What is a recession free portfolio

In November 1911, a Swiss racing driver named Louis Chevrolet and his colleagues started a start-up called "The Chevrolet Motor Car Company" in a Detroit backyard. The founders were probably not aware of creating one of the most famous car brands in the world. Nor would they have thought it possible that corporate bonds from automakers would cost less than 10% interest a year - the rates customary at the time - or that bonds with a 90-year term could be placed on the market as a private company. A US government bond yielded around 4% p.a. in the winter of 1911 - there was a slight deflation in the US dollar. In Switzerland, the CHF Lombard rate was 4.50% p.a. in the same year - money still had real value.

Violent vandalism by the central banks
Realities have changed a lot. After the third cut this year by the US Federal Reserve, the key interest rate in the US dollar has reached 1.50% to 1.75% p.a. Swiss francs and euro investments are only suitable for suicide investors: since winter 2008, the European Central Bank (ECB) has de facto eliminated interest rates from 4.6% in EUR-3MLIBOR to -0.50% (“deposit rate”). Anyone who remembers the CHF 3M LIBOR in December 2007 is nostalgic. This returned 2.74% and is now also in negative territory. The Swiss National Bank (SNB) has had a precarious "permanent construction site" since the outbreak of the financial crisis: weakening the Swiss franc. At the latest since the final abandonment of the euro minimum exchange rate, the SNB balance sheet has been growing rapidly and seemingly unstoppable. According to the latest available figures, the SNB is sitting on a mountain of foreign currency worth CHF 797 billion. Compared to winter 2010 this is an increase of + 398%. The situation threatens to become increasingly uncontrollable. The global volume of outstanding bonds with negative yields reached a new high of USD 16 trillion a few weeks ago. "It is no longer absurd to worry about negative returns even on US government bonds," said Joachim Fels, chief economist at the American asset manager PIMCO, recently. The air is also getting thinner for private customers. At UBS, Credit Suisse and also at private banks, negative interest rates for account assets in Swiss francs and euros have become a sober reality. There has recently been a great outcry in Germany: 13 regional cooperative banks are now charging negative interest rates unchecked - some of them already have an account balance of EUR 100,000 or more. The unmistakable perception: interest rates will be abolished across the board.

 

Except for the edge and ribbon
Some EU central bankers (“Draghi & Friends”) and scientists argue that the radical cut in interest rates will support the eurozone's economy and stimulate growth there. The same dogma led, under the aegis of FED President Ben Bernanke, to “Helicopter Money” and a historically unique wave of interest rate cuts in the US dollar. This approach is absolutely correct in theory. But a negative interest rate like the one that prevails in the euro zone, or the interest rate level of 1.50% in the US dollar, would mean that there is an absolute recession, high unemployment and total consumption congestion in the real economy.

"The only source of positive performance in the bond portfolio is price gains."

None of the three factors apply to either the euro area or the United States. Even worse: The ECB and the FED have largely missed their powder. If there is actually an economic downturn in the euro zone or the USA in 2020, the house recipe for lowering interest rates will no longer really work. US President Donald Trump - who is actively doing everything possible to keep the stock markets running - explicitly recommended negative interest rates as an option to the Fed a few days ago. Political Washington has been upside down for a few days because of the impeachment, now also US government bonds, which in the end pay back less than when they were issued? Alexander Hamilton, the nation's first Treasury Secretary, would turn in his grave.

Prominent resistance forms
In the meantime, however, more and more experts are opposing the highly problematic effects of the interest rate slash. The main concern currently concerns the euro in particular, but also to a certain extent the Swiss franc. For example, the CEO of Goldman Sachs, David Solomon, recently blatantly hosted "negative interest rates as a monetary policy experiment that worries him" on Bloomberg TV. Herbert J. Scheidt, President of the Swiss Bankers Association, sees massive structural damage due to "persistent negative interest rates". German money experts put it even more drastically. The former chief economist of the ECB, Jürgen Stark, is certain: "The ECB itself has long since become a risk to financial stability". Christian Sewing, CEO of Deutsche Bank, simply believes that “negative interest rates will ruin the financial system in the long run”. Not an easy mission for the new ECB President Christine Lagarde. Even in the central bank itself, bitter trench warfare between monetary policy hawks and doves is increasingly breaking out. The same applies to the FED in Washington. Chief driver Powell has to remain strong in order not to completely turn the US Federal Reserve off its hinges.

