In a context of high inflation and near-zero interest rates, equities – even if they aren't as cheap as they were – remain the best investment avenue, according to Guy Wagner, Managing Director of BLI - Banque de Luxembourg Investments.
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Guy Wagner, the financial markets ended the summer in good heart. The current trend looks less rosy. Was this to be expected?
"It's always easy to say with hindsight, but it's a normal sequence. The markets rallied strongly this year, as was the case since the pandemic started at the end of March last year. After a certain time, it's normal for the markets to slow down a bit, especially since a number of things have arisen to disrupt them economically, as well as other reasons like the problems with the Chinese company Evergande. It was a natural time for this correction to take place.”
As feared, inflation levels are rising again, while economic growth remains weak. Is this the worst possible scenario?
"This scenario, which is called stagflation – a combination of economic stagnation and high inflation – is one of the worst that could happen. We aren’t there yet, but the latest figures are certainly pointing in that direction. This is worrying because the upsurge in inflation is based more on supply chain problems and labour or raw material shortages – which are shortages linked to supply, not demand.
At the moment, there is still growth, although the indicators are lower than expected. What we need to watch closely in the immediate future is whether the revival in growth is set to continue.”
How can, or should, the central banks respond to the current situation, with the surge in energy prices adding to the difficult context?
"For the time being, they continue to say that the rebound in inflation is temporary and they are not considering tightening their financial policy or raising interest rates before the end of 2022.
The problem is that the economic reality could perhaps put them in a situation where they would have to make a choice that they haven’t had to make in recent years: either to fight inflation, with all the negative consequences for social cohesion, or to continue to try to support growth and the financial markets.”
In your latest edition of ‘Perspectives’, which has just been published, you highlight the fragility of the financial system. How has this come about?
"To some extent, it’s a consequence of what we've been doing for the last 15 years, or even longer: the idea that when an economic or financial problem arises, interest rates should be cut. We thus created a system that has never been overhauled. And something that is never sorted out necessarily becomes more fragile. That’s the situation we find ourselves in today.
The central banks became increasingly hyperactive after the 2008 financial crisis. Today, there are risks we can’t yet identify, but which could come to light if interest rates are raised.”
It is nevertheless true that, taken over the year as a whole, equity markets have performed very strongly and posted some record highs. Does this mean that anyone who has not yet invested in the equity markets has missed the boat and it’s now too late for any hope of doing so in a worthwhile and profitable way?
"Clearly, with very high valuation multiples, equities are no longer cheap. That's the negative side. But on the other hand, they appear to be the best solution for investors who want to preserve their purchasing power in the medium and long term, especially in a context of rising inflation.
Because, when you look at good quality money market or bond investments, the US 10-year Treasury yield is around 1.6% while inflation is around 5%. That means that real interest rates, adjusted for inflation, are well into negative territory. The situation’s even worse in the eurozone. This brings us back to the idea that equities are currently the best investment by default.
Of course, given the risks on equity markets, you need to be extremely selective and accept the volatility inherent in any stock market investment. Over the last 10 years, investors who had kept their assets in cash and money market investments would have lost money, whereas if they had stayed in the equity markets, even during the difficult times, they would have more or less preserved their purchasing power.”
Earlier, you mentioned the problems of the construction giant Evergrande. Should we be worried about a Lehman Brothers-style disaster scenario?
"I don't think so. Even if we don't yet know how the Chinese authorities will respond to Evergrande, they are likely to want to avoid replicating what was done during the collapse of Lehman Brothers. When a heavily indebted company goes bankrupt, the creditors and shareholders lose their money. That’s how capitalism works: when you look for a higher return, you take a risk. That’s fine when it works out well. When it doesn’t, you lose your money. The people who need to be protected are the customers and suppliers. But after Lehman Brothers, it was the creditors and shareholders who were protected first.”
We always end this review with a word about gold, which has lost 7% since the start of the year. Does this mean that the yellow metal has lost its status as the ultimate safe haven?
"I wouldn't go that far, even though the situation is surprising. We always say that gold is a hedge against inflation so the fall in real interest rates should also have had a positive effect on gold. It would be more appropriate to view its correction as a logical consolidation after a rise of almost 20% in 2019 and 25% last year. Besides, investors seem to be more interested in oil at the moment. So yes, gold's current performance is disappointing, but that doesn't mean it has lost its safe haven status."
