The financial markets’ good health contrasts with the fragility of individual economies. Now is the time to shift from financial assets to real assets, says Guy Wagner, Managing Director of Banque de Luxembourg Investments.
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Mr Wagner, the Covid-19 crisis has been part of our daily lives for more than a year. And economic life continues. Does this mean it has fully adapted to this context?
“Adapted is a strong word, but it is clear that there are signs of improvement in a number of economic indicators: economies are partially reopening and vaccination campaigns are underway. This is not to say that the economy is firing on all cylinders, but it is starting to get back on track.”
The US economy, for example, is growing at its fastest pace for 30 years. Is this a direct effect of the massive stimulus plan introduced by Joe Biden?
"No, not yet, because the plan has only just been launched. We'll have to wait a few more months, but the impact could be less than might have been expected given the sums involved.
This improvement is firstly due to a base effect, since the comparison is with a bad situation in 2020. But there is also another very important factor: normally, during a recession, people work less or unfortunately lose their jobs and therefore suffer a drop in income. But this is not the case today: the logical drop in income has been compensated for by government aid, which has often even been higher than what people were earning before! And because they haven’t been able to spend, their savings have increased.
Now that economies are reopening, pent-up demand is kicking in and this is producing impressive figures, like the 9% rise in retail sales in mid-April. But this is a cyclical increase and does not indicate a high growth trajectory for the years ahead.”
In Europe, on the other hand, the gloom persists. Why is this?
"Generally speaking, Europe has lower growth potential for reasons related to its demographics and the fact that the single currency is not working very well.
Another reason is that the measures put in place in Europe are clearly more timid. There is no stimulus package equivalent to that of the US and the ECB is less aggressive than the Federal Reserve. It is difficult to coordinate these things in the eurozone which is composed of so many different countries.”
Nevertheless, are there any reasons to be hopeful for a better tomorrow?
"The eurozone is dependent on exports. If there is a global acceleration, that would have a positive effect. Also, disposable household income has not decreased and in some cases has even increased. Once economies really open up again, that could help growth. But this too will be cyclical, not structural.
Meanwhile, the financial markets have continued to thrive…
Like the last quarter of 2020, the first quarter of 2021 has been good for equity markets but not bond markets. There is consensus on the fact that economic growth will accelerate sharply in 2021, especially in the second half of the year, and in 2022. An acceleration in growth presumes an increase in company earnings. And as central banks are not expected to raise interest rates during this time, it provides an ideal environment for equities.”
But there has been a trend reversal, with some sectors that were buoyant in 2020 not doing so well now – the Nasdaq is even underperforming. How do you explain this?
"Yes there has been a rotation within the equity markets. It began in November, when the first vaccines were announced. Investors then shifted to more cyclical stocks that were expected to benefit from the acceleration in growth. The previous big winners, which were less dependent on the economy – technology, consumer staples and healthcare – were sidelined in favour of highly cyclical stocks like industrials and energy linked to raw materials. In the short term, these stocks benefit much more from an acceleration in growth than others that are less sensitive to the economic situation.
But it's important to bear in mind that these cyclical stocks are not good long-term investments.”
With valuations being so high, should we be worried about another bubble?
"Prudence is certainly the watchword because valuation multiples are high in absolute terms. But I wouldn't call it a bubble, because these valuations are not totally disconnected from the fundamentals, as is the case when we talk about a bubble. At the moment valuations are high but it's because interest rates are very low.”
What about gold? Should we be concerned about its current fall in value?
"In my opinion, this situation is temporary and is linked to the increase in bond rates. Since gold does not pay interest, if interest rates rise, the effect on the yellow metal is negative. But this is temporary, as all the current economic problems, such as exploding deficits and debts or longer-term inflationary risks, are historically favourable factors for gold. Furthermore, real interest rates, adjusted for inflation, are negative and likely to remain so for a while yet. This is another strong supporting factor for gold.
So even though there are – and will be – periods of correction and a degree of volatility, the fundamental trend is still upwards.”
What should investors with a long-term horizon do?
"They should focus on real assets – equities – and veer away from fixed-income – bonds. This may seem paradoxical since equities are relatively expensive. But they are one of the only asset classes which realistically still offer the possibility of a positive real return. What all investors are looking for is not necessarily to beat the benchmarks, but to protect their capital and prevent their purchasing power from declining. So, buy equities, yes, but be very selective.”