God Save the Bundesbank
The current situation of the Eurosystem's debt-liability mechanism is particularly spicy. The long-term credit programs granted by the ECB at zero or negative interest allow banks to grant almost all quality scales of loans at very low interest rates and thus to easily refinance outflowing deposits at the ECB. Cross-border transfers are processed in the euro zone via the “Target2” system of the ECB. The problem here is that national central banks cannot allow counter-financing or capital imports to take place in the long term. Thinly capitalized banks can therefore also give very cheap loans to companies from euro countries with poor credit ratings, which in turn have shaky public finances. The risk is passed on to the central bank, which finances the outflow of deposits through Target2 through loans to the Eurosystem. The largest lender in the eurozone today is the Deutsche Bundesbank with EUR 837 billion, albeit with a slightly downward trend (see chart). Sting heavily on the liability side, among other things. Spain and Italy stand out. The Bundesbank's TARGET2 claims are entirely unsecured and do not bear interest. Many an observer asks himself: a construct with a future or a house of cards? Bundesbank board member Burkhard Balz, a busy CDU politician, vehemently drummed for the all-clear in front of the finance committee of the German Bundestag: "Securing TARGET2 balances is not necessary, the system works perfectly".

 

Calls for help from the investment office 

Meanwhile, the mission “generate returns” does not work perfectly for pension funds, pension institutions and bond investors. The situation becomes more precarious from month to month: Very low coupons or negative returns result in irrationally low returns from the sometimes legally prescribed bond pot and an erosion of performance promises. Treasurers and investment managers call for help when they see newly issued bonds - the yields are completely in the basement. Risk is no longer adequately compensated. The only source of positive performance in the bond portfolio comes from price gains.

"It seems that interest rates are being abolished across the board."

The prices of ultra-long-term bonds have now climbed to schizophrenic levels - caused by the interest rate cuts of the past two years. For example, the 95-year Mexican government bond in EUR is quoted at 110% (3.56% p.a. yield), the 91-year corporate bond from Engie S.A. reached 192.5% (2.93%). It dawns on attentive observers that if even the slightest hint of a rate hike cycle sets in, all bond portfolios, especially those with longer-dated bonds, will suddenly be dramatically under water.

Hell jobs and the bond portfolio
Maturity transformation, i.e. the balance between investment funds and bank loans, is also seriously threatened. Regional, cooperative and cantonal banks in particular are currently losing their most important source of income - interest commissions. Desperate attempts to expand the mortgage volume in order to stabilize interest income are not a future strategy. The situation is also increasingly problematic in the global insurance industry. The solvency ratio of insurance giant Allianz fell from 213% to 202% between July and September 2019. The traces of the interest hammer are unmistakable. The massive intervention by the ECB in the bond market is no less threatening for portfolio managers. Since March 2015, the ECB has been buying government bonds from all eurozone countries on a large scale. At its peak with a volume of up to EUR 80 billion - per month! As a direct consequence, yields plummeted, no matter how good or bad the rating quality was. At the same time, the ECB has been shaking the market for corporate bonds from issuers in the euro zone since June 2016. In contrast to the purchase of government bonds, which is done via the secondary market to avoid obvious government financing, the ECB can also buy or subscribe to corporate bonds directly from the respective issuer. But yields are also at record low in other currencies. The risk premiums stick to the ground like lead.

