This article is based on an interview with Frank Suess, Chairman of BFI Capital Group, who heads up the BFI group of companies in Zurich, Switzerland. In this interview, Mr. Suess discusses growing market volatility, and gives his perspective on how investors can position themselves in these hard times. He covers precious metals investing, (negative) interest rates, monetary policies, a Swiss rock solid perspective on investing, and much more.
Frank, it is a pleasure to talk again. Let’s dive right in and talk about the topic that is on everybody’s mind right now: The Equity Markets. We witnessed one of the worst starts of the year in 2016. Do you believe that the equity market correction has hit a floor or will the correction continue? What do you believe are the major causes of this correction?
Frank: We had been anticipating a period of increased volatility for some time now. We recently alerted our clients to the spreading of the high-yield bond crisis in the US, which started in the energy sector, but has already captured other sectors and is now also afflicting banks. Frankly, we weren’t expecting such a dramatic drop in such a short period of time. I am convinced that the current levels don’t represent a floor. We are likely to continue to see a year of high volatility in the financial markets with wild up- and down-swings. However, despite possible rallies in the interim, we believe that the markets will tend downward as equities were (and still are) over-valued due to being flush with cheap cash and low- to negative-yield rates. The asset bubble that the central banks have created is starting to burst. To me, the only question appears to be how quickly the bubble will “deflate”.
The media is currently full of varied explanations of why we are seeing markets tank. In essence, it can be summed up as follows: Market participants are slowly realizing that the situation of the current global economy is substantially worse than it was believed to be a couple of months ago. There are several indicators that point to this: The collapse of oil prices and other industrial commodities, negative growth figures from China and many others. In connection with this, I believe that the faith people have in the central banks’ ability to manage economies has and will continue to dwindle. People are thinking: “After seven years of zero interest rates, this is how far aggressive central bank intervention has gotten us?” In the past couple of years, every word from the mouth of a central banker moved markets. As trust fades in the abilities of the central banks, so will their impact on the market in the future.
In looking at gold’s rebound since the beginning of 2016, do you believe that it will continue to increase on the back of continued market volatility? Do you think it could surpass the historic peak levels of 1980 of over $2,000/ounce, adjusted for inflation?
Frank: In essence, gold is the only true store of value that has passed the test of time. Especially in times of crisis or uncertainty, it fairs well in comparison with other asset classes. On the back of the economic uncertainties and increased volatility we are facing today, I am confident that we will see substantially higher gold prices in the next 18 months. In general, I don’t like to speculate on the price of gold and where it is heading. Should market participants lose faith in equity markets and central banks completely, then it is possible that we see the historic peak breached within the next 1-2 years. However, for this to be the case, the economic outlook has to become substantially worse than it currently is and this is not our current base case scenario.
What would be the best risk-management strategy, given today’s investment climate, other than precious metals?
Frank: Classic hedging strategies employed are options and futures. These instruments help you to reduce the risk of a portfolio. These strategies, however, are often costly and timing is essential. Instead of relying on derivatives, we prefer to construct robust portfolios that are broadly diversified. In the current situation, we are underweighting stocks, the simplest and most straightforward way of reducing your risk. In turn, we are allocating an increased portion of the portfolio in alternative investments.
Hedge funds are attractive in today’s context due to their risk-adjusted performance reflected in their relatively low volatility, and their down-side protection reflected in maximum drawdown numbers, which are significantly better than those in general stock markets.
The best hedge funds are actively managed with flexible, non-traditional portfolio management techniques, allowing for allocations across all asset classes. The managers are also invested so that their interests are aligned with their sophisticated investors, such as HNWIs and institutional investors. Their fees are performance-based in order to further align interests and ensure that they seek absolute returns by employing flexible, proprietary investment techniques and strategies.
In an environment where more central banks are turning to negative interest rates and the Fed is leaving the option for negative rates on the table, what investment strategy or approach provides investors with the best alternative for wealth protection and creation?
Frank: Firstly, I would like to mention the absurdity of the current central bank regime. Negative interest rate policies would take this to a completely new level. Let me illustrate this with an example: Imagine that the Fed decreases rates into negative territory to -3%. This could lead to mortgage rates entering an absurdly low or even negative level. Now imagine an unemployed person with a mortgage rate of -0.5%, meaning that having a mortgage would actually pay a return. This would create a bubble never seen before. Of course my example with the mortgage is only an extreme. Though imagine companies able to borrow money at negative rates – as is already the case with some corporations in Switzerland – that means that, in theory, even loss-generating projects would make sense as a corporate investment strategy. Low interest rates always lead to bubbles that eventually deflate. Imagine now the depth and duration of the correction after a prolonged period of negative interest rates.
In addition to my comments in connection with risk-management above, what we are currently adding are 10Y Treasuries to our portfolios. We believe that there will be an increased flight into treasuries with the current market volatility. Should the Fed introduce negative interest rates, then these Treasuries would additionally offer a substantial upside.
Do you believe that the Swiss Franc is overvalued? Provide us your Swiss perspective, please.
Frank: If you look at the classical valuation methods, such as purchasing power parity, then the Swiss Franc seems to be overvalued in comparison with most currencies. However, I think that there is a certain “Swiss premium”, which the Swiss Franc trades with, despite the recent adventurous level of monetary inflation delivered by the Swiss National Bank in their endeavor of suppressing the Swiss franc. Ultimately, the fundamentals of the Swiss Franc are very solid. And, more importantly, the fundamentals of the US dollar and the Euro are very weak, by comparison. Switzerland has a long tradition of political stability, economic prosperity and a long-established rule of law. At the foundation of Switzerland’s success, stand its independence and its system of direct democracy. The overall package has led to a long tradition of trust in a currency that is considered strong and a secure store of value – the embodiment of “sound money” so to speak.
What about the highly leveraged European banking sector? Recently, DB made headlines and had to come out with a statement confirming its ability to meet an interest payment. Do you think its possible that DB will turn into the European Lehman?
The house of cards built by printing money is beginning to break and the central banks are losing control. They are increasingly becoming powerless in managing economies and markets. The banking system in Europe has some fundamental flaws and DB is in a dire situation. Despite that, the bank is too significant for the state of Germany and – if worst comes to worst and no other solution is found – it could be partially or fully nationalized, as occurred with Citibank U.S. in 2008 (though they never called it a nationalization), during the financial crisis. However, I agree that the issues at DB should be considered a sign of the times. Even more than European banks, a lot of US banks are starting to look distressed in the midst of yet another junk bond crisis in America. Investors should take a closer look at the spreads over the past few months.
Do you believe we are entering a deflationary or an inflationary period?
As I mentioned before, I believe the bubble that has been artificially created by central bank money printing is slowly but surely bursting. This leads me to believe that in the short- to medium-term we are likely to see a more deflationary environment. If one takes the long-term perspective, inflation is the only logical outcome of continued money printing.
In addition to investment strategies, are there any other ways of achieving asset protection and wealth preservation (for example by acquiring a second citizenship)?
I should mention that I lived in the US for several years during my studies and I love and believe in the core values that America stands for. However, I believe that countless developments in the past few years have been very worrisome, therefore having a “Plan B” ready is essential. Devising a Plan B for your wealth, but possibly also for you and your family, is always important. One hopes to never have to use it but it is necessary as a way to mitigate risk, especially in today’s economic and political climate.