It almost sounds like a call to run for the hills. Get rid of your risky assets, go defensive, and play volatility as an asset class. Sell European equities and buy Swiss. Now that the Russia-Ukraine war shows no signs of abating, Christophe Donay, Chief Strategist at Swiss-based Pictet Wealth Management, fears that excessive global debt has made the world economy vulnerable to a new systemic crisis.
“The risks of a systemic crisis are still well on,” Donay told InvestmentOfficer.lu in a telephone interview. Pictet, with a Luxembourg office next door to the European parliament on the Kirchberg plateau, is a leading international investment firm with close to 700 billion euro under management.
“This is my concern and for the time being we are not safe yet.”
Donay’s comments on systemic crisis risk first resonated in world financial markets last week after he appeared on Bloomberg television with his warning. A week later, further elucidating his perspective, he said his views have not changed. His analysis, he said, is anchored in the record-high debt-to-gdp levels, in Europe, the US and in China.
Total debt double 1980s levels
International discussions on debt-to-gdp tend to focus specifically on public debt, and generally ignore the influence of corporate debt and household debt, including mortgages. For Donay and the Pictet team, what matters is the total debt in relation to the size of the economy as measured by GDP.
When one considers the total debt-to-gdp, comparing total government, corporate and household debts relative to the economy, then this debt now is well at record levels well above 300 percent of GDP, Donay pointed out. That’s more than double the 140 percent or so that Europe experienced during the early 1980s.
“It’s a global phenomenon,” Donay said. “If we look at the US, if we look at Europe, if we look at China, the ratio is the same. Very similar.”
While the composition of the total debt may differ in different parts of the world, the outcome is the same, he said. Excessive debt makes the world economy vulnerable. Particularly China is a case in point, after it saw its total debt-to-gdp ratio rise from about 120 percent just after the 2008 subprime crisis to well above 300 percent, while it took nearly 40 years for the US and Europe to reach such debt levels.
Debt drifting
“The pace is different, however the result is exactly the same,” Donay said. “So the excess in debt is there, as the debt-to-gdp ratio is continuing to drift on the upside.”
Pictet’s chief strategist drew attention to earlier crises such as the collapse of the Internet bubble in 2001 and the 2007-8 Great Financial Crisis. Each one of these, he said, delivered knock-on effects in the global economy because of a build-up in excessive debt. Each crisis had its own constraints - corporate debt, country debt like Greece, or household debt - but all of them led to a systemic crisis.
“And then, when you have something like we had, nowadays, in terms of war, in terms of potential disruption in the supply of commodities or raw materials, it could be a trigger, at a point in time, for a systemic crisis,” Donay said.
Nothing different
“The crisis we are experiencing nowadays is another example of a crisis like we had in the past. No reason to change this approach,” he said.
Asked about his advice to investors, he said Pictet teams have advised clients to move away from risky assets and look for quality. “We decided for example to downgrade the euro equities in favour of Swiss equities as we prefer high-quality equities or equities with resilient turnover and resilient earnings and profit growth. We also decided to downgrade our risky asset exposure by downgrading for example the euro high yield in our asset class stance.”
Donay said Pictet now favours defensive growth themes, looking for companies and sectors with stable earnings. A well-known example of defensive stocks are food companies, considered attractive because consumers will always need to eat, even at times of war.
Volatility trades
What’s more, he advised clients to take profits and to consider volatility trades such as for example the VIX index, a real-time index traded on the CBOE market that considers market expectations for the next 30 days. The VIX index on Tuesday traded above 30, a level - at above 25 - which shows there is a risk of a systemic crisis. In 2008 it peaked just below 80 while in March 2020 it topped 66.
“For the time being we don’t see any panic. We don’t see any panic. Our clients are cautious of course and we advise our clients to be cautious and decrease their allocation to risky assets on the one hand but on the other hand, we don’t see any panic. Not only for our clients, but also not for international investors in general. No panic for them.”
Asked what he sees as a potential positive signal that could remove the threat of a systemic crisis, Donay said this could be a capitulation of the Ukrainian government or an agreement in the peace talks with Russia.
Sanctions add to instability
“But we are not there yet. Even if one day we will see an agreement or eventually capitulation, it would probably still take weeks, not days. In the meantime, these risks of a systemic crisis are still well on,” he said, adding that additional sanctions, such the ones adopted by the EU on Monday evening, add further instability.
“More sanctions means more instability, and more of a rising risk of a systemic crisis.”
Related articles on Investment Officer Luxembourg:
- ‘European emerging-market bond funds pose limited contagion risk’
- Supervisors step up efforts to maintain financial stability
- Fresh sanctions put Russia ETFs on liquidity watch
- Esma, Eiopa ‘closely monitoring’ cyber risk amid Russia threat
- Ukraine war: future of 855 funds with Russia exposure uncertain
- ESMA & national regulators examine investment fund valuation
- Systemic fund risks daunting challenge for regulators, industry
- Grain market greets Ukraine war with volatility