 


Fresh ideas in portfolio design are in demand
From the point of view of investors and asset managers, there is now only one alternative: active search for pearls for the portfolio - both for bonds and stocks. “We used to enjoy the inflow of new customer money. Today it is an extremely arduous feat of strength to generate reasonable returns and to keep customers happy, ”said a Zug asset manager at an industry meeting. Those who are not subject to any regulations are well advised to reduce their bonds and instead opt for stocks with high dividends paired with option strategies. It is also very promising to play the sector rotation actively and use it as an element for diversification. Technology will therefore remain a growth segment for the next few years - despite the current, in some cases, high ratings. Focused Exchange Traded Funds (ETFs) such as the Global X Internet of Things ETF (ISIN: US37954Y7803; ticker SNSR), Amundi STOXX Global Artificial Intelligence ETF (ISIN: LU1861132840) or Bluestar Israel Tech ETF (ISIN: US26924G8704, ticker ITEQ) are available as contemporary admixture recommended.

“Dividend Darlings” for the gift table
In addition, stocks with high dividends and yield optimization products are important in order to achieve the desired target returns. For interested investors, large cap stocks with stable cash flows such as Swisscom (4.3% div. Yield), Swiss Re (5.4% div. Yield), E.ON (5.2% div. Yield), AT&T (5.2% div. Yield) , Royal Dutch Shell "B-Shares" (6.3% div. Return), or the shares of Total SA, which are currently very exciting in terms of chart technology (5.5% div. Return), and ING Groep (6.4% div. Return). Specialties for more risk-conscious investors, but no less exciting, include: Telefónica Deutschland Holding (9.6% div. Return), one of the largest mobile and interprovider in the country, or the Dutch Fallen Angel ABN Amro (8.38% div. Return). Blackstone Mortgage Trust (7% Div. Yield), and Apollo Commercial Real Estate Finance (10% Div. Yield) are specialist mortgage financiers who live well as long as interest rates in the US do not fall into negative territory, and a catapult if they do USD interest rates will rise again at some point. The US gas station chain Sunoco (10%), which is a highly profitable bet on a recession-free US economy, is a big hit. But be careful: surprising dividend cuts cannot be ruled out. Examples such as Kraft-Heinz or Nielsen Holdings show that the board of directors can degrade shares from “dividend needle” to lousy returns with the stroke of a pen. Investors who have yield optimization products (Barrier Reverse Convertibles - BRCs) structured, especially in the case of price fluctuations in their favorite stocks (high premiums), benefit from above-average coupons. However, the barriers should be in the region of 55-60%. An exception of up to 70% may be permitted for conservative stocks. Many issuers also offer BRCs “off the shelf” week after week, which often contain one or the other pearl. You can still earn something like this even in Swiss francs.

Visually tempting, real risky
Investors should consciously filter out bonds from debtors with unstable cash flows or geopolitical challenges. Regardless of whether it is a corporate bond or a government bond: the risks are now rarely adequately compensated. If government bonds like the Republic of Armenia are still yielding 2.9% per year, that is a clear indication of total craziness in the bond market. Those who have the right portfolio size are increasingly considering spicing up their returns through private debt, private equity or direct lending. Bonds from issuers in China are currently visually attractive. Yields of 8% to 15% in USD dollars, such as at Guangxi Financial Investment (a kind of state investment agency in the former boom province of Guangxi in southern China), however, hide the new reality that Beijing is no longer insolvent at any cost Assists regional governments in bankruptcies. General Motors, today's parent company of the Chevrolet Motor Car Company, had a similar experience. The largest automobile company in North America was not saved by the American state in June 2009, but had to file for bankruptcy at the bankruptcy court in Detroit. In the midst of the financial crisis, every chance to get refinancing on affordable terms imploded. The historically highest debt burden ever borne by a company at that time, USD 89 billion, caused the fatal emergency stop. The Italian government debt currently stands at EUR 2.3 trillion. Woe if someone turns the interest rate screw.