Counter-cyclical investing in equities
While other investors were selling equities in May, Christian Schmitt, Senior Portfolio Manager at Ethenea, was buying. He explains why.
The profitability prospects of companies decline as inflation increases. Higher production costs reduce profit margins and consumers rein in their spending because inflation is eating into their real wealth. These factors have been impacting the equity market of late. “The situation may even worsen, depending on what happens with inflation - especially since the current valuation level cannot be described as attractive despite an already steep fall in prices,” says Christian Schmitt Senior Portfolio Manager at Ethenea. “The price-to-earnings ratio (P/E), a classic heuristic valuation metric, suggests that the current price level – of the S&P 500, for example – is around its average figure for the past five years. However, this does not take into account the fact that companies’ profit margins were at record highs of late - which will not be sustainable given the high inflation. Cyclically adjusted metrics such as the popular Shiller P/E ratio, on the other hand, indicate that valuations are still relatively high.”
Given the constellation of numerous medium-term stressors as well as lower - though not cheap - valuations, Christian Schmitt keeps a cautious positioning of the Ethna-DYNAMISCH. This caution can be seen in the low net equity allocation, for one thing. Throughout April, it was below 30%. “However, we recently raised it to almost 50% to 60% in an opportunistic and counter-cyclical move during a period of overselling in mid and late May,” he says. “For another, our temporarily high cash position, which in recent months has ranged from almost 40% to 70% – including cash substitutes (short-dated AAA bonds) and synthetic cash (via equity hedging) – acts as a stabiliser in the current, difficult market environment for risk assets.”
At the same time, he recognises that the recent equity market correction is also creating many opportunities at individual security level. “We have already begun to gradually build up positions in quality companies and intend to step this up as soon as the overriding stress factors abate or are sufficiently priced into markets.”
