The current depletion of billions of euros from the European Central Bank creates a tide of liquidity, pushing investors to invest in riskier assets. Compared to US equities, European equities have risen a lot this year, boosted by a stronger dollar and expectations of earnings growth.

In the US, we have seen it most recently since 2012, and currently we see it in Europe. Expansionary monetary policy measures by central banks weaken the currencies and cause stock prices to rise in the expectation that the fundamental conditions for companies at some point change for the better. But what happens when the monetary tide withdraws and the companies have to stand on their own feet again?

Tides, trunks and stock returns

Tides, trunks and stock returns

“Only when the time goes out, you discover who’s been swimming naked,” said legendary US investor Warren Buffett, explaining why one cannot only measure a company’s success on share price increases.

Because when the tide – or the shares – rises due to expectations, increasing risk appetite or lack of real alternative placement opportunities, one cannot see who is frolicking in the waves without swim trunks. Only when the tide is withdrawing can one distinguish the nude baths from the rest – or in other words, who has utilized the increasing appetite for risk and the positive expectations for obtaining a portfolio return without a corresponding background in the earnings strength.

The dressed-up quality portfolio typically has a harder environment with the rising tides and falling risk aversion, but conversely, it must be expected to maintain a long-term attractive return, because the return is supported by real earnings.

The tide is already here

 The tide is already here

In the United States, the third Quantitative Easings program (QE3) was launched in 2012 around the same time as the Outright Monetary Transaction (OMT) facility made available to member countries with challenges in financing directly due to rising interest rates in Southern Europe in the market. Since then, investors globally have been willing to send the price of shares up to the expectation that monetary policy measures in the US and Europe would translate into real earnings growth.


By taking the price on the index and setting it in relation to the overall earnings that the index is expected to generate, you get a measure of how much investors are willing to pay for a one-dollar earnings.

The tidal effect was clearly seen in the US from the summer of 2012. OMT and QE3 were launched in July and September, and shares were valued at DKK 12 and 10, respectively. expected earnings crown. Today, investors have changed their views on the shares in the US and Europe and are now willing to value the companies at 17.4 and 16.7 times, respectively, the expected earnings.

In other words, the price of a krone’s share earnings has increased by about 50 percent in the US and just under 70 percent in Europe. An increase in valuation, which comes as a result of the improvements we have seen in the macroeconomy and in the companies, but also to a large extent in the expectations of future earnings effects.
In other words, the prices since 2012 have risen more than the realized earnings, and thus the shares have become considerably more expensive.

The figure also shows that the valuation of US shares is around the historical average. Measured by P / E, valuation in Europe is somewhat above the historical average. Therefore, it is difficult to see a further tidal effect in the two indices, without the risk – and thus the risk of disappointments – rising significantly.

Staggered tides allow to stay under water for a little while

Staggered tides allow to stay under water for a little while

World central banks have tried to bring the economies out of the problems following the financial crisis with different speeds and not least different methods. This has resulted in an asynchronous global upswing and a huge global divergence in monetary policy. However, due to the coincidence of the central banks’ zero interest rate policy, the divergence in global monetary policy does not seem to be particularly significant at first, but monetary policy stimulus is, above and beyond the traditional interest rate weapon, an attempt to achieve growth and inflation.

It also means that where the US now “just” has zero interest rates after several rounds of monetary stimulus programs, Europe in March this year has started its first program worth EUR 60 billion a year. month. Initially, it will last until September 2016.

Therefore, Europe is now experiencing the effects of a rising tide on both the interest rate, foreign exchange and stock markets, while the water in the US stands still. It has created massive investor flight towards Europe, where equity markets have increased by 18 percent this year, while in the US, equity returns of about 0 percent have been needed.

Expectations of happiness are often the greatest, but where the US is to be more effectively drawn to the future, expectations of the positive currency effects in Europe are rising as a result of the huge sums the European Central Bank is channeling into the European economy each month. An effect that is also clearly seen on the valuation in the figure.

What happens when the tide moves?

 What happens when the tide moves?

Precisely the companies’ earnings are and will be decisive when the tide subsides. Since 2012, the central banks have had a major effect on returns and pricing (cf. the above section), but in the future it is to a much higher degree earnings that must affect the pricing, including P / E, than before. At present, US equities are priced at 17.4 times the expected earnings, but in order for the shares not to become even more expensive, the price must in future reflect more of the actual earnings growth.

