We hear more and more about inflation and rising interest rates. Not a good prospect for investors.
Helge Müller: Yes, it’s a big issue. The waters on the markets have sloshed back and forth in the first two months of the year. Technology stocks initially experienced another price surge. But a few weeks ago, things turned around, and the NASDAQ 100, the technology companies index, is now trailing the Standard & Poor 500, the index of America’s largest companies, for the first time in recent memory. And this trend will continue, I think.
Since November, we’ve seen a sector rotation from value stocks, companies with much substance, to growth stocks, companies with high growth and earnings potential; paradoxically, investors opt for stocks in one category at a time, but rarely for both at the same time. This behavior may be linked to inflation expectations. For example, in the eurozone, annual price inflation was still 0.2 percent in November 2020, but by February, it was already 1.4 percent.
Which was also due to certain factors, such as the end of the temporarily reduced German value-added tax.
Agreed. But the underlying issue responsible for this is the sharp increase in the money supply that has been brought about by the pandemic. We’re seeing massive interventions by governments, stimuli in double-digit percentages of economic output, and by central banks in the form of bond-buying programs.
We are talking about classic investment drivers, basically.
According to economist Milton Friedmann, yes. But after the financial crisis of 2007/08, when comparable measures were taken, even if on a smaller scale, there was no increase in inflation.
The financial crisis was, at its core, a banking crisis.
Precisely, which is why the banks have passed on very little of the money made available to them by the central banks. This time, we are not dealing with a banking crisis. So the banks are now providing companies with liquidity on a large scale, on credit. This means that more money is getting into circulation, which further pushes the economy. Interestingly, central banks have indicated that they are not intending to raise interest rates for a long time. We see a combination of factors leading to an exciting situation.
Has this kind of initial situation existed before, and if so, can we learn from it?
Indeed, and it happened in the 1950s. The lesson, in a nutshell, is that it took quite a long time for inflation to set in, about five years. And during that time, we had so-called financial repression: government debt fell in real terms during the inflation years, while interest rates remained low.
Stocks and bonds are tangible assets and actually offer protection against inflation, don’t they?
Yes, they do. Although in the case of, say, 30-year U.S. Treasury bonds, a one percent increase in interest rates translates into about 30 percent in the bond price. In recent months, interest rates have gone up about one percentage point at the long end, after previously trading at about the same level as 10-year bonds, which is not normal. Let’s be clear: We don’t expect interest rates to rise quickly across the board. But we do expect the global economy to do well again soon, partly because of the stimulus packages and the further liquidity getting into circulation.
So what do you recommend to investors?
We need to identify companies that will benefit. Those that can pass on inflation-related additional costs to their customers. Then they will earn more because the higher prices bring in more money.
To do this, we look at the profit growth forecasts and assume that the direction and pace of growth can be roughly maintained. This allows us to say how a reasonable price/earnings ratio could look like in ten years’ time. For Alphabet, the parent company of Google and YouTube, we arrive at a potential of 400 percent share price growth in ten years – even at a discount from today’s P/E ratio and without inflation – that is, around 20 percent per year. Alphabet is not an isolated case, nor do we see the bubble described by some observers.
Alphabet is a technology company, and the stock is a growth stock. Do you have a value stock recommendation?
Yes, there are so-called cyclical stocks that appeal to us: chemical companies, industrial or commodity companies, and banks. They are representative of sectors that have been left behind recently but are now benefiting from the scenario described.
Can you name any companies?
For example, the Swiss/British commodities producer and trader Glencore. The stock’s P/E ratio, after earnings, is only at about 11; 17 seems reasonable to us. In banks, we look at Deutsche Bank; investors currently value the institution at about 0.35 of its book value, which is pretty low – is the bank going bust, or is the business model obsolete? We do not think so. We also hold the broad-based German chemical and conglomerate BASF, industrial giant Siemens, or the car and motorcycle manufacturer BMW. Nevertheless, we continue to focus our investments on technology companies, global consumer goods companies, and the healthcare sector.
A unique selling point of your asset management is expertise in fixed income. What do you currently say about bonds?
There is still money to be made in high-yield, high-interest corporate bonds. From the fast-food group Yum! Brands, investors who invest in dollars receive 4.5 percent interest. In euros, Burger King France, for example, pays 5.25 percent. And in pound sterling, we recommend the bond issued by the company that operates Heathrow Airport, which pays 4.6 percent. For government bonds, on the other hand, we still have only two words of advice: hands off.