Market commentary: Winners of the pandemic are correcting
February 1 | Market Commentary
In the last two years (since April 2020), the stock markets have almost exclusively risen. There have been no notable setbacks, and the U.S. market in particular – the world’s largest and most important stock market – has performed better than average. Our portfolios also achieved impressive returns (even considering the pandemic). However, the performance of stock market indices and securities portfolios is never linear. Good and bad phases alternate in an unpredictable way. After this long positive phase, we are now in a temporarily worse phase. How long this will last and when a phase change will occur cannot be determined and is always known only in retrospect. What is clear, however, is that negative phases are usually of shorter duration than positive ones, but for psychological reasons they are perceived as much more intense and painful.
Pandemic-winners are fluctuating
The greatest fluctuation is currently apparent in companies whose business models are driven by digitization. The pandemic has fundamentally given these companies enormous tailwind. In the last two years, capital has flowed disproportionately to these obvious winners. The market paid little attention to fundamental valuations. This trend has been reversed since October 2021 and is now taking on panic-like proportions. Analogous to the euphoria on the way up, there is now also only limited differentiation in the correction phase with regard to the quality and long-term opportunities of the companies concerned. However, since our portfolios include some companies that can be counted among the winners of the pandemic, we are not spared from the current setback, but temporarily affected even to a greater extent than an index. However, we consider our companies to be very attractively valued compared to their long-term potential and compared to other companies in this sector. We expect the fundamental results of the companies to play a bigger role again in the course of the year. We believe we are very well positioned for this phase. Our long-term expectations for the companies have not changed in recent days and weeks, and we anticipate unchanged long-term value growth potential for our companies, even if share prices in some cases paint a completely contrary picture. When share prices fall, our return expectations increase over the duration of our investment horizon.
Setbacks during the year are completely normal
In the last 42 years, the prices of the S&P 500 fell by an average of -14% within one year. In 32 of the 42 years, however, the stock market year ended on a positive note despite these setbacks. The index managed an average annual growth of 9.4% or a total of around 4,350%. In the chart below, the red dots symbolize the intra-year lows, while the bars in the positive area represent the year-end performance.
There are a wide variety of reasons for setbacks, some better, some worse. All setbacks have one thing in common: they are associated with investors’ worries. Depending on the strength of the setbacks, these worries change until at some point only the pure fear of further price falls is in the foreground, and the original reason has moved far into the background. Setbacks of this kind tend to be short-lived, as they are not related to an economic crisis or the bursting of a bubble. In our view, the current concerns of market participants mainly revolve around the possible negative impact of rising interest rates, the withdrawal of monetary measures by central banks, and a rise in the inflation rate, but are increasingly turning purely into fears of falling prices. Overall, we take a relatively relaxed view of these issues and do not see ourselves confronted with any difficult new questions or changed fundamental developments (as was still the case in March 2020, for example).
Rising interest rates are no threat to our technology companies
Why are rising interest rates an argument for lower valuations for (technology) companies? For one thing, rising interest rates make loans that such a company has taken out more expensive. For most of our companies, this is not an issue, as they generate ample earnings themselves and are hardly dependent on borrowed capital. Second, the fair value of a company is calculated from its discounted future earnings. That is, all projected earnings that the company will generate in the future are discounted at the current interest rate plus an appropriate risk premium. If the interest rate rises (as announced by the Federal Reserve), the future earnings are worth less, which reduces the valuation. The justification for a reduced valuation due to a higher discount rate is equally unjustified in our view. In addition to the risk-free rate (which the Fed intends to gradually increase), the discount rate used to discount future earnings also consists of a risk premium, which is usually significantly higher than the risk-free rate itself. A gradual increase in the risk-free interest rate by the Federal Reserve therefore raises the much smaller part of the discount factor – and to a manageable extent (from 0% at present to perhaps 1.5%). The decisive factor in the calculation is still the significantly higher risk premium, which can be 6%, for example. In any case, this does not justify discounts on the scale seen to date for our technology companies. Incidentally, many technology companies have performed better than average in times of higher interest rates.
Don't try to be smarter than the masses
Especially in these phases, it is essential to remain calm. Usually, more money is lost than gained in rushed reactions. In this context, we explicitly advise against trying to profit from such a phase by means of tactical asset allocation, i.e. by selling shares with planned later repurchases at lower prices, or even by trying to bring the assets temporarily into safety. Here, one is rarely smarter than the rest of the investors. The broad mass of market participants has the same idea and thus one acts procyclically exactly at the wrong time. In most cases, the attempt to act tactically “smart” ends in a serious loss of returns. The smartest thing you can do in this situation is to be patient. We would like to help you to keep a cool head and show you once again, based on some data, how common worse phases or setbacks are on the capital market.
Our portfolios are well diversified, both geographically and in terms of sectors, despite a bias towards high-quality, attractively growing companies (which are currently out of fashion). We see no need for action for the time being, and if any action at all, only to take advantage of new opportunities. The fundamental results of the companies continue to look good and do not correspond to the current price trend. As always, we will do our best to optimally protect and grow your assets over the long term. This applies not only to your capital, but also to our own, which in our cases is invested in line with our strategies. We thank you for your trust, which is particularly required and sought after in difficult market phases.
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