Therefore, demands will again be made on the share portfolio when the tide withdraws. This applies, among other things, in relation to the companies’ earnings on the assets and attractively priced business models, which must at the same time contain a security that can withstand a contractual monetary policy, where shares cannot expect the same tailwind as they have had in the past four years.

When the tide withdraws, the portfolio’s equity returns must be created with a focus on quality companies and the ability to generate earnings more than the expectations of a possible positive earnings development and lack of investment alternatives. The transformation will, as I said, take time, but the likelihood of the tide withdrawing will increase in line with the increase in the underlying economy.

Interest rate increases in the US are the first step

 Interest rate increases in the US are the first step

The first step on the way back to a more normalized world is initially a tightening of US monetary policy in the form of interest rate increases.

It will seriously exhibit the divergence that prevails in the global monetary policy and strongly indicate that future equity returns in the United States will to a greater extent than previously be deducted from earnings and not multiple expansion (that is, as an investor willing to price shares more expensive per share). earnings crown).

The global economy has never experienced such massive monetary stimuli as we have seen in recent years. Therefore, one must also be careful in comparing how shares have reacted in previous business cycles, where the US central bank has raised interest rates.

But if one nevertheless looks at the shares’ reaction during periods of interest rate increases since 1965, there has been one common characteristic. Only in one out of 15 cases has the valuation multiple of the US stock index S&P 500 managed to increase.


Thus, investors have only once (August 1980) been willing to let the stock multiples rise over a contractionary interest rate cycle. In the other 14 cases, the share multiples have fallen because earnings have risen more than the share price.

This does not mean that shares cannot rise, but it is earnings growth that dictates the share return, and not stimulus from central banks or rising expectations (see figure 1 or the article American regime change in the stock markets in 2015, FORMUE 01 // 2015 ).

Already, there are segments of stock markets that are too expensive priced. Thus, as an investor, one must begin to prepare for the tide to disappear.

What ensures the quality of the wealth management portfolio?

 What ensures the quality of the wealth management portfolio?

Regardless of investors ‘risk aversion and market sentiment, the main objective of the wealth management associations’ equity portfolio is to put together a group of shares that over time generate a highly competitive excess return in relation to the general market. We focus on selecting companies that, in relation to the share price and earnings generation, must be characterized as being significantly undervalued.

The above figure shows a number of measurement parameters for quality, which, for example, show that the equity portfolio’s 58 companies generate a return on invested capital of 24.5 per cent, where the benchmark for comparison generates 12.5 per cent.

The companies in the equity portfolio thus return their invested capital twice as good as the market as a whole, while the volatility of the return is 30 per cent lower and considerably more stable. The other pillars show the same picture of the return on equity, significantly lower share of debt and higher earnings growth. All quality parameters have been achieved at the same time as the valuation of the equity portfolio is in line with the benchmark. Precisely here lies the underestimation.

In addition to the quality requirements of the companies invested in, there is a risk management that defines the scope for the composition of the equity portfolio. In relation to risk management, it is intended that the portfolio has a risk level with the market. Deviations from the market must be made at company level. The portfolio must therefore not generate its excess return on factors such as geography, sectors, growth, value or the like. It must be created where we have focus – namely on the individual company.

The choice of the individual company is largely a AllianceBernstein / CPH Capital, while it is Wealth Cared to assess asset allocation and including the size of its shareholding in each Portfolio Management Associations . The equity exposure has been fully utilized since 2011, and it remains, but the divergence in the global monetary policy, the way in which equity returns will be generated in the future, and the investors’ risk aversion are factors that can change this allocation to a greater extent than before.

The water disappears sooner or later

 The water disappears sooner or later

In recent years, the monetary policy tide has had a huge effect on the financial markets – also in the stock market. In some places, a real economic effect is seen, although the transformation to the companies’ earnings is slow. Elsewhere, the markets are driven by expectations and hopefully still benefit from the positive expectations.

One thing is certain: the monetary tide in the United States is coming out, and so will other regions. If you do not ensure that your vulnerable areas are covered, it may have negative yield effects when the waves have settled, the water is gone, and you are standing on the sandy bottom – without bathing trunks.

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