier”) as of the date of issue. This document is not intended for distribution, publication, or use in any jurisdiction where such distribution, publication, or use would be unlawful, nor it is directed to any person or entity to which it would be unlawful to direct such a document. This document is furnished for information purposes only and does not constitute an offer or a recommendation to purchase or sell any security. The opinions herein do not take into account individual clients’ circumstances, objectives, or needs. Each client must make his own independent decisions regarding any securities or financial instruments mentioned herein. Before entering into any transaction, each client is urged to consider the suitability of the transaction to his particular circumstances and to independently review, with professional advisors as necessary, the specific risks incurred, in particular at the financial, regulatory, and tax levels. The information and analysis contained herein have been based on sources believed to be reliable. However, Lombard Odier does not guarantee their timeliness, accuracy, or completeness, nor does it accept any liability for any loss or damage resulting from their use. All information and opinions as well as the prices indicated are subject to change without notice. Past performance is no guarantee of current or future returns and the client may consequently get back less than he invested. Performance data of mutual funds do not take into account the commissions and fees charged on the issue and redemption of the units or shares. The investments mentioned herein may be subject to risks that are difficult to quantify and to integrate into the valuation of investments. Generally speaking, products with a high degree of risk, such as derivatives, structured products, or alternative / non-traditional investments (Hedge Funds, private equity, real estate funds, etc.) are suitable only for sophisticated investors who are capable of understanding and assuming the risks involved. Upon request, Lombard Odier is available to provide more information to clients on risks associated with specific investments. If opinions from financial analysts are contained herein, such analysts attest that all of the opinions expressed accurately reflect their personal views about any and all of the subject securities or issuers. In order to ensure their independence, financial analysts are expressly prohibited from owning any securities that belong to the research universe they cover. The description of the rating system used by Lombard Odier for its financial research is available on www.lombardodier.com. This document may not be reproduced (in whole or in part), transmitted, modified, or used for any public or commercial purpose without the prior written permission of Lombard Odier. © 2009 Lombard Odier Darier Hentsch & Cie – all rights reserved.
  7. 7. SWITZERLAND London Lombard Odier Darier Hentsch (UK) Limited Geneva Queensberry House · 3 Old Burlington Street · London W1S 3AB · England Lombard Odier Darier Hentsch & Cie Wealth Management Services company authorized and regulated by the Financial Services Private Bankers regulated by the FINMA. Authority (FSA). Rue de la Corraterie 11 · 1204 Genève · Suisse E-mail: london@lombardodier.com Fribourg Madrid Lombard Odier Darier Hentsch & Cie, Bureau de Fribourg Lombard Odier Darier Hentsch & Cie (España) S.V., S.A. Rue de la Banque 3 · 1700 Fribourg · Suisse Paseo de la Castellana 66 · 28046 Madrid · España Investment company supervised by the Comisión Nacional del Mercado de Valores (CNMV). Lausanne E-mail: spain@lombardodier.com Lombard Odier Darier Hentsch & Cie Place St-François 11 · 1003 Lausanne · Suisse Paris Lombard Odier Darier Hentsch & Cie (France) Lugano 8, rue Royale · 75008 Paris · France Lombard Odier Darier Hentsch & Cie, Agenzia di Lugano Investment company approved by the Comité des Etablissements de Crédit et des Entreprises Via Vegezzi 6B · 6900 Lugano · Svizzera d’Investissement (CECEI). E-mail: paris@lombardodier.com Vevey Lombard Odier Darier Hentsch Gestion Lombard Odier Darier Hentsch & Cie, Agence de Vevey 8, rue Royale · 75008 Paris · France Rue Jean-Jacques Rousseau 5 · 1800 Vevey · Suisse Portfolio management company approved by the Autorité des Marchés Financiers (no. GP O1-011). E-mail: paris@lombardodier.com Zurich Lombard Odier Darier Hentsch & Cie Prague Utoquai 31 · Postfach 1457 · 8032 Zürich · Schweiz Lombard Odier Darier Hentsch & Cie – Representative Office Prague Praha City Center · Klimentská 46 · 110 02 Praha 1 · Czech Republic E-mail: prague@lombardodier.com EUROPE Amsterdam MIDDLE EAST, AMERICAS, ASIA | PACIFIC Lombard Odier Darier Hentsch & Cie (Nederland) N.V. “Weteringpoort” Weteringschans 109 · Postbus 58007 · 1040 HA Amsterdam · Nederland Bermuda Holds a bank license from De Nederlandsche Bank and is registered with the Autoriteit Financiële Lombard Odier Darier Hentsch (Bermuda) Limited Markten. Lombard Odier Darier Hentsch Trust (Bermuda) Limited E-mail: amsterdam@lombardodier.com 3rd Floor, Victoria Place · 31 Victoria Street · Hamilton HM 10 · Bermuda Barcelona Dubai Lombard Odier Darier Hentsch & Cie (España) S.V., S.A. Lombard Odier Darier Hentsch & Cie – Representative Office Dubai Avenida Diagonal 399 · 08008 Barcelona · España The Fairmont – 25th Floor · Sheikh Zayed Road · P.O. Box 212240 · Dubai · UAE Investment company supervised by the Comisión Nacional del Mercado de Valores (CNMV). E-mail: spain@lombardodier.com Hong Kong Lombard Odier Darier Hentsch (Asia) Limited Brussels 1501, Two Exchange Square · 8 Connaught Place · Central · Hong Kong Lombard Odier Darier Hentsch & Cie (Belgium) S.A. Avenue Louise 81 · Box 12 · 1050 Brussels · Belgium Montreal Bank supervised by the Banking, Finance and Insurance Commission. Lombard Odier Darier Hentsch (Canada), Limited Partnership E-mail: brussels@lombardodier.com 1000 Sherbrooke Street West · Suite 2200 · Montreal (Quebec) · Canada H3A 3R7 Düsseldorf Nassau Lombard Odier Darier Hentsch Deutschland, Niederlassung von Lombard Odier Darier Hentsch & Cie Lombard Odier Darier Hentsch Private Bank & Trust Limited (Nederland) N.V. Goodman’s Bay Corporate Centre · West Bay Street · P.O. Box N-4938 · Nassau · Bahamas Düsseldorf-Stadttor · Stadttor 1 · 40219 Düsseldorf · Deutschland Branch of Lombard Odier Darier Hentsch & Cie (Nederland) N.V. regulated by De Nederlandsche Bank Singapore and the BaFin. Lombard Odier Darier Hentsch & Cie (Singapore) Ltd. E-mail: dusseldorf@lombardodier.com 9 Raffles Place · Republic Plaza #46-02 · Singapore 048619 Gibraltar Tokyo Lombard Odier Darier Hentsch Private Bank Limited Lombard Odier Darier Hentsch Trust (Japan) Limited Suite 921 Europort · P.O. Box 407 · Gibraltar Izumi Garden Tower 41F · 1-6-1 Roppongi, Minato-ku · Tokyo 106-6041 · Japan Bank supervised by the Gibraltar Financial Services Commission (FSC). E-mail: gibraltar@lombardodier.com Jersey Lombard Odier Darier Hentsch (Jersey) Limited P.O. Box 641 · N° 1 Seaton Place · St Helier · Jersey JE4 8YJ · Channel Islands E-mail: jersey@lombardodier.com

×