The CAPE ratio has reached 41, a level that Wall Street has only seen on very rare occasions in its history, and yet the indices remain at high levels. For Loïc Schmid, this calm is only skin-deep. Beneath the surface, rotations are accelerating at an unprecedented rate of repricing, whilst a new generation of investors – more speculators than analysts – is amplifying the effects of momentum.
Where do you find reasons to be enthusiastic about the markets today?
It is the broadening of the market that strikes me as the most interesting development at present. Beyond the mega-caps, numerous opportunities are emerging among small and mid-caps, as well as in markets outside the US. We are particularly keen on natural resources and healthcare at the moment.
Natural resources because several long-term trends are converging. Structural demand is being fuelled by the electrification of the economy, the development of artificial intelligence, data centres and investment in electricity grids. At the same time, the mining sector has suffered from under-investment for many years, which is limiting the growth in supply. Finally, sovereignty concerns are driving governments to secure their supplies of critical metals. We believe this combination points to a sustainable cycle for commodities.
I also favour gold and silver at their current levels. These are two safe-haven assets that benefit not only from demand from central banks but also offer protection against the deterioration of public finances and the gradual diversification of central banks’ foreign exchange reserves away from the dollar.
On the bond side, we are only buying top-quality debt, primarily high investment grade with a maximum duration of five years, whilst deliberately avoiding corporate yield bonds, whose risk profile we believe is currently under-remunerated.
To what extent do you believe US equity valuations are still justified?
The market is clearly stretched, and the risk strikes me as asymmetric. The CAPE ratio, which smooths earnings over several years, currently stands at around 41 – a level that has been reached only on very rare occasions in the history of US markets. The S&P is also trading at around 20 times expected earnings. At first glance, the multiple appears more reasonable, but it could in fact be much higher than it seems, as earnings have been significantly revised upwards in recent quarters. In the event of a downward revision, the multiple would automatically rise.
Nvidia, for example, is trading at 20 times expected earnings, which is not expensive in itself given such growth, but the risk lies precisely in these growth forecasts. We could see, for certain stocks, a return to reality similar to what Novo Nordisk experienced following a series of upward earnings revisions, followed by a sharp reversal once competition emerged.
We have therefore reduced our directional exposure – that is, our beta – and allocated a growing proportion of our equity portfolio to long/short fund managers capable of generating alpha. For whilst the index appears to have been stagnant for several weeks, the rotation beneath the surface is dizzying, with considerable divergence between stocks, which favours active management.
Could the massive funding requirements associated with the development of artificial intelligence spark a revival in the bond markets?
The rise in bond issues by major technology companies could offer more opportunities for investors, but only if the risk premium becomes sufficiently attractive again. It is an appealing prospect, but one that is hampered by a generational shift. Younger investors are largely losing interest in bonds, an asset class they still perceive as the preserve of their elders. With yields becoming attractive once again, they may well reconsider their stance. Nevertheless, it is advisable to remain selective, particularly with regard to hyperscalers, whose colossal funding requirements to finance investments in computing capacity warrant special vigilance. CDSs and credit spreads on some of these issuers could widen rapidly in the event of panic in this segment. It is therefore better to adopt a cautious, well-researched approach rather than broad exposure to the theme.
Is China currently the major market overlooked by international investors, or do the structural risks still warrant great caution?
At present, tactical exposure to China seems justified to me. Beijing’s ‘Made in China 2.0’ strategy, driven by innovation in electric vehicles, cleantech and robotics, warrants a slight repositioning. China has lagged behind in recent months, even as its technological fundamentals improve. That said, structural risks remain very real, ranging from persistent difficulties in the property sector, a declining population, deflationary pressures, regulatory uncertainty and geopolitical tensions that remain high over Taiwan. I would therefore describe this as a potential for tactical catch-up, which could hold some genuine positive surprises, rather than a genuine long-term structural conviction.
What are the key convictions currently driving your asset allocation strategies?
Healthcare remains one of our key convictions. It is a sector that the market has largely overlooked in favour of artificial intelligence, even though valuations have once again become particularly attractive. In the longer term, we also maintain a constructive view on Asian markets, provided we remain highly selective. Taiwan and South Korea have significantly skewed the performance of emerging market indices this year, whilst markets such as Brazil now offer an attractive risk-return profile.
From a strategic perspective, our key themes centre on natural resources, healthcare and infrastructure linked to the artificial intelligence revolution. We believe that the best way to capitalise on this trend is not only to invest in large-cap listed technology stocks, but also to gain exposure to the infrastructure that makes it possible: data centres, electricity grids, fibre optics, energy generation and storage, and digital infrastructure. Private markets currently offer particularly attractive opportunities in these areas. Evergreen funds facilitate access to private markets and meet growing demand from investors. However, this enthusiasm must not lead to a relaxation of selection criteria: the quality of the fund managers, the assets and the structure of the investment vehicle remains essential.
Finally, we remain cautious on the US dollar. The rebound seen in recent weeks gives us the opportunity to continue reducing our exposure, given the US fiscal imbalances and our conviction that the underlying trend remains less favourable in the medium term.
Over the past few years, which have been marked by some turbulence, what has changed most in the way you analyse or approach the markets?
We now rely much more heavily on our own quantitative asset allocation models to filter out market noise and objectively assess market attractiveness – an approach we have significantly strengthened in recent years. Another major development is the increased vigilance we are exercising regarding the growing concentration associated with passive management, particularly in equities, as this concentration has become significantly more pronounced compared with five years ago.
We favour active management in emerging markets, where it is often preferable to select a specialist fund manager – for example, for Vietnamese equities – rather than relying on an ETF that is overly concentrated in the financial and banking sectors. We also monitor flows and liquidity very closely, particularly those of central banks. The recent reduction in liquidity by the Chinese central bank, for example, has had an immediate impact on the price of gold in recent months. Finally, the speed at which markets react and reverse direction has increased considerably compared with ten years ago, driven by the combined effect of retail flows, social media and momentum effects, as we have seen recently in a spectacular way in the semiconductor sector.
And in all of this, what surprises you the most?
What surprises me most, first and foremost, is the speed of repricing in the markets – the ability of indices to reverse direction in the space of just a few trading sessions. Added to this is the emergence of a new generation of international investors. They are very much present even in the US markets, with behaviour that sometimes resembles gambling more than rational investment. These excesses always eventually run out of steam, but the phenomenon is now amplified by multi-strategy players who are heavily momentum-driven, generating extremely pronounced rotations. This is the very paradox of momentum: it is both the investor’s best ally and their worst enemy.
Conversely, companies with solid fundamentals, particularly in the pharmaceutical sector, find themselves shunned simply because they are no longer in vogue – a phenomenon also observed in Switzerland. Apple is a good illustration of this flow mechanism. The share acts as a temporary safe haven whenever the rest of the tech sector pulls back, without any fundamental change to justify it.