Stefan’s weekly: Inflation and Debt / Equity Investments in an Environment of Uncertainty

Dear Ladies and Gentlemen

My friend Andy replied to my last weekly mail, agreeing basically with what I wrote. However, he was mentioning that currently only the U.S offered decent interest rates on their government bonds, while Europe’s government bond yields were still mostly close to zero and therefore offered no real alternative to equities. He also mentioned that investing in U.S. debt and hedging the USD currency risk would probably eat up most of the interest for Swiss Francs or Euros investors. I couldn’t agree more. Nonetheless, interest rates in Europe may stay close to zero for a while and therefore European equities should still perform well for some time. Yet, European equities markets will follow American equities markets and thus may be more affected (at least short to mid-term) by the performance of the Dow Jones Industrial Average Index than by low base rates in Europe.
Now, going back to equities investments in an environment of uncertainty brings me to one of my favourite topics. Nassim Taleb mentioned in his book “Antifragility” the concepts of fragility, robustness, and antifragility.

If we take Taleb’s concepts into consideration while thinking of equities investments, we can maybe identify three types of companies.

Number one, the (rather) fragile one (that may offer superior returns during booming markets) typically is a company with a leveraged or even highly leveraged balance sheet, producing products and services in a competitive environment without being market leader in its sector, thus occupying a peripheral market position. (Logics of Organization Theory by M. T. Hannan, L. Pólos, G. R. Carroll). As long as interest rates decline or stay low, the leveraged balance sheet may lead to decent margins, maybe even margins above the industry average. Now, if interest rates start to increase margins decline because of higher financing costs. In a recession the company may even go belly up because of failure of debt servicing. Equities of such a company are under heavy pressure during difficult market conditions and recover only very slowly if at all. Fragile companies may pay dividends during boom cycles, but regular dividends are not part of the investment concept.

For number two we look at a (rather) robust company, we see a stable business model, near-centre market positions (Logics of Organization Theory by M. T. Hannan, L. Pólos, G. R. Carroll) with limited amount of debt that could easily be serviced or even redeemed with current cash flows. Increasing interest rates have only a limited influence on such a company’s margins and profitability. Its equities will also come under pressure during difficult market conditions but usually tend to recover reasonably quickly once markets stabilize. Robust companies typically pay dividends even during difficult market conditions, regular dividends are part of the investment concept.

Number three, the antifragile company, shares many of the qualities of a robust company. The company generally operates with no debt at the market centre (Logics of Organization Theory by M. T. Hannan, L. Pólos, G. R. Carroll), during a crisis it will have the financial power to acquire companies or parts of companies that are under financial strain. Antifragile companies usually emerge stronger from a crisis. Its equities will also come under pressure during difficult market conditions, but they usually recover quickly and may even reach new highs once the crisis is over. Like robust companies, antifragile ones typically pay dividends even during difficult market conditions, regular and very often increasing dividends are part of the investment concept.

And as always, Ladies and Gentlemen, if you want to share any of your thoughts with me, please feel encouraged to do so but please don’t forget (instead of hitting the reply button) to send your messages to:

smk@incrementum.li

Many thanks, indeed!

And now, Ladies and Gentlemen I wish you a great day and weekend!
Kind regards

Yours truly,

Stefan M. Kremeth