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We look at the way many investors are reacting and we compare it with the Bank's investment methodology.
Accepting and responding to the uncertainties
From a scientific view there is certainly reason for concern. Currently it seems that, based on medical evidence and simple mathematics, a majority of the population is going to be exposed to the virus over the next two years, even taking into account the series of measures that have been or will be taken by the authorities in different countries.
On the economic front, investors need to accept and respond to the uncertainties facing the global economy. While the impact of coronavirus is being felt across all sectors of activity, the extent of the resulting economic downturn will depend largely on how long the confinement imposed on the world's leading economies lasts. Initially, corporate earnings – inevitably affected by the demand shock and deterioration of the macroeconomic environment – combined with the impact on the stock market of lower market capitalisations will very likely lead to a significant reduction in capital expenditure. However, once the peak of this health crisis has passed, companies could subsequently benefit from a delay in demand.
Bad as the current situation might seem, as investors, our working hypothesis has to be that eventually the current crisis will resolve. The virus will be contained and the situation will normalise.
Keep calm and stick to a method
In this situation, it is important to return to the fundamentals of our approach: a strict investment process that reduces the impact of emotions on investment decisions. This is the only thing we can really control in this very uncertain market environment.
Our investment process is built around two main pillars:
- the quality of the fundamentals of the companies we invest in
- and their valuation.
Nobody can quantify and estimate the short-term impact that this pandemic will have on the economy and stock markets. However, this crisis clearly has the potential to significantly damage corporate earnings and have a knock-on effect on investor attitudes for some time. This lack of short-term visibility is not specific to the current situation. We are convinced that making short-term predictions is a vain exercise and that the only way to be successful investors is to take a long-term view. We are sticking to our process that allows us to identify companies that offer the potential for profitable growth, not only for one or two years, but for longer periods of time, capitalising on strong competitive advantages and favourable investment trends.
We might be facing the situation once described by Warren Buffett in his famous quote: “You never know who’s swimming naked until the tide goes out.” Companies could go out of business or have trouble reinvesting in growth opportunities due to declining cash flows. The companies we invest in have solid balance sheets that allow them to weather any kind of crisis. Their competitive advantages will permit them to stay profitable and generate high levels of free cash flow and thus help them to emerge stronger from the crisis than most of their competitors. They can capitalise on a strong brand power, captive customers, large networks, technological know-how or cost advantages in order to generate attractive long-term returns for their shareholders.
Our focus on valuations prevents us from overpaying for investments and allows us to seize investment opportunities when they arise, for instance in stock market corrections like the current one. The current crisis does not significantly impact the intrinsic values of the companies. These values are not based on the results of one or two years, but mostly on the cash flows the companies are estimated to generate after the pandemic is over.
The stock prices we currently see flashing red on our screens don’t tell us what a company is worth – but our valuation model does. When fear continues to drive down stock prices further, our process allows us to be ready and to discipline ourselves in order to buy stocks when they trade with a sufficiently high discount to their intrinsic value. This could look like a wrong decision if markets continue to tank, but as long as we are right over the long term that doesn’t matter.
Our analysts will keep you regularly informed about how the health situation is impacting the economy and your investments. Should you have any particular questions, please contact our private banking advisers.