What strategy for your life insurance?

Francois d'Hautefeuille

(Photo credits: Adobe Stock - )

(Photo credits: Adobe Stock – )

The rise in ECB rates marks a turning point in the monetary history of the Euro zone. It’s time to adjust the strategy on your life insurance. The economic cycle is entering a new phase. The political cycle remains very uncertain between the war in Ukraine and the risk of Italian and British elections. We are adjusting our long-term strategy accordingly.

Foreign exchange: adjust your dollar exposure

has. The USD represents more than 50% of global foreign exchange reserves and investable financial assets. Many investors are very underweight in USD. It can be argued that a neutral portfolio should include around 50% in USD via stocks and bonds. In fact, a 60 40 World and not Euro portfolio held up much better to the market decline. We believe that the Euro’s decline may not be over. Historically, the Euro has tested levels of 0.80 against USD and even 0.7 in the Reagan years (if we reconstruct the price of the Euro from its basket of historical currencies). The economic undergrowth of the Euro zone for 20 years is undoubtedly due in part to the overvaluation of the Euro which has favored relocations to China as the factory of the world. As the President of the FED, Mr. Powell affirmed in Lisbon, China is no longer a privileged partner of the West but on the contrary increasingly its biggest strategic rival. The fall in the Euro favors relocations from China to Europe.

Euro dollar rate recalculated since 1972. (source: Bloomberg LLP)

Euro dollar rate recalculated since 1972. (source: Bloomberg LLP)

Equities: start to reweight your equity exposure

has. Do not over invest in European equities but diversify as much as possible via world equities and world bonds. It should be noted that we can very well earn on these assets even in a scenario of continued decline in equities and bonds from the moment this fall is offset by the fall in the Euro. Many investors have a bias towards European equities because they know them better. We recommend Fidelity World, or Lyxor MSCI World WLD FP, or ACWI US (Ishare MSCI All Country World Index ETF)

b. Start returning to long-term growth stocks. We can think that we are close to the level of “cherry picking in a mine field” on certain “long term growth and super growth” stocks (growth stocks and nuggets of the market). Some funds such as Varenne Sélection or Indépendance Expansion Europe have shown a major ability to identify these stocks in Europe. They begin to rebound before the rest of the market. Likewise, global technology equity funds such as Fidelity Global Technology seem to have entered a phase of reversal.

vs. Look at long-term growth sector themes such as healthcare and biotech. This sector is on the verge of a major health revolution via genetic treatments. Valuations are attractive after the bursting of the bubble. You can use ETFs like XBI US or Vanguard Healthcare. In life insurance, you can use Fidelity Sustainable Healthcare, or AB International Healthcare.

d. Stay away from emerging and particularly Chinese stocks. China is facing a Minskian crisis over its over-investment in real estate. The ghost towns that have been built pose a credit risk to the entire real estate chain, which has played an important role in recycling Chinese savings. The increase in military spending and prestige projects will also weaken Chinese power by sterilizing its productive capacity in a context of the beginning of the outflow of global capital due to the relocation of production chains. Evergrande’s only debt is 200 billion USD, which is the GNP of Greece. This shows the systemic extent of debt risk in China. Admittedly, the Chinese government has been able to manage this risk very well to date by taking on the risks in public companies, but the systemic fragility remains.

Obligations. Stay away from European bonds and therefore euro funds

has. The rise in euro rates has so far been limited. This may be linked to the still massive interventions of the ECB in the market, as is the case in Japan. The desire is certainly not to break the still fragile investment recovery and avoid the mistakes of the 2008 crisis which saw Europe tip into deflation and economic stagnation creating a lost generation in Italy.

b. We strongly recommend that investors exit their euro funds entirely. This fetish investment of the French has had its day and is a sterile and even dangerous tool to protect its savings in a scenario of major reflation of Western economies. This is all the more so with the systemic risk posed by the Italian elections, the weak link in the Euro zone after 20 years of economic stagnation and impoverishment vis-à-vis Germany.

vs. Begin to return to short-dated US high yield bonds, global convertible bonds and other equity/bond hybrid assets. High-yield bonds are an ideal asset for taking advantage of the possibility of a “soft landing” in the USA without overexposing themselves to equity risk, in particular funds focusing on the short term (SJNK US for example for US high yield term, and HYG US for the high yield Ishare ETF).

d. Stick to international bond funds. These funds make it possible to win on two levels. First of all by limiting the risk of a depreciation of the Euro insofar as a large part of the assets are invested outside the Euro zone (USA, Japan). But also, in the event of a lower rate increase than currently expected by the market. In this case, we will gain not via the exchange but via the rise in bond prices. We can look at funds like M&G Global Arbitrage, Blackrock BGF Global Multi-Asset Income Fund A2 USD cap.

Getting out of raw materials

has. Many industrial raw materials, starting with copper, have already broken their upward cycle for many months. The Fed and ECB rate hikes and associated liquidity withdrawals will undermine the bullish structure for commodities. The current media excitement over the risk of an energy shortage this winter is typical of an end to the upside if we take a “contrarian” approach. Commodity markets need to be watched carefully given their major role in the “bull whip” of the production cycle. We believe that the oft-repeated goal of central banks is to make their prices converge on their natural long-term equilibrium prices which balance their production against long-term demand.

b. We have the first signs of a turnaround in oil following President Biden’s trip to Saudi Arabia. We must understand the full significance of such a move in the historical context of the partnership between the Ibn Saud dynasty and President Roosevelt via the Quincy Accords. To be sure, the Ukraine crisis remains complex despite Kissinger’s calls for peace both in Davos at the WEF and again in recent weeks. Presumably his calls for a return to the long-standing recognition of Russia as a strategic player in the European Balance of Power will eventually be heeded.

vs. We are therefore negative on agricultural commodities which have reached valuations above the survival prices of poor African countries and therefore create a risk of global famine. There is certainly still a lot of bullish speculation in these markets.

d. We are very wary of gold and precious metals. Gold mining is clearly down despite major political tensions in Russia. In our view, this reflects the impact of the Fed’s rate hike towards the long-term natural rate and the exit from the liquidity trap of zero rates and deflation into which the Western economy had fallen for 10 years. For us, there is a major downside risk for gold in the coming months if the central banks succeed in pulling the Western world out of the stagnation of the past 10 years and therefore in driving up real rates.

Back to real estate stocks

has. This is an asset class in its own right and not a sector choice. Real estate represents a major share of household wealth. A real estate shock would jeopardize the economic recovery. A major component of a “soft landing” (stabilization of the economy) will depend on the ability of central banks to avoid such a real estate crisis by not raising rates above the natural rate. However, the recent stabilization of rate hike expectations goes in such a direction. We recommend funds like AXA Aedificandi, Allianz Real Estate, or real estate ETFs like VNQ US (Vanguard Real Estate).

Conclusion

The financial crisis will celebrate its first anniversary around October November. If we look in detail at the non-GAFA values, it started at the beginning of 2021 and will therefore soon be 2 years old. The FED rate hike cycle will be one year old at the end of 2022 and the markets see it ending in 2023. So there are major factors to start seeing a “silver lining” in the “cloud” ( dark period) of the markets even if the seasonality remains negative until September/October, a fortiori because of the British and Italian elections. For these reasons, we are returning to neutral in terms of risk and we believe that the next wave of market declines could open up interesting buying opportunities.


This financial analysis is not investment advice. Evariste Quant Research and its clients may hold securities mentioned in this analysis.

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